October 11, 2022
The funny thing about idioms is that they get old, and people may not always understand them. This post was to begin with the idiom “Like a broken record”, but then I realized that almost everyone reading this comes from the CD era. Not the cassette era or the 8-track era and certainly not the vinyl era. So a broken record may be difficult to understand. era. So a broken record may be difficult to understand. era. So a broken record may be difficult to understand. era. So a broken record may be difficult to understand.
Maybe that helps.
It was 18 months ago when “The Effect of Liquidity” was posted on the blog, and it dealt with the meme stock activity that was going on at the time. The world was awash in so much capital, that it was being used to artificially boost prices of individual securities (Since that time the key players, GameStop, AMC, Blackberry and Bed Bath and Beyond to name some key players, have settled down (GME and AMC) or returned to earth (BB and BBBY). Yet the effects of liquidity on the larger markets is probably just becoming clear to even professional investors.
In January, the post “Turn Off The Taps” highlighted that the Federal Reserve was going to remove liquidity from financial markets, and that process is underway (but keep in mind it is just 6 months into a 5 year plan. These are early days). The pain to financial markets has been quite severe.
These changes are just beginning to reach the minds of average investors, but some of the world’s best and smartest investors are talking openly about the consequences of this normalization of monetary policy.
Mohamed El-Erian, who is one of the brightest economic minds today, has highlighted repeatedly recently that liquidity risk is something that isn’t getting enough attention. It’s also worth noting that he thinks the Federal Reserve will go too far (raising interest rates) causing a severe downturn.
Others such as Jamie Dimon, CEO of JPMorgan Chase, also thinks that inflation and high rates are hurting the consumer and will result in liquidity problems.
Often this is just talk, but headlines show that last week’s potential problem (Credit Suisse) may actually be this week’s real problem. Despite spending a great deal of time last week with analysts and policy makers calming markets and saying Credit Suisse had sufficient liquidity, the news this morning is that the (very large) bank is facing an $8 billion capital shortfall in the next two years. Of course that assumes that everything goes reasonably well in that time frame. There is no such guarantee.
Meanwhile in the UK, where things have gone from bad to worse, the Bank of England had to step in (again) today to calm financial markets. These are red flags for anyone with a portfolio of investment assets.
In an almost laughable note, Cathy Wood, a fund manager who came to fame when all of this liquidity forced up all kinds of mediocre assets and her funds (ARK Invest) skyrocketed, published an open letter to the Federal Reserve, essentially begging them to stop reducing liquidity lest it bring asset prices down. It’s a bit of a shame when the rich have to beg for the rest of the world to be pushed further into poverty so they can protect their assets, but in a nutshell that is exactly what is beginning to happen.
The current reality may change on a dime. Governments have spent 40 years succumbing to the will of the ‘growth’ economics. Grow at any cost has been the mantra and it may come to pass that central banks cave yet again. But for now, it is pretty clear that asset prices will continue to be under pressure (read: probably decline) until much of the excess liquidity has been drained from the market.
The impact of that will be unexpected currency fluctuations, business shrinkage and even failures, difficulty getting access to credit (to buy a house or fund a business for example) and prices for many assets declining. Of course businesses will continue to try to push their costs to consumers, particularly for food, energy and housing, because people NEED those things. So there will be pain. Individuals will suffer and the economy will suffer. Protect yourself with excess cash and stand aside with new investible assets until there is more stability.
Finally, because these posts almost always have a negative spin to them, note that history has seen these events hundreds perhaps even thousands of times. Most people on the planet are already ridiculously poor by North American standards, and so don’t worry too much about how to make the next dollar from investing. As liquidity drains from the market, there will be a dry spell. On the other side of that, there will be a good time to invest. It’s just not now.
Practical Advice 