The core of global risk appetite recovery and stock market gains lies in loose US dollar liquidity. Risks may emerge from Federal Reserve policy changes or cross-border capital flow shifts causing US dollar liquidity reversal, AI capital expenditure being temporarily disproven leading to tech stock corrections, and Trump policy changes causing TACO expectation reversals.
The degree of global market risk appetite recovery following reciprocal tariffs is remarkable. After each TACO (Trump Always Chickens Out) trade, capital becomes more determined in its bets. US stocks, European stocks, and Japanese stocks among developed markets, as well as Korean stocks, Taiwan stocks, and Vietnamese stocks among emerging markets, have all reached new highs. A-shares and Hong Kong stocks have also entered bullish sentiment under the guidance of new hotspots and narratives, strengthening the stock-bond seesaw effect.
Beyond the TACO trading of "policy risks turning favorable," what are the roots of global risk appetite improvement? How do we measure market bubbles? We attempt to observe these issues from an odds perspective.
**I. The Root of Global Risk Appetite Improvement - US Dollar Liquidity**
The main source of this round of global stock market gains comes from the United States: on the policy front, Trump's frequent TACO moves externally have given capital further confidence to place bets; on the asset front, increasingly loose US dollar liquidity has spillover effects on global markets. US dollar liquidity covers multiple markets and assets, closely related to Federal Reserve monetary policy rhythm and cross-border capital flows.
Recently, we observed changes in US dollar liquidity across five dimensions:
First, the US Dollar Index has declined significantly.
The US Dollar Index is the most direct reflection of US dollar liquidity. Dollar strength may result from Fed marginal tightening tendencies causing US-non-US interest rate differentials to widen, or from overseas dollar scarcity or higher attractiveness of dollar assets. The dollar shows a clear negative correlation with non-US stock markets, while the dollar and US stocks briefly shifted from negative to positive correlation after 2023.
Over the past quarter, the US Dollar Index fell 2.4%, down 10% year-to-date, well explaining the funding conditions for the collective warming of non-US stock markets. As of July 25, the US Dollar Index was at the 0.9%, 0.6%, 32.1%, and 45.5% percentiles for the past one, three, five, and ten years respectively.
Second, US real interest rates have declined from April-May highs.
Real interest rates after removing inflation are another reflection of US dollar liquidity, affecting both US and non-US stock markets. For US stocks, real interest rates serve as a benchmark for required capital returns, affecting future cash flow values and determining the relative attractiveness of US stocks. For non-US markets, widening US-non-US interest rate differentials may create pressure for foreign capital withdrawal from emerging markets, push up US dollar debt costs, and exacerbate currency depreciation risks. US real interest rates may also transmit to developed country bond markets and create tightening effects on stock markets.
As of July 25, the 10-year US Treasury real interest rate has declined over 20 basis points from its post-reciprocal tariff high (April 11) and 30 basis points from the beginning of the year, laying some foundation for risk sentiment release. However, from a historical percentile perspective, real interest rates remain elevated (at the 38.4%, 61.2%, 76.7%, and 88.4% percentiles for the past one, three, five, and ten years respectively).
Third, global central bank money supply has accelerated marginally.
Although the dollar is the world currency and most central bank money supply cycles follow the Federal Reserve long-term, there are still timing differences in the medium and short term. Using Bgeometrics' global central bank M2 data, the US dollar M2 accounts for only about 20%, and non-US central banks collectively still have some liquidity discourse power. Despite the Federal Reserve "staying put" this year, multiple major global central banks including the European Central Bank, Bank of England, and Swiss National Bank have already cut rates. This year, global central banks have cumulatively raised rates 19 times while cutting rates 76 times, bringing liquidity benefits to non-US markets.
Over the past quarter, global central bank money supply growth has rebounded nearly 7 percentage points. Historically, global central bank money supply has a greater impact on non-US stock markets (correlation coefficient = 0.53), but overseas risk appetite recovery also stimulates US stock rebounds (correlation coefficient = 0.43).
Fourth, offshore US dollar funding costs have declined.
US dollar liquidity indicators differ across markets. Generally, short-term borrowing costs of large financial institutions within the US are key to measuring dollar funding costs, but such indicators mainly affect money markets and fixed income markets. In equity markets, offshore market US dollar funding costs are more important, reflecting both the overall liquidity of non-US equity markets and the financing costs for non-US funds going to US stocks.
Observing through cross-currency swap basis (XCCY) in offshore markets - the additional cost overseas investors need to pay when borrowing US dollars with their local currency or specific financing currency as collateral compared to direct dollar financing - the more negative the basis points, the higher the additional cost of offshore dollar financing and the tighter offshore dollar liquidity, and vice versa.
The Euro, British Pound, and Japanese Yen are currently important non-US reserve and trading currencies globally. Their cross-currency swap markets with the US dollar are the deepest and most liquid globally, with the most sensitive price discovery mechanisms. As of July 25, the 1-year EUR, GBP, and JPY cross-currency basis with USD (measured by OIS-USD SOFR) were -2.0 points, 3.6 points, and -29.6 points respectively, at the 85.4%, 96.5%, and 99.8% percentiles of the past two years, indicating no dollar shortage in major global offshore dollar markets.
