Will the Liquidity Floodgates Never Close?
In our latest AHA! conversation (which you’ll find below), special returning guest Jesse Felder, author of The Felder Report, addressed a question that neatly captures the current mood of the market: “Is this what a market intoxicated on liquidity looks like?” It’s a rhetorical ask, of course, but one that relates to a deeper truth investors would do well to confront.
Markets today aren’t just somewhat elevated. Rather, they’ve been pumped up to, by several measures, the most expensive valuations ever seen. This asset price inflation has been caused by a unique, yet unstable, cocktail of speculative narrative, abundant capital, and the probability of even easier monetary policies.
At the center of this dynamic, as Jesse rightly points out, is artificial intelligence. In many ways, AI has become the dominant narrative of the cycle, absorbing investor attention, capital flows, and euphoric earnings expectations in equal measure. The technology itself is undoubtedly transformative. But its market impact, at least in the near term, has less to do with what it is than with what investors need it to be.
For the rally to continue, AI must not only deliver long-term disruption, it also needs to generate enough earnings growth to justify the hundreds of billions, soon to be over a trillion, being invested in its deployment. In addition to the direct cost of this AI arms race, the indirect burden of soaring energy costs to power AI data centers also needs to be factored in.
Consider just how concentrated this is: the “Magnificent Seven” — including, of course, NVDA — have added nearly $7 trillion in market value since the start of 2023, an increase that now accounts for virtually the entire gain in the S&P 500 over that span. Meanwhile, the broader market has been far less impressive. As discussed in this podcast, the S&P 400 Mid-Cap Index trades at just 16 times forward earnings, compared to 22–24 times for the S&P 500. That spread represents not only a valuation anomaly but also a rare instance of relative sanity in what could be fairly described as an irrationally exuberant, and then some, market environment.
But the case for mid-caps, and the broader market resilience, depends on a key assumption: that liquidity will remain abundant. And while it’s certainly true that markets have shrugged off higher rates more easily than many expected, the reality is that much of this resilience has been made possible by the willingness of bond investors to continue financing $2 trillion federal deficits. The ballast this has provided to both the economy and asset prices should not be minimized. The multi-trillion-dollar question is: How long can America, the nation with by far the largest fiscal and trade deficits, get away with such reckless policies?
The mounting concern is that the Fed is ensnared in a particularly acute version of its now-familiar dilemma. Inflation, while lower than last year’s peak, remains sticky, particularly in services, shelter, and electricity prices. At the same time, still-elevated borrowing rates are beginning to expose fault lines in credit markets, regional banking, and commercial real estate. The Fed is keenly aware that cutting too early could re-accelerate inflation, but maintaining restrictive policy indefinitely risks further strain on sectors already showing stress.
Complicating matters further is the behavior of the Treasury market itself. Deficits are climbing, and net interest payments are now projected to consume more than 20% of federal revenue during the current fiscal year. Investor demand for long-dated Treasurys is already waning. Should auction coverage ratios begin to slip, or foreign buyers (particularly Japan and China) continue to back away from the Treasury market, the result could be a sharp repricing of the entire risk-free curve. That, in turn, would ripple across equities, mortgages, and corporate credit.
In such a scenario, the assumption that capital will merely “rotate” from overvalued tech into undervalued mid-caps looks overly optimistic, as much as we’d like to see that happen. Markets don’t always rotate, sometimes they just sell. And when positioning is as concentrated as it is now, in both asset classes and narratives, the risk of a broad-based de-risking event rises considerably.
The gravity-defying power of liquidity should not be discounted, but the uncomfortable truth is that it may be conditional, not structural. It is not a permanent feature of the market, but a temporary byproduct of dovish Fed signaling, global central bank easing, and unconstrained U.S. government spending.
So where does that leave us?
We appear to be in a moment of suspended risk appreciation. Stocks continue to price in growth, resilience, and innovation, while the underlying economy drifts closer to constraint, fatigue, and risk.
As noted in this podcast, liquidity is a formidable force in the markets and presently it is supportive of lofty stock prices. But the history of liquidity-driven markets is that they can reverse course very quickly. As Jesse points out, insiders, with their aggressive selling, are emphatically demonstrating they appreciate this risk.
The Haymaker Team
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AHA! — August 2025 Edition
Note of correction: Towards the end of the discussion, I mistakenly stated that 30-year Japanese bonds have risen by 3.60. The actual number is around 3.2.
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