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One week before the end of November, JPMorgan issued a startling warning: according to calculations by the bank’s quant, Nick Panigirtzoglou, some $160 billion in negative equity rebalancing (read selling) was on deck by various pension and balanced mutual funds, and – should the rally continued into December – an additional $150 billion in forced selling could emerge from funds who have to keep their 60/40 stock/bond asset allocation. While many on Wall Street braced for a late November drawdown following this note, expecting a deluge of selling into an extremely illiquid market, with Emini top-of-book depth near the lowest levels on record…

… aside from a modest dip on Nov 30, stocks continued their upward ascent with the S&P hitting an all time high last week, just above 3,700.

That said, it may be too early to give the “all clear”, for two reason: first, it is possible that the rebalancing fund “forced selling” has merely been pushed back to December, and year-end, and if JPM’s calculation that we could be facing over a $100 billion in forced selling in the coming, even more illiquid days is correct, it is unlikely there will be enough buying interest to offset the coming pension rebalancing. The second reason why we may experience market turbulence in the last days of the year, is over a little noticed piece of legislation which according to Larry McDonald’s Bear Traps Report, could open the floodgates to 401K selling, leading to a “selling deluge.”

As McDonald writes, buried deep in the CARES Act (the Corona Aid, Relief and Economic Security Act) which was enacted on March 27, 2020, and provided $2.2 Trillion of fiscal stimulus to offset the impact of the coronavirus on the U.S. economy, “is a clause that gives temporary flexibility on early withdrawals from retirement accounts. These temporary changes to the rules give more leeway to make emergency withdrawals from tax-deferred retirement accounts without incurring a penalty.”

Specifically, Section 2022 of the CARES Act eliminates the 10 percent early withdrawal penalty if you are under the age of 59 ½ and withdraw up to $100,000. It also allows for the spread out of your income tax liability over three years rather than the same year you withdraw the money. And since the window to make these penalty-free early withdrawals closes by the end of 2020, millions of cash-strapped households may have no choice but to sell tens, if not hundreds of billions in passively-managed funds to take advantage of this one-time offer to avoid a 10% early withdrawal charge.

McDonald then goes on to highlight the importance of passive investing which over the past decade has emerged as the dominant price setter in a world where actively managed funds have been fading. As the Bear Traps author writes, “the explosive impact of passive investing is significant. In recent years, passive equity funds have enjoyed inflows of more than $2T, even as traditional, active ones have suffered outflows of over $1.5T, according to data provider EPFR.” Indeed, the main story on Bloomberg this morning picks up on this, writing that “roughly $427 billion has poured into U.S. exchange-traded funds this year, divided almost evenly between equity and fixed-income funds, according to Bloomberg Intelligence data. Meanwhile, mutual funds have bled roughly $469 billion of assets in 2020, on track for the worst year on record in Investment Company Institute data going back to 1990.“

While we have for years covered the staggering divergence between active outflows and passive inflows – which threaten to make conventional stock pickers obsolete and make market prices meaningless – and thus the topic is familiar to regular readers, Bloomberg writes that “this stark divergence in fortunes is part of a tectonic shift that’s seen investors favor ETFs over mutual funds for nine consecutive years, lured by the industry’s ultra-low fees and tax advantages. That trend was accelerated further in 2020, thanks to a well-timed rule from the Securities and Exchange Commission and the Federal Reserve’s first foray into the $5.3 trillion U.S. ETF market. Combined with another rocky performance from active managers, it’s clear why ETFs are winning out, according to State Street Global Advisors.”

In any case, as McDonald summarizes, “there is now over $12T in index funds globally —either passive mutual funds or the increasingly popular ETFs.”

And while the 401(k) provision is intended for those hardest hits by the pandemic, such as people who lost their jobs, the rules are applied rather loosely. For example, a qualified person includes those that “experience adverse financial consequences from being quarantined, being furloughed or laid off or having their work hours reduced.” Also qualified are those who “experienced adverse financial consequences as a result of being unable to work due to lack of childcare [or] closing or reducing hours from a business that you own or operate due to SARS Cov-2 or Covid-19”. Since virtually anyone can argue that they are qualified under these criteria, the language is open to interpretation and the IRS is unlikely to enforce the limits of this provision to the letter of the law according to McDonald, especially since banks and retirement management companies – who have themselves benefited greatly from the CARES act – are giving considerable leeway to allow their customers to use the CARES Act early withdrawal exemption.

