Morning Comment: How Far Can Liquidity Take Us?

  • New uncertainties have developed in the market place.
  • However, the last round of “uncertainty” didn’t cause any problems, so complacency is high.
  • This rally is liquidity fueled, not fundamentally fueled (just ask Drunkenmiller & Tepper).
  • The Fed knows they’re creating dislocations (just ask Rosengren & Kaplan).
  • When the liquidity eventually stops, the markets will decline.
  • Therefore, have a plan in place in advance to deal with this eventuality.

The impeachment process and (especially) the deadly virus in China have introduced some uncertainty into the markets this week. Given that the U.S. stock market has become quite overbought (see charts below), it is no surprise that this news has the markets trading lower around the globe today. The declines in Asia are more dramatic than the ones in Europe…or for the domestic futures, but none of them would come close to what anybody would call a scary decline.

One of the reasons the declines are quite muted is because the last time some new “uncertainty” was introduced into the market place…when the U.S. killed Soleimani & Iran responded with some attacks of their own…the stock market did not fall much at all. The S&P 500 index did not even fall 1% on a closing basis on those developments, so we guess it should not be a big surprise that this morning’s reaction is not an outsized one either.

Needless to say, if the virus in China…which we now know is being spread person to person…becomes a much bigger problem, it should have a more important impact on the global markets. For now, however, market participants are very complacent about any possible negative reaction the markets might have to this new-news……Who can blame them, the Fed seems to have the markets’ back and people like Stanley Drunkenmiller and David Tepper are saying that today’s momentum is powerful and should take markets higher.

The problem is that this incredibly strong rally for the stock market is not being fuel by an incredibly strong improvement in the fundamentals. We found it quite interesting that the both Mr. Drunkenmiller and Mr. Tepper focused on the markets “momentum”…and not improving fundamentals…in their reasons for being so bullish. These two legendary money managers have the confidence (and the record) to believe they can get out before the music stops. That’s great for them, but what about other institutional investors? Many of them cannot go short…and many can only raise the cash levels in their portfolios to a limited level. This will make things dicey when the situation turns (like it ALWAYS does…eventually).

Our point is that outsized rallies that are based on liquidity and momentum…and that begin when the market was already near all-time highs…do not end well. Sure, the liquidity-based rallies that we’ve seen over the last decade have been fine. However, they all began when the stock market was down in a significant way and had become washed-out and undervalued. This time around, the Fed’s QE program was initiated (in the fall) when the stock market was strong and overvalued. In other words, we’re at risk of creating what was created in the second half of the 1990s…when the liquidity programs that prevented Y2K from becoming a disaster…created the tech bubble.

With this in mind, we believe investors need to have a plan in place…in advance…so that they are prepared for when the stock market starts to reprice itself so that it can get back in line with its fundamentals. That might not happen for a long time, but there’s no reason to wait before putting a plan in place.

We also have to point out that the liquidity could dry-up sooner than many people believe. The Fed knows they’re creating dislocations in the market place. (Just listen to what regional Fed Presidents Rosengren and Kaplan said last week.) If they do not want to create another bubble, they’re going to have to figure out a way to stabilize the repo market with another tool besides their “not QE” QE program. When that happens (which will be an act of tightening), the same thing that happened to the stock market that took place the last time they tightened.

Therefore, whether the liquidity is pulled a short-time from now…or a long time from now…it will be critical for investors to have a plan in place in advance. It will be a very, very, very difficult time to navigate within the markets whenever this takes place…but it will be much, much more difficult for those who haven no plan in place.

Matthew J. Maley

Managing Director

Chief Market Strategist

Miller Tabak + Co., LLC

Founder, The Maley Report

275 Grove St. Suite 2-400

Newton, MA 02466


Although the information contained in this report (not including disclosures contained herein) has been obtained from sources we believe to be reliable, the accuracy and completeness of such information and the opinions expressed herein cannot be guaranteed. This report is for informational purposes only and under no circumstances is it to be construed as an offer to sell, or a solicitation to buy, any security. Any recommendation contained in this report may not be appropriate for all investors. Trading options is not suitable for all investors and may involve risk of loss. Additional information is available upon request or by contacting us at Miller Tabak + Co., LLC, 200 Park Ave. Suite 1700, New York, NY 10166.

Posted to The Maley Report on Jan 21, 2020 — 8:01 AM
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