Liquidity: The Most Important Fundamental

I’m sure you’ve heard analysts, financial pundits, and other babbling heads yabber on and on about how these markets don’t reflect the “fundamentals”.

They’ve ranted non-stop about how the fundamentals prove that a bear market is around the corner.

They’ve raved about valuations being stretched and how stocks will collapse any day now…

If you’ve been taking investment advice from these doomsdayers, then please accept my condolences for your portfolio loss.

These broken clocks should heed the words of Mark Twain:

Denial ain’t just a river in Egypt.

No, denial is not just a river in Egypt, it’s also the perpetual state most market participants live in.

Now I’m not bashing the usefulness of what are commonly thought of as fundamentals. Things like earnings per share, book value, and revenue growth are indeed important.

What I’m saying is that these are only a few pieces of a much larger puzzle.

The dictionary defines the word fundamental as, “a central or primary rule or principle on which something is based.”

If there’s one “central or primary rule” on which all fundamentals are based, it’s liquidity. Liquidity is the Mac-Daddy of fundamental inputs. And not surprisingly, it’s the least known and understood.

Here’s one of the greatest of all time, Stanley Druckenmiller, on the importance of liquidity (emphasis mine):

Earnings don’t move the overall market; it’s the Federal Reserve Board… focus on the central banks and focus on the movement of liquidity… most people in the market are looking for earnings and conventional measures. It’s liquidity that moves markets.

So what is liquidity exactly?

In simple terms, liquidity is demand, which is the willingness of consumers to purchase goods and other assets. This demand is driven by the tightening and easing of credit.