The Market's Methodical Melt Up - It's All About Liquidity

by: Toro

This, to me, is an amazing market. The unrelenting nature of the ascent is remarkable. A daily trading pattern that has been common over the last few weeks has had the market starting off sluggish at the beginning of the day, perhaps selling off, then the buyers kicking in around 10:30 am and marching us methodically higher into the close. Or, the market meanders until 2:00 pm, then the programs kick in, taking us higher until the end of the day.

The market feels like it did during the second half of last year, when we marched relentlessly upward and didn't have a 1% down day forever. Every dip was bought, every minor sell-off an opportunity as we stair-stepped higher.

When markets move up in such a methodical manner, that, to me, is because of liquidity. There are other reasons why the market is going up, of course - earnings are coming in better than expected, valuation is reasonable compared to other asset classes, $4 billion a day in stock is being retired through buybacks and takeouts, etc. But to me, its all about liquidity. And there is an ocean of it flooding the financial system.

Housing will bring down the market, the bears say. This is a plausible argument, in my opinion. It forms my longer-term bearish outlook on the market. However, it is possible a falling housing market will have no effect on stocks. After all, when the stock market was getting hammered at the beginning of the decade and thousands on the Street were being thrown out of work, prices for Manhattan apartments went up. In Silicon Valley, where a true depression was occurring in the teleconomy, house prices fell for a bit, then zoomed to heights even nuttier than during The Bubble years.

True, the government was engaged in tremendous stimulation at the time, through the monetary pump and a 1% Fed funds rate as well as tax cuts and soaring government spending. However, the analogy Marc Faber uses to describe excess liquidity is that of a water balloon. When you push down on one part of a water balloon, another part pops up. Perhaps the housing market is the part being pushed down and stocks are are the part popping up.

I'm not necessarily making this argument. Rather, it is something to consider.

At some point, I am going to want to be far, far away from stocks. And because we have done nothing but go up the past five weeks, we are certainly due for a pullback. However, I think that we will ultimately reach loftier heights during the year, and it might surprise observers how far we go. I would not be surprised if the high will be marked by a blow-off top.

We'll see.