Liquidity is Draining from the Markets

It was a great week for the US Dollar. On the flip side, it was a terrible week for any kind of investments. Everything sold off against the dollar including all stocks, bonds, crypto, foreign currencies, and commodities. Thanks to Friday’s rally I’m only down 6.4% on the week, which is better than the prior 3. My portfolio is actually down 35% since the beginning of April, so it’s quite volatile.

As you can see above, these last few weeks have been tough on all investments as everything was sold down together. Above is the S&P 500 next to proxies of everything in my portfolio.

As you can see, margin debt peaked around October and has been coming down. This is the tip of the iceberg as far as market liquidity goes. Margin debt is lending directly on stock portfolios to buy more shares, but it is just one small form of leverage in the system that happens to be visible.

In the fall of 2019, there was a dollar shortage which led to a spike in the repo markets leading the Fed to intervene. This was dubbed “Not-QE” by the fed, and let to a market meltup prior to the crash in March.

Lately, the federal reserve has been intervening heavily in the reverse repo markets instead. Notice how reverse repo ramps up and flattens roughly in sync with QE (Total Assets). The way I interpret this, the federal reserve wanted to keep QE going because they thought it would “provide liquidity,” helping the stock markets and the economy. This led to a shortage of collateral, especially among money market funds that have to invest in short-term treasuries. The Fed intervened by effectively selling treasuries in the Reverse Repo market to put a floor under the yields and prevent them from going negative. Once QE stated to top out, so did RRP. Using this logic, as QT progresses (Total Assets falls), I would expect the RRP to follow it down. What does this mean? Does this reflect excess liquidity in the system? These questions are certainly up for debate.

One thing that is very clear these last couple of months is the spike in the economically sensitive 10 year treasury yield, on which many loans such as mortgages are based. In addition, the recent rate hikes (matched with hikes in the RRP rate) set a higher floor on interest yields which increases the cost of margin debt and borrowing in the repo markets while reducing the value of the bonds and stocks used as collateral for those loans. Margin debt is still 25% above 2019 levels and 40% above the march 2020 trough, so I expect that to continue falling which means more general selling pressure in all the markets.

Note that all bear markets see sharp rallies, sometimes for months, but I expect general de-leveraging and selling of risk assets to continue as long as the Fed keeps hiking interest rates. I actually have my 401k (which is much smaller than my portfolio below) sitting in money market funds until the Federal Reserve announces it is done hiking rates, at which point I plan to move it back into a stock fund.

Here’s where my portfolio ended up:

  • HEDGES (14.1%)
    • 14.1% TLT Calls
    • 4.3% AG
    • 4.0% SILV
    • 3.8% MTA
    • 2.9% SLVRF
    • 2.9% EQX
    • 2.7% LGDTF
    • 2.1% SSVFF
    • 2.0% SAND
    • 2.0% RSNVF
    • 1.9% HAMRF
    • 1.9% MGMLF
    • 1.3% MMNGF
    • 1.3% DSVSF
    • 0.9% BKRRF
  • URANIUM (20.3%)
    • 4.3% CCJ
    • 3.1% DNN shares & calls
    • 2.9% BQSSF
    • 2.6% UROY
    • 2.3% UEC
    • 2.0% UUUU
    • 1.7% ENCUF
    • 1.5% LTBR
  • US CANNABIS (16.0%)
    • 1.6% AYRWF
    • 1.9% CCHWF
    • 1.8% CRLBF
    • 2.3% CURLF
    • 2.2% GTBIF
    • 2.4% TCNNF
    • 1.8% TRSSF
    • 2.0% VRNOF
  • BATTERY METALS (10.5%)
    • 5.1% NOVRF
    • 3.8% SBSW
    • 1.6% PGEZF
  • CRYPTO (2.2%)
    • 2.2% XRP
  • OTHER (3.1%)
    • 2.5% DOCN (cloud computing)
    • 0.6% OGZPY
    • 0.1% ATCO calls
  • CASH (-0.2%)

Note that I actually managed to keep margin near zero. This isn’t easy when all of your assets which you believe to be long-term buys keep falling. I have to admit though, a bonus check enabled me to buy some this week so it wasn’t purely discipline there.

I am happy with my portfolio allocations overall, despite the current market pressure. Still, I consider my mining stocks as my biggest priority right now – Uranium, Gold, Silver & Battery metals – so if these low levels persist then I won’t be adding paychecks to any of my other holdings. You can see how unbalanced my cannabis shares are getting as a result, as I had been keeping them above a minimum market value as they sank in the past whereas now I’m just letting them fall where they land.

These are dangerous times in the markets for sure, but there are also opportunities. Last note, Dave Rosenberg was interviewed on the Macro Voices podcast a few days ago, and I was very happy to hear that his views aligned with my portfolio. He believes that 10Y interest rates are in the process of topping out for the cycle and will be much lower by year-end, that gold will start to outperform likely by the end of the summer when Powell announces a freeze in future rate hikes, and that he is bullish on certain commodities such as Uranium from a supply perspective. It always makes you feel better when one of your most trusted financial analysts talks up your positions.

About johnonstocks

I've been trading stocks since 2003, active on Motley Fool's discussion boards and using first Hidden Gems, then Global Gains. I no longer have the newsletters, but I keep up on the WSJ and read David Rosenberg everyday at Education: CFA level 2 candidate MBA-focus in Finance, Marshall, University of Southern California - expected Dec 2010. BS Mechanical Engineering, UC San Diego, June 2002
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