Why is the stock market ripping?
Last week, we joined Real Vision’s Raoul Pal and Maggie Lake to discuss Liquidity, Debt Monetization, Recession Risk, and MUCH more.
In case you missed it, here are seven highlights from what many are calling “the best Real Vision Daily Briefing yet”:
Liquidity Drives Asset Markets
Although we believe the stock market will continue to squeeze bears well into the fall, poor liquidity conditions will likely drag asset markets down this summer.
Additionally, we are not sure we’ve seen this market cycle’s ultimate lows because we did not price in a recession last year. What we priced in, in our opinion, was a change in the Liquidity Cycle.
The markets will eventually need to price in the credit cycle downturn associated with the liquidity drain we’ve experienced in 2021 – 2022. We expect that to start in Q4 2023 – Q1 2024.
Understanding and Monitoring Liquidity
Changes in liquidity, driven by factors like central bank policy and the activities of commercial banks, can significantly impact asset markets.
We have tested this extensively: our proxy for liquidity has a 97% correlation with the S&P 500 since 2009 and an 89% correlation with #Bitcoin since inception.
Over the short and medium term, we expect liquidity to fall with the return of Uncle Sam to the international capital markets.
We do not believe we have reached a durable positive inflection in the liquidity cycle yet. Liquidity bottomed in October, but we haven’t met those conditions yet in terms of getting an unimpeded rise in liquidity.
Central Banks and the Concept of Debt Monetization
Debt monetization is when a government issues bonds and the central bank purchases them, thus increasing the money supply. This mechanism can prevent the public sector from crowding out the private sector.
“Crowding out” happens when the government borrows so much that it drives up interest rates, making borrowing more expensive for businesses and individuals.
We believe the central banks are currently playing a Debt Monetization game. However, we do not believe central banks are purposely causing economic deterioration to monetize public sector interest payments. Instead, we believe they are responding as crises occur.
The Liquidity Cycle
Our research shows there’s a three and 1/2-year cycle in global liquidity, with approximately 2 ½ years from trough to peak.
Assuming the most recent trough occurred last fall, we expect the cycle’s peak to occur sometime in the first half of 2025.
Similar to Raoul, we’re bullish in terms of the destination. We just differ on the path to get there and believe there will be pain in asset markets along the way.
The Drivers of the Global Liquidity Cycle
To forecast global liquidity, we analyze the YoY change of a group of proven leading indicators, including equity market performance, real 10-year yield, real effective US dollar exchange rate, OECD composite leading indicator, core CPI, and the unemployment rate.
All of those factors combined imply that:
- Short Term: no liquidity
- Medium Term: falling liquidity
- Long Term: potential for rising liquidity
Although we expect the liquidity environment to be positive in 2024, we expect there will be a period of 2022-style liquidity conditions along the way.
Recession Expectations
We believe the recession will commence in Q4 2023 or Q1 2024 and will overwhelm whatever favorable liquidity conditions are present at the time.
When the economy goes into recession, and people start losing jobs, risk assets decline (the median S&P decline in a recession is -24%).
Even if liquidity is increasing, there can still be corrections. And we expect that will happen at some point over the next year. The maximum drawdowns of the S&P 500 and Bitcoin during the Liquidity Cycle upturns experienced since 2009 are -34% and -74%, respectively.
When will this rally end?
We still believe most investors have the recession playbook on too early.
The economy will likely stay resilient until sometime around Q4 2023 – Q1 2024. History shows that the stock market is NOT forward-looking heading into recession – largely because it is busy squeezing bears. Rather, it tends to peak on a coincident basis with the peak of the Employment Cycle.
That’s a wrap!
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Macro Market Outlook: Pivot Soon?
We joined Paul Barron last week to discuss inflation, the jobs market, crypto outlook, and much more.
In case you missed it, here are 7 takeaways that will SIGNIFICANTLY help your portfolio over the next 6 months:
1) Although inflation is moving in the right direction, we still have some work to do.
Given the stock market’s (relatively) high current valuation and the bond market pricing in a quick Fed pivot, the inflation numbers we are currently at are scary.
2) “The Fed has been explicit about waiting to see slack emerge in the labor market.”
Two significant labor metrics, Job Openings / Unemployed Workers & the Employment Cost index are 2x their pre-covid levels.
The Fed won’t pivot to rate cuts & QE until they see change.
3) The Fed doesn’t have enough data yet to determine the damage we will see in regional bank lending.
Pausing is how they can buy themselves time & assess those effects.
Given its change in guidance at the May FOMC, we believe the Fed has already implemented the pause pivot.
4) “Inflation tends to peak at or in recessions. It’s a very late cycle indicator, like the labor market itself.”
We’re currently experiencing an unusual inflation cycle – a lot of inflation was pandemic and fiscal stimulus-related.
Pandemic and fiscal stimulus-related inflation aside, we still have structural ~4% core inflation.
We’re going to need a recession to get that structural inflation back to where the Fed wants it to be.
5) What’s the outlook on Crypto?
Pre-halving years are extremely volatile for Bitcoin; there are usually several large drawdowns throughout the year
On top of that, global liquidity isn’t ubiquitously improving anymore (and it will likely worsen throughout Q3).
The liquidity narrative that propelled BTC from $16k to $30k made sense; liquidity was improving back then.
But, it’s not anymore.
Bitcoin needs more liquidity to go higher.
Realistically, that likely won’t happen until next year.
