Michael Howell: Liquidity Is Turning Against Stocks — What Happens to Gold Next? – Transcript

00:00We should be seeing more and more evidence of tensions in financial markets and as I said the bond markets which tend to be leading are already suffering that particular episode. The implied crude price looking at what we're paying for diesel now is actually $160 a barrel. So that even surpasses uh what we saw you know back in back in sort of the period of past crises.

00:25What's happening right now is that the earnings momentum is still pretty good, right? But the PE multiples are starting to contract. So valuations are coming down and earnings growth is accelerating. You can see that it's been a major catalyst of driving the gold price both on the way up and on the way down.

00:48Okay, ladies and gentlemen. So today we have Michael Howell back on the show who is the founder and managing director of GL Indices. And today we'll focus on liquidity and try to determine what the current liquidity cycle means for various asset classes including stocks, precious metals, cryptocurrency, and we will cover many other very interesting topics. So Michael, thank you so much for being here.

01:15>> Always a pleasure, Vlad. Thank you for the invitation. It's always a pleasure having you on the show sir. So if we could start by looking at liquidity and I'll try to set a table first before we look at what liquidity actually means for these various asset classes. So the last time we spoke Michael you emphasized that well we have a final amount of money and that money can be in real economy or in financial markets and if the real

01:42economy is doing relatively well that means it puts pressure on financial markets. So if we could start by looking at that if possible >> I think the best way to summarize that V is to say that you all money that's anywhere must be somewhere. So it can't really be in two places at once and if it's in the real economy it's not in the financial markets and if it's in the financial markets it's not in the real economy. So we need to understand that balance and what normally happens is you

02:08get a sequential move. So money begins in the financial sector. That's really the origins of of liquidity and money. And then it tends to spill over into the real economy and then the real economy gets momentum [clears throat] and tends to feed on liquidity and that liquidity gets dragged out of financial markets.

02:25So you kind of get a seesaw effect uh between the two and um the main reason that the liquidity cycle cycles is basically because of that draw of liquidity to uh the real economy. So you get an initial surge of money coming into financial markets. Uh that peaks and around the peak uh that's a signal the real economy is beginning to pick up and absorb more and more cash and drag it out of financial markets. And that's pretty much what's happening now. So if

02:53you look at what's um what's happening in the bond markets for example, bond yields are rising significantly. In other words, bond prices are falling. A lot of that is to do with a very strong read economy. So that's what the bond markets are really telling us. They're not telling us uh contrary to what the media continues to say um that the debt situation is bad, unsustainable, deficits are too big or whatever. I mean there are cases where that's true.

03:17Britain is not in a great situation. Neither is France, neither is Japan, but you know the big economies. Let's think about the US uh Germany. I mean the these are these are kind of untroubled by those questions and yields are rising primarily in those markets because of strong economic growth. So that's that's the major reason. Now, if we turn to where we are in the liquidity cycle, what I'm going to do is to uh pick up um some slides and if I go to this first one, which

03:45hopefully you can see, >> y >> um is looking at the global liquidity cycle and this as it says is a cycle. Uh this is measuring the flow of money through world financial markets. Uh it goes up and it comes down. uh it tends to see regular fluctuations as you can uh uh spot there. They tend to be a five to six year cycle which really reflects the average maturity of debt in the

04:10world economy. So this is principally uh a refinancing a debt refinancing cycle. And what you're seeing here is liquidity um falling. The black line essentially peaked in late 2025 and we've seen several months now of decline. It's been a sort of a bit of a jagged uh sawtooth move down, but the trend is very clear that liquidity is tightening and that really reverses or has been reversing a

04:36lot of the upswing that began in late 2022 which has really powered this bull market and so we should be seeing more and more evidence of tensions in financial markets and as I said the bond markets which tend to be leading are really suffering that particular episode. Um, so that's really the story of what liquidity is doing and why it's uh why it's falling right now.

04:59>> Yes. Thank you for sharing that, Michael. And the last time we spoke, you mentioned that there is usually about a 9mon gap between liquidity and its effect on stocks, right? >> Mhm. Correct.

