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If you are wondering why the stock market is swooning every other day, here’s the explanation: there’s no liquidity. I have made the same statement before, and have received blank stares, but that’s really it. It’s all about liquidity.

The word is understood differently by different people. To the market maven, liquidity simply means whether he can put through a deal (buy or sell) without rocking share prices too much. For fundamentalist stock pickers — ace investor Warren Buffett among them — liquidity has no meaning whatsoever; they usually buy stocks for keeps. A share is like a family heirloom to them; they buy and sell only when they think the price is right. If it’s not, they go back to hibernation. They couldn’t care less if the markets were shut down for renovation or recuperation.

For the rest of us folks — who hope to make some money by willing share prices to go up — liquidity should be god. Liquidity, in our context, means there should be oodles of cash chasing stocks, so that our own itsy-bitsy, Penny Share Ltd bloats to Tiger proportions on a tide of ever-rising market purchases.

Liquidity is the sheer volume of money chasing shares. When there’s less of it -as at present, when the world’s moneymen are raising interest rates, pulling money away from stocks — share prices go down. The only way to make money is to wait for the tide to turn.

So what is one to make of the umpteen predictions about where the market is headed? What about stock analysts who ask you to buy “fundamentally sound” stocks and put out buy recommendations every now and then? Some of them even put target prices for scrips, which the gullible accept as an invitation to profit.

Well, the truth is the market target-setters are no better than astrologers who predict your future. As for the fundamentalists, they may know their company well, but when it comes to predicting share prices, they have a tough time differentiating between backsides and elbows. Picking a number out of a hat is easier and less biased.

The forecasts churned out by analysts using arcane mathematical models forget one simple fundamental: prices depend less on overall profitability than on how market players’ expectations about future prices pump up or drain liquidity from the markets (or a stock).

A related point: the demand for buying shares is not independent of the investors’ inclination to sell them. Put another way, investors’ willingness to buy or sell shares often depend on whether other investors want to buy or sell shares. It’s circular logic, and no one can actually predict market prices.

So if you were to ask me when liquidity will return, I don’t know. Nor should you be asking the “stock experts”. They can’t know either. This is because the market’s final direction depends on the collective trajectory of all our guesses, and not just on “fundamentals” like economic growth or corporate profitability. I am not saying the underlying economic factors do not matter; what matters more are our perceptions and biased interpretations of that underlying reality. These perceptions, as George Soros says, alter that reality once again, as investors start acting on their biased beliefs.

My own guess is that the Sensex will bottom out around 10,000. This is not a recommendation to start buying when the market hits that level, but merely my personal statement of intent. At 10,000, I will probably put every additional rupee I can save into the market, even if the market heads towards 5,000.

Look closely at what the analysts are saying. The targets they are projecting may be merely meaningless numbers which they themselves may or may not believe in. When a broker or investment bank pays you a salary to project the future direction of the market, you will have to produce some number. Which they do. Ultimately, they are as clueless as you are.
Email: r_jagannathan@dnaindia.net