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Wall Street has been declining for three consecutive weeks. Compared to the highs of the end of March, the S&P 500 index lost 5.5%, losing the symbolic threshold of 5,000 points in the last session. At the moment it is a physiological correction after five months of increases without pauses which led the main stock index in the world to post a record +28%.
Geopolitical tensions in the Middle East are contributing to the current phase of weakness, but it must be said that the price lists were overbought and were probably waiting for a trigger to turn around. When a correction starts, the questions everyone asks are: how long will it last and to what extent can the downturn take root? Nobody has a crystal ball to predict the future. But there are fundamental reasons, beyond exogenous factors that can fuel capital movements such as those of a military escalation. Two of these are negative in the short term. Two others, however, are decidedly positive.
Let’s start with the bearish factors. We are in the midst of the quarterly reporting season (next week we will discover the accounts of some of the magnificent seven) and this means that the block on buyback plans has been triggered. A trend, that of the buyback of own shares, which contributes to making company shares increasingly scarce and which is a very widespread practice on Wall Street, so much so that it is one of the reasons why the US stock market constantly trades at a premium compared to the European stock markets where the use of this tool is only recently growing. Without the help of buybacks, operators are freer to sell because on the other side of the book they do not find the firepower of the liquidity of the company which has allocated a significant budget to buy back the shares. There is another bearish factor in the short term. The liquidity in circulation is reducing. This can be seen by analyzing the availability in the US Treasury’s current account at the Fed and the other main commercial banks. We are close to 1 trillion dollars.
Last May, before the agreement on the debt ceiling valid until next December, this account had practically disappeared. Technically, an increase in Treasury cash is equivalent to a drain on liquidity. The recent increase is also linked to the key date in the US for filing tax returns which this year fell on April 18th. In essence the Treasury is collecting taxes. This is taking away liquidity from citizens and filling up their account. Furthermore, the Treasury is selling government bonds at a rapid pace to finance a growing deficit that is reaching 6% of GDP. This is also a form of liquidity drain. Therefore the temporary suspension of buybacks (less financial support) together with the drainage of the Treasury (less fiscal support) have in fact reduced the liquidity formula (which is obtained by subtracting from the Federal Reserve balance sheet the liquidity present in the Treasury account and that present in the of the Fed’s deposit called reverse repo market) from 6,500 billion in March to the current 6,200 billion. And we know that financial markets, in particular risk-on, rests primarily on the driver of liquidity. If this decreases for various reasons it is difficult to see a stock market rally.
But this is where the bad news ends and the good news begins. Because if liquidity is actually in reverse in the short term, it could start up again in the coming months, potentially offering new fuel to equities.