McDonald then makes one final point – the same one we noted three weeks ago – namely the lack of market depth or liquidity, to wit:

This potential selling deluge comes as positioning in U.S. equities is becoming stretched and implied volatility for the Georgia runoffs is above average. Year-end rebalancing by pension funds is still expected to create supply in equities as funds rebalance their (now) overweight in equities. Overall, for 2021 we should expect volatility to grind lower as the removal of trade war risk, the declining corona risk with the advent of the vaccines, the removal of the uncertainty of the elections, and rebounding GDP growth with 0% Fed funds rates provide a supportive backdrop for risk assets. Notwithstanding that, we first need to pass the year-end hurdle of retirement withdrawals, pension rebalancing, and Georgia runoffs.

Ultimately, The Bear Trap report’s conclusion is identical to that of Morgan Stanley’s Michael Wilson, who has recently cautioned that a near-term “drawdown” is coming, but that would be followed by a brisk episode of BTFD and new highs in 2021, or as McDonald puts it, while the coming selling deluge “could take an overstretched market by surprise…. we would then use a meaningful pullback to prudently add to the risk.”

Authored by Egon von Greyerz via GoldSwitzerland.com,

Is the global investment world about to be caught in the Hannibal trap?

Hannibal was considered as one of the greatest military tacticians and generals in history. He was a master of strategy and regularly led his enemies into excruciating defeats.

The trap that investors are now being led into has many similarities with Hannibal’s strategy in his victory over the Romans at Lake Trasimene in 217 BC.

Hannibal was a general and statesman from Carthage (now Tunisia) who successfully fought against the Romans in the Second Punic War.

THE BATTLE AT LAKE TRASIMENE

In 218 BC Hannibal took his troops, with cavalry and elephants, over the Alps and into Italy. Hannibal enticed the Roman Consul Flaminius, and his troops, in 217 BC to follow him to Lake Trasimene in Umbria. The Romans followed Hannibal’s troops into a narrow valley on the northern shores of the lake. When the Roman troops were inside the valley, they were trapped. They had the Carthaginians ahead of them, the lake on their right and hills on their left.

What the Romans didn’t know was that Hannibal had hidden his light cavalry and part of his army up in the hills. So once the Romans were locked into the valley, they were attacked from both ends with nowhere to escape.

Over 15,000 Romans were killed and 10,000 captured in a catastrophic defeat.

So what has Hannibal got to do with the present world? Well, it is pretty obvious. It is all about being led into a fatal trap without even being aware.

COVID ATTACKED AN ALREADY WEAKENED WORLD

As we are approaching the end of an economic era in the world, anything that can go wrong will. The Coronavirus certainly fits that picture, since it could not have hit the world at a worse moment. Whether Covid-19 was accidentally or deliberately created by humans or just a product of nature, we will never learn.

What we do know is that Covid was like putting a match to a timebomb. The timebomb being a global financial system which is about to explode.

Major businesses in retail, leisure, travel, airlines are closing by the day and most won’t open again. Globally, 100´s of thousand of small businesses have closed with devastating effects for their owners.

The coming depression will affect all levels of society.

BILLIONAIRES WEALTH UP 70% IN THREE YEARS

At the top of the global wealth pyramid, we have the biggest wealth trap in history. These are the 2,200 billionaires in the world. In the last three years their fortunes have swelled by a staggering 70% or $4.2 trillion. Their total wealth is now $10.2t.

These billionaires are likely to lose at least 90% of their wealth, in real terms, in the next 5-10 years. But not a single one of them expects this to happen or prepares for it.

As regards the number of millionaires in the world, the estimates vary between 13 and 46 million. Escalating house prices have clearly created a lot of extra millionaires.

GLOBAL DEBT FUELS GLOBAL WEALTH

Total global financial wealth is up almost 3x since 1990 from $80 trillion to $225t.

But this massive wealth accumulation is resting on a very weak foundation of debt.

It was only possible to treble wealth by, at the same time, more than trebling global debt from $80t in 1990 to $277t today.

BIGGEST WEALTH TRAP IN HISTORY

So there we have it. The world hasn’t created any net wealth. Instead wealth has just been inflated artificially by credit creation and money printing of the same magnitude.

