Brian Pretti Cautions Investors on Stock Market - Prepare for Any Outcome

For the future of the market it’s all about liquidity.

This was a major theme and concept mentioned numerous times in our recent interview with Brian Pretti, Chief Investment Officer at Capital Planning Advisors. Here he says:

“We know full well that the Federal Reserve is going to move really really slowly. I think the bigger issues are rather than these little quarter point (interest rate) moves—that's not the key—what may be the real key is what happens to the Fed's balance sheet as we look forward and the much much bigger issue of liquidity in the open markets.”

Before we move on, let’s first define exactly what liquidity is (via Investopedia).

DEFINITION of ‘Liquidity’
“Liquidity describes the degree to which an asset or security can be quickly bought or sold in the market without affecting the asset's price.
Market liquidity refers to the extent to which a market, such as a country's stock market or a city's real estate market, allows assets to be bought and sold at stable prices. Cash is the most liquid asset, while real estate, fine art and collectibles are all relatively illiquid.”

Since the Federal Reserve is said to have ‘pumped liquidity into the market’ by swapping less liquid securities out of the banking system in exchange for more liquid ones—essentially digital cash—liquidity and money or cash are often used interchangeably.

For Pretti, the greater risk to the stock market at current levels is not whether the Federal Reserve continues to hike interest rates by quarter point increments from near zero—it’s about the Fed’s willingness to maintain its very large holdings of illiquid or less liquid securities accumulated since the Financial Crisis.

Of course, this is not just theory. Large financial institutions are very concerned about the level of liquidity in the global banking system as well since it has clear implications for the overall health of the financial system and whether the stock market may be at risk of a major downturn.

Currently, the BofA Merrill Lynch Global Liquidity Tracker is in the red zone, showing global liquidity is contracting. Plotted next to the S&P 500 (in black), we can see that the two prior market peaks and ensuing bear markets took place when global liquidity was on the decline.

Source: Bloomberg, Financial Sense

Given the above and a number of other risks and opportunities Pretti outlined in the interview, the CIO for Capital Planning Advisors stated:

“Have a game plan for any outcome in the markets ahead, whether the fingerprint characters of deterioration are telling us that we are heading for a meaningful cycle top or global capital causes some type of blow-off in US equities—I think it’s a binary outcome and I don’t know which one it is but I just want to make sure I have some sort of game plan for either side of that equation.”

Here are a few excerpts from his recent interview (preview below), which subscribers can access in full by logging in and clicking here. To subscribe or for more information on our premium interviews with market strategists, book authors, and others, click here.

Ground Zero

"There's commentary about this already so this is not a big inside secret or rocket science by any means but to maintain that 25 basis point target rate, the Fed is going to have to drain liquidity and maybe even a little more liquidity than the market anticipates and then as you look forward at the maturities of not only Treasuries but also mortgage backed securities on their balance sheet too they are facing close to a trillion and three-quarters to two trillion dollars of run-off over the next few years and I think that's really the mother lode—that's really ground zero."

Tell-Tale Signs of Prior Market Tops

"If you look at some of the really broad measures of the stock market and at the fingerprint character of the market on the way back up from the lows late-August into September and October...we haven't seen ubiquitous participation—it just hasn't been there...really the large-cap (stocks) have been the ones (driving the market)... So whether it's narrowing of breadth, whether it is trouble in the high yield land spreading into other parts of the credit market—in one sense, we've seen this movie before. And I think for a lot of investors getting out in front of that and saying, 'Hey, wait a minute—this looks a hell of a lot like the 2000s, 2007.' I mean these are some of the fingerprint tell-tale signs we saw prior to the broad market giving way."

Listen to this full interview with Brian Pretti, CIO of Capital Planning Advisors, by logging in and clicking here. For a complete archive of our broadcasts and podcast interviews on finance, economics, and the market, visit our Newshour page here or iTunes page here. Subscribe to our weekly premium podcast by clicking here.

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