All the money that’s anywhere must be somewhere.
– Anonymous
“Stock Bulls Power S&P 500’s Historic Winning Run” headlined Bloomberg at month’s end. “Since the April meltdown, the S&P 500 has soared almost 40%, notching its longest monthly advance since 2021. The superlative is even better for the Nasdaq 100: a seven-month surge that turned out to be the longest winning run in eight years…” added the accompanying story. The shaft of the arrow of this rising market is indeed increasingly led by the point at its head representing all things AI as the growth part of “the 500” has returned 51% since the market low of April 8th, more than twice that of the values share of the index’s 23%. Adding an exclamation mark to this market, information technology’s 6.2% return in October contributed 2.2% of the index’s 2.3% return for the month.
The key to the “unlocking” of our understanding of the financial markets is the recognition that we are living through a time of extraordinarily high level of global debt with U.S. federal debt having grown ten-fold since the onset of the 21st century. 70% to 80% of all capital market transactions now relate to the refinancing of existing and issuance of new debt and 77% of that borrowing is collateralized by pre-existing, predominantly U.S. Treasury, debt. This has led to the paradox that this system needs liquidity for that refinancing while also requiring ever higher levels of debt to serve as collateral to support the ever-higher amounts of liquidity required. Imagine, if you will, a cat chasing its tail. When that collateral is plentiful, we experience asset “bubbles.” When it is insufficient it leads to financial crisis with the resulting consequence that the financial market “tail” is now “wagging” the economic “dog.”
Since its founding in 1913 the Federal Reserve has been the source of most of the financial market’s liquidity and since the Global Financial Crisis of 2008 Quantitative Easing (QE) has contributed significantly to that liquidity with those funds available for investment in the financial markets. That is now being supplanted by a new form of liquidity being provided by the U.S. Treasury; the issuance of treasury bills with maturities of one year or less as a significant means of raising the ever-increasing amount of money it needs to borrow. Unlike the funds created by the Fed’s QE, treasury bills are cash-like instruments which are attractive investments for banks which can create the money they use to purchase them; a form of money printing, with the money created available to add to the flow of funds into the real economy. Investors may wish to take note of this transition as it may result in elevating economic growth rates at the expense of the very high rates of return investors have grown accustomed to realizing in the financial markets.
The risks that accompany these changes in the sources of liquidity are becoming visible. The Fed may be underestimating the level of reserves held by banks required to maintain stability in the U.S. Treasury market with the level of those reserves having declined from $2.6 T (trillion) to $2.2 T since early June resulting in the increased frequency the interest rate banks are paying for collateral spiking evidencing a collateral shortage. An additional concern is the near doubling of the amount of debt maturing from 2024 to 2027 with much of it needing to be refinanced at much higher interest rates than the near zero rates prevailing at the time of its issuance close in time to the global pandemic. A final challenge facing global financial markets is that we are near the inflection point of the sixty-five-month global liquidity cycle marrying a time of an increased need for liquidity and its declining availability.
50/50 portfolios returned .90% for the month and 17.90% year to date. The 50% equity share contributed 2% of the month’s return and fixed income .60% with variable rate securities and precious metals flat to modestly negative.
Mark H. Tekamp