Tuesday, 10 March 2009

Liquidity and Fear

One of my favorite bloggers, David Merkel, wrote an interesting piece today in which among other keen insights he makes the point that:

"Liquidity only exists when leverage is stable or being built up. When leverage declines, there is no liquidity."
Market liquidity has always been, for me, one of the most fascinating areas of finance and I have written quite a lot about it, including a long discussion in Long/Short Market Dynamics. In response to David Merkel I made the following comment.

There is plenty of potential purchasing power at hand so the lack of liquidity is not a lack of investable funds. Rather market liquidity requires a more pro-active kind of disagreement, amongst major players, about the future direction of price - a certain kind of fractiousness which is notably absent at present. Even contrarians, who are mounting the occasional tests to the prevailing sentiment which has become too one sided and coherently bearish, lack conviction and easily suffer relapses into fear and uncertainty.

The market will not really find the kind of liquidity required for a sustainable rally until the fear of getting left behind felt by money managers as they scramble to keep up with their peers overwhelms the fear of losing their jobs as fund redemptions continue.

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