Monday, May 21, 2007

MTA Market Forecast Notes: Liquidity Risks and Connecting the Dots

excerpts from this week's report.

“It is now the consensus of most practicing central bankers that monetary policy can’t do much preemptively to correct an existing substantial asset price misalignment. But if monetary policy is calibrated appropriately to keep aggregate demand growing roughly in balance with aggregate supply and to keep inflation low and stable, this reduces the risk that such misalignments will emerge and expand.”

Timothy Geithner
“Liquidity Risk and the Global Economy”
May 15, 2007
Remarks at the Federal Reserve Bank of Atlanta's 2007 Financial Markets Conference—Credit Derivatives, Sea Island, Georgia

Having moderated more than a half dozen Market Technicians Association (MTA) events over the past five years, I have noticed two distinctive features – market technicians tend to have a nearly unanimous perspective on the overall market (there were some differences around the edges) and audience participation is very lively.

Unlike fundamental analysts, market technicians utilize similar tools in their craft and, therefore, often end up coming to largely the same conclusions – at least at it pertains to the overall market. In the current case, the four panelists on last Friday’s panel – Acampora, Bartels, deGraaf, and Roque – were firmly in the bullish camp. However, the topic of liquidity came up during the audience Q&A segment and, in my opinion, it stood out on two levels – one in the form of question posed by Phil Roth, the other in form of an insightful observation made by Merrill’s Chief Market Analyst, Mary Ann Bartels.

Phil essentially raised the question, “When isn’t a bull market the product of ample liquidity?” This self-evident question is both simple and profound. And it cuts to the heart of all bull markets. Earnings can be as terrific as one could hope for. But without liquidity flowing through the bloodstream of the economy and markets, stocks can easily fail to produce favorable returns - which brings us to Mary Ann’s comment on a measure of liquidity – MZM – and how it connects to the above quote by NY Fed President Geithner.

Merrill’s Chief Market Analyst, Mary Ann Bartels, provided her usual terrific points on hedge funds. But it was her comment on MZM (money supply) that I found especially insightful. Mary Ann stated that the high growth in MZM was attributable in part to...

...The recent comments by Fed speakers make it crystal clear that financial shocks cannot be anticipated and a market discipline is the “first line of defense”. The Fed will play its liquidity supportive role proactively and preemptively...

...In my opinion, stocks should always reflect this uncertainty and not be priced to fair value (1650 for the S&P 500). Things are much too dynamic for such complacency. To help punctuate this point, Mr. Geithner states,“…we do not have the capacity...

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