My God, Mortimer, He’s Right! Look at it!
The Forecast That Broke
Ten days ago, I was stunned when the stock market did exactly the opposite of what I had forecast for July and August. Based on monstrous Treasury supply pressure that we knew was coming, I had expected a gathering crunch, not just for Treasuries, but also for contagion into other assets.
Not only did that not happen, stocks broke out, and even gold and precious metals started to recover. The Macroliquidity™ model, which I have tweaked and adjusted through the 26 years I have been publishing these reports, failed to foreshadow the stock market breakout. It correctly identified that the bond market would increasingly tighten. That part has played out, although so far somewhat more mildly than I thought. But the stock market breakout to new highs was a shock to the model.
I agonized over it. What did I miss! And then I had a flash of recognition. It was something I should have recognized, based on the teachings of finance guru, Professor Lawrence Berra. You can observe a lot by watching. I was watching. I was observing, but I did not see something that grew gradually and silently over four years. I was the frog on the sunny sidewalk, slowly succumbing to the increasing heat without realizing it. First, I slumbered, and then the model, or at least half of it, succumbed to the increasing pressure.
When Rule Number One Was Repealed
Back in earlier times, I adhered to Rule Number One. Don’t fight the Fed. But in 2022 the rebirth of the bull market in stocks showed us that Rule Number One had been repealed. The Fed was shrinking its balance sheet, removing money from the system. That had been bearish for a while. Short term money rates were rising in response. Stocks were falling, until October 2022. The Fed kept Quantitative Tightening but it no longer mattered.
The market found ways to finance itself through financial engineering. After the new processes were in force for some months, I recognized that repo financed Treasury and Treasury futures basis trade were contributing enough to the market that the markets had become self-financing. The Fed had become irrelevant.
I factored the basis trade/repo machine into the Macroliquidity™ model, and it served well. Money supply grew in lockstep with Treasury supply, as repo converted that ever-growing stream of perfect collateral into money that could be used to purchase more assets.
With stock buybacks, the supply of equities was relatively fixed. That increased the value of stock collateral, and more margin borrowing followed, on top of the Treasury market repo borrowing. Money growth surged. With fixed supply and growing liquidity, the trend turned persistently bullish. The markets were self-funding. The Fed’s game of make believe, that it had control over monetary forces, continued. But it was irrelevant. The Fed was sidelined.
That continued until September of last year. Then the basis trade subsided, and so did repo growth. The basis trade has been steadily reduced. Repo growth has stalled. The engine of liquidity that I recognized a few years back, had stopped running. But the onslaught of Treasury supply continued, and was growing. I expected a crunch.
It hasn’t happened. Something else was at work that I had missed.
When I finally recognized it, it was too late. The stock market had already moved.
Liquidity is about context. Technical analysis is about action, and the technical analysis had clearly foretold in a timely manner that stocks could, and likely would, break out. Higher projections were, and are, in the forecast. But I was leaning on the liquidity picture. I was unaware that the model was slowly boiling on the sidewalk. My forecast of impending doom, was, if not wrong, at least very early.
Yogi also told us that, “When you come to a fork in the road, take it.” We have seen the fork, and we have taken it. Given what is now clear in public data that has always been there but not recognized previously, the bearishness that I had previously settled on, must be tempered. The end doesn’t seem to be nigh. Yes, the Treasury market has big problems, and they will persist indefinitely.
But the game goes on. This previously unrecognized, massive flow of liquidity, also does not have a foreseeable end. As investors and traders we must suspend any disbelief that stocks will go higher. The deck is stacked, and the playing field is tilted in that direction.
What Doesn’t Matter, and What Does
Sky high valuations do not matter. Whether the bullish narrative is true or false does not matter. Whether AI will increase productivity (it won’t) does not matter. Whether the massive investment in AI will have a long-term economic benefit (it won’t) does not matter.
What matters is whether the narratives are believed by the majority. What matters is whether there’s sufficient liquidity flow to continue to drive the belief. Because liquidity is the mother of the narrative. And the narrative is the mother of liquidity. Which of these mothers comes first?
Does not matter.
What matters is that the flow of liquidity into the financial markets is growing enough to at least partially, if not substantially, offset the pressure of massive growth in already inconceivable levels of Treasury supply.
In fact, it is that burgeoning flow of supply that is the engine of liquidity growth. To see the evidence, and consider what lies ahead, subscribers, read on!
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