MacroVoices #507 Michael Howell: Is This The end of the Everything Bubble

Key Concepts

• Global Liquidity Cycle: A recurring pattern in the flow of funds through global financial markets, with a 65-month periodicity, driven by debt refinancing.
• Debt Refinancing Cycle: The primary driver of the global liquidity cycle, linked to the average maturity of debt in the global economy (approximately 5.5 years or 65 months).
• Debt Liquidity Nexus: The paradoxical relationship where debt requires liquidity for rollover, and liquidity requires debt as collateral. An imbalance leads to financial crises (too much debt, insufficient liquidity) or asset bubbles (too much liquidity).
• Fed Liquidity: Specific components of the Federal Reserve's balance sheet that create liquidity for markets, distinct from the overall balance sheet size.
• Treasury QE: A policy shift towards financing government deficits through short-term debt issuance (Treasury bills), which effectively acts as a form of monetary stimulus by encouraging banks to hold this debt.
• Capital War: A struggle for global economic dominance, particularly in terms of currency and capital, as opposed to a traditional trade war.
• Digital Collateral vs. Gold: The emerging dichotomy in global monetary systems, with the US leveraging stablecoins and technology, and China backing its currency with gold.
• Repo Markets: Crucial for debt refinancing, tensions in these markets signal liquidity shortages.
• Asset Allocation Cycle: The cyclical movement of investment across different asset classes (equities, commodities, cash, bonds) driven by the global liquidity cycle.

Global Liquidity Cycle and Market Outlook

This episode of Macrovoices features Michael Howell, CEO of Global Liquidity Indices, discussing the 65-month global liquidity cycle and its implications for financial markets. Howell argues that global liquidity, defined as the flow of funds through world financial markets (distinct from M2 money supply, focusing on fringe funds in repo markets and shadow banks), is a primary driver of asset prices.

The 65-Month Global Liquidity Cycle

• Periodicity: The global liquidity cycle exhibits a consistent 65-month periodicity, identified through Fourier analysis and independently corroborated by the Foundation for the Study of Cycles.
• Driver: This cycle is best explained as a debt refinancing cycle, with the average maturity of global debt being approximately 5.5 years (65 months). Capital markets are primarily mechanisms for refinancing existing debt rather than raising new capital for investment.
• Current Position: The cycle last bottomed in October 2022 and has been in an uptrend since. However, it is now showing signs of inflection, coinciding with the projected downturn around late 2025 to early 2026. This inflection point is a cause for concern, suggesting a potential end to the current equity outperformance.

Asset Allocation and Market Phases

Howell presents a schematic diagram (Slide 13) illustrating the asset allocation cycle overlaid with the liquidity cycle:

• Rebound/Calm Phases: Characterized by strong equity performance.
• Peak of the Cycle: Commodities tend to pick up strongly.
• Downswings: A shift towards cash for better absolute returns.
• Trough of the Cycle: Favoring longer-duration government debt.

The "traffic light" system (Slide 15) further elaborates on expected asset class performance:

• Rebound: Prudent asset allocation, moving into equities and credit. Commodities are too early, bonds not of interest.
• Calm: Equities pick up more strongly, first signs of commodity action. Caution on credit as spreads have narrowed.
• Speculation: Equities proceed with caution, commodities fully green.
• Turbulence: Exit equities, consider credit (more attractive spreads), and bond duration.

Industry groups also follow a pattern: cyclicals in upswings, defensives in downswings. Technology leads in rebound and calm, financials perform strongly around mid-cycle calm, and energy/commodities do well later in the cycle.

Current Market Observations and Concerns

• Equity Peak: Howell believes Wall Street is in a speculative phase, and other markets (Europe, emerging Asia) are in the late calm phase. The US market is considered near the peak of the cycle.
• Technical Signals: The recent market sell-off, with the S&P closing below its 50-day moving average for the first time since February 2025, is seen as a significant technical signal, potentially indicating a larger downturn. This aligns with the historical pattern where such a signal preceded a substantial market drop.
• Commodity Outperformance: The observation that commodities are starting to take off aligns with the expectation that they perform well after equity cycles peak.

Policy and Liquidity Shifts

• Main Street vs. Wall Street Stimulus: There is a perceived policy shift towards stimulating "Main Street" rather than "Wall Street." This is evidenced by comments from FOMC appointees suggesting a combination of interest rate cuts and Federal Reserve balance sheet shrinkage.
• Treasury QE: A move from Fed QE (Quantitative Easing) towards Treasury QE is anticipated. This involves changing the US issuance calendar towards bill finance (short-term debt), which effectively acts as a liquidity injection by encouraging banks to finance the deficit. This is seen as a form of deficit monetization.
• Repo Market Tensions: Similar to 2019, tensions are emerging in the repo markets, indicating stress in debt refinancing due to liquidity withdrawal. This could lead to unexpected market blowouts.

