#1040 - What’s Driving the Record Stock Rally? with Michael Howell

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0:59What's behind Stocks Record Rally? Hi, everyone. Welcome to the Real Vision Daily Brief. thing. I'm Maggie Lake. With me today is Michael Howell, CEO of Cross Border Capital. Hi, Michael. It's great to have you back with us. Hi, Maggie. Always a pleasure to be here. So we are looking at another record for the Nasdaq, S &P 500 up, gold up, crypto up. I mean, we've been seeing this sort of trend the last couple of weeks now, but certainly the last week has really been a record run. And everyone, of course, wondering, can it last? What is your work on liquidity suggesting? Well, the suggestion is that it is going to last.

1:36The sort of rule is watch the money. Money is flying back into the markets. And that's the fact. Our latest global liquidity tape, which looks at weekly data, came in at$173 trillion, which is a new record high. So that's on the weekly data. It's powering on up. I think it's going to keep rising probably until well into 2025. And then we've probably got a down cycle beginning. That will be well after the election. I think from now until the election, all pointers are suggesting that liquidity is going to grow. And I think it comes from a whole host of directions. Yeah, which I want to talk about.

2:17But let's just take a step back, because for those who are not familiar with your work, I mean, you've been trying, it's very popular now, but you've been tracking this for years. You're really one of the experts in global liquidity. But So what do we mean by that? Where is this liquidity coming from for those who are maybe not as familiar with this? Okay, well, let me step back and explain what it is. Global liquidity is a measure that we look at. It basically represents the flow of money through world financial markets. So that should be a good pointer to risk asset prices worldwide, and lo and behold, it is.

2:52It tends to lead risk asset markets by varying lengths, probably between, on average, three to six months. That's a pretty decent time frame. Global liquidity was a concept that we first pioneered way back in the late 1980s when I worked at Salomon Brothers. Salomon Brothers, as many people will probably remember, was the world's biggest bond trader and forex dealer. Actually, it was the markets in many cases. And to understand how bond markets were moving and forex markets were shifting, you had to understand capital flows and global liquidity. And that's why we began to research that and just track what these aggregates are doing.

3:31Global liquidity has boomed in the last 20, 25 years. It's now an aggregate of$173 trillion, which puts it about one and a half times world GDP. It continues to power higher. It leads economies. is, it's the important thing for investors to watch. But it's not money supply. Money supply is a somewhat archaic concept that really refers to money in high street banks and deposit accounts of retail investors or the retail segment. Global liquidity is much more about wholesale money flows going through world financial markets. And that's the key. It drives on markets, it drives stock markets, it drives forex markets, it drives gold, it drives Bitcoin.

4:15These are the factors that are really important to watch. Yeah, which is why the work you do at Cross Border Capital is so incredible because it is so critical. And as I said before, people are sort of, I think, understanding this more partly because of the work you do and tracking it more. But it is really critical. And Michael, the other thing that's kind of hard for folks to wrap their head around is this is not really controlled by anyone, isn't it? It's often called the sort of shadow money, I don't know what you call it, shadow money system or offshore money system. It's not like somebody pulls a lever and makes a decision about this, do they?

4:48Well, that's true. I mean, there are certain entities that have a lot of sway. The Federal Reserve is clearly critical. The People's Bank of China is important as well. Those are the two key central banks worldwide which really control or try and control the system. But the private sector also gets involved. I think one's got to understand some of the flows and the flowbacks into the system, which really drive global liquidity. One of those is the temper of the world economy. Now, if the world economy is hot, it's actually a bad thing for global liquidity because money will be sucked out of financial markets to fuel a rising real economy.

5:26So if you have faster inflation, higher oil prices, strong GDP growth, those are actually negative factors for global liquidity. And that will likely coincide with weak financial markets. OK, so actually what we want is a sluggish economy that central bankers are trying to stimulate. That's the ideal situation. And if you look at where we are now, I would say we pretty much got that. We've got a situation where the world economy is kind of flatlining. It's, you know, it's it's basically well off its peak. It's not going into recession, but it's really stumbling along. You look at all the economic data, it's zigzagging all over the place.

6:05We're not too sure whether it's a boom or a bust or whatever, but it seems to be sort of, you know, tracking sideways. And policymakers want to ease. And you look just around the world at what policymakers are basically saying. You've had, I would argue, half-hearted attempts to control their currencies by China and by Japan, given the weakness there. I mean, given what the yen has done, I mean, ones are more and more baffled why the Japanese don't stamp on the brake hard. They're clearly sanctioning this sell-off in the yen, as far as I can see. If you look at what the ECB is saying in Europe, they're saying, well, look, hey, guys, we're going to cut rates probably as early as June.

