Financial Liquidity & The Stock Market

Measured yr/yr, my broad composite of financial liquidity has been running about 6.3%.
Concerns that the banking system could be hoarding liquidity are not without some
validity as the system's loan book is up only about 4% over the past 12 mos. My "quick
liquidity" measure of the ratio of bank Treasury holdings to commercial and industrial
loans is running 1.2x, which is extraordinary for a fourth year of economic recovery. The
biggest sore spot within bank assets is the real estate portfolio which has been flat now
for an extended period as new loans only match the level of run-offs and charge-offs. In
typical post big bust fashion, the banks have gone from profligate lenders to mean spirited
liquidity hoarders.

However, system money and credit liquidity growth of 6.3%, albeit it rather moderate by
post WW 2 standards, happens to exceed the yr/yr growth of the business economy by
about two full percentage points. This development reflects both modest growth and low
inflation or business pricing power. The excess of liquidity shows up not just in the
banking system's investment account but has been flowing into the capital markets and into
residential real estate prices as well. With investor confidence elevated regarding risk
assets, the stock market has been a direct beneficiary of excess liquidity growth. Note
well here too, that the Fed's large new QE program is contributing significantly to the
growth of the broad measure of financial liquidity.

Total business sales seen globally not only reflects modest US economic expansion but
slow offshore growth as well plus currency translation penalties for US based businesses.
In my view, the sluggish business environment hardly warrants the recent sharp increase
of the market's p/e ratio, but investors at large have been more focused on the asset
inflation effects of the Fed's current QE program.

Speaking for myself, if I do not soon see that this big QE program is underwriting an
acceleration of real economic growth at least in the US, I will probably conclude that
the US stock market is overpriced and unattractive. Whether many other players will
think the same soon is not yet for me to say as folks seem smitten with the slow growth /
excess liquidity concept so visible in the stock market.