Still Some Gas in the Tank
Reserves Not Yet Depleted: Potential for Growth Remains
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Newsletter Rundown:
Reverse Repo is Favorable
Financial Conditions are easy
ECRI Weekly Leading Index is Strong
Final Word
Still Some Gas in the Tank
As you can see in the chart, the inverse blue line (reverse repo), has been steady —a constant pull upward on the black line (SPY) over time.
The flow of funds from RRP into T-Bills is beneficial for risk assets for a few reasons: a longer time to maturity, greater capacity for margin, and the Fed acting in a predictable way.
The consistent and steady decline allows market participants to remove the guesswork from risk-taking. This does not hold true when we get into April.
As we mentioned back in November, based on our projections, the current pace of the reverse repo drawdown suggests the balance will go to zero by April 2024.
The trend line shows a strong negative correlation (R² = 0.97), demonstrating a high degree of linearity in the decrease of RRP over time.
This pattern suggests a sustained and methodical release of funds from the Federal Reserve's tightening policy, serving as an intraday relief valve for the financial system.
We believe the April tax deadline to be a pivotal time for policy makers.
Until that time, we believe the drawdown is a reliable tool the Fed has to fight inflation and combat a large market selloff.
This chart displays the rolling 3-month correlation between the S&P 500 and Overnight Reverse Repo. The bars fluctuate between positive and negative values, indicating how correlation is not constant.
Despite this, when the bars are above the horizontal axis, this suggests a positive correlation (or concurrent movement) between the two, typically corresponding to a period where risk assets perform poorly.
On the other hand, the negative correlation periods may reflect risk-on sentiment or a strategic preference by market participants as the drawdown period continues to boost returns.
With ~$450B still in play, we believe there is still gas in the tank to run stocks higher.
Financial Conditions are Easy
Frequent readers should know I like using the Adjusted National Financial Conditions index.
The Adjusted National Financial Conditions Index (ANFCI) is a comprehensive weekly update on 105 U.S. financial conditions across three categories of financial indicators (risk, credit, and leverage).
We like this measure because adjustments are made to remove the variation based on inflation.
The weekly data goes back to the 1970’s, includes “shadow banking” metrics, and is a key input in our investment outlook.
Positive values have historically been associated with tighter-than-average financial conditions. (Bad for risk asset)
Negative values have historically been associated with looser-than-average financial conditions. (Good for risk asset)
We are clearly in a loose condition which is positive for risk assets.
Our research suggests that you need both ANFCI tightening and decreasing net liquidity— for risk assets to selloff. Source
ECRI Weekly Leading Index
The Economic Cycle Research Institute (ECRI) maintains a proprietary composite of leading economic indicators. It has an impressive record, going back decades, of signaling recessions and business cycle changes. Source
I like to use the Weekly Leading Index (WLI) as a high-frequency leading index of U.S. economic growth.
The latest ECRI Weekly Leading Index indicates a slight decline in growth, coming off an impressive peak of 9% in February.
We wanted to see the WLI gain back to positive territory to be pro risk assets.
We are now well above the zero level threshold.
Historically, this has been a good indicator of when recessionary pressures have subsided.
The significant rebound since mid-November and sustained rates above 7% indicate a strong trajectory that suggests continued growth is likely.
We consider this a positive sign for equity markets going forward.
Factors that might shift our optimistic (bullish) assumptions to pessimistic (bearish) include:
Larger than expected buildup in the Treasury General Account
Sharp drop in available treasury issuance
Forced deleveraging by a major market speculator
Restrictive shift in policy from the Bank of Japan to combat inflation
There's every reason to believe that the economic strength we've seen can indeed continue.
Final Word
Thank you for reading and I am grateful and humbled to be able to learn, grow, and invest alongside you at Tuttle Ventures.
Vision, courage, and patience leads to successful investing.
Don’t forget to follow Tuttle Ventures on Twitter, LinkedIn, or Instagram.
Check out the website or some other work here.
Best,
Darin Tuttle, CFA
This is not investment advice. Do your own due diligence. Past performance is no guarantee of future results. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. Investors are encouraged to perform due diligence, consider their risk tolerance, investment goals, and consult with financial advisors before making investment decisions. I make no representation, warranty or undertaking, express or implied, as to the accuracy, reliability, completeness, or reasonableness of the information contained in this report. Any assumptions, opinions and estimates expressed in this report constitute my judgment as of the date thereof and is subject to change without notice. Any projections contained in the report are based on a number of assumptions as to market conditions. There is no guarantee that projected outcomes will be achieved.
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