Financial markets are not driven by the economy; the economy is downstream from markets. The liquidity cycle, representing money available to the financial sector, precedes real economic activity by 15-20 months, making it a powerful leading indicator for macro investors and asset allocators.

Despite a significant repricing of Fed rate expectations and a correction in valuations, equity markets have remained stable. This is because accelerating earnings are potent enough to deliver returns, challenging the notion that markets need dovish monetary policy to advance.

A strengthening real economy isn't always bullish for assets. Increased activity, inventory building, and capital expenditures raise working capital demands, pulling liquidity out of the financial system. This starves markets of needed capital, creating a liquidity crunch independent of central bank actions.

The Federal Reserve is easing monetary policy at a time when corporate earnings are already growing strongly. This rare combination has only occurred once in the last 40 years, in 1998, which was followed by two more years of a powerful bull market run.

For the past decade, the Fed was the primary driver of liquidity. Now, the focus shifts to commercial banks' willingness and ability to create credit to fund major initiatives like AI and onshoring. Investors fixated on Fed policy are missing this crucial transition.

Despite the Fed's larger-than-expected asset purchase program, the primary near-term risk is that it may still fall short of the reserves needed for smooth market function, echoing the 2019 repo crisis.

While markets fixate on Fed rate decisions, the primary driver of liquidity and high equity valuations is geopolitical risk influencing international trade and capital flows. This macro force is more significant than domestic monetary policy and explains market resilience despite higher rates.

The market's "run it hot" narrative assumes supportive monetary policy, but the Fed is unlikely to cut rates before the current chair's term potentially ends. With a new chair possible in June, this creates a four-month window where the Fed may not ease, creating a "liquidity pocket" and risk for markets.

Asset allocation should be based on liquidity cycles, not economic cycles like GDP growth, as they are out of sync. An increase in liquidity precedes economic acceleration by 12-15 months. Strong economic data can even be a negative signal for asset markets as it means money is leaving financials for the real economy.