Wall Street is pointing to a weak open ahead of Tuesday’s earnings from Microsoft and other big names. That’s a day after soft-economic landing hopes fueled fresh 2023 highs for the S&P 500 SPX, +1.19% and Nasdaq Composite COMP, +2.01%.
Diving straight in, our call of the day taps into a potential market worry that may be off investors’ radars, from Stock Traders Daily and portfolio manager at Equity Logic, Thomas H. Kee Jr., who warns that liquidity leaving the financial system could upset markets in 2023.
In a recent report to clients, Kee noted similarities between current markets and 2019, when big banks started questioning levels of liquidity due to a Fed drain, and ultimately pushed overnight lending rates to over 8.5%. The Fed got things under control in a short space of time via massive liquidity injections.
Kee is worried about a 2019-style event for this year amid an increasingly “aggressive” Fed balance sheet runoff —the bank lets a portion of the securities that mature each month fall off its books — and already higher rates. But things could get ugly as it can’t “buy its way out of the problem” this time, he says.
Back then, the Fed “stopped the balance sheet reduction, slashed rates to 0% again, started asset purchases again, and the market took off in 2019.” Unlike now, back then “very few people were pointing to stimulus and asset purchases as catalysts for inflation and inflated asset price appreciation.”
He notes that another $1 trillion needs to come off the Fed balance sheet before it matches the 2019 balance sheet reduction.
Kee’s proprietary Evitar Corte crash indicator, which gauges Fed monetary policy to try to avoid market meltdowns, signaled a crash warning in 2019. He flagged budding liquidity issues to MarketWatch last November.
“We identified massive changes to liquidity (new money) last year, as the FOMC reduced stimulus to $0. This year the risks of a market crash warning is high, and we have identified liquidity drains from the FOMC (net negative stimulus),” he added in emailed comments. “Between last year and this year, the FOMC has gone from highly simulative, to a massive drain on liquidity.”
What to watch out for? “Recall that the banks became concerned months before the trough in the balance sheet in 2019, so the signals are likely to start to come months before it reaches a boiling point this time too,” he said.
How to prepare? “The best way to approach this is to remain in nimble strategies, like our SPY-Cash Model,” said Kee, referring to his long-favored strategy of alternating between cash and the highly liquid SPDR S&P 500 ETF SPY, +1.20% .
“There is also enough volatility in the market for some investors to improve cost basis, but everyone needs to be in nimble strategies. Our CORE Portfolio Strategy has been long all year, up about 8.5% YTD vs 4.4% for SP 500,” he said in emailed comments. (Read more on that here). “CORE also has the ability to neutralize market risk on a dime if the conditions call for it.”
Stock futures ES00, -0.30% YM00, -0.30% NQ00, -0.47% are lower, with bond yields TMUBMUSD10Y, 3.499% TMUBMUSD02Y, 4.219% easing, along with the dollar DXY, -0.09%. Oil prices CL.1, +0.27% BRN00, +0.11% are flat. Bitcoin BTCUSD, -0.43% is holding above $23,000.
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Earnings are rolling out from 3M MMM, +1.63%, whose outlook missed expectations, while GE GE, +2.69% also gave a downbeat outlook. Johnson & Johnson JNJ, -0.25% is getting a lift from its results. Verizon VZ, -0.93% and Lockheed Martin LMT, -0.45% are still to come, with Microsoft MSFT, +0.98% and Texas Instruments TXN, +2.99% headlining after hours.
Microsoft also announced a “multiyear, multibillion-dollar investment” in AI startup OpenAI, maker of ChatGPT. Our tech editor Jeremy Owens says it’s unlikely the tech giant will be challenging Google in search now.
January’s flash services and purchasing managers surveys are due at 9:45 a.m. Eastern.
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“We estimate that this has largely been a result of higher interest rates and the associated volatility, keeping passive flows on the sidelines,” they said, adding that commodity markets should start to tighten up on China’s reopening, drawing more investor flows.
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|APE, +5.17%||AMC Entertainment Holdings preferred shares|
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