The three key influences of market performance
In this week’s video insight, I explore the three key influences of market performance – inflation, economic growth, and liquidity – and how they can adversely or positively affect the market. In January and February this year we have already seen; the launch of a Chinese LLM (Large Language Model) which created waves in the Artificial Intelligence (AI) space, Trump’s imposition of tariffs (across China, Canada, Mexio and Europe), rising inflation, and increased geopolitical tension.
Despite all this negative news, adverse market moves seem to be getting erased by the end of the day. But why is this? Well, liquidity might be the reason why. But is liquidity enough to insulate the markets from the volatility created by Trump?
Transcript:
Hi, I’m Roger Montgomery, and welcome to this week’s video insight.
If, on 1 January this year, I had told you that China would launch a cheaper Artificial Intelligence (AI) Large Language Model (LLM), Trump would impose additional tariffs on China and announce new 25 per cent tariffs on Canada, Mexico, and Europe, that inflation would rise, and that geopolitics would become even less stable than it already is, what would say the S&P 500 has done in the first two months of the year?
If you had said it should go up at all, you’d probably be in the minority – but at the time we recorded this video, you were right. The S&P 500 had risen by just over 1.2 per cent for the first two months of calendar 2025.
It’s especially curious given the most recent American Association of Individual Investors (AAII) Survey revealed the sixth-highest spike in bearish expectations since records began in the 1980s.
Interestingly, amid all the negative news being released, there have been some sizeable adverse market moves during the day. But by the end of the day, they often have been erased.
So, what gives? Well, it probably all comes back to liquidity – something we have written about extensively on the blog. The good news has been that global liquidity has, according to CrossBorder Capital, been inching higher after declining during the latter part of 2024.
The lag between changes in liquidity and investor behaviour explains the 21 per cent drop in Bitcoin recently, as it does the recent 4.6 per cent decline in the S&P 500 from its highs.
Meanwhile, evidence of a slowing U.S. economy may also explain the 50 basis point drop recently in U.S. Treasury yields. Of course, newly appointed Treasury Secretary, Scott Bessent, will be cheering the lower funding costs associated with refinancing some US$3 trillion of treasury debt this year, but one expects the President Trump will want to engage in psyops (psychological operations) to blame someone else for the faltering economy.
That the U.S. economy is faltering can be explained by the reduction in the pace of liquidity growth from last year. Slowing liquidity growth impacts real economies, and the massive stimulus of last year has faded as many of the tools used – such as the U.S. reverse repurchase agreement account – have now been exhausted.
As we have indicated in other blog posts, a huge amount of debt refinancing is on the horizon, and this will drain liquidity from markets – meaning, unless central banks engage in Quantitative Easing (QE) to keep the punch flowing, markets could experience a bit more volatility.
For now, markets continue to climb a wall of worry and provided the macroeconomic backdrop includes disinflation and positive economic growth, that positive bias should continue. But if liquidity is put into question or inflation, or economic growth – and remember all three of those are needed for the market to generate a third year of impressive returns, then the market could succumb to price weakness. Unfortunately, even that backdrop of those three positive influences might not insulate markets from the volatility being created by Trump and his gleeful band of enablers.
This year, as we said right at the start, is likely to be more volatile, and the returns are unlikely to be as high as the last two years. But whether they are positive or negative really comes down to the expectation of those three things; inflation, growth, and liquidity. If any of those three stumble so will the markets.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
