All Hail Liquidity

The year 2012 has gotten off to a great start,

with risk back on with a vengeance. Global

equity markets are up across the board, and

suddenly everything once again looks right with the

world. In the US, the S&P 500 is off to its best start

since 1987, and is being led by deep cyclicals (materials,

home-builders, semiconductors) and financials.

The worst-performing stocks and sectors of

2011 are clearly leading the way (in the US, the 50

worst-performing stocks of 2011 are up 10 per cent in

the year to date, while the 50 best-performing stocks

of 2011 are only up 2 per cent). Bonds in the US are off

to their weakest start since 2003, with 10-year yields

back above 2 per cent. The S&P 500 is now up 20 per

cent from its early October lows, and is just about 3

per cent below its April 2011 post-crisis high. This pattern

is repeated across markets, with large emerging

markets leading the way.

Why has this rally taken shape? How much further

can it go? Is India, one of the best performers this

year, truly out of the woods?

The sources of this rally are ample liquidity, better

short-term economic data and some of the more

dire EU scenarios no longer being on the table.

The move by European Central Bank President

Mario Draghi last month to provide huge amounts

($635 billion) of low-cost three-year funding to the EU

banking system will clearly help banks de-leverage,

and also provide indirect support to the EU sovereign

debt markets. Investors have clearly taken time to

understand how significant this move was. There is

another round of such provisioning in February, and

it could turn out to be even larger than last month’s.

The ECB