Why was 2019 a paradigm shift in economy?

“Most stock market indices rose between 20% and 30% in 2019.”

Stefano Quadrio Curzio
Adviser to L1 Board


Even before COVID-19 came along, 2019 had been one of the most momentous years in my years studying investment markets. In my opinion, when looked at in hindsight in a few years, it will be seen as significant an inflection point in the West’s monetary structure as was the abandonment of the link between the US$ and gold in 1971.

What happened last year that was in my view so momentous? After 10 years of extraordinary fiscal and monetary stimulus, the US Federal Reserve tried to bring monetary policy back to a more normal stance, with interest rates reflecting closer nominal GDP growth and contained balance sheet expansion. They spectacularly failed in this goal at the end of 2018, and financial markets went into a tail spin.

As a result of the above failure, 2019 saw the Federal Reserve reverse its interest rate increases and begin a series of rate cuts, despite the unemployment rate being only 3.5% and most measures of inflation being over 2%. It also resumed balance sheet expansion at a rate comparable to the financial crisis period. By the end of 2019, the Federal Reserve was effectively monetising two-thirds of the US budget deficit.

The above actions had already led me to believe that interest rates were to stay near zero for many years to come and will stay negative in real terms for at least a decade. It is also now clear that central banks in the western countries and Japan are now embarked on a course of full monetisation of the debts of their governments.

The results of these policies were immediate and substantial. Most stock market indices rose between 20% and 30% in 2019. Gold returned 20%. Bonds were also repriced, giving returns in excess of 20%. None of this reflected an improved earnings picture for corporates. It was just asset inflation, indiscriminate and widespread, as investors sought to reprice assets in the face of a significant regime change.

COVID-19 did not change any of that; it simply made what was already likely into a certainty. Central banks’ monetary stimulus is now on steroids and irreversible. The expansion of Central banks balance sheets has now reached $20trn, with half of that achieved in the last two months. And an inexorable trend will see them grow to $25trn and beyond.

While the real economies are in dire conditions, asset inflation continues unabated after a brief correction in March. This makes the job of investors very easy and very difficult at the same time. Easy because Central Banks liquidity decisions are the only factor that matters. Difficult because at some point the gap between cash flows and valuations will be revealed in stark contrast and a changed sentiment towards risk aversion could unleash a major inversion. It is now the time to become more discriminating, differentiating between businesses that amidst this monetary laxness will prosper and those that will be harmed by these same forces.