6:42So they're actually giving you forward guidance that this is coming. The British finance minister actually cautioned the Bank of England about a week ago to say, please don't cut interest rates too quickly. That's an astonishing statement from a finance minister who's having an election in probably six months. So it's kind of curious. And then you've got the Federal Reserve, which keep telling us time and time again, we're at peak rates. So, you know, what we're looking at is a situation where liquidity is likely to expand. Now, what I haven't gone into as well are other factors. You can throw in there Janet Yellen, what Janet's doing at the Treasury.

7:19I mean, everything that as far as I can see is going on here is there's deliberate duration management somewhere between the Fed and the Treasury to make sure the supply of coupon debt into the markets is not too onerous. There's a reliance increasingly on bill finance. The banks or, in general, the credit providers like bills and short-dated debt, in other words, two-year, five-year debt, they tend to hoover that stuff up. But that is pure monetization. And that's another way of fueling liquidity. So what you've got here is a lot of the pointers are all pointing towards higher liquidity. What I haven't mentioned as well is a key factor in terms of expanding liquidity is the collateral base.

8:05After the GFC crisis in 2008, more and more, in fact, the bulk, the vast majority of lending now is collateralized in some way. Now, what's critical in a collateralized market is the size of the haircut that the credit providers would demand. And that haircut on the collateral, in other words, how much they reduce the value of collateral that's posted, will depend on the volatility, particularly of the bond markets. So if something like the move index starts to rocket up, in other words, volatility bonds is high, that haircut will grow and the value of collateral will diminish, the effective value will diminish, and global liquidity will be hit negatively.

8:45What you've actually had in the last 12 months is a collapse virtually in the move index. So the move index, if you go back to the SVB crisis back in March of last year, what you saw in March 2023 was basically a move somewhere near 200 on the move index. It's currently down at the 90s. So you've had halving over that period. So that reduction in bond volatility has been a huge fillet for global liquidity. So all these factors are coming together. The Fed is not doing QT in the way that it's been saying. It's been inching liquidity into the system. They've even pared down, they've tapered, in other words, their QT program as of a week or so ago.

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10:43So it's so interesting. You said something that I think that is always worth underscoring as people try to figure this stuff out. Let's call it the financial economy. The financial economy and the real economy always at odds? Because you were just talking about when the real economy is doing well, then it's not great for liquidity and it tends to be difficult for financial markets. are they always at opposite? Are they opposite forces working on each other? Because most people, if you don't hold assets, you kind of think, oh, unemployment's low, the economy's growing, things must be good. Yeah, I mean, broadly, you're correct.

11:20You know, all money that is anywhere must be somewhere. And if it's not in the financial markets, it's in the real economy and vice versa. So strong economies do not have strong financial markets. Now, equally, one would say that if you've got a recession, that's not necessarily great news for risk assets, because investor sentiment gets hit negatively. But what you'd really want is a situation where the economy is like stumbling along, rather like now, but policymakers basically want to try and stimulate it. They want to get growth higher, for a variety of reasons. One being elections, which are upcoming.

11:55Clearly, the administration in the US would want a stronger economy going into November. And I would imagine that Janet also has that agenda in front of us saying that we want to probably spend a bit more money to try and get the economy enlivened for the November election date. So all these things are really feeding into more liquidity coming into markets. Now, on the basis that the real economy will take some time to respond to liquidity injection, liquidity injections first have to travel through financial markets, and then they spill over into the real economy. Now, I think one of the things to remember or try and think about is the nature of the economic system has changed as well.

12:36But one of the things that I keep banging on about is that we're no longer in a world where capital markets are there to raise capital or raise new capital, where interest rates are the dominant factor. So if you've got an economy driven by a traditional investment cycle, interest rates are the key thing to watch, because that's the cost of capital. That rations your capital spending. And if the Federal Reserve hikes interest rates, then the economy cools down. But we're not in that world anymore because we're in a world of debt refinancing. Capital markets today are really a giant debt refinancing mechanism.

13:11And it's not interest rates are the critical thing. It's the capacity of the system to actually roll over debt. The point about debt and our massive debt burden is that it has to be refinanced periodically. And something like$70 trillion of debt has to be rolled each year, of which you need balance sheet capacity, which is what we define broadly as liquidity. And therefore, liquidity is the dominant factor. If you push liquidity into a financial system, it is fungible. In other words, it will spill over. It spills over into higher asset prices. You get wealth effects. You get more consumer spending.

