Reblog: The Importance of Liquidity and Leverage


If you want to trade macro, you need to understand liquidity.

PTJ, Druck, Soros, Dalio — all these legends have expressed this fact multiple times.

Liquidity is what moves markets.

This is even more true now than in the macro heydays of the 70s and 80s.

With the rise of “blind investing” in the form of passively buying and holding ETFs, the majority of investors don’t care about valuation or merit. They just auto-shuttle their excess funds to the nearest robo advisor without a second thought.

This amount of “excess funds” is largely dependent on liquidity conditions.

When liquidity is loose, it’s cheap to get levered. People have extra cash and plow it into risk assets. Prices rise.

When liquidity is tight, people have less cash to spend. They may even sell stuff to service their existing debt. Prices fall.

There are a myriad of ways to measure and monitor liquidity conditions.

No single method is best, but one of our favourites is using the Chicago Fed’s National Financial Conditions Index (NFCI).

This index combines over 105 different indicators of financial activity to form one easy-to-read liquidity measurement. Money markets, debt markets, equity markets, traditional banking systems, “shadow” banking systems — they’re all included.

The zero line represents average liquidity conditions. Positive values indicate tighter-than-average conditions and negative values indicate looser-than-average conditions.

The Chicago Fed also publishes the Adjusted National Financial Conditions Index (ANFCI).

Since financial liquidity conditions are highly correlated to economic conditions, this index isolates the uncorrelated component. It tells us what liquidity conditions are like relative to economic conditions.

Positive values indicate liquidity conditions are tighter than would be suggested by current economic conditions, while negative values indicate the opposite.

You can see the difference between the standard and adjusted index in the graph below.

We prefer the ANFCI because it isolates liquidity conditions better than the NFCI.

The NFCI doesn’t always tell you when liquidity is deteriorating. In the late 90’s and 2014/2015, liquidity conditions were worsening but the strong stock market and strong economy kept the NFCI below 0, signalling liquidity was loose.

In contrast, the ANFCI was above 0 during the same period, signalling conditions were actually tightening.

The ANFCI is a little noisy to look at, but if you smooth the data with a 12-month MA, you get a nice picture of liquidity conditions in the U.S.

The cyclical nature of our economy becomes clear and it’s easy to see how liquidity predicts business cycles. You can use this tool to help you trade on the right side of the market.

When liquidity is tightening, take bearish trades. When liquidity is loosening, take bullish trades.

This index is also broken down further into 3 sub indices — risk, credit, and leverage.

Risk is a coincident indicator, credit is a lagging indicator, and leverage is a leading indicator of financial stress.

For trading purposes, the leverage part of the equation matters the most to see where the stock market is headed.

Above average leverage sows the seeds for a recession and a falling stock market. Below average leverage precedes economic booms and stock market rallies.

Ray Dalio discovered this logic long before the Chicago Fed and has made billions trading off it.

The leverage index can be broken down yet again to only include non financial leverage.

Non financial leverage is one of the most powerful leading indicators of stock market performance.

Liquidity, The NFCI, And Leverage

This graph might look familiar to you because it’s basically the short-term debt cycle, which can help you time markets.

For example, debt was at obscene levels before 2008 and signalled a shorting opportunity. And by 2010 debt was back below average and signalled a buying opportunity.

People are always the most levered at a market top and the least levered at a bottom.

A skilled macro trader wants to do the opposite. Paying attention to non financial leverage will help you do that.

Lever up when others are unlevered and de-lever when others are highly levered.

Despite all the financial doom and gloom we’re drowned with nowadays, non financial leverage readings tell a different story.

Current levels are only average.

Before making your next trade, take a look at these indicators.

How’s liquidity? Where are we at in the debt cycle?

Knowing these answers will make you a lot more confident in your trading. It’s hard to get blind sided by a big crash or miss out on a huge rally when you have a handle on liquidity.

