Markets Need A Lot More than A Rate Cut
The comments below are an edited and abridged synopsis of an article by Daniel Lacalle
The recent market downturn suggests a combination of profit-taking, concerns about US jobs and manufacturing data, and an abrupt unwinding of the yen carry trade. With valuations having soared, investors are now demanding central bank easing. However, mere rate cuts may not be sufficient to push markets to new highs. Sustained growth in the money supply and further quantitative easing are necessary to support these elevated valuations.
Investors are shifting focus to utilities and real estate stocks, which traditionally benefit from low interest rates. Yet these sectors need more than rate cuts; they require a strong economy and robust consumer demand. Interest rate decisions alone may not be enough to stimulate growth in these areas.
In the long run, markets remain in a cyclical bullish phase, but the rise in volatility signals caution. Markets have been rising in anticipation of an increasing money supply and potential currency debasement. However, the next wave of central bank easing might not arrive until 2025.
Fundamentally, market earnings have been weaker than what elevated valuations demand. Yet investors recognize that rising government spending and debt will ultimately necessitate ultra-loose monetary policies. These policies make sovereign bonds more expensive, erode currency purchasing power, and, by comparison, render equities and riskier assets more appealing.
Investors are less worried about a potential recession than they are about the ongoing fiscal and monetary policies, which they perceive as inflationary and harmful to currency stability. As a result, they continue to accept higher valuations for equities and riskier assets as protection against real inflation.
Extreme monetary policies erode the currency’s purchasing power, making equities and riskier assets attractive as inflation hedges. Murray Rothbard’s True Money Supply (TMS) provides a clearer picture of inflation and liquidity in the market. TMS measures, which include US government deposits, foreign official institutions’ deposits, and demand deposits from foreign banks, offer a more accurate gauge of market liquidity than traditional M2 and M3 aggregates. This liquidity fuels demand for risky assets and drives bullish market sentiment.
Macro analyst Mike Shedlock highlights that TMS is a key indicator of market buying pressure. As liquidity increases, demand for risky assets rises, and markets grow bullish. Conversely, a decline in liquidity signals bearish market trends.
Keynesian economists often view deposits and savings as idle money, advocating for increased government spending as the only productive use of currency. However, these savings are crucial for investment and growth in the real economy. Inflationary policies, driven by government spending, transfer wealth from the middle class to the government by eroding wages and savings.
Market participants recognize that liquidity and sentiment are critical drivers of market trends. Bullish sentiment stems from rising TMS, while bearish sentiment arises from its decline. Despite the central bank’s hawkish rhetoric, its policies remain looser than they appear. Investors anticipate future liquidity injections to offset fiscal imbalances and support higher valuations for risky assets.
As central banks grapple with persistent inflation and bond portfolio losses, the timing of the next market correction and subsequent rally becomes critical. Investors must stay alert to shifts in liquidity and central bank policies to position themselves for the next wave of growth.