13:46And that's what drives the economy. And the US economy, like the European economy, is now much more service-orientated. They're not based on manufacturing investment cycles or inventory cycles. It's really about the consumer and about the service economy. And that's why financial markets increasingly are driving real economies, no longer vice versa. And I think that there was a lot of statements. Rick Reader at BlackRock has recently said, one of the things the Federal Reserve ought to think about is actually cutting interest rates right now because it would actually alleviate inflation. Now, that seems a topsy-turvy thought, but actually we're in a topsy-turvy world.

14:24In a debt refinancing system, that is the sort of thing that makes absolute sense. Yeah, because you're basically paying bondholders, right? You're paying the wealthy to sit on their money. Exactly. Yeah. Adam has a question since we're talking about the balance sheet. Mike, can you explain how government funding by bills adds to the liquidity in a way that funding with bonds doesn't? Yeah, well, in actual fact, to draw the distinction, it's not necessarily the bill or the bond split that's the important thing. It's who buys the government debt. So if it's a credit provider that buys the debt, that is a monetization.

15:06So if you think about the credit provider's balance sheet, what will happen is that, for example, the government writes a check for its spending. the deposit side of a bank's balance sheet will expand and they need to essentially match that with another asset of which if they buy government debt that matches the asset okay but they've got the increased deposit and therefore the balance sheet expands which is a monetization so that's that's basically what a how a bank functions and how you get monetization of government of government spending now banks tend to like and this is the key point shorter dated coupons so they're not going to buy a long-dated US government bond.

15:45They're going to buy something like a two-year bond, maybe a three-year bond, or a bill. They love bills. And therefore, if the government is issuing, the Treasury is issuing this tenor of paper, then it's much more likely the banks are going to be buying it. So when we're talking about liquidity flowing in, does it naturally flow, does it flow to all financial assets, or does it tend to really support the riskier assets out there? Well, it's rather like sort of throwing a pebble in the middle of a pond and what you get are ripple effects and those ripples expand outwards and you see certain assets performing early on.

16:24Now, what traditionally used to happen was it was the forex markets and then the fixed income markets that would really feel the first impact of a liquidity increase. And then it would tend to spill out into equities and then commodity markets. One of the things that you've seen in the last five years with the advent of crypto, and particularly Bitcoin, is that Bitcoin is a very early feeder on that liquidity increase. Why? I'm not too sure. It's hard to explain, but the facts are in front of us, and that's how it works. So if you look at global liquidity, it tends to be a very important driver of Bitcoin prices.

17:02That's so interesting. It's very eloquently exposed as well. Yeah, that's right. And it is so interesting because it's so new. You know, it'll be interesting to see as history develops what is exactly driving that. But we certainly have seen, we know we saw that bottom and we know crypto has been moving up. So it is rather undeniable. What do you think of the fact that we're back to sort of meme stocks? And do you think that is a sign also of liquidity? What do you make of that? Some people get worried about it as a sign of excess. Well, I think that there's a, yeah, I think it's a sign of more liquidity in the system.

17:42And I think it's really a combination of the fact that if you get, if you throw liquidity at the system, what you're going to get is longer duration instruments like growth stocks or technology stocks performing first. They're the things that really get a big kicker initially. Value stocks may take time, some time to get going. But it's really these growth stocks or tech stocks that really fill the first wind of liquidity in the system. Now, the other thing about those types of stocks, as we know, is that they're in the indexes. There's a lot of index investing going on. But the free float of those companies, as it happens, tends to be relatively small.

18:19So if investors are chasing those MAG7 stocks or whatever it may be, what you find is that price tends to rise disproportionately for every dollar that's put in. And therefore, if you've got a flow of money coming into the market, that's going into the indexes. They tend to be big, big performers. They have a high beater to the market. Yeah, great point. And for those of you who caught the conversation with Jim last Thursday, he was also talking about some of these structural flows and the fact that you can get the kind of moves, Michael said, even in other parts of the market, too. And so, you know, you have the potential to get these really powerful short squeezes that catch some people off guard.

