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Liquidity Composite At Record High

The composite liquidity indicator was virtually flat last week, for a second week, on a mixed performance in its components. In February and March, the indicator had accelerated upward away from its 39 week moving average, but it has stalled over the last 4 weeks. With less abundant liquidity, the government and Primary Dealers have targeted the Treasury market for support, trying to keep yields as low as possible and trying to give the dealers time to distribute their overly large long positions.

I would expect the indicator to develop a negative divergence before the stock market tops out ahead of the next major cyclical bear market. Therefore I strongly suspect that Monday’s stock market break is just a matter of the market owners shaking the stock market tree to benefit their Treasury positions, and their primary client’s desire to keep its borrowing costs as low as possible. In weeks such as this one when the government must roll over a huge amount of long term paper, not to mention adding new paper to that pile, the focus will be on funneling available liquidity toward that purpose.

In those alternate weeks where Treasury supply is confined to short term bills, they’ll find reasons to support stocks while they let yields drift up a bit. This round robin could continue for months with the potential for nominally higher stock prices as a bearish divergence forms in the macroliquidity line. In the past, such divergences have developed at both tops and bottoms over periods of 4 to 6 months. If form holds, then the final top of this bull market is at least that far away, given that the indicator just recently made new highs. As long as no bearish divergence develops, the timing of the high would be pushed further into the future.

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