"Excess Liquidity" Turns Negative, U.S. Stocks May Face Strongest Headwinds Since 2021
While the US stock market is still reveling in the AI boom and the record-breaking rally of tech stocks, some key macro indicators are sending warnings.
According to the latest article by Bloomberg strategist Simon White, the global financial environment is entering a new tightening cycle. Excess liquidity has turned negative for the first time since 2021, the yield curve continues to flatten, and real interest rates keep rising, indicating that the core drivers supporting the ascent of risk assets over the past few years are gradually fading.
Although newly appointed Fed Chair Kevin Walsh signaled a hawkish stance during his first policy meeting, the market had already started tightening ahead of time. The bond market's pricing of higher interest rates has been intensifying, and financial conditions have tightened the most since the post-pandemic inflation shock.
Excess liquidity turns negative, market adjustment risks are building up
The core indicator watched by Simon White is "excess liquidity", which refers to the money supply growth rate after deducting inflation and economic growth.
In recent years, an accommodative monetary environment provided ample funding for the stock market, but this indicator has now turned negative and continues to decline. As economic growth rebounds and inflation reemerges, the extra funds brought by monetary expansion are being rapidly depleted.
Historical evidence shows that a decline in excess liquidity typically causes the yield curve to flatten and puts pressure on the stock market over the next 3 to 6 months. At the same time, the current relative valuation between stocks and bonds is at the 95th percentile of the past 50 years, meaning that even a simple mean reversion could trigger a stock market correction and further changes in bond yields.
The interest rate gap narrows, global monetary policy tightening intensifies
White believes that the key to determining whether monetary policy is restrictive lies in the gap between the interest rate and the neutral rate.
Although it is widely believed that the AI-driven wave of capital spending has pushed up the neutral rate, expectations for the terminal rate have risen even faster, leading to a continuous narrowing of the gap. This means monetary policy is becoming increasingly restrictive.
Globally, this trend is equally evident. As inflationary pressures driven by wars spread worldwide, central banks have adopted more hawkish stances, and the market's expectations for future rate hikes and the persistence of high rates continue to rise. According to models, global long-term real interest rates still have room to rise further in the coming months, and the process of tightening financial conditions is far from over.
Liquidity ebb plus increased supply puts pressure on stocks
For the stock market, the problem more troublesome than interest rates is the accelerating withdrawal of liquidity.
Historical data show that excess liquidity is highly correlated with future stock market returns, and persistent liquidity deterioration is often accompanied by weaker risk asset performance. Not only is liquidity shrinking, but supply-side pressure is rising in tandem—the net supply of US stocks has turned positive for the first time since the pandemic, with a revival in corporate financing, secondary offerings, and IPOs, meaning the market needs to absorb more new shares.
Against a backdrop of insufficient liquidity, expanding supply directly increases valuation pressure. In short, the market will face not only a shortage of funds in the future, but also more assets fighting for limited capital.
AI boom can't hide liquidity concerns, sentiment-driven upturn will ultimately face funding reality
Of particular concern is that there is a clear divergence emerging between market sentiment and the liquidity environment. Data show that US equity ETFs recently recorded the second-highest single-month inflow on record, with a large number of retail investors re-entering the market, betting on continued gains in tech stocks and the AI theme.
Historically, retail investors are often the most aggressive buyers in the final phase of a bull market. When increasingly more funds chase returns late in a rally, the market often enters a sentiment-driven surge, but such exuberance often signals the accumulation of risk.
In White's view, the real challenge now is not an economic recession, but the contradiction between sustained liquidity contraction and high valuations. The AI boom may be able to lift sentiment in the short term, but if the liquidity supporting the rally in risk assets continues to drain away, the stock market will eventually face an even harsher test.
Disclaimer: The content of this article solely reflects the author's opinion and does not represent the platform in any capacity. This article is not intended to serve as a reference for making investment decisions.
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