Why Historic Relationships in Markets Have Been Totally Upended

Episode Summary

Executive Summary: Matt King argues that since the post-2008 era, central bank liquidity—not just fundamentals—has been the dominant force in driving asset prices, compressing volatility, and breaking traditional valuation relationships across credit and equities. He warns that as the Fed, ECB, and BOJ withdraw support, markets may become more two-way, volatile, and less reliant on easy liquidity.

Main Topics: Central bank liquidity as the key market driver (Priority: 5/5): King says market behavior since 2009 is best explained by global central bank purchases and liquidity conditions, which increasingly overrode fundamentals. Breakdown of historical valuation relationships (Priority: 5/5): He cites multiple examples where long-standing correlations—like spreads vs. leverage, VIX vs. policy uncertainty, and earnings revisions vs. equity returns—broke down around 2011-2012. Why low rates are an incomplete explanation (Priority: 4/5): While acknowledging low rates matter, King argues they do not fully explain tighter spreads, lower volatility, or re-ratings, and that the evidence better fits liquidity flows than rate levels. Flow versus stock of central bank buying (Priority: 5/5): A major point is that it is the pace of central bank purchases, not just the size of balance sheets, that matters most for risk assets. Risk of market fragility as policy support fades (Priority: 5/5): He expects the Fed, ECB, and BOJ to pull back simultaneously, which could leave markets more vulnerable because prices were inflated by artificial demand and reduced net supply. Volatility suppression and bifurcated markets (Priority: 4/5): King argues central banks created one-way markets with low day-to-day volatility but high tail risk, making sudden drawdowns more likely once support fades. Interaction between markets and the real economy (Priority: 4/5): He cautions that markets may drive the economy rather than simply reflect it, citing past episodes like 1999-2000, 2007-2008, and 2015 stress events.

Key Arguments: Traditional valuation tools stopped working broadly around 2011-2012, suggesting a structural shift in market drivers rather than normal cyclical behavior. Central bank asset purchases globally are highly correlated with equity gains and credit spread tightening, even without invoking fundamentals. The argument that low interest rates alone explain expensive markets is incomplete; leverage, volatility, and valuation patterns do not line up cleanly with that story. Markets are being supported by flow effects: central banks have absorbed much of the available net supply of securities, leaving prices bid up across assets. The withdrawal of liquidity by the Fed, ECB, and BOJ could be destabilizing because multiple major buyers are pulling back at once. Markets may have become fragile and one-directional, with low everyday volatility masking the risk of sharp reversals. Economic strength alone may not protect markets if the liquidity backdrop worsens; in some episodes, markets lead the economy downward. Central bankers may underweight these market correlations because they conflict with their theoretical models of how QE should work.

Data Points: Broadcast length: 5 minutes or less - Referenced in the Bloomberg Stock Movers promo, describing the product format. Timing of research note: September 2008 - King discusses the note 'Are the Brokers Broken?' written shortly before Lehman’s collapse. Lehman collapse lag: About 2 weeks later - King notes Lehman failed roughly two weeks after his funding-risk note. Breakdown period: 2011-2012 - He repeatedly identifies this period as when historical correlations began to fail. Earnings revision deterioration: 5 years - Analyst earnings expectations were revised lower for about five years while markets still rallied. Recent market sell-off: About 1.5% - Mentioned as a November pullback that was historically modest. Global net supply impact: About $1 trillion more net supply next year - King says balance-sheet reduction by the Fed and ECB will add to global net supply. BOJ purchases: Halved - He says Bank of Japan purchases had already been cut roughly in half as policy shifted away from pure QE. Volatility regime: 0 or 16 - King describes markets as producing either near-zero volatility or abrupt jumps, rather than smooth middle outcomes.

Pivotal Quotes: "Are the Brokers Broken?" — Matt King: Title of King’s 2008 research note that flagged funding stress in U.S. broker-dealers before Lehman’s failure. "Valuations do matter. They're indeed the most important factor, but only over the long term." — Matt King: He pushes back on the idea that valuation no longer matters, arguing timing is the issue. "It's not just that volatility is low, it's that volatility is bifurcated." — Matt King: Used to describe how central bank support compresses day-to-day swings while increasing tail risk.

Implications: Listeners should expect a less one-way market as major central banks reduce support. If King is right, valuations, liquidity, and the pace of policy withdrawal will matter more than recent calm and upbeat macro data, increasing the odds of volatility and sharper corrections.