The counterintuitive reason the stock market went up during the pandemic–as we were all stuck in our homes and the economy struggled–is that central banks were pumping money (liquidity) into the system.
Here’s a view of that using data from the Federal Reserve Bank of St. Louis. What’s measured is M2, which is one way to count how many dollars there are in the world (turns out that’s a rather tricky thing).
At the far end, you’ll see a huge spike in that blue line relative to the COVID recession. Here’s a close-up.
That big spike is why the market went up and cryptos soared.
You’ll also notice that the blue line has declined since then. And so too did the stock market and the crypto market.
You might even think that’s a reasonable thing, given that the increase in the money supply was artificial and without that kind of tightening we’d be in for too much inflation (as we are already experiencing).
But, you’d be wrong.
You see, the reason r/WallStreetBets likes to claim that “stonks only go up” is that M2 has historically only increased–with very few exceptions. Look at that first chart again.
In fact, we’re facing the largest M2 decline ever recorded. And how long do you think that will last?
So recently, Jerome Powell delivered a 25bps hike in line with expectations and managed to say nothing of substance in the follow-up questions afterwards. The market reacted positively, with the S&500 up some .8%, as this signaled that the regime of tightening was ending.
Janet Yellen spoke to congress and indicated that the Treasury was not going to backstop all banks–at least not necessarily. And the market cratered (cryptos even more). The reason, less liquidity would be provided to the broader economy, if true.
Now, whether the Treasury is willing to let all mid-sized banks fail seems unlikely. I don’t even think they’ll let 1 such bank fail with depositors being hurt.
And that brings me to my main point.
Tracking the M2 is slow, so the market looks to events like Yellen’s statements to assess its future trajectory. Presently, the market is betting on looser liquidity guidance, so that we'll reach a turning point for cryptos--law suits of BINANCE notwithstanding.
If liquidity trading is really the most important variable (and not recession worries), then some optimism about the future looks warranted.
The most obvious gainers for this liquidity trade are $BTC and $ETH. Why? Because now institutional investors have access to them via Fidelity
That will have an indirect effect on the rest of the market, but don't mistake the reason for the inflow to $BTC and $ETH specifically. Institutional investors want access to crypto, but they need to follow the appropriate channels. That's what will drive liquidity into this market in the first instance.
We're not in alt-season yet.
Happy Trading!
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