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The stock market is under pressure because 3 key sources of liquidity have dried up, Bank of America says

Written by test | Feb 23, 2023 12:56:18 AM
Matthew Fox @ Market Insider
  • The stock market is under pressure because key sources of liquidity are drying up, according to Bank of America.

  • Quantitative easing from the Fed, fiscal stimulus from the government, and stimulus from companies have all ended.

  • Demand for cash is growing thanks to high interest rates, which means long duration stocks should underperform.

The stock market is likely to stay under pressure because three big sources of liquidity are drying up, according to a Monday note from Bank of America.

BofA equity strategist Savita Subramanian highlighted the end of quantitative easing from the Federal Reserve as the big liquidity source that is now being pulled back as the Fed reduces its more than $8 trillion balance sheet by nearly $100 billion per month.

"The two biggest buyers of treasuries - China and Fed - are done," Subramanian said. The implications are higher interest rates and scarce cash, which could put pressure on long duration assets like unprofitable growth stocks, the same stocks that have soared so far in 2023.

On top of that, fiscal stimulus from the US government has ended and its unlikely there will be any more going forward because of gridlock in Congress. With Republicans threatening a debt ceiling showdown later this year, Subramanian sees little possibility that the fiscal stimulus the government got used to throughout the COVID-19 pandemic will make a return any time soon.

"Fiscal stimulus is unlikely with gridlock plus deficit hawks' nuclear option - using the debt ceiling to force spending discipline," Subramanian explained.

Finally, corporations are tightening their belts and have embarked on a wave of layoffs, especially in the tech sector. This comes after years of firing freezes due to the pandemic as companies look for places to cut costs ahead of a potential recession. 

All three sources of liquidity, from the Fed, Congress, and corporations, have the effect of pushing up interest rates which makes cash more attractive to investors at the expense of riskier assets like stocks.

"Cash is scarce and 5% more valuable: cash users (long duration growth) should cede leadership to cash sources," Subramanian said. In other words, expect a risk-off environment in which more stable investments outperform riskier ones. Essentially, a continuation of what worked and what didn't in 2022.