Asset markets are driven by liquidity. We monitor Global Liquidity and fit this into a dynamic framework to understand the likely position of markets within the investment cycle. Liquidity measures the flow of funds through World financial markets. It is different from traditional measures of ‘money supply’ and primarily begins where standard measures such as M1 and M2 end. Liquidity essentially measures balance sheet capacity across financial intermediaries. Liquidity is vital when our whopping US$350 trillion of global debt need to be rolled over. We argue that modern financial markets have become a ‘refinancing’ mechanism for debt and no longer ‘new financing’ vehicles for capital spending.
The Global Liquidity cycle is related to the traditional business cycle, but it tends to lead activity by around 15 months. It moves in advance of popular leading economic indicators, such as business surveys, by around 6-9 months and precedes changes in the interest rate yield curve by a similar margin.
We think of the liquidity cycle as passing through fours investment zones: Rebound, Calm, Speculation and Turbulence. Each zone characterises a different investment regime indicates by the eponymous title. Turbulence is ‘bad’ for risk assets, whereas equities tend to excel in Calm.