In this week’s video, Economist Andrew Hunt argues that the liquidity driven buying frenzy we have seen  in recent months may be ending. After months of surprising resilience, global markets face a confluence of challenges that could test investor nerves through late summer and autumn.

The Liquidity Tide Turns

Markets have enjoyed a goldilocks scenario recently. Abundant liquidity from the US Treasury's cash drawdown, minimal bond issuance, and strong foreign inflows chasing the dip. This cocktail has allowed investors to shrug off geopolitical tensions and economic uncertainties with remarkable ease.

However, this favourable backdrop is set to reverse dramatically. Within weeks, the US Treasury will exhaust its cash reserves and need to flood the market with new debt issuance, potentially during the traditionally thin trading days of August. This supply surge could pressure yields higher just as economic data deteriorates, creating a particularly uncomfortable combination for risk assets.

Trading the Inventory Cycle

The pre-tariff import surge that boosted global trade in recent months is now unwinding. Companies that frantically stockpiled inventory are shifting to drawdown mode, which will likely manifest in softer economic data through the third quarter. Container shipping and air freight volumes are already rolling over, suggesting this headwind is materialising.

For equity investors, this means earnings season could disappoint as companies digest higher inventory carrying costs and softer demand. Sectors most exposed to global trade flows warrant particular caution.

China's Economic Transition

China's economy faces structural headwinds as it grapples with high debt levels and excess manufacturing capacity in certain sectors. While policymakers remain constrained by the need to balance growth with financial stability, they're likely to deploy targeted stimulus measures periodically over the coming 18-24 months.

This creates a complex environment where the broader Chinese economy may flatline with alternating periods of contraction and expansion. However, astute investors should note that Chinese equities already reflect considerable pessimism in their valuations. The market's tendency to rally on even modest stimulus announcements suggests potential opportunities for contrarian investors willing to navigate the volatility.

Positioning for Divergence

The synchronised global liquidity boom is fracturing. As correlation breaks down, country and currency selection becomes paramount. Look for economies with:

- Current account surpluses

- Sustainable debt dynamics

- Productivity growth potential

- Political stability

We tend to agree that a shift in sentiment and liquidity decisions could favour active management and tactical flexibility as the so called 'rubber band’ (where valuations in hot sectors get stretched to breaking point) get tested. Therefore, the next few months require a different playbook than the post-pandemic period. While not necessarily catastrophic, the shifting dynamics suggest lower returns, higher volatility, and greater dispersion. 

Looking further out it seems very possible that the regime of abundant liquidity that markets have enjoyed for the past decade and a half that lifted all boats could be transitioning to one where selectivity and timing matter more. This creates both risks and opportunities for those prepared to adapt their strategies accordingly.