Market When Closed, Sunday 9 November
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Liquidity vs. Fundamentals
by Alex King, CEO, Cestrian Capital Research, Inc
In the very long run, corporate earnings, income and spending levels, inflation, the relatively standing of one country to another, all these things matter in securities pricing. In the very short run, panicky reactions by investors and apex predator responses by market-makers are probably primary. And somewhere in between on the timeline is liquidity.
It looks likely that the market is about to see a material increase in liquidity. It appears that interbank lending between the US money center banks is returning to normal levels (it has been thin in recent weeks). This means that more money at lower prices will become available to investors to deploy into securities markets. The prime brokerage desks of large banks are dependent upon Federal Reserve largesse or otherwise, interbank lending or otherwise, in their supply of money to their fund clients. The availability and price of margin capital to a large swathe of funds drives securities pricing fairly directly.
The chart below is very simple but if you understand interbank lending it gives you a heads up that probably more money is going to roll into securities markets shortly. It’s a ratio chart of SOFR (Secured Overnight Financing Rate, the price of interbank lending, which is to LIBOR what statistical analysis is to astrology) to EFFR (the Effective Federal Funds Rate, the cost of money as directed by the Fed). If SOFR > EFFR, interbank lending is expensive ie. unattractive, and if SOFR <= EFFR, interbank lending is cheap ie. attractive.
Now, I don’t understand interbank lending all that much. It’s one of the many aspects of the securities market that is not my wheelhouse. Fortunately, I don’t need to be an expert in this important area (an area which like a handful of others can give you just a little glimpse into the future of securities prices, just enough to be useful), because I have a colleague who is.
If you don’t subscribe to Yimin Xu’s work, you really should. Yimin is a professional investor; his career began as a market-maker in the rates market and today he manages his own capital and publishes the research and algorithms that he uses to do so. I’m delighted to be able to host his work here at Cestrian.
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Me personally? I use AI/ML signals every single day. Why would I not? Do I write these notes with a quill? I do not. Do I illuminate my office with a candle? I do not. Do I conduct fundamental research by visiting the local library to read securities almanacs? (I probably would if I could, but since the library closed in 2017 it’s hard to do so). Algorithms are here now, and working now - don’t miss out.
Now, let’s take a look at where all the moving parts stand. Join our Inner Circle service if you want the good stuff every day in your inbox.
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