Liquidity Cycle Reaches Pivotal Turning Point, Driving Potential Market Growth and Opportunity

Liquidity plays a crucial role in financial markets as it refers to the ease with which an asset can be bought or sold without impacting its value. Liquidity is an important factor for investors as it allows them to quickly buy and sell assets without significant losses. In recent times, the CEO of Cross Border Capital, Michael Howell, has been vocal about the current state of the liquidity cycle, stating that it has bottomed and is now set to push markets higher. In this article, we will explore the concept of liquidity and its impact on financial markets.

The Importance of Liquidity in Markets

Before diving into the liquidity cycle, it is important to understand the significance of liquidity in markets. Liquidity enables investors to buy and sell assets quickly and with minimal impact on their value. This allows investors to exit a position quickly if they need to raise funds or if they perceive a risk in the market. Liquidity also plays a critical role in price discovery, as it ensures that the price of an asset is not distorted due to a lack of buyers or sellers.

Market Liquidity Diagram (Doris Zhang, 2022)

Global Liquidity and the Shadow Monetary Base

According to Michael Howell, global liquidity can be broken down into two parts – the “shadow monetary base” and private sector liquidity. The shadow monetary base comprises central banks, cross-border flows (such as currency markets), and collateral (such as bonds or mortgage-backed securities). This creates a foundation for private sector liquidity, which is 170% the size of the base supporting it.

Structure of Global Liquidity (Crossborder Capital, 2023)

The Inflection Point in Global Liquidity

Global liquidity demonstrated a clear inflection point in October 2022 and is now moving up, according to Michael Howell’s company research. The premise of liquidity to equity market cycles is that there is approximately a 6-9 month lag, which aligns with the time we are at now. This means that we are now at down the road from a turning point in the liquidity cycle, which could have significant implications for financial markets. In his investment reports, Howell argues that the bottom of the liquidity cycle was put in during October last year. While economic indicators may continue to decline, Howell believes that financial markets overall are set to perform well moving into 2024, given the tailwind of liquidity that will be behind it.

Global Liquidity Cycles (Crossborder Capital, 2023)

The MOVE Index

One notable observation by Howell is the MOVE index, which is a market-implied measure of bond market volatility. Howell noted that the MOVE index hit its high at the same time that the liquidity charts inflected up. When bond volatility contracts (MOVE index decreasing), equity markets typically perform well.

MOVE – Bond Volatility Index

Buying into Risk and Inflation Hedged Assets

The CEO of Cross Border Capital also highlights the historical precedent of buying into a combination of risk and inflation-hedged assets when unemployment begins to rise and the yield curve begins steepening (undoing its inversion). This is because historically, these conditions have marked the beginning of many cyclical bull markets across the board.

In conclusion, the liquidity cycle appears to have bottomed, according to Michael Howell, and this is set to push financial markets higher. While there may be further declines in economic indicators, the tailwind of liquidity is expected to support markets moving into 2024. The MOVE index and historical precedents further support this thesis. As always, investors should conduct their due diligence and consider their risk tolerance before making any investment decisions.

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