Could a liquidity crisis derail the bull market in stocks?

Key Markets report for Monday, 30 Jun 2025

In early February of this year, which feels like it was forever ago, Nasdaq and S&P 500 were trading at new all time highs. But from there, they took a bruising plunge, and two months later, in early April Nasdaq was down around 26% and the S&P 500 dropped 22%. The sharp correction was widely attributed to Donald Trump’s tough tariffs talk. Another three months later, all is well again, both the S&P 500 and Nasdaq are trading at new all-time highs and market volatility has dropped to post-pandemic lows suggesting that all is well and the markets are as happy (and complacent) as could be with not a worry in the world.

It’s all about central bank monetary inflation

So was the big Q1 2025 correction really about Trump’s tariff saber ratling, or was it something else? I believe we’ll always be closer to the right answer if we focus on liquidity and the actions of the central banks. As it turns out, they are the main movers behind the market cycles. A few years ago Stanley Druckenmiller, articulated the same basic idea:

“Earnings don’t move the overall market, it’s the Federal Reserve Board… focus on the central banks, and focus on the movement of liquidity… most people in the market are looking for earnings and conventional measures. It’s liquidity that moves markets.”

If the markets are going up, it is a sure indication that the Federal Reserve is flooding the system with liquidity. Although they neglected to teach us about this in school (it took me substantially my whole career in the hedge fund industry to understand this), the evidence is unmistakable, as I laid out in my November 2019 article titled, “The One Force Moving Stock Prices and What it Tells Us About the Future,” citing the empirical data from Jens O. Parsson’s masterful 1974 book, Dying of Money:

“Monetary inflation invariably makes itself felt first in capital markets, most conspicuously as a stock market boom. … This happened at the commencement of the German inflationary boom of 1920, and it happened again at the commencement of the American inflationary boom from 1962 to 1966. Indeed, every monetary expansion in the United States since World War II was followed by a stock market rise, every cessation of monetary expansion by a stock market fall. Conversely, every stock market rise was preceded and accompanied by money inflation. Bull markets rest on nothing but inflation.”

Parsson looked at 9 individual Fed easing or tightening cycles, showing that each time the Fed “eased,” stocks went into a bull cycle, and each time they “tightened” or significantly reduced the rate of monetary expansion, the stocks went into a bear market correction.

For whatever reason, the Fed is stuck with quantitative easing and this is true for with all other developed economy central banks, which is why I was confident to predict, already in 2016, when the “smart money” was distinctly bearish on equities, how the situation would continue to evolve:

… the markets might not collapse and that instead,“we could see a significant and sustained rise in equity markets,” if central banks remain committed to supporting asset prices. Now we know. We also know that this commitment has not changed. …The Fed can’t risk tightening anymore; keeping the bubble going is the only option, requiring an ever-expanding QE. This may have sealed the endgame: an accelerating bull run accompanied by hyperinflation after which comes an epic crash.

Nevertheless, as last week’s article by Valuewalk, published on ZeroHedge suggested, liquidity conditions in the markets do appear to be deteriorating and could trigger the next correction until the Fed once more steps in, as in 2019, as the last-resort, open ended liquidity provider to the repo markets. I suspect that, unlike 2019, the Fed will not wait until a liquidity crisis becomes apparent. Instead, they might step in, preemptively, at the first sign of a liquidity crisis.

As we saw in the UK, the Bank of England already took on that role last year without waiting for a significant market event to take place (I also provided a more detailed explanation about repo markets in the linked article). But for the time being, it does appear like we are experiencing an accelerating bull run. I hope that my prediction about hyperinflation followed by an epic crash actually proves wrong, but we’ll see.

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Today’s trading signals

With Friday’s closing prices we have the following changes for the Key Markets portfolio: