Get Set, the Liquidity Rally Is Back On!

Last month, in the wake of the Fed's June rate-setting committee meeting, I announced that the liquidity rally had died. Three weeks on, and it now appears that my report of its death was an exaggeration. Consider the following:

  • The S&P 500 gained 1.4% today, making a new record (nominal) high, and extending its winning streak to six days. The index put in its previous high on May 21 -- one day prior to the Fed first disseminating the notion that it might begin to reduce its monthly bond purchases ("quantitative easing") this year.

  • The narrower, price-weighted Dow Jones Industrial Average also achieved a new record high on the back of a 1.1% gain. The Russell 2000 Index of small-capitalization stocks also established a new high -- its fifth in as many days.

  • The CBOE Volatility Index (VIX) , Wall Street's "fear index," fell another 1.4% to close at 14.21, its lowest closing level since May 24. (The VIX is calculated from S&P 500 option prices, and reflects investor expectations for stock market volatility over the coming 30 days.)

All it took to achieve these new index highs were the following 11 words from Fed Chairman Ben Bernanke, uttered yesterday in response to a question following a speech in Cambridge, MA: "Highly accommodative monetary policy for the foreseeable future is what's needed."

Alright then, if the liquidity rally in equities is still on, has the notion of a "tapering" in the Fed's bond purchases had any broader, lasting impact on financial markets? The answer is yes. Just look at "safe haven" assets, such as Treasury bonds and gold. Sure, they've rebounded somewhat over the last couple of weeks, but they're still below where they stood on May 21. Look, for example, at the graph comparing the SPDR Gold Shares , the largest gold ETF, to the S&P 500:

^GSPC Chart
^GSPC Chart

^GSPC data by YCharts

As mentioned above, the S&P 500 has just made a new high; meanwhile, using the ETF as a proxy, gold is still down 6.5%, which exceeds stocks' maximum loss during this period. Investors' bout of "taper anxiety" may have been just a hiccup on the new road to new equity market highs, but for gold and bonds, the condition looks rather more serious. Talk of the taper was enough to break the spell that had investors believing they could no wrong by putting money into these assets. It's too early to do a postmortem, but I stand by my preliminary conclusions: The bull market in gold and bonds is dead.

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Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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