6)Will there be opportunities to find outperforming single stocks?
Absolutely.
When the yield curve is inverted, we’re typically in the late stages of the economic cycle.
When you’re in the late stages, you usually see good companies continue to grow, while other firms increasingly fall by the wayside.
It becomes a stock pickers market.
7) How long will the recession last?
The recession will most likely happen in Q4 or Q1 of next year.
But, there’s a lot of time before then; we can easily see a short squeeze at some point.
So, be patient.
Remember, these are the times when great wealth is made.
That’s a wrap!
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Have a great day!
Whose portfolios are at risk over the next six months? The bulls or the bears?
1) The Bond markets are pricing in significant Federal Reserve easing in the coming 12-18 months.
In addition, the Fed Funds futures show easing is likely to start as early as November of this year.
But, our view on liquidity and factors in the real economy show that market positioning should change over the medium term.
As a result, we expect to see an increase in bond market volatility over the next quarter or two before we get into a recession.
2) The US consumer has been resilient.
Real PCE, which measures the value of goods and services purchased by households in the US, adjusted for inflation, is growing at twice its pre-covid trend.
Real Income is also growing at a three-month annualized rate of 7.6%.
The uptick in real PCE and Income signals increased demand for goods and services. This increase in demand can lead to higher prices, causing inflation to persist.
So, a resilient US consumer means sticky inflation.
3) The recession is likely to be delayed relative to investor consensus.
Many investors have been calling for a recession for over a year.
On top of that, many analysts are predicting negative GDP growth in the second quarter of the year.
But, our research shows the economy is resilient and will likely stay resilient until at least Q4.
And this delay could trap both bulls and bears, leading to significant volatility in both the stock and bond markets.
4) The AI bubble will eventually meet the wrong part of the Liquidity cycle.
The rise of AI is similar to the internet boom in the early 2000s. We could see a similar blow-off top in late-2023.
And while emerging technologies bring about significant societal changes, they don’t prevent market downturns. Investors would be wise to sell into strength later this year.
5) Is the bad news priced in? Are markets forward-looking?
We’ve backtested asset markets extensively and found that markets only look 2-3 months ahead at most.
Despite what people think, markets are more reactive than predictive.
And they’re most reactive to changing liquidity conditions. Since 2009, equity markets have been highly correlated to global liquidity.
Liquidity drives markets, and we believe the recovery in liquidity might not be as linear as many investors believe.
6) We expect a negative liquidity backdrop over the next few months.
We’ve probably seen a medium-term high in liquidity.
The expected increase in the Treasury General Account and the return to net coupon issuance by the US Treasury are negative for liquidity.
As a result, the Dollar could trend higher in the near term, harming #Bitcoin and other risk assets.
That’s a wrap!
If you found this article helpful, go to https://42macro.com/macro-bundle to unlock actionable, hedge-fund caliber investment insights.
Have a great day
Rough Summer Ahead?
We joined Anthony Pompliano earlier this week to discuss the Debt Ceiling, Recession, Global Liquidity, and more.
Every investor will want to review the following six highlights from the interview:
1. We expect the Debt Limit Crisis to negatively impact global liquidity.
The US government will return to the international capital markets to borrow more money (after resolving the crisis).
When that happens, a material amount of liquidity will be removed from the system, driving asset prices down.
2. Understanding the Treasury General Account Balance
The Treasury General Account Balance, essentially the checking account of the US federal government, is a crucial component of global liquidity.
When this balance decreases, it signifies that the government is spending more, increasing liquidity in the economy.
The TGA has declined for the past few quarters, supporting global liquidity and risk assets.
We anticipate a significant increase in TGA in the coming months, which will drain liquidity from the private sector.
3. Inflation is running at 2-3 times the Federal Reserve’s price stability target.
Given current inflation rates, it doesn’t make sense for Secretary Yellen to support financial easing by flooding the market with T-bills.
Easing financial conditions would drive asset markets higher, only making inflation worse.
4. The Impact of the Inverted Yield Curve
An inverted yield curve occurs when short-term debt instruments (like T-bills) have a higher yield than long-term debt. It’s often seen as a predictor of an upcoming recession.
Because the Treasury needs to pay interest on issued debt, they are incentivized to lock in the lowest rates, which are currently notes maturing in the 3-10 year range.
This is another reason we believe Secretary Yellen is unlikely to flood the market with T-bills, supporting our view of lower asset prices in the quarters ahead.
5. Changes in Global Central Bank Policies
Global Central Banks also have massive implications for global liquidity and, therefore, asset markets.
We foresee another headwind for asset markets:
The two central banks responsible for the improvement in global liquidity the most over the past year, the People’s Bank of China (PBOC) and the Bank of Japan (BOJ), have been draining liquidity over the past quarter (on a trailing 3-month impulse basis).
The impulses take time to flow through financial markets, but we expect the actions of the PBOC and BOJ are likely to serve as a headwind for risk assets in short order.
6. Potential for a Rough Summer
We expect a shift in liquidity conditions from a very positive trailing six months to a more challenging period over the next two to four months.
The actions of the Fed, Treasury, and Foreign Central Banks over the next 1-2 quarters are not supportive of a positive liquidity environment.
Our advice to you is: if you are invested in risk assets, be careful.
That’s a wrap!
If you found this thread helpful:
1. Go to https://42macro.com/macro-bundle to unlock actionable, hedge-fund caliber investment insights
2. Have a great day!