Can asset prices be forecasted by global Liquidity ?

During the period leading up to the global financial crisis in 2008, and during the period after the 2020 Covid19 pandemic, many asset classes registered rapid price increases. This coincided with a significant rise in global liquidity brought in by the central banks in an effort to save the economy.

Logic would say : if you increase the amount of money in circulation, the assets get “assigned” a higher price for the same share of the market liquidity. After reading up on the literature on the topic, I can confirm that’s the case. We find an asymmetric impact of global liquidity on asset prices classes — with a much stronger effect on house prices compared to equity and commodity prices. This result is broadly consistent with the findings of other studies in the literature and vindicates the use of an alternative measure of global liquidity, which captures more broadly developments in the global medium of exchange.

This is actually reassuring if you were an investor, it’s harder to remove liquidity than to add it, so your current post-covid gains are mostly safe. Stock prices, for example, remain right in the middle of the channel surrounding the liquidity line on the Composite Liquidity Chart. This means the market isn’t overbought. Nor is it oversold. Regardless of how many people are screaming “bubble” on Twitter. It’s just tracking the growth of systemic liquidity, Not too hot, not too cold, but just right.

This means we can easily forecast asset and stock prices by the liquidity injection into the M1 and M2 dealers (apologies for the jargon). And to make it simple, there won’t be a stop in the asset price growth until the central bank makes changes in its policy.

So keep an eye on the economic calendar, and expect volatility and asset sale before the central bank’s reports in the coming year.

Thanks for reading,

Yacine Daoud.