- Liquidity is a major factor in high beta names.
- The FOMC is set to cause a net drain on liquidity.
- This will erode the monies earmarked for high Beta stocks.
With the FOMC policy decision coming on Wednesday, investors are concerned. It's not unusual to have tensions before FOMC policy decisions, but this one is especially important. In recent weeks, we have witnessed a clear transition out of higher beta stocks into what traditional investment philosophy has described as more conservative stocks. Traditionally, those stocks are found in the Dow Jones Industrial Average, and the higher beta names are usually found in the Russell 2000 or the NASDAQ.
Although some investors are looking at this through a different microscope, my observations are quite clear. Higher beta names require higher amounts of liquidity in order for those stocks to remain attractive. Netflix (NFLX) is a great example. This is a high flyer, high beta, with lots of news, and the stock moves like the wind. After the investment by the Soros family, Netflix is also something that everyone pays attention to, at least to a degree.
The problem is that the liquidity earmarked for high beta stocks is drying up, and ultimately the business of the stock market is one based on supply and demand. Assuming that supply remains relatively constant, it is the demand side of this equation that directly influences stocks like Netflix. As liquidity is drained from the overall economy, the first impact is on these higher beta stocks.
Therefore, the upcoming FOMC decision, which will most likely be accompanied by another decision to taper, is one that also directly influences liquidity on a broader scale. In fact, our macro economic analysis has already proven that net real stimulus came to an end on April 1. If they taper again, it will actually drain liquidity from the Financial System for the first time in years.
This is absolutely a concern for investors in high beta stocks like Netflix. The free flow of liquidity that existed last year is no longer there, and if tapering continues it will actually be reversed out of the system. That poses serious risks for people blind to the supply demand equation.
When it all comes down to it, that's all that matters. If the free flow of liquidity is not enough to generate interest in higher beta stocks, higher beta stocks will not increase. In addition, the higher those higher beta stocks increase, the more liquidity is necessary to further the increases, so after what happened last year, the liquidity challenges are bigger now than they were at the beginning of 2013.
Not unlike what happens in the stock market, you cannot churn old money that is invested into these higher beta names and expect them to increase. They rely on new money, new capital infusions, and that means new liquidity to increase. If the broader measure of liquidity in the Financial System is actually zero, and possibly poised to turn negative given the upcoming FOMC announcement, stocks like Netflix are going to continue to experience natural pressure that goes far beyond the news of the day.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: This article was written by Thomas H. Kee Jr. for Stock Traders Daily and neither receives compensation from the publicly traded companies listed herein for writing this article.