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Posts tagged ‘market fundamentals’

It’s All About Liquidity,Stupid!


The Nifty has crossed 5500 and the Sensex is at 18300. There may be no core fundamentals backing a rally of this magnitude but that does not matter. As I wrote in my previous article, we are in a purely liquidity driven rally.

However, this rally has also taught me a lot in addition. First of all, rallies are powerful only when driven by liquidity, not fundamentals. Fundamentals play only a supporting role. The Fed’s unleashing of liquidity in 2009 kickstarted the recovery from the lows. The ECB’s unleashing has done it now.

It doesn’t really matter if there are no fundamentals because when money is cheap, risky assets like stocks will move up. It is also true that the markets will fall but that will happen not because of waning fundamentals but waning liquidity. Go back to 2008 and you will see that decreasing liquidity preceded the fall and the bottom was reached at the time of the worst liquidity crunch in a long, long time.

When there is a clear trend in stock markets, fantastic money is made in a very short time frame. However, then the fall, consolidation etc. comes which tempers the long term returns significantly. Thus as the time in the markets increases, the returns become far less impressive. We have witnessed a 20%+ rise in the benchmark indices and more in the midcap indices. People have made more much money in this time frame than investors have made in four years(even not adjusting for inflation.

The very long term is supposed to belong to fundamentals but that is entirely a function of the point at which the investor is evaluating his investment. Companies with great fundamentals languish at lows because there is no buying interest (no liquidity) while bogus companies run up like crazy.

The fundamentals basically are needed to sustain a stock at higher levels otherwise it falls when liquidity dries up. However, when liquidity for the entire market dries up, even strong stocks fall rapidly and so one can avoid losses only if one has entered at lower levels.

In toto, better to play liquidity for market trends than fundamentals. As long as liquidity continues to flow in the financial system, there will be no correction in the Indian bourses.