Four Ways the Financial Venturi Effect Can Drive Big Stock Market Rise | Private Equity Weekly

What is driving this stock market meltdown that is not backed by unusually strong fiscal flows and defies usual seasonal patterns?

The table below shows U.S. segment balances as of last year moon. This information is prepared based on United States national accounts.

In March 2024, the private sector recorded a $380B surplus, which was a very positive outcome for asset markets as private sector financial balances increased and led to an increase in aggregate demand for goods, services and investment assets.

As you can see from the table, the $380 billion private sector surplus came from $297 billion in capital injections from the federal government (including about $8B in new reserve interest funding from the Fed, which was invested directly) banking sector), minus -$65 billion flowing from the domestic private sector into the Fed’s foreign bank accounts (external sector X) in exchange for imported goods and services. Bank credit creation increased by $148B, more than double last month’s rate.

The numbers for the last six months or so are nothing special from those during the 2020 COVID-19 emergency spending and the sharp stock market recovery shown at the beginning of the table. Fiscal flows alone cannot explain the sharp and sustained collapse of the U.S. stock market.

The chart below shows how much money the federal government has withdrawn from the Fed’s bank accounts. When the government spends money, it gives more money to the private sector and helps the stock market rise.

The table shows that total spending decreased by nearly $500 billion from last month, to about $2.5T. This month, federal taxes, fees, charges and bond turnover kept $297B of that spending in the private sector, creating a federal deficit equivalent to a private sector surplus. When the current account deficit is subtracted from this result, the domestic private sector balance is $228B. In terms of purchasing power, the situation improves again when adding in bank credit creation of $148B.

While the results were strong, they were not enough to explain the stock market’s strength over the past six months.

The chart below shows how the rise and fall of the balance between the US private and domestic sectors led the SPX Index.

Last month, domestic private sector balances led forecasts (SPX) that they would end March higher than where they started, and that’s exactly what happened.

This month’s chart predicts the same outcome for April, given continued strength in domestic private sector fiscal flows. So far, this has been the case, and it will likely continue to be the case.

The chart below shows how the information in the U.S. segment balance sheet changes over time, taking into account any delays in the impact of these changes. This is like a tool that helps us understand what is happening in the market from a distance.

The blue line represents funds spent by the government and credit created by banks minus the current account balance. It can predict economic changes four quarters in advance.

Changes from last month were gains in the SPX, as well as increases in GDP and bond yields. The leading blue line continues to rise.

The chart below shows five-year averages of seasonal stock market patterns for the SPX (SPX), Nasdaq (NDX), Dow Jones Industrial Average (DIA), Russell 2000 (RTY), and the Biotech Market Index. The black oval shows where we are now.

This chart clearly shows how the green line ignores the expected seasonal pattern set by the orange line. The orange line is the five-year average of the SPX. By convention, the SPX should fall toward the end of the first quarter of 2024 and provide a bargain-hunting opportunity. There were supposed to be at least two seasonal dip-buying opportunities this year, but they didn’t materialize, and people are starting to ask why.

Four factors come to mind:

1. The interest income of the treasury brought by high interest rates.

2. Global fiscal spending by governments around the world.

3. The peak of the real estate cycle is coming.

4. The interest paid by the Federal Reserve Bank to banks on their reserve balances rises as interest rates rise.

These factors are discussed in more detail below.

1. Interest income from national debt:

One thing that has been very different over the past 18 months or so is the Fed’s stance and its interest rate policy.

Unlike previous years, we now have very high interest rates, and this may simply be an increase in fiscal revenue for wealthy recipients, who then purchase paper assets in a narrowly focused manner beyond the scale of normal asset purchase patterns.

The chart below shows the very long-term, broad-based growth relationship between federal interest payments and the stock market.

Federal interest payments appear to be ahead of the stock market by several quarters, and this effect is accelerating as the stock of Treasury securities grows, making the curve steeper over time. The curve is now almost vertical.

2. The convergence and rise of the lagging effects of G5 fiscal flows.

G5 flows are the combined spending of the world’s five largest economies. C5 is the balance sheet of the five largest central banks in the world.

The financial flows of G5 and C5 together affect what in fluid dynamics is called the carrier wave on which all other financial flows and market effects are based.

The chart above shows that by 2024, the brown carrier wave will rise sharply, which tends to boost asset markets in its wake.

The brown line in the image above shows this carrier. The next chart shows this in a more granular format, but isn’t as in-depth as the one above.

A more recent view of the same message shows how the brown line fell in the first quarter of the year and then rose starting in the second quarter.

These charts are not very detailed, and it could be that the macro boost from G5 traffic arrives earlier than expected, which could explain the unusually active market. It also suggests that things are likely to get better, not worse, over time.

3. The economic rent effect of the final, mania-driven winner’s curse phase of the real estate cycle.

The chart above shows the progression of the housing cycle and how it has now entered its final and most explosive and speculative phase. Rising house prices have created a concentrated wealth effect among homeowners and are the peak of price growth since the 2009 recovery. In the past 15 years, land price growth has reached its peak, monetized, and then entered the asset market.

Land prices rose and reached such a peak that there was a wealth effect based on the equity value of ordinary people’s homes. Some of them will then take out home equity loans, monetize the wealth that came from nowhere and spend it on paper assets, further concentrating the stock market meltdown. There you can see how rising land prices drive credit creation, which drives aggregate demand, even for ordinary people (not just the big tycoons in towns and cities), and that money funnels into the stock market.

It’s important to check the housing market regularly as it is closely tied to the overall economy and is expected to reach its peak in 2026.

This chart shows various aspects of the real estate market. In this case, we see that lumber prices (orange line, which tends to rise during boom times) appear to have bottomed out and are approaching local lows, but are still not rising. Now, the homebuilder ETF Home Depot is down month over month. Still, housing starts and permits increased. Rates on Freddie Mac’s 30-year contracts are down (which is generally good for housing, and could explain why permits and approvals are increasing at the same time as more people get slightly cheaper loans and choose to build or buy). The purple government spending line trends upward through most of the remainder of 2024, before falling and rising again in 2025. This line is the same as the fiscal carrier wave, which sets the general trend for all other waves that follow, as shown in the second point above.

4. Interest on Fed Reserve Balances

Another important factor is the interest earned on reserve balances, which goes directly to banks due to high interest rates and is related to the first factor listed above.As shown below

Banks tend to invest idle income into income-producing paper assets such as stocks and bonds at a rate of about $10B per month.

Four-way financial Venturi effect.

The above four factors support the thought experiment that the current and ongoing stock market circuit breaker is driven by the financial Venturi effect under conditions of only average fiscal flows.

Treasury interest income, IORB, and monetized wealth from the real estate cycle are sources of income for which the recipient is essentially already wealthy. In search of yield and high levels of discretionary spending, recipients sought to invest the money in paper assets, causing a stock market rally that was extraordinary compared to the actual strength of current fiscal flows.

This Venturi effect is supported and reinforced by the background effect of an overall rise in the lagged impact of G5 fiscal flows.