“Where’s the money Lebowski?”: The question that drives markets. What actually drives markets, rather, is the response. As was the case in that film montage of flawed logic, random circumstance, good intentions, and half-baked plans, the answer is sometimes murky.
In conversations that I have recently been having with fund managers, there are two principal motifs that stand out. The market is now trading on fear rather than opportunity; and business fundamentals have increasingly been pushed aside by factors related to capital flows and liquidity. “Where’s the money.”
The two motifs are related in that both are suggestive of momentum and emotion rather than the evaluation of an underlying asset. The trade is based on anticipating future money flows, and estimating relative demand for a particular type of security in a market in which money could flow in multiple directions. In this way of thinking, the various classes of financial assets are increasingly interchangeable, and bubbles may develop or burst in any one, or several, because the issue is always one of refinance rather than repayment. The question being one of take-out or exit, (“Where’s the money?”), qualifiers such as seniority and duration are important to the extent that these might impact the nuance that impacts the answer to the question. It’s always a question of liquidity.
When capital flowed into equities so abundantly as to push market indices up by more than 50% in less than 12 months, this was not because the underlying collateral justified the pop, but because – how often have we heard this? – money had nowhere else to go. When this is the basic rationale, the investment is predicated on future capital that will also have nowhere else to go. In fact, there should ideally be much more of that kind of future capital around, if prices are to continue rising. And the system falls apart, as we have recently begun to witness, at the point where we realize, or at least fear, that money may be accounted for elsewhere, if it even exists. It is possible that future capital may be required to keep banks from being insolvent, or Greece from being bankrupt, or China from not ceasing to grow. When the playing field has been leveled, and when securities are interchangeable on the basis of “nowhere else to go,” the money goes to the high offer. And the trade, again, will be based on momentum.
In such an environment, perception can have a compounding effect, as it is the major – if not only – market driver. In such an environment, statements can be at least as important as facts, and my sense is that traders are monitoring momentum with at least the same level of scrutiny as they might in other times have watched the fundamentals. “The Dude abides.” Perhaps this tenet is after all fundamental enough.
