OVER the 26 years I’ve been in markets managing money and publishing proprietary research, one indicator that I developed to follow what the Federal Reserve is actually doing, as opposed to what they’re sometimes saying, has been most successful in keeping portfolios on the right side of major trends.
My pH-Liquidity Indicator pH-L connects what the Federal Reserve is doing in the real economy with how the stock market is pricing the Fed’s monetary policy and activity. It compiles Federal Reserve Net Free Assets in a ratio with the price of the Dow Jones Industrial Average and a long term constant designed to standardize price through the decades of time since the Fed was first formed in 1913.
Changes in trend, and in particular, divergences in the indicator from price, have given timely signals about stock market direction.
SO it has only been natural to undertake research and application of a similar Liquidity Indicator for the newest asset on the block – Bitcoin –that I’ve been following since its inception, not only because I believe in its growing acceptance as a widely held asset in economies of the future, but because I believe it does indeed bear a relationship with interest rates, Federal Reserve policy, and the real economy of the present.
A LOOK at pH-L applied to the stock market since the 2020 lows shows that the strong uptrend initiated in March of 2020 by the indicator was broken the week of January 14th of this year just ahead of the break of the corresponding trendline in prices that has led to this year’s stock market correction, which is still ongoing.
As you can see, the all-time high in price of the Dow coincided with an all-time high in the indicator at the end of last year. Experience with this indicator around such dual highs suggests that we are indeed in a correction, not a Bear market, and that prices will make at least one more run at another new high.
Highs in price that are not accompanied by highs in this indicator are strong signals that a major trend change is at hand just as lower lows in price that are not accompanied by new lows in the indicator signal major lows.
Needless to say, we will be watching closely to see if pH-Liquidity confirms the expected next move up in price, or if not, forms the type of divergence that signals that a major high in stocks has been put in.
A LOOK at pH-Liquidity applied to a chart of Bitcoin tells an equally interesting, if very different, story.
We can see that the indicator did make an all-time high along with the price of Bitcoin in November of last year, suggesting that, as with the stock market, Bitcoin can be expected to make another run at new highs.
But in a very different pattern from the stock market, while the price of Bitcoin has broken its uptrend line off the 2020 lows, the corresponding uptrend line in pH-Liquidity has not been broken.
As price has been moving sideways in a volatile corrective pattern that has broken through its trendline, Bitcoin pH-L has moved sideways, but has remained well above its trendline.
I believe that it will find support at this trend in Liquidity if indeed it even touches it, and that a successful touch of trend will signal the start of Bitcoin’s next run toward new highs.
IN SHORT, we have seen over decades of observation in markets that pH-L’s measure of Liquidity based on what the Federal Reserve is doing with monetary policy, when plotted against the way that policy is being priced by markets, can provide meaningful signals about market direction.
And these signals have been found to be particularly important around times of monetary policy change such as we are experiencing with the Fed in the real economy in 2022.
How pH-Liquidity responds to further moves from the Fed here -- in both the stock market and in Bitcoin -- will tell us much about how we will want to be invested for the balance of 2022, and beyond.
A run at new price highs in stocks that does not produce a corresponding new high in pH-Liquidity will likely signal the kind of divergent topping pattern in this indicator that leads to a major trend change in the stock market from Bull to Bear.
And in a very different pattern currently playing out in Bitcoin, a run up in Bitcoin’s price accompanied by a corresponding run up in Bitcoin pH-Liquidity will tell us that Bitcoin prices have further to go in an ongoing Bull market, possibly much further.
Richard Lees and clients of Richard Lees Capital Management may be long cryptocurrencies mentioned in this article. Clients invested in any of RLCM's managed digital portfolios have undergone thorough risk evaluation to deem these investments appropriate for them, as should anyone considering speculative investments. A quick questionnaire about risk tolerance, like the one below, might shed light on such a tolerance:
Richard Lees, author of this article. has attained the Certified Digital Asset Advisor designation.