Against the backdrop of loose US dollar liquidity, we observe foreign capital inflow trends into various non-US stock markets. Taking A-shares as an example, in the second quarter of this year, foreign shareholding market value in A-share listed companies reached 22.2 trillion yuan, up 0.75% from the end of last year. Financial, telecommunications, and utilities sectors all saw significant net foreign inflows.
Looking at Hong Kong stocks, by the end of July this year, foreign shareholding ratio under the Hong Kong Exchange's "international intermediary" caliber rose 0.87% from the end of the first quarter, with industrial, consumer staples, and healthcare sectors leading in net foreign inflows, possibly related to the recovery of Hong Kong's primary market this year.
In broader non-US equity markets, signs of foreign capital inflows are more evident. According to Bloomberg's foreign portfolio flow data, since July this year, Asian markets including Japanese, Korean, Taiwan, Thai, and Vietnamese stocks have all received net foreign inflows, while over the past 12 months, these markets were all net outflows.
**II. Using US Stocks as Example, How to Measure Stock Market Bubbles?**
Under the catalysis of global risk appetite and liquidity, US stocks, Japanese stocks, European stocks, Vietnamese stock markets, etc., have all reached historical highs. Besides observing valuations, how else can we measure the degree of market bubblization?
Taking US stocks - the storm center of this AI wave - as an example, the market's main concern about US stocks lies in the effectiveness of current tech giants' massive capital expenditures, which is especially important for tech stock valuations. Reviewing the "Internet Revolution" period, tech companies' blind money-burning later became ineffective investments, leading to significant valuation adjustments. Under the current AI craze, tech giants are frantically expanding capital expenditures betting on the future. The average capital expenditure growth rate of tech stocks from 2021-2024 reached 18%, even higher than the 11% average in the 1990s. Even if market valuation bubbles don't match those of the late 1990s, similar history may repeat whenever the effectiveness of capital expenditures is questioned.
Additionally, recent US stock gains also show a barbell structure, with one end being tech giants represented by M7, and the other end being "small-cap stock fever and high-beta stock strength." The market is simultaneously pricing in the triple benefits of economic growth resilience, Fed rate cut expectations, and policy risk fade (TACO). Investors are beginning to try more leveraged and speculative sectors, which may have exacerbated market fragility.
From a more macro perspective, a country's stock market valuation should not long deviate from that country's economic aggregate. The "Buffett Indicator (US stock total market cap/US nominal GDP)" is built on this point. As of July 25, the Buffett Indicator reached a historical high of 2.1. Even though 40% of S&P 500 component companies' overseas revenues are not included in GDP but are included in market cap, the current "Buffett Indicator" standing 2.9 standard deviations above the mean still warrants caution.
Similar to the Buffett Indicator, stock market returns can also be compared with economic driving factors (debt and liquidity). As of the end of 2024, the growth differential between US stock total market cap and US public sector debt reached 17.4%, and the growth differential with US M2 year-over-year reached 18.7%, at relatively high percentile levels of 84.6% and 76.9% over the past decade. This is because, under the era themes of AI tech revolution narrative and American exceptionalism, capital is giving US stocks additional valuation premiums beyond economic momentum itself, while those tech giants with monopolistic positions can even receive more valuation premiums.
**III. Global TACO Bull Market: Which Has Bigger Bubbles?**
Under the catalysis of global risk appetite and liquidity, we can draw the following conclusions by comparison:
First, in the environment of ample global US dollar liquidity, the market cap to economic output ratios (i.e., "Buffett Indicators") of major stock indices are generally at high levels, with most developed market stock risk premium levels at decade lows.
Second, comparing major stock index P/E ratios horizontally, US stocks, Indian stocks, Vietnamese stocks, and German stocks have relatively high absolute levels, with US stocks, German stocks, Taiwan stocks, and French stocks having higher P/E ratios.
Third, comparing the difference between stock price gains and earnings growth rates of major indices vertically, US stocks currently haven't significantly deviated from the fundamentals of large US companies. A-shares and German stocks have higher "non-fundamental premiums," while Taiwan stocks and Korean stocks have the lowest "non-fundamental premiums."
Fourth, US stock vulnerability may come from challenges to economic cycles and AI narratives; non-US vulnerability may come from global US dollar liquidity withdrawal; their common vulnerability may come from TACO trade reversals. If risk appetite driven by capital and sentiment retreats in the future and global stock markets stage a "contraction" drama, markets with high "non-fundamental premiums" may be more sensitive than US stocks.
**Risk Warnings**
Public market funding data has certain lag effects and may not reflect the latest market dynamics timely; global AI commercialization may accelerate again; Trump policy uncertainty may increase, causing backlash from "TACO" trading.
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