For recent 12 month periods over 2010, total financial liquidity growth has been
between 1-2% or barely above the inflation rate. For the 12 month period ended 6/10,
total Us business sales rose by more than 9%, as did the $ value of industrial output.
Thus, the velocity of money + credit rose sharply and liquidity declined. Relative to the
growth of the economy, liquidity has been in "deficit" since early 2010. The strain on
liquidity peaked around Jul. 2010, and has been improving sharply as 12 month economic
growth momentum has eased. The absorption of liquidity by the real economy has been a
headwind factor for the stock market this year. The situation is improving but is still a
drag factor on stocks.
Financial system liquidity growth made a cyclical top over Half 1 2007, and trended
down from 10% yr /yr back then to an astounding -3.5% in early 2010 when measured on
a comparable basis. As mentioned above, the liquidity situation has turned positive in
recent months as the worst of the contractions of private sector lending and funding has
ended. This process may well improve further as banks are stepping up funding growth
and liquidity would accelerate sharply if private sector credit demand rebounds.
The moderation in the recovery of business sales and production momentum is not
unusual after the initial sharp bounce that ends a recession, and so long as it remains
moderately positive, further liquidity improvement would be normal as credit demand
responds. These processes should eventually alleviate the liquidity strain on the stock
market over the next 12 months. Further quantitative easing of monetary liquidity by
the Fed will be a plus, obviously.
Now, you have to keep in mind that the liquidity analysis is but one facet of looking at
the stock market. If economic momentum slows too much, then profit margins will
decline and earning power will be hurt. That would not be good. However, if the
recovery proceeds even at a mild pace, then liquidity should follow suit, which
would eventually roll into a nice tailwind for the stock market.
The visibility of liquidity growth going forward is not nearly as good and clear as
it has been after most post recession periods. I have a positive stance on this issue, but
we really need to see how the Fed plans to manage quantitative easing and the
credit situation as 2010 draws to a close. Not to make a pun, but the Fed needs to get
off the dime on these issues soon.
Over the past 50 years, economic growth has been fueled more by the expansion of
credit per se than money per se. But, form 1933 - 50, in the wake of the Great
Depression, it was money growth more than credit which drove the economy. the
stock market can rise in either environment, but it would sure be helpful to glean
the drivers going forward and that the Fed needs to address pronto.
- Peter Richardson
- Retired chief investment officer and former NYSE firm partner with 50 plus years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!