There is one rule that is very powerful and tends to work very well in all situations where it’s suitable to use it: “follow the money”. In our case, this rule applies to the amounts of money central banks handed to traders who then fueled the stock market bubble to the nosebleed valuations reached today. Currently, the total amount of M2 money supply in the global financial system continues to grow, so central banks cannot be blamed for not supporting traders’ euphoria.
Those who will be blamed for not supporting the traders’ euphoria right now are the US government. Why? Because it’s the US government that is draining liquidity from the financial markets faster than central banks can print fresh currency into existence right now, as I explained more than a month ago in “NO ONE WILL CARE ABOUT A US SHUTDOWN, UNLESS IT SPARKS A BANK RUN” and warned again last Friday in “THERE ARE ONLY 5 DAYS LEFT TO AVOID THE BEGINNING OF A BANK RUN“. What many people out there fail to grasp is that not only are financial bubbles created by too much fiat currency chasing a limited number of financial assets, but that financial asset prices are set “at the margin”.
Allow me a paradoxical example here to make this point very clear, and then move on. Assume right now the only 2 traders who are in the market trading Nvidia shares are me and trader B. If I input a buy order for 1 share of Nvidia at $1, and trader B, for whatever reason, hits my bid, then the last price of Nvidia shares will be $1 or roughly $199 lower than its last one. Ok, now that Nvidia’s price is $1, trader C wants to jump on the opportunity to buy the stock, but trader B realized his mistake and adjusted the offer price for the next share he puts on sale back to $200. If trader C has $200 to spend and is still willing to buy Nvidia shares at that price, then there will be a second trade, and the price of Nvidia will be back at $200. However, if trader C cannot afford to buy Nvidia at $200 per share and there is no other trader coming along to bid, then the Nvidia price will remain stuck at $1 until the next transaction is executed.
Now, what do you expect the impact on financial markets will be when the US government drains money from them while asset prices are driven up or down mainly by the rise or fall of the liquidity tides that pushed prices higher and higher? Come on, it cannot be that simple; there are surely more factors at play, like technical, fundamental (insert GIF L.O.L. here), behavioral, and so on. Sure, this is correct, but for example, euphoria alone isn’t enough to push stock prices higher if you do not have the money to pay for it, right?
Currently, the US Treasury General Account is growing by between $3 and $5 billion for every additional day of shutdown. Depending on which part of the economy or financial markets you consider, the impact of one dollar less in the overall system is equivalent to multiple dollars in a specific part of it. At this point, let’s consider all these elements:
1 – Leverage in the stock market is at an all-time high and has grown very fast in recent years.
2 – Asset managers’ cash positions are at decade lows according to the latest surveys.
3 – People’s allocation to stocks, especially among US people, is at an all-time high, while cash allocations are at decade lows.
Without including any consideration of how asinine stock valuations are right now, especially in the tech sector, the 3 elements I just mentioned are evidence of how the whole system stretched its cash resources to the limit in order to chase stocks running higher and higher. Now that cash is being forced out of the system instead of being forced in, the cascade effect to all other elements that altogether contributed to inflating the bubble is inevitable. Furthermore, if you consider how prices are set on the margin, panic selling triggered by ultra-leveraged people rushing to scale back their exposure so as not to risk being wiped out can really play vicious tricks on a bubble.
Don’t worry, though, the US shutdown can end at any moment, and once that happens, a flood of liquidity temporarily drained from the system by the US TGA will re-enter the financial system. Every single time the TGA has been heading lower, stocks reacted positively, and it is fair to assume the same will happen this time as well. Unless it is too late.
What does “unless it is too late” mean? Imagine farming a vast piece of land. The harvest is almost ready, but then it suddenly stops raining. You can’t water all the land because it’s too big. If the drought lasts too long, the harvest will start dying off in larger and larger amounts. Even if water suddenly starts hitting the ground again, there’s no bringing it back—the crop is already dead. This is exactly what is going to happen to the financial system and the stock bubble if the liquidity drought caused by the US shutdown lasts too long, claiming the lives of banks, shadow banks, brokers, and over-inflated stocks that will crash from such an altitude that every impact with the ground is going to be mortal.
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