05:12>> So uh so if we look at that, would would that mean that we should start to see some weakness in the relative near future? Yeah, I think that's the case. I mean, probably the the best way to do this is to look at uh maybe some of this sequencing and to see how it it uh it unfolds. And I'm going to move on to this chart, which is basically uh sort of identifying more or less what you said. And this is saying that you've got

05:38a global liquidity cycle that we show there in red. That's the schematic diagram at the top. uh it shows that there's a transmission from left to what right as that um diagram at the bottom essentially says and the yellow line that we put on top of the red uh red cycle is looking at where the real economy is really positioned. Now you can see that those two cycles don't align uh but one tends to lead the

06:06other. So the red line tends to leave the yellow line. And what you can see as well is that when the red line is falling, it's typically associated with the yellow line, the real economy accelerating. And that goes back to this point that I made at the beginning that all money that's anywhere must be somewhere. So if you've got a strong real economy, uh that's telling us that money is draining or likely draining from financial markets. And that's pretty much the case. Now what we can

06:33see on this chart is uh a couple of other pointers. One is that we label the phases of the liquidity cycle generically. I mean we we'd like to say that you know we can try and broadly speaking predict uh or understand where um the investment cycle is. Um you know it's better to be approximately right than precisely wrong. So we try and say that we're in a phase called turbulence

06:59or rebound or calm or speculation. And that gives a flavor as to what asset allocation broadly should be doing. The second thing that you can see there is a red dot or two red dots and those red dots refer to uh what's happening in the fixed income markets and particularly the yield curve. Now the yield curve is uh probably one of the key metrics to watch in the fixed income markets. It's uh measures the slope of

07:24the term structure and what you typically find is that uh it tends to follow movements in the liquidity cycle. So the yield curve, the slope of the term structure will peak about 9 months after the peak in liquidity and it will tend to bottom uh and begin to steepen about 9 months after the low point in liquidity. And that's pretty much what's going on right now. So if you look at this sequencing, you can see uh what's unfolding. Now what I would just say

07:53before we move on to some further evidence is that if you said uh and this is very crude that if you take the red line the liquidity cycle and said that predominantly affects or exclusively affects bonds um the bond markets will broadly speaking align very closely with that liquidity pool. Um the commodity markets at the other extreme are almost entirely real economy phenomena and they will

08:20tend to align almost exactly with the yellow line. Equities are kind of a little bit of both but the PE multiple the valuation levels of equities tend to move very much with the financial cycle the red line and the earning cycle tends to move very closely with the real economy that is the yellow line. So if you like equities kind of fall between the two. So if you look at the movement of uh asset allocation, it should begin

08:47with bonds, move to equities, and then end up with commodities. And that's pretty much the sequencing that we're looking at right now. Let's say commodities or real assets, something that is affected directly by the real economy. Now, here is the evidence uh of what's happening right now, which almost uh precisely um confirms what I was just saying theoretically. And what you can

09:13see there is that the orange line is looking at the latest data on liquidity. Um the uh black line is looking at the world business cycle. So, this is uh really just a collection [clears throat] of all the major business surveys worldwide. So um this the CPI in the UK uh it looks at the EOS serve in Germany, the Tankan in

09:38Japan, uh the ISM in um uh in the US aggregates those together and comes up with that um index shown as the black line. So that's the world business cycle. The orange line is our liquidity index again. And what I've done is I've cheated slightly and I've just shifted uh the black line on a tad. U so it does seem to almost exactly move anticylically with liquidity but broadly speaking you know what I'm saying that

10:05these cycles are out of step uh is borne out by this chart. So as the real economy is accelerating it's pulling liquidity out of uh financial markets as you can see. Now the other thing that you can say which is relevant to this discussion is this following chart which is looking at the world business or sorry the US business survey I should say here and what's happening to US profits growth and you can see that the

10:32business cycle the black line is absolutely crucial for understanding what's happening to profits reported profits of US companies and what we can see here is that the orange line which is reported earnings tends to follow by a few months the movement of the business cycle. So in other words, not surprisingly, um the real economy is very important for reported profits and you can see in the

11:00current data that the US economy is recovering, but you're actually seeing a sort of an accelerated or multiplied impact on earnings, which is not unusual, but uh it's certainly underway. So you're getting a lot of earning surprises still coming because of the strength of the real economy. So that that's really the backdrop. Now let me just answer your question after that that sort of um going down that rabbit

11:25hole. But what you can see here is basically uh the whole process unfolding uh for equity markets. The this is for the world index and what it's showing is that um the dotted line is the earnings background and the solid orange line is changes in PE multiples. So what's happening right now is that the earnings momentum is still pretty good right but

11:52the PE multiples are starting to contract. So valuations are coming down and earnings growth is accelerating. Now, what you should be seeing if you look at the history of the chart is that the drop in valuations tends to coincide with um that earning cycle. So, what we're seeing at the moment is slightly unusual, but it's quite likely that you're going to see a catch up soon

12:20where earnings start to peak and come down and that's really the thing to start uh factoring in to any asset allocation. >> I would like to ask you for a small favor. about 90% of people who watch these videos are not subscribed to the channel. Having a higher subscriber count would help me dramatically to get new guests, including some of the names that you have been mentioning in the comments below. So, if you do enjoy these videos, if you could please hit