Tuesday, November 20, 2007

Liquid Refreshments

To paraphrase the old Johnny Carson/Ed McMahon schtick: "The punchbowl is dead. Long live the punchbowl. The punchbowl lives!"

There is an argument being made by some investment strategists that money, while abundant, is not as readily available as others have claimed. With bankers on the run, credit conditions are tightening and the US economy is feeling the effects. This may be true in the real economy but there is another side to the liquidity story that should not be ignored – money available for investment in the financial economy. Here the facts go in the opposite direction.

Hedge fund and private equity funds remain flushed with liquidity. Investors have not only not taken funds out, but have actually added to their existing and new positions as reported by various sources, including in yesterday’s Wall Street Journal.

A fascinating aspect of this hedge fund and private equity bounty is the argument made by activist investors (like hedge funds and private equity) to corporate management that capital should be deployed to earn a rate of return in excess of their required return. If applied to the equity markets, that means the capital in the hands of professional investors (mutual fund and other portfolio managers included) must earn a rate of return in excess of at least the historical return on large stocks, which is 12%, or some other appropriate benchmark. If this cannot be achieved, a return of capital is the prudent thing to do. Now I ask you, what do you think the odds are of that happening?

Investment Strategy Implications

The anchor under the global stock market is two-fold: the global growth story and abundant liquidity. The global growth story is likely to survive a US slowdown, this despite the groaning from certain Chinese officials re the “devastating” effects such a slowdown will have. Think politics.

The second anchor is the abundant capital that must be deployed by professional investors to earn alpha. This capital has to find a home, which is not the bank account of the investors who are not asking for their money back. Moreover, the liquidity is also abundant in two other areas that are beneficial for equities – sovereign wealth funds ($3 trillion and counting) and corporate balance sheets (non financial).

Perhaps, it is the abundant liquidity available for investment that explains why 7 of the 10 economic sectors have not violated their moving averages principle, why in the style cateory only the Micro Cap style has, and why on a global markets basis only Japan has*.

*see prior blog postings and reports for more details on the moving averages principle

1 comment:

Anonymous said...

Dear Vinny,
As always money, it's supply & velocity, is at the heart of the matter. I think the burning question is this - at what speed will Sovereign & Corporate liquidity move? It's a variant on Keynes "Liquidity Preference" question.