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Market Lab Report - Higher rates ahead? On liquidity vs. market direction; Lopsided markets

Market Lab Report

by Dr. Chris Kacher

The Metaversal Evolution Will Not Be Centralized™ 

Lopsided markets

Begrudging rallies in the major averages continue. The weekly charts are telling. When they have bounced since the bear market began in late 2021, the bounces are sharp. But when you look at the current bounce on the weekly charts, even the leading NASDAQ Composite is not as sharp as the last three bounces it had since the bear market began in late 2021. The slower indices such as the S&P 500, DJIA, and NYA (NYSE Composite) are looking weak even on this bounce.  

In addition, the Dow as well as the broad-based 3,700-plus stock NYSE Composite remain in downtrends off their February highs.
The market presents one of the most lopsided, narrow situations as the large tech stocks which are looking to profit from AI and hold much of the weighting of their respective indexes such as the NASDAQ Composite push to higher highs while their respective advance/decline lines remain poor. Meanwhile, economically-sensitive areas like machinery, industrial metals, and retail underperform badly. The majority of the S&P 500's gains in 2023 have been due to buying big tech names such as AAPL, AMZN, MSFT, META, and GOOG which fund managers buy to keep up with the pace of the rising indexes. They have become part of the class A contingency since they are rock solid, blue chip names.

They also hold promise in the growth of AI. Without exposure to such stocks, the S&P 500 would be down -1% for the year (as of May 12) according to a report by Société Générale. That said, Goldman Sachs' senior strategist said, “Over the next 10 years, AI could increase productivity by 1.5% per year. And that could increase S&P500 profits by 30% or more over the next decade.” An earlier report incorrectly cited a figure of 4%. Still, new technologies often get overhyped though companies such as NVDA and AMD are greatly benefitting by demand for their GPU chips from cloud vendors as well as large consumer internet companies which use NVDA chips to train and deploy generative AI applications like OpenAI’s ChatGPT.

Higher rates ahead?

The Fed's Bullard suggested higher rates as insurance against inflation. He is inclined to back another rate hike with reductions in rates not seen until 2024. He believes the main risk is that inflation doesn't go down or even turns around and goes higher, as it did in the 1970s. The cost of home prices, rent, food, and general goods & services remain at issue. The Fed's Kashkari is concerned services inflation will remain elevated so thinks rates may have to go above 6%. On the other hand, Fed Chair Powell has stated credit conditions are so tight making more rate hikes unnecessary. A credit crunch, rate hikes, or rates kept at elevated levels will induce a recession. CPI inflation is now back below the upper bound of the Federal Funds rate, historically a good indicator that rates have peaked. But should inflation rise again, it would likely force the Fed to hike again.


The US dollar and 10-year Treasury yield are both trending higher which should act as a headwind for stocks should they continue to trend higher.

On liquidity and market direction

Actual liquidity that correlates with market direction in both stocks and BTC is calculated as follows:

Fed balance sheet - TGA (treasury general account) - RR (reverse repo) = Liquidity

The Fed boosted its balance sheet to address the Silicon Valley Bank disaster on March 15. This pushed markets higher out to the end of March as shown below by the steep arrow but major indices such as the S&P 500 as well as BTC remain at similar levels since then.

Meanwhile, once the debt ceiling is raised once again, this may create a temporary bounce in the markets. TGA has been shrinking over the last month but will get a big boost once the debt ceiling is raised which will reduce liquidity so expect liquidity to continue to trend lower overall. This will act as a headwind for markets.

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