Stock market selloff still has another 20% to go, says godfather of liquidity

As earnings season kicks off, it’s worth noting what investors have learned so far. The short version is, apart from a few isolated companies (cough, Netflix, cough), not much: the forecast rise in earnings per share of the S&P 500 for this year is 8.9%, compared to 8.1% at the end of March, according to S&P Global Market Intelligence.

But even as earnings expectations have improved, the market has struggled, with the S&P 500 SPX
6% less this month so far. So what’s going on?

Well, Federal Reserve reserves fell $460 billion last week, which according to Citigroup was the biggest weekly drop in history. So let’s hear what that means from Michael Howell, dubbed the godfather of global liquidity and CEO of CrossBorder Capital, a boutique he formed in 1996 after leading the research teams at Baring Securities and Salomon Brothers. Howell explained to Blockworks Macro’s Jack Farley that by global liquidity as opposed to market liquidity, he means the ability to change investment positions with relative ease. “If you put more liquidity into a financial system, what happens is that you are lowering systemic risks, because it is much easier for any particular entity to obtain financing, and if financing is easy, people will move along the risk curve towards riskier instruments,” he said.

Central banks, through monetary operations, control much of the liquidity. It also monitors the actions of commercial banks, shadow banks, large corporations like Microsoft and Alphabet, and cross-border investors. And in response to rising inflation, around 95% of central banks around the world are applying tightening measures. The Federal Reserve, in the minutes of the last meeting of the Federal Open Market Committee, outlined a plan to reduce its balance sheet by about $2 trillion.

Howell says a normal tightening cycle would see the S&P 500 drop about 15%, add a recession, that’s a 30% drop, and if there’s a banking crisis on top of that, that’s a 50% drop. . “I don’t think we’re getting the third, I think we’re getting more than the first, so I’m thinking about the middle, which is about a 30% correction from the peak to the trough,” he said. saying.

Since there is already about a 10% decline from the peak, Howell says another 20% drop is coming.

“The point to remember about the financial system is that, contrary to what the economics profession and economics textbooks say, the financial system is much less a new financial system than it is actually a refinancing system,” says Howell. With some $300 trillion of global debt and an average maturity of about five years, some $60 trillion needs to be refinanced each year.

That dwindling liquidity has already been seen with the Japanese yen USDJPY tumbling,
rising Treasury yields and rising commodity prices. The higher volatility makes it harder for people to borrow against that collateral, as lenders will require more margin. Howell says its liquidity ratio is about to enter the “turbulent investment zone”

Howell also said market leadership (utilities and brands outperforming cyclicals and tech) and the yield curve are saying investors want safety and a recession is increasingly likely.

The buzz

Twitter’s TWTR
The board has suddenly warmed to Elon Musk’s offer now that it has financing, The Wall Street Journal reported, citing people familiar with the matter. Bloomberg News said the talks are in the final stretch.

China’s capital Beijing appears to be moving towards the strict lockdowns seen in financial hub Shanghai in response to a new outbreak of COVID-19.

The European Parliament and European Union member states agreed over the weekend on a proposed Digital Services Law, which will force tech companies to take greater responsibility for the content on their platforms.

French President Emmanuel Macron comfortably defeated his far-right rival Marine Le Pen. The German Ifo business climate index rose in April from a 14-month low in March.

The People’s Bank of China said it is cutting foreign exchange reserve requirements by a full point, following a recent rise in the dollar against the yuan USDCNY.

Coca-Cola K.O.
it beat earnings estimates as its organic growth guidance came in just slightly below consensus.

The market

ES00 US Stock Futures

pointed to another sharp decline, after Friday’s 981-point drop in the Dow Jones Industrial Average DJIA.

CL crude oil
futures tumbled and the 10-year Treasury yield BX:TMUBMUSD10Y
fell to 2.83%.

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