The Floodgates of Liquidity Remain Wide Open

Updated on

Last week’s stock market price action smacked of a rally that had run out of good news to trade on. All of the heavy hitters that tend to pack the top quartile of the S&P 500 had posted great numbers – with the exception of the house that Bezos built. The Fed beat the drum for more QE, but they also gave a wink and a nod that somewhere down the road a taper here (and a taper there) might be in order.

Get The Full Ray Dalio Series in PDF

Get the entire 10-part series on Ray Dalio in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues

Q2 2021 hedge fund letters, conferences and more

Fed’s Balance Sheet Keeps Climbing

Meanwhile, the Fed’s massive balance sheet currently stands at $8.2 trillion and climbing.

Fed balance sheet Liquidity

Lastly, Congress lined up more than 60 votes – all that’s needed to pass a $550 bipartisan infrastructure bill that tees up President Biden’s $3.5 trillion economic plan. The infrastructure package should pass the Senate by the end of this week, assuming that everyone wants to break for the traditional summer August recess that was established in the Senate’s earliest years to escape the DC heat wave, in order to spend time with family, meet constituents in their home states, and catch up on personal affairs.

Going back home without an infrastructure package following decades of delay would be a political setback at a time when the country is facing further challenges with outbreaks of the Covid-19 variant. The current infrastructure plan, as proposed, includes $110 billion in new spending for roads and bridges, $73 billion for electric grid upgrades, $66 billion for rail and Amtrak, and $65 billion for broadband expansion. It also provides $55 billion for clean drinking water and $39 billion for transit needs.

Spending these funds will begin just as federal unemployment benefits are set to expire on September 6 (Labor Day), but the fresh outbreak of the delta variant might give Congress an excuse to extend benefits, but most companies at the top tier of each sector of the economy are making vaccinations mandatory.

The Show Must Go On

For businesses to grow, clearly “the show must go on,” regardless of Covid. The momentum for vaccine mandates has been building, with Joe Biden starting last week off with a new requirement that all federal employees and on-site contractors be vaccinated or submit to regular testing and mitigation requirements.

To date, the notion of returning to lockdowns and shut-ins is off the table because the position of the Biden administration is that vaccines work. According to Reuters, during the latest week, the U.S. averaged 610,020 doses administered per day. At that rate, it will take 108 days to administer enough doses to reach another 10% of the population. This raises questions about stopping the highly contagious delta variant from infecting the population versus the time needed to vaccinate those needing to be vaccinated.


Don’t Forget the Conflict Between Hong Kong and China

And then there is the rising flight of capital from Hong Kong and China amid the growing crackdowns on businesses and free society there. Tensions are increasing in reaction to the new set of security laws. If escalated further, the U.S. could respond by invoking sanctions through the Hong Kong Human Rights & Democracy Act, which allows the U.S. to revoke Hong Kong’s special economic and trading status.

The U.S. can impose tariffs on Chinese products that flow through Hong Kong, and the U.S. Treasury can restrict portfolio flows to and from Hong Kong. Such actions could trigger widespread capital flight, but the fraying relationship between China and the U.S. has been largely ignored by the U.S. equity market.

The reason Hong Kong is so vital is that it represents the outlet for western financial markets in China, so investors, venture capitalists, and businesses that want western dollars have to go through Hong Kong to access capital via the western banking connections in Hong Kong. There is a sense that these relationships are at risk, fueling a steep 28% correction in China’s market and a 16% drop in Hong Kong’s market.

Hong Kong and China

Hong Kong is unique in that it has an open capital account structure without any capital controls, so that money can move in and out very quickly, creating a fuel for capital flight if triggered by a material decline in real estate values and intervention by Chinese government authorities. The fear arising from the regulatory rampage on Chinese Internet platform companies is that it will spread to other industries.

Major global financial firms with a big presence in Hong Kong – like BlackRock and UBS Wealth Management – are on high alert to protect client assets against future policy changes that could create more downside risk to asset valuations. Hong Kong residents are currently fleeing to the United Kingdom following China’s crackdown, where protestors can face life imprisonment for resisting China’s control.

Hong Kong is a city that operates under a real estate-based economy. It now is suffering under the highest number of vacant homes on the market in 18 years. The exodus has rental rates sliding by 10% according to a recent Bloomberg report. My point here is that there are plenty of new reasons for capital to leave China and Hong Kong and find a new home in the U.S. bond and equity markets.

There may be more backing and filling after a stellar earnings season and Fed policy hints, but with so many leading companies raising third-quarter and full-year guidance, the firehose of liquidity from the Fed, Congress, and global investors should cause any corrections in U.S. stocks to be short and shallow.