When fundamentals no longer support markets, the only answer to continued rising asset prices must be liquidity.
Liquidity in my mind can be broken down into direct and potential liquidity.
I would like to define direct liquidity as central bank open market purchases a.k.a. expanding their balance sheets. Below you will find a chart that is the most up to date aggregate of central bank assets that I can find. I am unsure why the PBOC is not included, but this chart is still a useful proxy.
The main point is that there is a clear correlation between growth in central bank balance sheets and rising equity prices, and it appears that the contraction has resumed its course.
Next, we can touch on potential liquidity. Companies have the option to either buyback their stock with the money they earn or accumulate via debt issuance. Should the company choose to allocate their capital towards buybacks, then it should be fairly straightforward that this is a form of a liquidity injection to the price that will help to support or to boost prices. Below, you will see the trend in stock buybacks over time.
The reason I called this potential liquidity was not just due to the fact that it was the companies’ choice of how to allocate their funds, but that during earnings season some companies will go into what is called a buyback blackout period. The “potential” ceases temporarily as these companies are restricted from purchasing their own stock via buyback. Below, you will see that one is approaching now.
At the cusp of a liquidity drag, it should come as no surprise to the contrarian investor that investors are possibly jumping in at one of the worst times. This can be seen in the below tweet, which displays that investors are piling into a growth equity ETF at the fastest pace ever.
At times like these, prices can always get a lot crazier before they return to “normal,” but it is imperative to proceed with caution.