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Weekly Market Update May 31, 2024

May 31, 2024

Fed Funds 5.25% - 5.5%, US Ten Year 4.505%, Oil $77.26

Liquidity in U.S. financial markets may be declining, which could it make it difficult for stocks and other risky assets to advance from here. According to JPMorgan analyst Nikolaos Panigirtzoglou, liquidity has entered “a mildly contracting phase.” The chart below shows the United States’ M2 money supply, consisting of commercial bank deposits and assets under management at money-market funds.

Since the end of March 2024, Panigirtzoglou estimates U.S. money supply has contracted by around $200 billion, due to three factors: the Federal Reserve’s continued, if reduced, quantitative tightening; a bottoming out of usage of the Fed’s reverse repo facility; and more subdued growth in U.S. bank lending. “In all, U.S. liquidity or money supply appears to have entered a mildly contracting phase from Q2 2024 onwards, similar to 2022.” This may pose a risk for stocks. Some may recall that similar tightening at the beginning of 2022 was a precursor to the stock market’s sell-off in that year.

I raised the possibility of a stock market correction as recently as the May 17 Weekly Market Update, based on an historically high earnings yield (inverse P/E ratio) of stocks. From a technical perspective we may have witnessed the beginnings of such a correction this week. From the chart below we see that as the S&P 500 climbed out of April’s funk in May, it hit resistance at about 5,236 (purple line). It succeeded in breaking above that resistance on the third attempt. Often when a resistance line is finally pierced after multiple attempts it becomes a new support line. The question now is, will the support line hold? Today the index dropped below the line intra-day, but recovered in the last two hours, closing above the new support line. This is a classic test of the resistance-becoming-support thesis. That the index would test the support was no surprise; when it broke through resistance on May 14 it left a gap, denoted by the blue triangle. Such gaps often need to be “filled” before the index can move higher, which was indeed the case here.


The possibility of a stock market retracement exists with the money supply contracting. If that factor overcomes the technical support we can have a significant correction, a regular occurrence during the summer months. A decent-sized cash reserve earning 5% interest is a good place to park some cash during this uncertain period.

 

Wishing You a Great Week,