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Liquidity And Speculation Dominates First Half Of 2023. New Drivers Likely In Second Half.

Unlike the Volcker Fed, today’s Fed supports persistently growing excess liquidity and low real interest rates. Durably containing inflation will be a challenge.

The gap between recorded inflation and real inflation continues to widen.

Liquidity had a double boost in H1 2023. The debt ceiling chaos reduced Treasury issuance and so boosted cash holdings, and the bank crisis led to the Fed also boosting liquidity and violating stated policy objectives.

Speculation reached new all time highs. Position sizes in options in the Nasdaq 100 and S&P 500 are at record highs, 4x what they were in 2015. Nearly 50% of these options expire within 24 hours!

Retail investors purchased $1.5 billion of single stock for the week ended Tuesday which is an ALL-TIME record. NVDA sees record insider selling.

Fundamentals have become increasingly irrelevant to market action. US equities reach a record gap from US GDP growth.

Technology stocks in the S&P 500 index are underperforming on fundamentals, with declines in LTM reported earnings per share.

US recession probability reaches levels above any period going back to 1980. Money Supply is declining at the fastest rate for 40 years.


Over the last two decades, a whole generation of investors has learned different investment behavior from relentlessly expanding market support, from negative real interest rates and liquidity intervention. For many investors the US stock market appears to be a long term one way bet over their investing lifetime, regardless of persistently declining growth. However, the rally through the 1950s and 1960s was just as impressive and had much more underlying economic growth. Then along came inflation. Why won’t the 2020s be worse than the 1970s?

Policy makers now have new contraints, not just from inflation, but US debt which is now multiples higher than in the 1970s. How will ever increasing intervention with low real interest rates and excessive liquidity resolve inflation and excessive debt without damaging US equity performance post the biggest bubble in history?

Here is the Federal Reserve liquidity explosion post 2008.

Fed liquidity was flat from 1955 until 2008. Since then it has increased by more than 27%.

This is not the way Volker reduced inflation from the record levels in the 1970s.

When I hear complaints about less liquidity, remember there is such a thing as too much liquidity.”
Paul Volcker

Furthermore, positive real interest rates boosted inflation fighting credibility and limited the incentive to speculate. Volcker also took real interest rates significantly positive. Whereas, today’s Fed has had real interest rates negative almost permanently since 2008.

The liquidity and low real interest rate induced explosion in speculation has been remarkable.

Position sizes in options in the Nasdaq 100 and S&P 500 are at record highs, which are 4x what they were in 2015.

The chart below shows that not only is volume now dominated by option trading, but almost half of the options traded are positions that will no longer even exist within 24 hours. ODTE means Zero Days To Expiry. Here is a link to further deeper analysis, in options gone wild.

Retail Investors Chase The Rally Too

Retail investors purchased $1.5 billion of single stocks for the week ended Tuesday which is an ALL-TIME record.

Meanwhile, Nvidia insiders seem to have a longer term more valuation driven perspective. The record shows that they are more in line with my “avoid” recommendation I mentioned a week or so ago. There is only insider selling since 2020, with the highest concentration over the last two weeks.

Technology is underperforming on fundamentals. This is massive speculation!

Furthermore, The long term revenue growth of the mega cap tech stocks has weakened significantly.

Markets Separate From The Economy

No wonder that asset prices have become seperated from normal economic relationships. Position taking has never been more short term. The chart below shows the substantial risk involved in any passive allocation to US equities when the stock market diverges this much from GDP.

Economic policy is front and center in the current economic dislocation.

While the Fed has been tightening rates at a record pace over the last year, at the same time it has supported excessive liquidity, even in H1 2023, against its stated policy. Part of this resulted from the debt ceiling crisis, which suspended a substantial amount of Treasury issuance. The money that would have bought Treasuries became additional liquid assets available for speculation. In addition, the Fed’s banking crisis solution in March/April was to boost liquidity even further. Fed liquidity was supposed to decline but over the last 6 months it rose! So no wonder speculation reached new records in H1 2023.

Remarkably, the Fed has achieved declining growth and profits from rising interest rates and yet has also contributed to a substantial rally in the stock market through excess liquidity and negative real interest rates which support record speculation.

