Credit spreads have narrowed significantly since the beginning of the year. Check out the graph below via Citi Bank.
Credit spreads and stocks move together because all market moves are governed by liquidity conditions. When liquidity conditions tighten (credit spreads widen) the cost of capital goes up, and therefore the returns investors receive in equities relative to other assets looks less attractive.
It’s important to stay in tune with liquidity conditions because that’s how you give yourself a chance to actually time the market. Stanley Druckenmiller earned his breathtaking track record by paying close attention to liquidity in the financial system. (Quote below)
I never use valuation to time the market. I use liquidity considerations and technical analysis for timing. Valuation only tells me how far the market can go once a catalyst enters the picture to change the market direction.
Central banks around the world have been easing significantly since the start of the year, injecting liquidity into what was a panicked market back in December.
And because of this the Dow has rallied almost 4000 points this year! Until liquidity conditions tighten up again we remain bullish and in sync with liquidity flows. Shorts must use extreme caution until liquidity conditions deteriorate again.
For more information on how to measure liquidity, check out our Free Stuff tab of the website to download our Advanced Liquidity webinar for free!
Co-Founder of Macro Ops, Trader, Poker Player, Game Theorist, Volatility Specialist