The Music Hasn’t Stopped Yet, But Keep an Ear Out

Shah Gilani|December 14, 2020

“As long as the music is playing, you’ve got to get up and dance.”

That’s your Capital Wave Forecast. It’s short and sweet and reminiscent of another time when markets were rocking, and investors were raking in the dough.

You might even say, “It’s like déjà vu all over again,” as famously said by Yogi Berra.

Here’s what I mean, and what to listen closely for as we close in on the end of the year…

We’re Not in Crisis Mode – Yet

That first quote, courtesy of Chuck Prince, former CEO of Citigroup Inc. (NYSE:C) in the summer of 2007, actually starts out, “When the music stops, in terms of liquidity, things will be complicated,” then Prince goes on to say, “But as long as the music is playing, you’ve got to get up and dance.” He’s talking about the leverage in the subprime mortgage market and liquidity in all ancillary markets related to MBS (mortgage-backed securities).

That was July 2007. A year and three months later, the music stopped.

October 2008 was beyond frightening, beyond surreal even. As we lived through it, it was like it wasn’t happening, like it was a movie, because how could it be real? How could the U.S. financial system, and a lot of the world’s financial systems, be on verge of collapsing to the point where we’d have to resort to a barter system to live?

Really, we were that close to the unthinkable. The crisis was that unbelievable.

We’re not there again, though there’s a lot of dancing to a lot of music. The thing is, however, liquidity issues could be the straw that breaks this rally’s back. Again, we’re not there, as far as anyone can see, but that’s a problem too.

At least in the subprime market, it was possible to see how illiquid things were getting if you knew where to look. And there were plenty of places, if you looked, where you could see liquidity getting squeezed into a narrowing funnel.

Today, the liquidity issue no one’s talking about is the trading nature of markets. The equity and bond markets aren’t ruled by investors anymore; they’re ruled by traders.

Traders are highly leveraged and subject to liquidity constraints when markets unexpectedly turn upside down. Again. I’m not saying we’re turning; I’m saying if we do, liquidity will be an issue.

Mechanically, and everyone sees this, but they don’t all understand it, markets move up and down with a degree of quirkiness, meaning they can sometimes move a few hundred points (in Dow terms) in a matter of seconds. A thousand-point move can be traversed in a matter of minutes. That’s what I mean by quirky. Things generally smooth out fairly quickly after sudden moves, but they don’t always.

The nature of how spread out buy and sell orders are, meaning they’re directed to different venues for execution, how dark pools operate, how order flow is monitored and front-run, and how retail investors have become the tail wagging the dog, are all mechanical issues that underlie liquidity issues.

Because we’ve been in a raging bull market, those increasingly worrisome “liquidity” issues are under almost everyone’s radar.

Coming into the end of the year, there are a few mechanical pressure valves, such as dollar liquidity and treasury bond liquidity (in a constrained market for Treasuries) that could blow if there’s any sudden selling that knocks markets down at the exact same time almost everyone’s expecting a year-end rally and the bull market to keep on raging.

I’m not betting against the bull market, and you shouldn’t either.

This forecast is just a warning, that until we’re into the middle of the first quarter of 2021, there are some valves holding back some bubbling liquidity issues. And they could start whistling.

Stay the course, just make sure you’ve got your stops in place in case the silence you hear is the music stopping, right before a whistling sound that’s not a tune anyone can dance to.

Sincerely,

Shah

P.S. – The holidays are a time to celebrate one another, and today I want to highlight the successes of my friend and colleague, America’s #1 Pattern Trader, Tom Gentile. He’s done it again… this time, he discovered a pattern that showed up during an audit of 12 months of his own trade recommendations. It revealed the four criteria the biggest winners all met, and the surprisingly simple way you could turn these trends into cash in your pocket. He’ll walk you through every step during private Zoom calls three days a week. All the details are going LIVE tomorrow – keep an eye on your inbox. You’ll hear more about it all soon.