This Day On The Street
Continue to site
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

Why Stocks Are Rising: It's The Liquidity, Stupid!

NEW YORK ( TheStreet) -- Macro and micro fundamentals are deteriorating in the U.S. and around the world. Two questions are begged: Why are stock prices represented by indices such as the S&P 500, Dow Jones Industrials and Nasdaq rising so dramatically? Is this rally sustainable?

The answer to the first question is that stock prices are rising due to a confluence of extraordinarily high levels of liquidity on household and business balance sheets, combined with a simultaneous normalization of liquidity preferences. On the margin, this is driving a demand for equity investments.

The answer to the second question is that the current rally is sustainable in the intermediate term and could indeed morph into a full-fledged bubble for reasons described in this article.

Deteriorating Fundamentals

An overwhelming plurality of economic indicators are signaling that the U.S. and global economies are slowing sharply relative to the already modest pace of growth in the first quarter of 2013. ISM and Markit PMI surveys, along with various indicators of industrial production, show that manufacturing activity in the U.S. is slowing sharply.

Furthermore, indicators of consumption such as real disposable income and retail sales are showing signs of weakening. Finally, the pace of employment growth seems to have slowed notably in the months of April and May.

Globally, the macroeconomic situation is even more worrisome, with a brutal recession accelerating in much of Europe, and pronounced slowdowns evident in Australia and China.

U.S. corporations are starting to show signs of these macroeconomic strains. US corporate earnings estimates for 2013 have come down dramatically in the past month, and look to be revised downwards much further once the lackluster first quarter performance is fully digested by analysts. US corporate earnings are contracting on a year over year (YoY) GAAP basis and is only growing at slightly over 2% YoY if measured on an operating EPS basis.

So why are stock prices rising so dramatically?

Excess Liquidity and Normalization of Liquidity Preference

Below I present a chart of "systemic liquidity." This metric measures most readily available sources of liquidity for U.S. households and businesses as a percentage of total nominal income or GDP. The black trend line is an estimate of a "normalized" level of systemic liquidity, derived by linear regression.

There are two important things to observe in this graphic. The first thing to note is that from 1959 until 2000, U.S. systemic liquidity as a percent of GDP behaved in a cyclical and mean-reverting fashion, just as standard economic theory would predict.
1 of 3

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Only $9.95
14-Days Free
Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Real Money

More than 30 investing pros with skin in the game give you actionable insight and investment ideas.

Product Features:
  • Access to Jim Cramer's daily blog
  • Intraday commentary and news
  • Real-time trading forums
Only $49.95
14-Days Free
14-Days Free
AAPL $93.24 0.00%
FB $117.81 0.00%
GOOG $701.43 0.00%
TSLA $211.53 0.00%
YHOO $36.94 0.00%


Chart of I:DJI
DOW 17,660.71 +9.45 0.05%
S&P 500 2,050.63 -0.49 -0.02%
NASDAQ 4,717.0940 -8.5450 -0.18%

Free Reports

Top Rated Stocks Top Rated Funds Top Rated ETFs