The reach for liquidity

The Federal Reserve has raised 75 basis points since last March and the markets have already gone into a liquidity seeking mode, purely on the basis of setting expectations of increasing interest rates. There is an implied expectation of another 200 basis points worth of increases in the next year but this expectation has already traded down as the markets have tanked.

Recall that the amount of cash in the system does not materially change in any given day. Only the asset price changes on any given day.

When participants want to pay off their debts, they have no choice other than to seek liquidity in their assets – convert the asset into cash. Globally, this has been reflected in the mass depreciation of other currencies, including the Euro and Japanese Yen:

The Canadian dollar, by comparison, has had limited depreciation, presumably due to our trade links and also commodity export:

The underlying point is that the markets are seeking liquidity, and specifically US dollar liquidity. This has had a negative effect on the entire market, including precious metals (Gold and Silver have been sold down during this process – people want the US dollars and not the shiny metal stored in their safes!).

The one commodity that has exhibited signs of stability has been energy – oil and gas has retained most of their value during this market meltdown. This may not continue – if the rest of the market causes consumption of fossil fuels to decrease beyond the ability to supply them to market, then energy prices will drop. There is a huge amount of margin of safety in energy equities at the moment (e.g. Suncor at half of the current price for spot oil is still profitable with dividend intact) but clearly a continued high commodity price environment coupled with low equity prices is the formula to accelerate returns through cheap share buybacks.

Most technology companies, especially unprofitable ones, have been slammed in the past half year. Most of them, even the ones trading 75%-80% below their November 2021 peaks, in my estimation still have rich valuations. That said, markets are volatile beasts and there could be a lot of “regression to the mean” type of investors coming up given the carnage seen in the marketplace. I don’t have much commentary other than that if you were leveraged long on companies like Palantir from last November, chances are at around this point you would have been cleared out of your margin account. Don’t even get me started on the amount of leveraged capital that must have been present and taken a severe bruising in the cryptocurrency space!