The gradual flattening of the CLI is now visible. Starting in June, it should turn negative. The Fed will begin literally removing cash from the banking system and the markets in June, when it starts shrinking its balance sheet. That will have ripple effects in at least 3, if not all 4, or the components of the CLI.
In the meantime, however, stock prices have gotten ahead of the curve. They are now oversold versus the historical norms of the liquidity band over the past 13 years. Does it matter? Or is this a new paradigm?
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No question it’s a new paradigm. The Fed has ended, for the foreseeable future, its previous 12 year campaign of aggressively adding money to the financial markets in its program of inflating asset prices.
It had a trial run of this policy once before from October 2017 to December 2018, but stocks were bubbling then and the ECB and BoJ were still printing massively. That help from the rest of the world kept US markets liquified, resulting in a series of overbought readings that lasted 22 months.
The market cracked a bit in the middle of that tightening experiment, and finally fell apart when Covid 19 came around. The Fed then panicked and opened the QE floodgates. Now, we’re reaping the whirlwind from that.
As the Fed persists in tightening, in its fight against CPI inflation, my thought is that if the market can stay overbought versus liquidity for most of 22 months, it can stay oversold against it for just as long. However, with the oversold condition comes the likelihood of vicious vertical spike rallies along the way, as overconfident short sellers load up on their positions.
When they do, and the market starts to rally, they’ll spontaneously combust, driving inexplicably big advances in stock prices. Wall Street will come up with all kinds of recovery narratives to justify those rallies, but they will merely be, as Joe Granville called them, of the genre, “The Rally that Fools the Majority.” I’d make that plural, because of the probability that there will be more than one of those before this bear market is finished.
This report lays out in graphs and clear analysis, just what you should expect in the weeks and month ahead, along with how I’m approaching both the short term tactical aspects, and the longer term strategic approach for both stocks and bonds.
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