E The S&P 500's YTD Rally Is More A Function Of Liquidity Than Earnings Results And Sentiment

To more succinctly state the aforementioned, the Fed or central banks did not create a new button, lever or instrument to drain liquidity and named them QT. Marko Kolanovic mirrors this sentiment in the following paragraph.

“To our knowledge, there is no broadly accepted understanding of the exact mechanics and magnitude of QT’s impact (e.g., how much it is a signal to the market, vs. mechanical supply/demand and price impact). There is a significant relationship between the Fed’s balance sheet changes and the market, but the big drivers of this relationship are points when the large QE programs were announced such as March 2009 (e.g., when this point is taken out, the relationship no longer appears statistically significant; Figure 7 shows the weak contemporaneous relationship since the start of 2010). Whatever the real mechanical impact is, likely the impact on market sentiment is much larger (i.e., self-fulfilling impact). In support of that are recent intraday movements on balance sheet mentions, as well as the price action of the S&P 500 during Q4 shown in Figure 8. While there may be little or no mechanical impact on equity prices, most macro traders are not ‘fighting the Fed’ – when liquidity is added they are buying assets, and when liquidity is removed they are selling assets.  

Investors have assigned a value to risk assets along the lines of Fed activity. When the Fed is easing this assumes a higher value on risk assets. When the Fed is tightening, investors assume less value on risk assets. In both Fed conditions noted, the investor is sentiment driven, not mechanically driven. Investors are drawing conclusions or end results from Fed activity and as such, the self-fulfilling prophecy is commenced.

Given the topic of market liquidity and as we’ve mentioned it several times throughout this report, we are forced to understand that even as the Fed has paused future rate hikes, it’s balance sheet is still contracting. The Fed remains with its selling of Treasury’s, balance sheet run-off activities. Given the facts about the Fed still draining liquidity from the market, I'm forced to question where the excess market liquidity has come from. Why is the economy more heavily flushed with cash/USD? 

The chart above speaks volumes. The U.S. debt ceiling is approaching on March 1, 2019. Therefore, the U.S. Treasury will not be allowed to have as much excess cash at its account with the Federal Reserve. As the U.S. Treasury draws down this account in January, this liquidity will enter the banking system. This >200bn liquidity addition will overshadow the scheduled liquidity drainage from maturing Treasuries (40bn). The drawdown can happen in different ways, such as via less tax revenues or via less bill issuance, but the end result will still entail greater dollar liquidity in the banking system. The greatest impact from the liquidity injection occurs when the USD weakens. With a weakened USD from excess liquidity risk assets tend to gain. By and large, this is what has and is continuing to happen in the month of January. It’s not the fundamentals; it’s the technicals that are juxtaposed with improving liquidity given the U.S. Treasury’s forced activity ahead of the debt ceiling. In fact, the U.S. Treasury has added $50bn of excess ‪USD to the system so far this year? Another $100bn+ is likely over the next 4 weeks

I can’t just stop here with respect to defining what has produced this injection of market liquidity, the U.S. Treasury. It’s unlikely that the U.S. Treasury by itself could produce a global equity market resurgence.

When we dig that much more deeply into the global money supply trends we’ve come to find that global money supply has ticked higher in late 2018 and into 2019, as depicted in the chart above. While the U.S. Federal Reserve is tightening, most other central banks are still pumping liquidity into their system, especially China and Japan. (Chart of central bank balance sheets from around the globe, below)

Some of the excess liquidity being pumped into the global money supply finds its way to the U.S. markets obviously. So when we suggest that the equity market rally of late is one of increased liquidity and technical repair, we urge investors and traders to refer to these research points in the future. Certainly, we don’t project that liquidity is all that matters, but as we understand, it is an important factor for market performance. 

S&P 500 Earnings

For the current earnings season, estimates have consistently been revised lower. Thus far, 11% of the S&P 500 members have reported results. In the coming week, another 56 members from various sectors will report results. Total earnings for the 55 index members that have reported are up +16.9% from the same period last year on +9% higher revenues. Earnings and revenue growth for the same members of companies had been +22% and +9.7% in the previous earnings season. The comparison chart below puts this growth deceleration in a historical context for these 55 index members. 

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