Monday, February 4, 2008

[Latest Global Dollar Liquidity measure: +11.4% annual growth rate; latest Endogenous Liquidity Index: -40.4%]

Hello everybody, I'm baaack! After a long summer break (I was in South America), I'm back in the saddle, trying to make sense of financial markets and liquidity indicators. Plugging in the numbers, here's what I see: business as usual. In other words: while funding liquidity is still relatively strong, market liquidity looks awful. Most of the damage is caused by surging credit spreads; volatility indicators, however, appear to behave in a way that is consistent with the "Great Moderation" of the business cycle thesis. Finally, and quite surprising, I note that my market-based "Goldilocks-Stagflation" indicator is trading at a ... 3-month high! In a nutshell: earnings will take a hit -- but the global economy still looks good. A recipe for an extended trading range?

[1] Funding liquidity is still strong. The Global Dollar Liquidity measure shows a 11.4% increase with respect to January 2007. That fits my definition of a "liquidity boom": a 10%-plus rate of growth. Moreover, January marks the 62th month in a row of this funding liquidity boom. There are no precedents for such an extended period of strong growth in central banks' dollar reserves.

[2] Market liquidity looks awful. At -40.4%, our Endogenous Liquidity Index is plumbing new lows. Within the index, however, we note two diverging trends. Volatility and financial innovation indicators (chiefly, the VIX index and the GS share price) are relatively well behaved. But credit spreads are hurting a lot. The Moody's Baa spread is approaching 300 bps, a five-year high. Not good in terms of corportate earnings!

[3] Surprising Goldilocks. At 1.94, the platinum-gold ratio (a market-based proxy for the world economy) trades at a six-month high. At 234 bps, ten-year inflation breakevens look reasonable, given the FOMC's aggressiveness. Thus the "Goldilocks-Stagflation" measure, which plots one indicator against the other, trades at a 3-month high. Against this background, stocks do not look particularly expensive, even after the recent rally.

[4] Long-term picture still bearish. On August 31, 2007, my trusted long-term model for risky assets went bearish. It combines the rate of growth of both the Global Dollar Liquidity measure and the inverse of the Moody's Baa spread. Because it does no take account of volatility indicators, the model may be unduly skewed to the bearish side. All in all, a very sharp fall in credit spreads (more than 100 bps) is required for the model to flash out a bullish signal.


Matthew said...

I know it's not a good idea with data to try to explain away changes, but in platinum/gold there is a good reason - the South African mines, from which 80% of mined platinum but only 10% of mined gold come, shut down in late Jan on power concerns. So I don't think it works as a demand proxy. How about copper/gold?

Agustin said...

Matthew. Good point. I should have read more about the platinum story -- I´m usually cautious when analyzing very short-term trends. Having said that, I like the platinum-gold as an indicator, and I suspect that copper-gold would yield somewhat similar results. Cheers.

Henry Bee said...

Is there a quick link to your first post where I can get some background information on your methodology? It will help me greatly in interpreting your current posts.

Unfortunately, the archive feature only takes me to December 2007. To get to January 2007 I have to manually click on the "older posts" button a few hundred times.