Whether current Stock Market rally is fundamental or Liquidity driven?

In past few days, got many messages that current stock market rally is liquidity driven...so much noise. I see many analysts crying "liquidity" and claiming that a big market crash is coming. But every asset rise is always about liquidity first. Further, Can anybody say that stock market fundamentals are destroyed forever (say for 5-10 years)? No, not at all!! Liquidity is definitely there, but it could go to other asset class also. But it has come to stocks because investors know that they are cheaper as compared to their fundamentals. These talks of liquidity driven market rally may be coming from those who have missed the current rally and now they are trying to prove that "grapes are sour".

First of all, now the understanding of covid crisis is vastly improved and now we know that it is not that deadly except for old and vulnerable people and if you ask me this is very important. Market "fundamentals" were hit badly in March because nobody was sure about the covid crisis and how we would tackle this. So now, as our understanding is better hence "fundamentals" have been restored to some extent and that's the reason money has come to stocks otherwise the same would have gone to bonds or gold. Nobody wants to touch corporate bonds now and fall in Gold price itself means that money is flowing to riskier asset as investor are hoping for early economic revival as lock downs are gradually being lifted.

Today, US markets are hit badly but they are already recovered very fast from the covid lows of Feb-march while we are still way down from the Feb top. Also, in US they have distributed free cash of some $ 600 per week and this will keep the things and economy in control although job data may be weak. Fed is ensuring the liquidity by buying bonds. They are buying corporate bonds, including the riskiest investment-grade debt, for the first time in its history. Here, let me clear one thing. Many people say that this bond buying by Fed creates excess money supply. But it is not, it is just supplying or creating liquidity in “exchange” of an already existing asset (bond). Because due to covid, people are not willing to buy Bonds etc. so this may create big problems for the bond owners who may need money for crisis situation or for business purposes. So Fed is coming forward to manage this temporary gap in liquidity and Fed is buying real assets for money supplied. Fed will sell these bonds in the future when things will return to normal and it will sell these bonds back to market and will take out this temporary liquidity.

Similar steps I was also expecting either from RBI (direct Corp Bond purchase) or from our Government because Banks were not lending money as they were not ready to take risk in spite of big liquidity infused by RBI in banks. Hence, in order to create liquidity our Government has done a great job by announcing full loan guarantee scheme as this will push banks to lend to NBFC’s etc. Due to this scheme, banks do not have to make any provision for the loans in case they become NPA.

Also, the current demand slump is not due to structural deterioration of the economy. The current demand slump is due to the imposed/forced lockdown and demand for jobs will be back when they are re-opened. The images we are seeing now are that farmers in Punjab are doing everything on their own in their farms in the absence of laborers and in fact they are arranging transport etc. for the laborers to return back. So this is not a recession.  I have pointed out in many blog posts that recession is much more fundamental than fall in GDP rates alone. Recession is about significant misallocation of productive resources whose course correction is not possible in the short term and this will destroy the misallocated resources and so the jobs. So in a recession, an economy has to go through the labor pain to reverse the misallocation of resources. Same is not the case now.

But I was always worried about our migrant situation and this may still turn very bad. So this is the biggest risk for India and this may also hit jobs. But as we know interpretations are very easy in hindsight. When laborers started migrating in March then at that time there was very little clarity about the covid crisis and how it will hit the humanity and how hard will be the hit. So everyone has taken the decision keeping the worst in his mind. So laborers were allowed to move by their employers as they were also not sure about the situation and so were the laborers. So now the real challenge is to normalize this unexpected damage. In India, covid cases are rising fast but still recovery rate is almost 50% and tests have also gone up...death rate is still manageable. So i hope we will be in much better position by the end of this month. For stock market, i think we may see a mild correction now not a traumatic bear phase again. Let’s hope for the best.