U.S. Liquidity Picture Still Mixed
(September 2, 2011)
Dear Subscribers and Readers,
I want to wish all our U.S. subscribers a great long Labor Day Weekend! I would be Tulsa, OK for a wedding this weekend; and hence the publication of our weekend commentary would be a little delayed (until Monday evening). With a significant portion of Wall Street coming back from vacation, the market action will definitely get more heated after Labor Day Weekend.
The historically high volatility notwithstanding, our base case still calls for global equities to be mired in some kind of trading range going into early Fall (Autumn). While we are not very bullish on U.S. equities (despite very decent valuations), we do not believe a major bear market has started. Liquidity remains very tepid; while investors' sentiment is still too bullish. Combined with the ongoing European Sovereign Debt Crisis, there may be more surprises in store to signal a sustainable bottom has been put in place. Should the Dow Industrials decline below 11,000 again, however, we will seriously think about initiating a 50% long position in our DJIA Timing System. Note that there is significant support in the 10,000 to 10,500 range should the market embark on another correction.
The next several weeks are crucial as the markets take stock of the ongoing European Sovereign Debt Crisis—and whether the ECB is willing to continue its purchases of Spanish and Italian sovereign debt. We believe both the ECB and the Bank of England will engage in further easing by the end of this year (the former with a 25 bps rate cut; and the latter with purchases of Gilts). In the meantime, U.S. financial liquidity has steadily improved. While this is insufficient to prevent another market correction, this steady improvement is very promising from a longer-term economic standpoint. As we mentioned, none of our leading indicators (general liquidity, the stock market, corporate bond yield spreads, the ECRI Weekly Leading Index, the Ceridian-UCLA Pulse of Commerce Index, etc.) still do not signal a recession. From a domestic standpoint, both the Fed and U.S. commercial banks need to play a big role to revive bank lending and economic growth. Over the intermediate to long run, bank lending needs to revive for a sustained uptrend in asset prices and economic growth. Following is a monthly chart showing the state of U.S. bank lending—i.e. the year-over-year change in loans and leases by held by U.S. commercial banks for the period January 1950 to August 2011 (updated to August 17, 2011):
While the decline in bank lending in 2009 was unprecedented (the Great Depression notwithstanding, when one-third of all US banks failed), it has steadied in the last 15 months. Bank lending growth, while still negative on a year-over-year basis, is now only down 0.3% using data to August 17, 2011 (compared to -1.1% in July). In fact, the absolute amount of bank loans and leases outstanding (seasonally adjusted) rose by $42.2 billion (to $6.81 trillion) from the end of December 2010 to August 17, 2011. While this liquidity creation within the U.S. commercial banking system does not improve the stock market's short-term outlook, it does represent a slight improvement on a long-term basis. All that remains now is for the ECB and the Bank of England to inject more liquidity into the global financial markets.
Unfortunately, the overall liquidity picture, especially pertaining to the stock market, is still mixed. The one weakness is exemplified by the percentage of cash in equity mutual funds. In particular, cash as a percentage of equity mutual funds' assets just hit an all-time low of 3.3% as of the end of July 2011, after lingering at its previous all-time low of 3.4% since March, as shown in the following chart:
While cash levels have likely improved during August because of the general liquidation of stocks, it no doubt remains historically low. We will continue to take a wait-and-see approach to the markets. We are still looking for another correction over the next couple of months. Subscribers please stay tuned.
Henry To, CFA, CAIA