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Should you be worried about Global Liquidity pushing up a Stock Market bubble?

The recent resurrection and upsurge in the stock markets has come after some steep falls during the pandemic. Though an upward surge is welcoming to many, most stock markets globally have risen to new heights – raising concerns about a stock market bubble.

Here is a snapshot of how global liquidity supply has increased exponentially over the past four decades:

Global Liquidity Supply
Global Liquidity Supply
Image source: https://www.yardeni.com/pub/frodorcb.pdf

COVID economic relief stimulus checks

The US government had passed a bill to offer stimulus checks as a measure to uplift people impacted by the COVID pandemic. While the first stimulus checks worth of $1,200 each were issued in April 2020, the second round worth $ 600 each were sanctioned in late December. These COVID-19 relief measures also increased the purchasing power of the citizens, thereby, also increasing the liquidity in turn, increasing the global liquidity.

Federal Reserve printing more money

Within a few months of the outbreak of the pandemic and subsequent economic slowdown, the Federal Reserve started ‘printing money’ at a rate that wasn’t heard of. Banks have used their money creation powers to print more money against the ‘excess reserves’ they had with the Fed. With more money available with banks, they have started purchasing the unwanted assets of other market participants. These activities have only increased the liquidity supply in the market, further contributing to the stock market rise upwards

Rise of Inflation

As long as the fears of the COVID 19 pandemic would be there, the Fed’s actions would also persist. With the interest rates going down significantly and liquidity on the rise, inflation is almost inevitable. With the U.S. heading towards an inflation, other countries in the world might also follow the suite and be exposed to the risks of inflation.

The Rally of Tech and Pharma companies

The demand for smart technology has increased multifold during the lockdown— given most of the world’s population was working from home. This accelerated the growth of tech companies causing stocks of IT companies to reach new highs. Healthcare and pharmaceutical industries have been at the heart of the pandemic which propelled demand for this sector in the market. At least in the immediate future, these industries would continue their upward trend.

How long can this stock market bubble hold up?

One of the strongest reasons for the Fed to confidently print money is that US Dollar is the global reserve currency. However, with other things remaining stable, the status of U.S. dollar as the global reserve currency might gradually decline. What about the stock markets? Will they continue to rise and will the bubble just get bigger? The stock market history is proof that any extreme trend would never last for long. With the developments in the politics and pandemic, the stock markets will go through a correction and reset themselves. The only question to answer here is — ‘When?’.

Till then it makes sense to stay invested, while following an asset allocation (simply put, sufficient money in secure debt instruments). Not being in the market is also a risk and more money has been lost waiting for a correction.

Jama Wealth