I do realise that total global debt and global personal wealth is not quite like for like. Still it gives a very good indication how this additional wealth is created since 1990.

Yes, it was created by just simply printing money to the extent of $200 trillion in the last 20 years!

This is clearly the biggest wealth trap in history. Hannibal couldn’t have done it better.

Billionaires, millionaires and ordinary investors have all been sucked into a honeypot believing that they have real wealth based on sound foundations.

What they don’t realise is that they will in the next few years be ambushed by what to them is an invisible enemy.

This will initially involve total debasement of the currency, whether it is dollars, euros, pounds or yen. No they can’t all go down together against each other.

But they will all go down in real terms. Real terms means measured in the only money which has survived in history – GOLD.

The route there will not be straight forward. As currencies collapse, we will most likely first see hyperinflation. That could temporarily boost asset prices in nominal terms but certainly not in real terms.

There will also be an implosion of both the debt bubble and the asset bubbles in stocks, bonds and property.

ROBBER BARRONS

Robber Barrons were feudal lords in medieval Europe who robbed travellers and merchant ships.

The term Robber Barons was used from the 1860s for some of the entrepreneurs at the time. They used unscrupulous methods to acquire wealth, thus the term. Most of them started new industries that became dominant in their field.

They included Rockefeller (oil), Vanderbilt (railroads), Carnegie (steel), Ford (cars), Morgan (banking), and Astor (real estate).

Major fortunes were created by these Entrepreneurs and Rockefeller is still considered the wealthiest man in the world ever, adjusted for inflation. Interestingly, the sectors these millionaires were in are all major industries today except for railways.

The modern “Robber Barons” – Bezos, Gates, Musk, Zuckerberg and Buffet are in diversified areas like online retail, technology, car manufacturing and investments/finance.

FANTASY VALUATIONS

The big difference between the Robber Barrons in the late 19th century and today is how their wealth is measured.

150 years ago valuations were conservative and price earnings ratios for public companies were normally below 10!

Quick jump to today. Amazon has a p/e over 90, Microsoft & Facebook “only” in the 30s, and Tesla has a staggering p/e of 1,100!

So on a historical basis, all of the biggest companies in the world today are grossly overvalued at p/e’s of 32 to 1,100 !!

This is what happens when governments and central banks primary economic strategy consists of creating money out of thin air and then these funds are used to support the stock market.

A major part of the $150 trillion debt created since the Great Financial Crisis started in 2006 has stayed with the banks and not gone to consumers or industry.

Conveniently the money has reached investors and been invested in asset markets as I showed in the Debt/Asset table earlier in the this article.

STOCKS ARE DRIVEN BY LIQUIDITY – NOT VALUE INVESTING

Thus it is debt based liquidity which is primarily driving up asset markets. This is creating fantasy p/e’s and valuations which has very little to do with the growth of industry and finance 150 years ago.

So back to Hannibal although he has been dead for 2200 years.

We have major and potentially terminal problems in the financial system since September 2019. And we have a virus which has led to major parts of the world economy collapsing due to governments handling of this virus, But in spite of these massive problems, stock markets around the world are booming.

HANNIBAL TRAP

We have probably not seen the end of the stock market explosion as I explained in a recent article on the coming LIFTOFF & COLLAPSE. But at some point in the next few weeks or months, the market will burst.

Before this burst every investor, big or small, who has any spare liquidity must be sucked into the market just before the top.

This is the Hannibal trap. Everybody must be hauled into the stocks at the top of the market.

And then BANG! Just like Hannibal totally took the Romans by surprise, so will a violent stock market crash.

But this time it won’t be like in March 2020 with a quick recovery. Yes, of course most investors will buy the dips. That will only increase the pain. Because the coming collapse will be the start of a secular bear market that could last 10 years or more.

And just like Hannibal slaughtered the Romans, the coming bear market will slaughter investors.

Investors could easily see all the bubble assets, stocks bonds and property decline by more than 90% in real terms. Again, real terms mean constant and stable purchasing power.

THE DOW WILL LOSE 97% IN REAL TERMS – GOLD

The Dow/Gold ratio is today 15. In 1980 it was 1 to 1. The ratio topped in 1999 and the long term trend is now down as the chart below shows.

The target for the ratio is 0.5 to 1. This means that the Dow will lose 97% against Gold in coming years.

Few people believe this magnitude of decline is possible.

