Category: Fed, Central Bank and Banking Macro Liquidity

I have tried in these reports for the last twenty years to identify the most important forces driving the stock market. To some extent, I’ve been successful at that, although sometimes a bit early, or a bit late, in recognizing just what the hell is going on. I just hope that my analysis has helped you along the way.

But there are many forces to which people like me, operating on the outside of the system, are not privy. And there are forces at work that no one can see or understand.

Stock market analysis requires many disciplines. Unlike, physics, for example, it’s not rocket science. Hell, it’s not even science. But while physicists and astrophysicists understand more and more about how the universe works, there is much more that they don’t understand. For every theory that they confirm, more questions arise.

They say that approximately 80% of the mass of the universe is “dark matter.” They don’t know what it is. And there’s “dark energy,” that they don’t understand either. They see their effect, but they can’t see the cause, and don’t know what either of them is. So they observe and measure the effects, and make predictions and develop theories based on that.

Liquidity analysis isn’t science, but like physics, when we observe things, we find plenty of dark matter and dark energy. They move things. I don’t know what those dark forces are, but you and I can see their effects in the markets. We can measure those effects, and make predictions from observing them. We call that study, “Technical Analysis.” It’s the other facet of my research.

When darkness engulfs the forces driving the effects, then we all must pay particular attention to the patterns of those effects and learn what we can from them, that is, the technical analysis. Liquidity analysis provides, to the extent of the forces that we can see and measure, the context.

The Composite Liquidity Indicator is a hybrid of fundamental liquidity analysis and technical analysis. When I last reported on it about two months ago, I was forced to conclude, much to my surprise, that the stock market was oversold.

In other reports, I have shown my analysis and conclusion that when the 10 year yield rose above 1%, the Primary Dealers would be in trouble, leading to the potential for a crash.

Those two conclusions aren’t mutually exclusive. It’s a matter of timing. Markets only turn on a dime at bottoms. Tops take time, a lot of time. They can last a year or two.

The current situation reminds me of 1987, however. Then, the bond market began to crash in May. Stocks crashed in October. Will there be a similar 5 month lead time now? Doubtful. It’s a different ballgame today with the Fed aggressively supporting the market week in and week out, and vowing to do whatever it takes to keep the bubble from bursting.

In addition, we know that the dealers and other leveraged players are hedged. Apparently, those hedges are working well enough for now. They’re also getting a boost from individual stock traders.

So is my analysis and conclusion about the likelihood of a stock market crash following on the collapse of bond prices since August just flat out wrong? Or is it merely a matter of time?

I think the latter, but the financial system has far more moving parts than even the biggest institutions can track and understand thoroughly. Furthermore, there’s always something new that we hadn’t thought of before.

You have probably seen the reports about how a community of traders on Reddit is gaming the short side, madly buying call options on stocks that are heavily shorted. This forces options market makers who are writing and selling the calls to them to hedge by buying the underlying. These actions have resulted in ferocious short squeezes.

We all know that story with TSLA. But the poster child lately has been GameStop (GME), a struggling retailer whose stock was $4.00 a share, six months ago.

(Sorry about the busy-ness of this chart. These are what I use for my own trading and for stock picks in the technical trader. They are much larger in my charting program, so the detail is clear).

So the game now is to simply buy stocks of heavily shorted, troubled companies. The worse the fundamentals, the more bullish it is.

Alas this isn’t new. There are whale speculators who have made lucrative careers of just engineering short squeezes. The difference now is that the public is in on the game.

So not only are we dealing with dark matter, we’re dealing with a parallel universe that operates in reverse of what we consider normal.

To sum up, I made the huge call that the stock market would follow the bond market in crashing, because Primary Dealers were overloaded with long inventory and overleveraged in financing it. I set a line in the sand of 1% on the 10 year. Last month, they crossed that. Stocks are still going up.

Here’s what the components of the Composite Liquidity Indicator show us about that, from the perspective of the space-time continuum, dark energy, black holes, Black Scholes, Einstein’s Theory of General Relativity, Maslow’s Hierarchy of Needs, and, of course, Hobbes’s, “It’s solitary, poor, nasty and brutish to be short this market.”

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Both bonds and stocks have weakened over the past 2 weeks. It’s a sign that the Fed isn’t supplying enough QE.

We’ve known for a long time that it wasn’t enough to support twin bull moves in both asset classes. Have we reached the tipping point where it’s insufficient for either to move higher while the other descends?