18:58So you really need to kind of watch out for that. If we see this happening, Michael, with global liquidity, you said it was interesting. It used to go forex bonds. Now it seems to have flipped and it tends to hit crypto and maybe stocks, especially long duration stocks first. How do bonds perform in that kind of rising liquidity environment? Well, what you would expect to see is the yield curve begins to steepen. OK, that's really a key. And the way to judge what's happening with bond markets is think about the term premium, which is a wonkish concept. But the term premium is really the compensation that investors require for holding interest or risk over the duration of the bond or the maturity of the bond, the span of the bond.

19:42Now, if you've got a situation where there's lots of liquidity in the system, systemic risk will be low. And therefore, investors can take more risk. because they don't want to hold safe asset bonds. And therefore, the term premium tends to rise on a bond because basically people just don't want bonds. So in other words, the price of the bond will come down, the yield will go up, and the term premium will fatten out. If you've got a situation where there's a very tight liquidity, there is more systemic risk in the system. Investors will shift back to safe assets. They'll therefore demand government bonds.

20:19The price of bonds will go up. the yields will come down and the term premium will be compressed. Now, if you look at the yield curve, the yield curve, for example, between the 10-year and the 2-year is dominated by term premium. So that spread is not entirely, but it's a very large part explained by term premium. So if you get liquidity going into the system, extra liquidity, that term premium will widen out, the yield curve will steepen, and that's pretty much what we'd expect to see. And what you're beginning to see now is some evidence that term premium are fattening. In other words, they're a lot less negative than they were if people follow term premium.

20:59They're likely to go positive and probably a long way positive. And the other factor that's driving term premium is what's happening in terms of coupon issuance. There's a lot of issuance coming. We're talking about$2 trillion budget deficits to fund way into the foreseeable future. And it's getting worse, not better. Ralph also asks, are there any other markets that are bearish from a liquidity perspective? So I asked you specifically about bonds. Are there other markets that people need to be aware of that tend to underperform and that you might want to stay away from if you're in a rising liquidity situation?

21:33Well, I suppose the answer would be cash as well. I mean, cash is not necessarily going to be a great performer if liquidity is rising. But I think you've got to look at how liquidity moves and think again of this sort of ripple effect of a apple going in the middle of a pond and the ripples coming out. So if you think about this, we think of it in terms of phases. So the first phase in our liquidity cycle is something called rebound. In that rebound phase, what you want are equities and you want credits. And within industry groups, our choice is dominated by tech. So that tends to be what's really driving the market in that first phase of rebound.

22:11Then you move rather like the seasons to the next one, which is calm. And in calm, what you tend to see is equities again perform. Commodities tend to displace credits as the next choice on the list. Throughout that period, bonds are out or longer duration bonds are out. And in terms of industry groups, what you'd expect is tech keeps running. financials, particularly big financials like banks, take up some of the move as well. And energy stocks and commodities, commodity stocks tend to move as well. And I would argue that that particular configuration is what we're really seeing now. You've seen commodities starting to run quite nicely now.

22:55I mean, copper is clearly up a lot, but that may be special factors. But then you've got a lot of industrial metals, even platinum is starting to move, silver's jumping. All these are traditional signs that the cycle is beginning to move higher. And then if you look at the industry groups, financials, big financials are moving. Look how much JP Morgan's share price has jumped in the last few months. Another indication, the big energy stock should be moving. And these are all signs of a normal cycle. And one of the things we keep banging the table about is that, look, hey, this is a very normal cycle.

23:28There's nothing unusual about it. The only unusual part is probably the distortions that are affecting the bond market because of what Janet and maybe Jay Powell are doing in terms of manipulating or distorting the bond markets. We're going to take another quick break to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

23:53Yeah, it's funny you mentioned JP Morgan because that is right. Although today, Of course, it took a hit from some comments the CEO, Jamie Dimon, made indicating he may not stay for five years. Inevitable because he's been such a large presence in banking in general, no less J.P. Morgan, that any conversation about his potential departure would create a lot of stress among shareholders. So, you know, there's still news headlines once in a while that move things even for the day. So talk to us a little bit about, we have a question. We have a couple of questions about people dumping treasuries, which is really interesting.

24:31Two separate ones. Peter talking about, I saw a post on X yesterday about China dumping$53 billion of US bonds. Is this something that would be increasing global liquidity? We have also got one from Russ about Japan. Let's tackle China first. First of all, does that seem, you know, let's be careful when we read things on X, formally Twitter. But does that seem like something that would be happening? Are you seeing anything like that? And how would that impact liquidity? Yeah, well, look, I mean, it looks as if China is selling down treasuries. That's for sure. I mean, it's very difficult because the data is not wholly transparent.