Summary

  • Liquidity is a key variable in determining the macro landscape
  • We can monitor liquidity using the ANFCI
    • If the ANFCI is trending higher, liquidity is tightening and we want to lean bearish
    • If the ANFCI is trending lower, liquidity is loosening and we want to lean bullish
  • The non financial leverage component of the NFCI tells us where we are in the debt cycle
  • We want to buy risk assets at the bottom of the debt cycle (below average leverage) and sell risk assets at the top of the debt cycle (above average leverage)

This is a guest post by Alex @MacroOps which was posted originally here: Liquidity, The NFCI, And Leverage 

This post appeared on newtraderu.com and is available here.

stockarchitect September 23, 2019

Alex / Leverage / liquidity / macro-ops.com / newtraderu.com /

How to Earn Fixed Interest Income in Trading Accounts?


The original post is by Mastermind, Sana Securities, authored by Rajat Sharma and appears here.

I wasn’t really sure of the title to this post but the idea stemmed out of a question that I received from a subscriber.

Instead of repeating the exact question, I will break it up into 2:

  1. Can you earn fixed interest income on the spare cash lying in your trading account?
  2. Should you transfer spare cash into your bank account where you can earn up to 4% – 6% interest (savings account rate for Yes Bank and Kotak Mahindra Bank) or can you earn higher?

Cash Position: The best cash position is naturally the one that earns the highest possible ‘fixed income rate’ in the market. Fixed interest income can be earned on – money lying in savings/ current account, money market and liquid funds, ultra-short and short term funds and medium and long term funds.

As a trader or as a short term investor, you will require the money that you keep in your trading account at a short notice. For this reason, many short term investors believe that the best thing to do is to transfer funds from trading account to your savings bank account, perhaps at the end of the trading day (i.e. at 3.30 pm) and allocate them back to your trading account terminal when needed. It’s all in real time with internet banking these days. This is not the best thing to do.

How much are you going to earn by doing this?

Savings bank interest: In the most aggressive (bank) scenario you will earn ~ 0.06% on a weekly basis (i.e. ~ half of 6% divided by 52 weeks; considering that you transfer it exactly at 3.30 pm each day for until when the market opens on the next day).

Now consider a Liquid fund on the Mutual Fund Segment within your trading terminal.

Liquid and money market fund interest: Typically, these funds earn between 7.8% – 7.9% annual interest but that’s not all. You can actually stay invested in these funds unless you need to settle a trade (see example below). Here you will earn ~ 0.15% on a weekly basis (i.e. 5.8% divided by 52 weeks; see example below).

Example: You have Rs. 2,00,000 lying unutilised in your trading account and do not want to buy anything or make any position. You can either transfer this money to your bank account or buy a money market or liquid fund which typically earns 7.8 % return with very little volatility.

short-term-trading

If you have stocks lying in your demat account, you will typically get 4 times their market price as margin to trade / invest (i.e. if you have stocks with current market value of Rs. 2,50,000 in your demat account, you will be allowed to buy/sell for up to Rs. 10,00,000/-). No interest will be charged on such buying and selling for up to 3 days**. Even on the 3 rd day, all you have to do is sell your liquid fund and your account is settled immediately. So practically, you may never have to sell your cash position. All you have to do is to define how much of your capital would you want to keep in cash at any point, based on market factors.

** These margins and limits may vary. The above is based on the limits we provide to all our clients.

Now consider this:

If you choose an ultra-short to short term fund where interest rates are 8.9% – 9.6%, and can stay invested for up to 15 days, then you earn ~0.18 % on a weekly basis (provided that instead of 2-3 days, as above, you can plan your buying and selling for up to 15 days).

Depending on market factors you do get opportunities to invest in even higher interest bearing instruments. For now, if you are still worried about losing out on basic interest income in trading account and are constantly transferring money back and forth between your accounts, STOP. There are easier solutions in life and better things to do after 3.30 pm.

stockarchitect June 1, 2016

Bank / cash / Fixed / Income / interest / Kotak / liquidity / Mahindra / Sanasecurities / short / term / Trading / Yes Bank /