Liquidity

It’s no secret that liquidity is the oil that keeps the market engine running smoothly. Corporate earnings should be (and in fact they are) the main driver of stock returns, but there are times where the amount of money available in the market is so vast, that the amount of goods and services is not enough to reach a balance, and the only adjustment mechanism is price. We’re looking at a liquidity driven market, where a combination of money creation (monetary stimuli by central banks through lower rates and money printing) and fiscal stimuli (deficits, debt and lower taxes) is the invisible hand pushing and pulling into new highs. In the chart below, you can see the M2 (money in circulation) proxied by banks deposits and Money Market Funds, since 2021. The only year the U.S. experienced restrictive policies, 2022, equity markets had a down year ( -18.11% fo S&P500 and -33.10% for Nasdaq100). For the other 4 years, both indices experienced positive double digit returns. The Trump administration understand this, and needs monetary stimuli, but Powell is concerned about inflation and the probability of a rate cut in 2 weeks is 5%. In other words, it won’t happen. Furthermore, they have announced QT, where they will let the Fed bond portfolio run off without replacement. If liquidity stops growing, it will be very difficult to keep the stock market party going.

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