US macro liquidity has grown slowly over the past year. Meanwhile, stock price inflation has surged, setting up a large divergence versus liquidity. It suggests that the market has become overextended due to excessive bullish sentiment. This is the mirror image of the oversold reading in February 2016.
The difference today is that the Federal Reserve has announced that it will soon begin withdrawing liquidity from the system. The Composite leading indicators (CLI) will flatten later this year and probably turn lower next year. Today’s market overextension represents an extreme level of risk.
My proprietary macro liquidity indicator combines 5 different measures of US systemic liquidity. The most important of these is a measure of the cash flowing from the Fed to the Primary Dealers. Other components include a measure of the change in bank deposits not resulting from flows from money market funds, and several measures of commercial bank trading and investment activities. Finally, I include a measure of direct foreign central bank purchases of US securities.
This post was published at Wall Street Examiner on June 27, 2017.