LIQUIDITY

Capital Market Comment
March 15, 2018
Frank Mastrapasqua, Ph.D.
Principal, Chairman & Chief Investment Officer

As we enter changing fiscal and monetary policy cycles, our strategies will increasingly reflect the evolving investment landscape. Liquidity and the management of that liquidity will play an even more important role. Rising short-term rates should generate a higher return on liquid assets, and short-term bonds also become a viable option. Increased liquidity will help lessen portfolio volatility and sensitivity to the market. At the same time, a higher level of liquid assets provides the resources to take advantage of opportunistic situations due to market volatility and its impact on stocks. Algorithms, quant models, hedge funds, program trading, and mispriced ETFs produce outsized moves in individual stocks, making liquid resources even more important.

Equally important, as the business cycle matures, increased focus will be upon the key secular trends (themes) and the companies that should experience improved profitability and/or cash flow, regardless of the fluctuating nature of the business cycle. Defense, cybersecurity, cloud computing, artificial intelligence, and healthcare technology are just some of those themes.

At the same time, our cyclical exposure is likely to diminish as peak earnings and profit margins are approached. The impact of growing monetary restraint will impact the business cycle.

Currently, the monetary climate remains supportive of business activity and the equity market. With negative real interest rates and inflation adjusted money supply growth still positive (although less so), and the European Central Bank remaining aggressive, conditions are still favorable and likely to remain that way for some time. However, we remain diligent and sensitive to the changing environment and will closely monitor liquidity conditions.

M Capital Advisors’ Liquidity Index which is the product of many years of research, attempts to capture the degree of stress in the financial markets and assist in influencing asset allocation decisions. For example, an index decline from 100 toward 80 would suggest growing financial stress, and a basis to review and adjust asset allocations further. The index, along with other quantitative and behavioral factors should be helpful in assessing the evolving monetary dynamics.