But remember the Dow in itself went down 90% from 1929 to 1932 and that it took 25 years before it recovered.

This time the situation is drastically worse both from a debt point of view and overvaluation of stocks. So 95%+ is not unrealistic.

HISTORY PROVES THAT ONLY GOLD PRESERVES WEALTH IN REAL TERMS

Only gold fulfils the role of always holding its value in real terms. Again history proves it.

One ounce of gold bought a good costume for a man in Hannibal’s days, 2200 years ago, just as it does today.

Since investors have been saved by central banks for decades, they expect the same today. This is why they will stay invested and also buy every dip until they run out of money.

Sadly very few investors will get out before the bottom.

BIGGEST WEALTH DESTRUCTION

That is why we will see the biggest wealth destruction in history. Instead of the 2,200 billionaires currently, the world might have as little as 200 in 5-10 years time (in today’s money).

All businesses will of course not disappear. But earnings will decline dramatically and p/e’s will collapse.

Let’s take a business with a share price of $300 today and earnings per share of $10.

Thus the p/e is 30 (30x$10=$300).

If profits decline by 70% in a recession/depression and the p/e goes to 5 it will look as follows: Eps $3 x 5 p/e = $15 share price.

So this company is still making a profit, albeit smaller. Still, the share price is down from $100 to $15 or by 95%.

P/e’s of 5 or less are not unusual during depressions/recessions. I experienced this in the 1970s. The same happened in the 1930s.

HISTORY, HISTORY HISTORY

Again, as I often stress, the best lessons we learn are from history.

Everyone thinks “It is different today” but I promise it isn’t. Almost everything we experience today has happened before.

So vast fortunes will be wiped out in coming years. And other fortunes will be made in areas like hard assets and the resource industry. Precious metals will be an obvious major beneficiary.

Some of the shrewd Swiss private banks like Lombard Odier advised their clients to hedge their portfolios with gold earlier this year. Very few wealth managers are as clever as 200 year old Swiss banks.

Precious metals mining stocks are likely to do spectacularly well in the coming currency collapse and so will gold and silver.

But the ultimate wealth preservation in the next 10 years is physical gold and silver held outside the banking system as history confirms.

Remember that markets can always go higher even though they are massively overvalued.

But when risk is at a maximum, investment is not about squeezing the last bit of profit out of your portfolio. Instead, it is all about protecting your profits. And you can’t do that by staying fully invested in overvalued assets.

Remember that in a secular bear market everyone is a loser. The trick is to lose as little as possible.

“Oil is the cheapest of all reflation assets,” said Amrita Sen, co-founder of London-based consultant Energy Aspects Ltd.

“With vaccines slowly rolling out, we expect investors to start returning to the oil sector and for prices to continue firming.”

And judging by the surge in energy stocks and Brent crude topping $50 for the first time since March, it would appear investors are returning en masse in the hope that things will “return to normal” sooner rather than later.

Source: Bloomberg

As Bloomberg notes, while the COVID-19 pandemic is worse than ever in the U.S., demand in Europe is bouncing back as a second wave of lockdowns eases and Asia continues to pull in huge volumes of crude.

In some corners of the world, the recovery in demand is almost complete. 

India’s largest refiner said last week its plants are processing at full capacity and it’s expecting a v-shaped rebound in fuel use.

Consumption of gasoline is also at or near pre-Covid levels in China and Japan, the world’s second and fourth biggest oil consumers.

European motorists are hitting the roads again as governments relax national lockdowns in countries including the U.K., Spain, and France, according to an index of road usage and traffic compiled by Bloomberg News. Road freight is sharply higher as companies rebuild inventories and the Christmas shopping season gets in full swing.

All of this as US continues to lag.

 

 

The Bear Traps Report (with Larry McDonald) agrees, positioning bullish for 2021, expecting to see $80 Crude a year from now…

We think the oil industry is at a very interesting crossroads. While the headlines are obvious, ESG, green initiatives and capital broadly being reallocated out of the energy space, there are some positive tailwinds that are starting to enter the equation. At current multiples and sentiment, we think some of these more positive forces are worth factoring in.