The Debt Liquidity Nexus and its Implications

• Paradox: The core of the global financial system is the debt liquidity nexus: debt needs liquidity for rollover, and liquidity needs debt as collateral.
• Collateralization: A significant portion (77%) of global lending is collateral-based, often using US Treasuries or German Bunds.
• Equilibrium: An equilibrium exists around a debt-to-liquidity ratio of approximately 200%.
  • Above Equilibrium (Too much debt, insufficient liquidity): Leads to financial crises and refinancing tensions (e.g., Global Financial Crises).
  • Below Equilibrium (Abundant liquidity): Leads to asset bubbles (e.g., the "everything bubble").
• Current Trend: The debt-to-liquidity ratio is rising, indicating a move away from the "everything bubble" and towards a period of refinancing stress.
• Debt Maturity Wall: Slide 23 highlights a significant "debt maturity wall" for advanced economies, particularly in the late 2020s, with a substantial increase in debt needing refinancing. This requires significant liquidity, which policymakers are not prioritizing.
• Monetary Debasement: The increasing debt burden and the need for refinancing are driving a "monetary debasement trade," as governments may resort to printing money to manage their debt. This could lead to accelerated M2 money supply growth, incompatible with central bank inflation targets.

China's Role and the New Currency Wars

• China's Debt-to-Liquidity: China is also facing a high debt-to-liquidity ratio and is being forced into currency devaluation. This is partly a response to the threat posed by US stablecoins.
• Gold Accumulation: China is aggressively accumulating gold, both through production and open market purchases, potentially amassing significant official holdings. This is seen as a move to back its currency with gold, creating a "tangible collateral" system versus the US's "digital collateral" (stablecoins).
• Capital War: This dynamic is framed as a "capital war" between the US and China, with the US leveraging technology and stablecoins, and China relying on gold.
• Impact on Commodities: Increased Chinese liquidity and economic activity are expected to drive up commodity prices.

Outlook for Gold and Commodities

• Commodity Outperformance: Howell reiterates that commodity markets are expected to perform well.
• Gold as a Hedge: Gold is seen as a crucial hedge against monetary inflation. Projections suggest a significant increase in the gold price by 2030s and 2050s, driven by the exponential growth of US federal debt.
• Mining Stocks: While mining stocks offer value, their performance is tied to both earnings (driven by commodity prices) and the broader equity market's price-to-earnings (PE) multiple. The underlying commodities are considered a safer bet.
• Gold Market Dynamics: The gold market is influenced by China's gold buying and the US's potential strategy to destabilize gold prices. The outlook for gold involves playing the trends, with both gold and Bitcoin being essential assets for hedging against monetary inflation.

Trade of the Week: Interest Rate Outlook

Patrick Serzna translates Howell's outlook on interest rates into a trade idea:

• Core View: The Federal Reserve is likely to shift towards a more dovish stance, cutting rates sooner and faster than the market currently prices in, due to liquidity pressures, Treasury issuance, and a focus on Main Street.
• Trade: A 3-month SOFR December 2026 97.12 to 98.50 basis point wide vertical call spread.
• Rationale: This trade aims to profit from the market repricing lower policy rates, offering a defined risk with a potential 5:1 payoff if deeper cuts are priced in.

Postgame Analysis: Equities, Dollar, Oil, Gold, Uranium, Treasuries

• Equities: The market has experienced its first 5% correction since February. Despite positive Nvidia earnings, the underlying market breadth is deteriorating, with a majority of stocks in a downtrend. The S&P 500 is struggling below its 50-day moving average, suggesting a potential topping formation.
• US Dollar: The US dollar index (DXY) is showing signs of a breakout, which could be a headwind for risk assets and the reflation trade that has been dominant. Synchronized dollar strength is observed across major currencies.
• Oil: Crude oil is consolidating but has defended the $58-$59 level. While the primary trend is down, there's a quiet accumulation phase. A catalyst like an attack on Venezuela could spark a short-term breakout. Political considerations suggest a desire for lower gas prices into the midterms, followed by a potential rise post-election.
• Gold: Gold is forming a pennant or symmetrical triangle pattern, indicating consolidation. Dips are being bought, and the 50-day moving average is holding. Further consolidation is expected into December, with a potential breakout in the first quarter of 2026.
• Uranium: The uranium ETF (URRA) has pulled back significantly, moving from overbought to oversold. The AI trade's resilience (due to Nvidia's earnings) suggests the correction might not be over, but tactical buying opportunities may emerge. The physical uranium trust is in a larger consolidation, with uranium prices generally favored due to asymmetry.
• Treasuries: 10-year Treasury yields have been rising since the last FOMC meeting but have not yet established a new bull trend. The jobs report delay and potential Fed hold in December suggest yields may remain muddled through the fourth quarter, with major moves expected in the new year. Mean reversion around current levels is the most likely outcome for the remainder of the quarter.