The quote at the start of this newsletter is about Bitcoin and from legendary investor Stan Druckenmiller.

We have quoted him before. On the previous occasion his wisdom was something that also applies at present. Namely:

Earnings don’t move the overall market; it’s the Federal Reserve Board… focus on the central banks and focus on the movement of liquidity… most people in the market are looking for earnings and conventional measures. It’s liquidity that moves markets.

Therefore, one possibility that emerges to answer our earlier questions about what is going on and can it continue is the fact that, very quietly, liquidity is back to being plentiful in financial markets.

We have spoken about this concept before. Liquidity is the idea that there is an ease (or not) with which you can convert an asset - any asset - into cash. Obviously some assets are always more liquid than others. A share of Apple stock is very easy to sell, a piece of land or a baseball card collection is far harder.

But there are also different levels of liquidity at different times. Selling a mint condition Mickey Mantle rookie card is easier when everyone is interested in baseball cards. You don't just get a better price (though you do) but people will be clamoring for it.

One good way to think about it is whether it is easy or hard to sell your home. In a hot market, liquidity will be, by definition, plentiful. You won't just sell your house for what it is worth (or more) but also you will be able to sell it quickly and easily. There will be lots of liquidity out there chasing your home and others like it.

The question then becomes: why is liquidity plentiful now?

There are a few drivers but overall answer might surprise you.

The first is that new products such as Bitcoin ETFs have been approved and arrived on financial markets. This obviously made buying crypto assets far easier. You can buy Bitcoin roughly in the same why you buy the S&P 500 now. This has led to a flood of new capital into the space and also, of course, a ton of publicity and excitement that becomes a self fulfilling prophecy.

People read about it becoming easier to buy Bitcoin -> see Bitcoin going up -> buy Bitcoin -> Bitcoin goes up in price -> more articles about Bitcoin being easier to buy -> rising in pice -> etc.

Second are some changes that have occurred from the US central bank, the Federal Reserve.

​We have already covered the sudden pivot from raising to potentially cutting interest rates.

But what this has done is eased financial conditions as equity prices have risen and market volatility has fallen. This has happened even though long term interest rates have stayed very high - at least so far.

See here:

Financial conditions incorporate a lot of elements but they are one pretty good measure of liquidity. Here is the St Louis Fed's definition of what goes into their index:

Measures of equity prices (also commonly referred to as stock prices), the strength of the U.S. dollar, market volatility, credit spreads, long-term interest rates, and other variables.

In other words, while interest rates have stayed very elevated others drives, like stock prices and the strong dollar and declining credit spreads, have helped financial conditions ease.

But that isn't all. One of the biggest changes has been hidden and missed by most analysts (including us) because it has been happening deep in the financial plumbing.

You might remember last spring when various American banks failed or came close to failing when the "ultra-safe" assets they owned declined in price and people became concerned they would need to raise more equity and this started a death spiral as investors and then customers began withdrawing their assets.

The authorities responded with a whole host of measures but one of them was the opening up of their Reverse Repo Facility and letting it run off.

See here:

What does this do?

This chart heading down indicates the steady drip drip of money entering the financial markets and supporting credit conditions.

Why does this matter?

This gets very boring very quickly but the US central bank has been stashing some of the money they printed in 2020-2021 under quantitative easing in this reverse repo facility. After the bank crisis last spring, they began to let it run off by providing it as a cheap source of collateral. In so doing US policymakers provided more liquidity to the financial and especially bank funding market.

This liquidity was the entire point despite the fact that it is largely hidden from view for most of us mortals.

This liquidity for the banking system came at a critical time and likely kept things afloat back in the spring and summer. Now that Fed has paused its increase of interest rates this liquidity is being felt even more because it is soaking up US Treasury issuance at a time when financial conditions are easing.

This gets esoteric very quickly but all you have to remember is the US government has been deploying a shock absorber to help soak up the unholy amount of Treasury Bills we are issuing to cover exploding debt and deficits at higher rates of interest.

It is like a hidden boost that is keeping financial markets awash in liquidity and letting speculation take off. It might be hard to imagine that failed US banks in April of last year lead to Jeo Boden coin up 100,000% nearly a year later and yet here we are.

What is interesting about all of this is, as the chart demonstrates above: it can't go forever. It will run out.

This then leads to....

The final question, which is: how long this can go on?

It is obviously hard to say but likely a bit still.

As the reverse repo graph indicates, there is a ways to go yet and as we have covered so many times, economic growth is still very strong. This was underlined with yet another strong employment report this past Friday. Even if the unemployment rate rose slightly, the US economy is still adding jobs.

Most estimates of the reverse repo facility have it beginning to run out some time in May. Keeping that date in mind and a close eye on the economic data as the weeks flow by.

A different way of looking this is that the US stock market had a very strong 2023 but most of its performance was in the back half and especially the fourth quarter. This year, that is increasingly looking like it could be the inverse.

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