The global economy, with plenty of speed bumps to come, is in the early phase of recovering from a once in a generation shock. Typically, in economics, a shock is either demand or supply-based, covid was really both. For oil, the grounding of flights, domestic lockdowns, and heightened levels of general uncertainty, have meant oil and oil names have traded very poorly this year. The thing that is worth noting in the context of this perfect storm is, who are the survivors, because the companies that are able to survive this shock will be in a good place from an operating leverage perspective, i.e. reduced competition, and will be the most able to benefit from the changing tides of global risk.

Emerging market countries are benefiting from the weaker U.S. dollar and stronger CNY in China.

One of the things that are becoming clear in this early phase of the global economic recovery is, China and the US’ approach to stimulus has actually been quite complimentary. China has been focused on the supply and production side while the U.S. has been focused on the demand, fixing the private sector balance sheet side. On the one hand, this has led to age-old problems. Case in point, the external accountbalance with the trade deficit between the U.S. and China going back to all-time wide levels. However, this combination of policy support has largely been a positive for the global economy, especially emerging markets. The positive multiplier impact from a stronger yuan in china is significant. This is oil bullish.

How Does this Work?

China gets the factories open and supports the supply side, the U.S. gets households money which they spend on goods instead of services. Given covid restrictions, this data has been impressive. This duality effectively sends money to China, strengthens the RMB, and allows China to import more from the rest of the world. This downstream of demand is critical to getting the global trading back to its pre-covid levels again. It is also why this transition of fiscal policy and transfer payments is so important for the global economy right now.

If the famous fiscal handoff from monetary policy is here, oil and other industrial commodities will be prime beneficiaries. This is where there could be a bit of irony in the wall street narratives. One of the main consensus views takes place on the street is that oil names will struggle with a blue wave, given green focus, regulations, fracking, etc. However, the same people are saying that a blue wave will be positive for risk assets and growth has given it is the most likely medium for expansive fiscal spending. As we have seen, when the U.S. does fiscal and household consumption is strengthened, it has a positive spillover on global growth and global trade. When growth and trade are improving, oil and oil-related names typically do well. We think this is especially true as the supply response from OPEC and U.S. shale will be much more muted if growth and demand-side lead to a re-rating higher in oil prices in 2021. We believe the famous fiscal handoff is here and a large fiscal response only reinforces that dynamic which should end up being positive for oil and oil-related names in 2021.

But The Bear Traps Report notes there are some short-term issues to watch…

We believe the oil market has been leapfrogging many factors in the short term including the current covid concerns and the short term demand issues that will develop from economic shutdowns along with Iran production coming back.

Overlooking these issues is fine if they don’t develop momentum.

However, they are developing momentum so we do not think that one should remain naked in this respect. We would take advantage of lower volatility today to layer in some risk offsets due to both covid and the knee-jerk reaction the market might have to a democratic government pursuing a more positive relationship with Iran. This will likely be a short term concern so make your risk offsets short duration.

If momentum picks up that Iran will be allowed to reinstate as a full producer of oil to the market, we think that both the pace in which the production is added as well as the absolute amount of production added does not overshadow the daunting supply crunch that is only going to become more apparent to the market as the ’21 develops.

In fact, it would be naive to think that OPEC+ was not considering this issue in its decision to increase production by 500,000 b\d in the new year, which would indicate that there is a supply crunch already happening and OPEC+ is trying to avoid the price of oil moving too high too quickly.

Energy equities are acting very well in this current market and it is worth noting that oil prices may come under pressure and equites could act better due to the value/growth transition that seems to have legs of late.

We think that the Venezuela concern is not of merit as the scope of capital required to reinvigorate the production will make it’s an entrance back into the global market a very slow one.

Offsetting the COVID and Iran (new supply) headwinds are the following tailwinds:

1) Crude has flipped into backwardation which is indicating a tighter physical market

2) The Brent – WTI spread is the widest it has been in 6 months and that tied to time spreads are indicating a tight market

3) The two foremost physical market indicators (Atlantic Basin physical crudes and Asian refining margins) that we deem as imperative leading drivers for a sustainable oil market rally, have both improved lately.

And so it is a bet that these physical market indicators worsen because of covid – right now they are indicating a tight market.

However, not everyone is so positive of medium-term recovery over short-term hiccups.

“Right now, oil has priced in that promising future,” said Victor Shum, vice president of energy consulting at IHS Markit Ltd. in Singapore.