The answer, my friends, is blowing in the wind—the wind of margin calls now blowing through dealer balance sheets as leveraged fixed income positions continue losing value.

Meanwhile the $2.9 trillion Biden stimulus proposal may boost the US economy, but it will be a disaster for the increasingly fragile stock and bond markets. Here’s why, and what you should do about it.

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Back in September I wrote to you about why I was giving up on the banking system indicators. I’ve reposted that rant in an addendum to this report. Essentially it boils down to this. Every time there’s a critical problem in the banking system due to banker malfeasance, the Fed steps in to paper it over and reward the criminals.

That’s why we focus on the Fed more than anything else.

The banking indicators were useful once upon a time. The Fed has rendered them irrelevant. But I promised to keep an eye on them, so herein is a review. It makes me sick and should make you sick too, but we’re not here to fight the Fed. We’re here to make money by understanding and playing according to the Fed’s rules. The Fed’s first order of business is always to protect its banker clients. And it does that very well indeed.

Once again trouble is brewing, and the Fed will need to come up big again to prevent it from blowing up the banking sector. If history is any guide, the Fed will be there. It may be to the detriment of those who don’t own capital, but they don’t matter. The Fed doesn’t care about them, and refuses to take responsibility for the intractable problems that has caused our society.

Consequently, being a bear for the right reasons does not pay. To make money in these markets you must play on the side of the criminals that run the show, the Fed and its client banks.

These banking indicators help us to understand just what they’re doing, and where the landmines might be that one day could blow this whole game to smithereens.

This brings us to a recurring theme. The first sign of potential systemic blowup would be an upside breakout in the 10 year Treasury yield. It would mean that the Fed had lost control, and that the system was careening toward an abyss from which there might be no Fed response big enough to escape.

We’ll take a look at that, but also some other problems in the banking system balance sheet that the banks and the Fed are pretending don’t exist. Well, they exist and they’re bubbling up just below the surface, to burst forth one of these days in the not too distant future.

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The Fed’s policy remains stable at about $170 billion per month in QE, give or take a few billion depending on the level of MBS replacements. The balance sheet is growing on trend.  The stock market is tracking with it, as usual.

This will lead to a huge problem when the economy begins to react to enlarged stimulus.

This report discusses how to position trading strategy to take advantage.

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Yesterday we looked at the overview of the CLI and the issue of new and secondary stock offerings. The CLI is still bullish. And the supply of new stock issues has not been sufficient to absorb enough of the demand to stop the advance of stock prices, although it has probably contributed to slowing the rise. Likewise, new corporate debt issuance, while massive, hasn’t been sufficient to pull enough of the demand for securities to cause a reversal of the rise in stock prices.

In this Part 2 of the report, I cover the remaining interesting and important indicators that comprise the CLI. Each has its own story to tell, but they all lead to the same conclusion. Still bullish, and, unbelievably, one key component says that the stock market is oversold.

I find it difficult to wrap my head around that. But I won’t argue with it. If there’s one thing I’ve learned in 53 years of watching markets virtually every day, it’s not to argue with impartial indicators. They don’t care what I think should happen. They just show what is happening.

So here we are. The Fed is creating enormous amounts of excess liquidity, “liquidity” being a fancy word for “money.” I use the words interchangeably.

The Fed is creating that excess by pumping money directly into the markets via its POMO operations—buying bonds from Primary Dealers and paying for them by crediting the dealers’ accounts at the Fed with newly imagined money. That leads to secondary effects of increasing money in the system via credit growth, particularly increasing margin credit that results from rising securities prices.

This works, and will continue to work, for as long as the players have enough confidence in the game to keep buying. This keep pushing prices higher, increasing the value of collateral. That, in turn, allows for and promotes ever more credit creation. It’s the quintessential nature of bubble finance. Circular, and more. Always more.

There are those who say that this isn’t sustainable. There are also those who say that an expanding universe isn’t sustainable, that it will collapse in on itself.

In a few trillion years.

I’m agnostic about whether this must finally end in collapse within the foreseeable future. I assume that it will, but I sure as hell don’t know when. So I’ll just operate in the here and now, and respect the trend. We’ll always be alert for signs of change, but at the same time, never forgetting Rules Number One and Number Two.

Don’t fight the Fed.

The trend is your friend.

Meanwhile, as Yogi said, you can observe a lot by watching. I’m confident that by always being vigilant, and open to anything, we’ll be ready just in time to take advantage of, or at least protect ourselves from, whatever is to come.

Now to the indicators.

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