Getting by with a little help from a friend

Global stock markets found a friend in the world’s central banks in 2012 as Bernanke and his pals worked to pump liquidity into the global economy. It’s hard to say exactly how much global liquidity has been created, but in the United States the Fed’s liabilities are triple what they were before the 2008 financial crisis.

As this chart illustrates, most of the Fed’s increased liabilities are in the form of “excess reserves.” Excess reserves are created when banks receive liquidity from the Federal Reserve, but then leave that liquidity on depost at the Fed instead of lending it out. But things may be changing. Note the slight downward slope of the excess reserves line (orange) relative to the monetary base line (yellow). This indicates that some excess reserves are trickling into the financial system. Since easy money usually finds its way into the financial markets, if this drawdown in excess reserves increases, it may provide fuel for strong equity markets in 2013.

Stock markets around the world did well in 2012. The S&P 500 gained 16%, while developed foreign markets rose 17.3%. Emerging markets did even better, advan­cing 18.2%. Considering every­thing the markets had to deal with over the past 12 months—a bruising presidential election, fiscal cliff worries, the ongoing Euro-zone saga, etc.—equity mar­ket returns weren’t too shabby. Bonds, on the other hand, returned only 4.2% for the year as mea­sured by the Barclay’s Aggregate bond index. Commodities lost 1.1% on the year as oil prices fell 7.1%.