As previously discussed, the Fed’s intervention is swinging from one policy extreme to the next with often coincident and violently opposite consequences for markets. Policy and intervention has become a source of ever increasing instability. No wonder investment and growth have been in long term decline, as we have shown before. The Fed’s behavior creates considerable uncertainty.

Liquidity Will Likely Subside in H2 2023

Now that the Debt ceiling has been resolved much of this excess liquidity will reverse in H2, and with the banking crisis now subsiding it becomes likely that liquidity will have less effect and speculation may also subside from these extraordinary levels.

The Probability of a US Recession is Very High

One of the most reliable forward indicators of a recession has been the yield curve. The composite yield curve indicator below has a remarkably accurate track record, and suggests this is a 70% chance within the next year.

There is a range of corroborating evidence for a recession.

Leading economic indicators provide a wider analysis, as well as a good track record and point to the same outcome.

LEADING ECONOMIC INDICATOR (LEI): US Economy to Contract over Q3 2023 to Q1 2024

Bankruptcy filings have also just moved up to recessionary levels.

Money Supply is declining at the fastest rate for 40 years.

Time to Reallocate to VTIP or STIP?

With everything discussed above this could be a good time to reconsider short maturity Treasury Inflation Protected Securities. With US equities so extended, growth challenged, and the inflation outlook so unsure, increasing your allocation to 5 year maturity TIPS could be a timely allocation. The chart below shows a record high real yield over the last 14 years. Beating inflation by around 2% with low risk could be valuable component of portfolio allocation.

Real assets are a key portfolio component when long term inflation is a key risk.

TIPS have the great advantage of being amongst the lowest risk real assets. However, there is always the question of how representative the CPI is to any one individuals own long term cost of living.

The chart below shows how significant differences can emerge between the CPI’s own methodology and other representative measures. Taking the case of used cars, it is clearly important to recognise the almost 100% difference between what the CPI measure and the Manheim index.

Naturally, directly investing in real assets usually involves taking more risk than TIPS and this most likely needs careful allocation and risk management. Most likely an appropriate mixture of both could produce optimal outcomes, and there are good real asset choices available.


Markets have evolved to almost unrecognizable behavior by the standards of most historical text books. One of the most significant evolutions has been escalating intervention of policy makers, especially since 2008, although the driving rationale for intervention and the growing chaos of markets today has its roots in the 1930s.

It was Keynes’ offhand dismissal of Say’s law, or the law of the markets, in 1936 which is leading us into an economic and monetary crisis.  It was dismissed by him to invent a role for the state.
Alasdair Macleod

Investors need to take great care over their investments at the current time. Constant and excessive intervention means economic policy is now on tilt. Policy seems to be dominated by excess liquidity and deficit spending to move growth forward. The signs are that although this is arguably an effective temporary solution, policy now faces a range of inter-related challenges in term of financial security, debt, inflation, and growth.

It is crucial to differentiate between fundamentals and speculation, and also between facts and data rather than narrative. It is important to recognize that we are in a period of instability. Make sure you have a robust and flexible process to manage your investments in these uncertain times.

“Best Investor” Standards Safeguard Optimal Investing

In order to optimize opportunities safely, investors need to be set up with the most productive framework possible. Why not adopt the methodology of the most successful investors of all time? They all ended up embracing their own version of “Capital Preservation and Compounding”. You can find out why here.

The great additional advantage of “Capital Preservation and Compounding” is it’s clear definition. Just 5 metrics which can be illustrated in the Risk/Return Performance grid tell you in seconds how well you are doing.

Raise your accountability, transparency, understanding and control of your investing in real time by having access to this information.

Transform Your Investment Experience

The room for policy manoeuvre, and the stability of the current system should not be taken for granted. Volatility has increased and is likely to continue to stay high. The outlook has rarely been this uncertain. Investment management needs Best Investor metrics and techniques as never before.

Market and economic events are moving fast at this stage. If you need a quick review of the issues that you may need to know about for your own circumstances, schedule a FREE consultation today.

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Chris Belchamber is an IRMAA Certified Planner

Medicare’s IRMAA impacts every retirement plan. Learning how to mitigate it is available via IRMAA Certified Planners designation.

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