“While we have to deal with the immediate dark Covid winter.“

As Bloomberg warns, there are reasons to think $50 could be oil’s ceiling for now. The price could tempt producers from Baghdad to Oklahoma to increase production. There are already tensions within OPEC+, with some members chafing at the cartel’s self-imposed supply limits.

“A persistent rally could turn OPEC+ much less conservative, in turn driving a price pullback,” said Citigroup Inc. analysts including Ed Morse.

Additionally, the backwardation highlighted above, that’s attracting speculators, could also draw real barrels into the market, because the price structure isn’t profitable for any traders still storing physical crude. And relentless Asian buying may pause at some point, especially with Lunar New Year celebrations starting in early February. Higher-cost crude will start to dampen the profitability of refiners in the region.

“There’s been a distinct shift in the financial oil market,” said Michael Tran, an analyst at RBC Capital Markets.

Speculators are buying futures and holding onto them, scared that they’ll miss out on a further rally, he said.

So is oil really the cheapest reflation asset? Or is it caught up in the speculative excess sparked by vaccine ‘return to normal’ fear-of-missing-out exuberance… like everything else?

 

As Deutsche Bank continues with the biggest blood-letting on Wall Street since the collapse of Lehman Brothers, managers are reportedly planning to move thousands of Manhattan-based associates, often those with the most important front-office-type jobs in sales and trading.

Ever since DB moved to expand its presence in the Americas during the late 1990s-2000s, thousands of young employees, from interns to first-year analysts, have flocked to places like Murray Hill and other parts of Manhattan to work at the city’s investment banks, and generally live the young banker lifestyle of late nights out at bars on the lower east side and hooking up with wannabe model types at the clubs and bars that dot (or rather, once dotted) the East Village and the LES.

In the post-COVID era, many of these analysts might be sent to other more cost-effective parts of the country where Deutsche Bank already has a “presence”, according to DB Americas CEO Christiana Riley, one of the highest-ranking women on Wall Street.

Riley told the FT that the NY head count could “conceivably” be cut in half in 5 years (a pretty aggressive time table). The bank currently has roughly 4,600 staff in Manhattan, which means some 2,300 could soon be reporting to DB’s offices in Jacksonville Fla., long considered a dumping ground, where the bank houses its compliance department. According to media reports, the bank’s compliance workers in the city have long been treated “lower than janitors” by a bank that’s become almost synonymous with criminal malfeasance (an impression that has only been strengthened, as unfortunate or undeserved as that might be, by the endless MSM reporting on the bank’s lending relationship with the Trumps.

The FT specifically cites the Jacksonville office, along with another office in Cary, North Carolina, as likely destinations for these displaced workers. The British paper also noted that NYC has been  losing financial services jobs to cities like Dallas and Tampa for years, but that the pandemic, with its radical experiment in remote work, will likely accelerate the process.

Florida seems to be a hot spot for financial workers, thanks to the warm climate and (more importantly) low taxes. Goldman Sachs is also reportedly moving its workers to the Sunshine State. And numerous hedge funds and family offices flock to the state for the tax advantages.

The cost cuts will help DB’s US investment bank hit its target for 11% return on equity by 2022, up from 9% projected this year. That 11% target was first unveiled during CEO Christian Sewing’s big cost-cutting initiative announced last summer in the wake of the bank’s failed tie up talks with Commerzbank. Sewing reiterated the target during the bank’s investor day a week ago.

Unfortunately, pretty soon, instead of spending summers, and then their first post-grad years, living it up in the big city “Young Money”-style, the bank’s incoming analysts will be kicking it in the Jacksonville swamp, a city that, despite its size, is probably best known as the hometown of rap-metal legends “Limp Bizkit”.

What’s the point of working all those 7-day, 100+ hour weeks if you can’t experience the thrill of being 23 and living in a flex double somewhere east of Lexington?

By Matthew Hornbach, chief rates strategist at Morgan Stanley

Liquidity. It’s What’s For Dinner

With futures contracts tied to the price of water starting to trade last week, this seems a good time to take a look at the impact of liquidity. Liquidity means different things to different people, so before digging in, let me explain what I have in mind. For some, liquidity is the ability to transact a high volume at a low price or bid/offer spread. Others define it as the ease of converting an asset into cash.

The liquidity I’ll discuss here is what greases the wheels of financial transactions and usually emanates from central bank balance sheets. As these balance sheets expand, so does the supply of transactional currency – think of it as electronic money – relative to a given set of investment opportunities. As the supply of this currency increases, financing costs tend to decrease. As a result, the valuation of assets, and usually their prices, change.

