In his latest note, currently making the proverbial rounds, Morgan Stanley’s Mike Wilson channeled Jon Krakauer in warning that equities are surviving in the “death zone” thanks to “supplemental oxygen.”

I’ve read Krakauer. And not just Into Thin Air. All Krakauer. Krakauer is an easy read, and you can binge on his work much as you’d binge on a Netflix series, except that unlike binge-watching, binge-reading is actually good for your sanity.

Admittedly, I have a visceral aversion to seeing literature of any sort (fiction or nonfiction, novels or short stories) being co-opted for purposes it wasn’t meant. That’s selfish and hypocritical on my part. I do it all the time, and I have no plausible argument for why I should have a monopoly on employing literary allusions in the course of editorializing around macro and markets.

I suppose I should applaud Wilson. Maybe someone who’s never read Krakauer will now, thanks to his note.

In any case, Wilson briefly recounted Into Thin Air, in the course of noting that although Everest isn’t the most challenging climb on Earth, it is the highest peak, which generally means a longer stint in the “death zone” on the way to and from the summit. “This is a perfect analogy for where equity investors find themselves today, and quite frankly, where they’ve been many times over the past decade,” he said, adding that,

More specifically, either by choice or out of necessity investors have followed stock prices to dizzying heights once again as liquidity (bottled oxygen) allows them to climb into a region where they know they shouldn’t go and cannot live very long. They climb in pursuit of the ultimate topping out of greed, assuming they will be able to descend without catastrophic consequences. But the oxygen eventually runs out and those who ignore the risks get hurt.

Over the past several weeks, some market participants have latched onto what at least one journalist inadvertently portrayed as a novel narrative to “explain” stocks’ befuddling resilience in the face of a sharp hawkish repricing in expectations for US monetary policy. That narrative revolves around liquidity — Wilson’s “bottled oxygen.”

I’ve fielded several e-mails about that narrative, which essentially argues that between Bank of Japan buying to defend the cap on 10-year JGB yields (which was raised in December), ECB and Fed draws, as well as PBoC liquidity provision, stocks are once again surfing on a tsunami, which is overwhelming the fundamentals.

Allow me to say a few things about that story. I’m going to employ bullet points to enhance readability.

• To me, the veracity of this narrative relies almost exclusively on the BoJ side. To briefly recapitulate, Haruhiko Kuroda’s insistence on preserving yield-curve control in 2022 meant defending a yield cap in an environment when government bonds suffered one of their worst years on record. That was a costly fight, and as explained here in September and October, raising the ceiling ostensibly as a pressure release valve, was very risky given the likelihood that, smelling blood, markets would immediately test the new cap, compelling the BoJ to buy even more bonds than they were already. That’s precisely what happened after the bank’s “shock” decision in December to double the cap. Conceptually, those JGB purchases “offset” balance sheet runoff in other locales.
• By contrast to BoJ bond-buying, some parts of this narrative relate to technical flow dynamics that result in mechanical liquidity injections which analysts tend to describe as “dilutive” to contemporaneous tightening. On the PBoC side, repos aren’t QE. Neither is MLF. It’s important to delineate. Maybe the cash finances risk-taking, maybe it doesn’t, but it’s not, “Oh, here’s some cheap RMB, we’ll have the Meta with a side of Apple.”
• There’s always something to the idea that liquidity provision is levitating asset prices, but it’s difficult to quantify with precision even over long periods. Quants tried, and mostly failed, to establish a reliable mathematical relationship between central bank purchases during the post-Lehman years and financial assets. Of course, it was obvious that the relationship existed. It was, as Harley Bassman put it, a “Me or your lyin’ eyes” phenomenon. Importantly, central banks didn’t deny it. On the contrary, the whole point was to levitate financial assets. Lest we should forget in our zeal to paint technocrats as a cabal of conspirators, Ben Bernanke in 2010 penned an Op-Ed for the Washington Post in which he explicitly said the Fed was endeavoring to “lower corporate bond rates” and engineer “higher stock prices.” So, yes, incremental liquidity provision like that inherent in the BoJ’s increasingly belabored efforts to defend the YCC ceiling, is, all else equal, bullish. But that isn’t some mystery, and to speak again to the second point above, we have to delineate between outright purchases, technical liquidity flows and high frequency liquidity management efforts. They aren’t the same thing, and they should be expected to affect markets differently.
• The popularization of this narrative over the past two weeks (i.e., using it to explain equities’ “baffling” resilience in the face of the hawkish rates repricing in the US) probably stems from an account penned by an analyst whose work I’ve enjoyed for more than a dozen years, but who, through no fault of his own, is frequently leveraged by web portals chasing traffic. The gist of that analyst’s notes hasn’t changed much over the past decade, and at least one mainstream media outlet cited him last week in briefly recapping the BoJ / ECB / PBoC narrative. To the extent that’s where the fascination emanated, I’d gently suggest it’s out of proportion.
• The idea, floated by some observers recently, that major banks are engaged in an effort to front-run clients or otherwise exploit this situation by, for example, publicly suggesting that stocks are overvalued to get a better price on securities they’re buying for their own book based on the liquidity narrative is, generously, specious. Less generously: It’s silly and doesn’t make any sense.
• Rolling up PBoC liquidity into this discussion could be misleading. You’ll argue that liquidity is fungible. And I won’t argue with you, other than to say that when it comes to assessing the impact of central bank liquidity provision on financial asset prices, it’s preferable, in my experience, to use aggregates that include the Fed, the ECB, the BoJ and the BoE. Including the PBoC introduces some “apples-to-oranges” risk, for lack of a better way to put it.

All of that said, there’s doubtlessly something to the notion that, as Morgan’s Wilson put it, “financial conditions are continuing to loosen thanks to the liquidity provided by other central banks mainly the PBoC and BoJ.” But when you say “thanks to,” you generally have to quantify that, preferably with statistics. Otherwise, it’s just Bassman’s “Me or your lyin’ eyes” description.

There’s nothing wrong with the “Me or your lyin’ eyes” characterization of the relationship between liquidity provision and financial asset bubbles, particularly given how intuitive (almost self-evident) it is and given that, as Bernanke made clear, it was deliberate, or at least in the first instance. But in this instance, your “lyin’ eyes” have to squint.

Wilson called the $6 trillion increase in global M2 since October “staggering,” which is true, but as Wilson’s own illustration (on the left, below) shows, this “staggering” increase doesn’t exactly jump off the charts at you. You need annotations to identify it.

Again (and I think this is abundantly clear by now), I don’t doubt the veracity of this narrative. Not at all. What I do doubt, though, is that it fully explains the resilience of equities in 2023.

Note that Wilson didn’t make such a claim, even as others have in recent days. In the same note, he wrote that the rally from the October lows “was based on a reasonable narrative that China’s long-awaited reopening was finally about to begin and could provide an offset to the slowing US economy.” Then, he cited misguided expectations for a Fed pause for what he’s now calling “a speculative frenzy.”

Ultimately, Wilson’s message was a familiar one. Regardless of what’s behind the rally, the figure on the right above shows that “with the P/E now at 18.6x and the ERP at just 155bps, we are in the thinnest air of the entire liquidity-driven secular bull market that began back in 2009.”

He doesn’t think it’s sustainable. “This oxygen supply can last a bit longer and help the climbers go farther than they should [but] it can also trick them into thinking they are safer than they really are, which leads to them getting hurt,” he wrote.

Then, in the traditional sendoff that always accompanies Morgan Stanley’s short “What’s Next In Global Macro” notes, Wilson wished readers an enjoyable day.