Last week I wrote about how mutual fund cash holdings had fallen to a 3.4 percent record low. That means mutual fund managers have never been more highly invested in the stock market than they are now!

History shows that low points in the mutual fund cash quote have been near perfect signals to get out of the stock market. But I think it’s smart to have additional confirmation.

So today I want to discuss another very important indicator that is part of my stock market and business cycle model: World liquidity.

Liquidity is one of the most important drivers of stock prices. Moreover, liquidity fuels commodity prices and the whole business cycle. That’s why it’s safe to conclude …

Overwhelming Liquidity Created the Rally of 2009/10

World governments’ answer to the financial crisis of 2008 was a huge wave of newly created liquidity. This tidal wave lifted all boats around the world — from commodity prices to stock markets. Now the liquidity glut has run dry. Hence this major bullish force has faded … and commodity and stock prices are running low on gas.

To calculate global liquidity I take:

The yearly percentage change of the M1 money supply,
Minus industrial production,
Minus consumer prices of the G7 nations.

Thus my global liquidity indicator shows the percentage change in the world’s excess liquidity — liquidity generally available to drive financial markets higher.

As you can see in the chart below this indicator reached a major high in mid-2009. Since then it has fallen off a cliff. In fact, according to this indicator world excess liquidity has been shrinking for three consecutive quarters.

chart Global Liquidity Drying Up — Commodities, Stocks and Economies at Risk!

The upper horizontal line in this chart shows the CRB Commodity Index. The thin vertical lines show how lower turning points in the liquidity indicator coincided with highs in commodity prices.

Clearly, a lack of excess world liquidity does not bode well for commodity prices, stock prices or the economy. And I interpret this important indicator as a major, recession-warning sign.

Best wishes,

Claus

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