How do central banks control the supply of reserves via their balance sheets? They can flood the system by purchasing securities in the open market, i.e., quantitative easing (QE), and drain it by selling them or more commonly letting them roll off without reinvesting. The need for liquidity with which to transact grows with the economy, so monitoring its supply becomes a dynamic process. Keeping tabs on it is also the starting point for an analysis of liquidity’s waterfall effect on broad asset classes.

Quantifying the impact of liquidity from its central bank balance sheet origins down the stream of risk-less and risky assets – the so-called portfolio balance channel – is difficult. Academic research has come to various conclusions, with consensus forming around the following: Central bank asset purchases affect prices of the assets that central banks purchase the most. As a result, opinions vary on the importance of incorporating liquidity into an investment framework.

In the end, tracing the impact of central bank QE on asset prices is like following an ounce of water from one end of a river to the other. It’s practically impossible. Instead, we look for clues that suggest how the cash must be flowing. The leaf that floats downstream leads us to conclude that the ounce of water has flowed along with it. In markets, we first point to the decline of the US dollar (which we thought would result from the liquidity deluge). Then we focus on the unwillingness of government bond yields to rise alongside equities, even though breakeven inflation rates were more than happy to do so.

In the absence of absolute proof, seeing is believing. Fixed income investors may remember the negative impact on financing conditions of reducing the reserves held at the Fed in 3Q19. And equity investors may recall how markets reacted in 4Q19 when the Fed reversed course, injecting reserves and improving financing conditions. But who will forget the never-before-witnessed liquidity injection in 2020? Central banks across the G10 will have injected US$4 trillion via government bond purchases alone by year-end.

In the face of that sum, the idea that this tsunami of liquidity hasn’t had far-reaching impacts on asset prices seems outlandish. Naturally, incentives need to align for people to invest available funds. One such incentive in 2020 was the surprisingly strong rebound in economic activity. Another was zero or sub-zero risk-free rates. But the potency of incentives to invest excess cash moderates as the cash piles up. And piling up is an understatement. 2021 is going to be another big year for liquidity injection.

On our projections, G10 central banks will inject another US$2.8 trillion of liquidity next year – just in their government bond purchases. To put this in context, that’s more than twice the amount of liquidity central banks injected in any year prior to the one drawing to a close. Of course, this liquidity doesn’t have to find its way into financial markets immediately. It certainly didn’t this year, as evidenced by the US$4.5 trillion sitting in US money market funds today.

But, if our economists are right and the global economy outperforms expectations, we think the ample liquidity environment will support riskier investments to the detriment of risk-less ones. That means the US dollar has further to fall against a host of G10 and EM currencies next year, and the safest investment of all – US Treasuries – will struggle to make ends meet.

Of course, if central banks signal a reduction in liquidity earlier than we expect, or our economists’ buoyant expectations aren’t met, risky assets could experience a wobble, a theme that might very well feature in our 2021 mid-year outlook.

According to Twitter account @_subia, her husband was driving a 2015 Tesla Model S when it “inexplicably” burst into flames in late November while driving down a neighborhood street in Frisco, Texas. 

On Nov. 23, @_subia tweeted, “my husband @usmaan008 heard bangs while driving his beloved ⁦ @Tesla ⁩ & pulled over moments before it burst into flames. I was told we were lucky he got out when he did.”

By Dec. 2, @_subia was hoping for an explanation of why her husband’s Tesla “suddenly caught fire.”

On Dec. 12, @_subia now assumes “the tesla car battery exploded,” adding that her “husband almost took our kids with him. What if kids were buckled in car seats? He hasn’t been able to shake that thought. Or me being in that front passenger seat.”

Weeks later, after the Model S “inexplicably burst into flames” – Tesla has yet to investigate the incident. 

“Tesla still hasn’t had a chance to investigate but I now fear for all our family & friends who drive Teslas. We just want answers.” 

Tesla vehicles randomly exploding is not a new phenomenon. We reported in 2019 that a Tesla Model S “spontaneously” caught on fire in a Chinese parking garage.

By late 2019, the US National Highway Traffic Safety Administration launched an investigation into a possible defect in the battery of some Teslas that could cause “non-crash fires.”