Excess Liquidity = Excess Behaviour

Macro Perspectives: Tue 30 Mar 2021

When the financial world is pumped with liquidity, as the central banks and governments have, we will see excesses. Financial markets are ground zero for risk taking, so it's not surprising that we see early excesses bubbling up there.

The news of the day has been another hedge fund blowup. We had a short seller called Melvin Capital blow up last month, on the wrong side of GameStop - they were bailed out. In recent days, we've had the unwinding of a long and overleveraged hedge fund called Archegos - the big losers here (in addition to the fund) appear to be Nomura (a Japanese bank) and Credit Suisse (Swiss bank).

It has historically been dangerous to call events like these contained, but this one seems contained. Still, if it were a systemic risk, we know (with certainty, in this era) how central banks would respond - they would bail-out and backstop, quickly.

Now, in these cases of forced liquidation, investors tend to sell what they can, not what they want to. With that, there was selling to end last week and to start this week, in what has been working and/or favored inflation trades…

Small caps have been leading the way in stocks this year, today, down 2.8%. If we are indeed seeing some forced liquidations in these spots, it presents a gift to buy at cheaper prices. Small caps are now off more than 8% from the highs.

Gold, a favored inflation trade, was down over 1% on the day. Coincidentally, the sharp move lower on this chart in gold, back in March of last year, was on forced hedge fund liquidations. It reversed quickly.