Evidence of Liquidity Boom: "The Market Loves Trash"

As we've been saying all along the global markets have been liquidity driven more than "fundamentally" driven.

This phenomenon seems evident including in the US, where small cap stocks have outperformed the big cap stocks.



From the Wall Street Journal, (Thanks to Bespoke for the pointer) [bold emphasis mine]

``After a brief swoon in January and early February, the riskier end of the stock market is back in favor.

``That includes small stocks, stocks badly hurt by the financial crisis and those most dependent on global economic growth. Safer stocks, including those that offer steady dividends, are out.

``That wasn't the case between Jan. 19 and Feb. 8, when the Dow Jones Industrial Average fell 8% amid fears that the global recovery could stall.

``Since then, the Dow is up 7%. And in most cases, investors are turning to the same stocks that led the market higher in last year's big rally.

"It seems like the lower-quality, smaller-sized names are taking the lead," says Jack Ablin, chief investment officer at Harris Private Bank in Chicago. "We are getting a junk dominance again."

``By a variety of measures, lower-quality stocks are out-gaining higher-quality stocks, says Paul Hickey, co-founder of Bespoke Investment Group in Harrison, N.Y.

"In the words of Oscar the Grouch," says Mr. Hickey, "the market 'loves trash.' "

``He has ranked the quality of stocks in the Standard & Poor's 500-stock index based on their market size, price/earnings ratio and credit rating. He even sorted them based on which get the most attention from short sellers, the bearish investors who bet that stocks will decline by borrowing the stocks and selling them.

"No matter how you look at it, so-called low-quality stocks in the S&P 500 have outperformed high-quality stocks" since Feb. 8, Mr. Hickey says.

``The 50 smallest S&P stocks have risen 13%, compared with a gain of 9% for the 50 largest stocks. Companies whose bonds are rated as junk have risen more than those with investment-grade ratings. The 50 stocks with the highest prices, compared with analysts' expectations for their 2010 profits, are up 16%. Those with the lowest price-to-earnings ratios are up 10%. The most heavily shorted are up 15%. The least-shorted are up 7%."

My comment:

Essentially the outperformance of small stocks appear to be driven by momentum, as punters pile in on the winners in the expectations of continued strength.

As we previously pointed in Are Stock Market Prices Driven By Earnings or Inflation?, a refresher on some of the valuable insights of Fritz Machlup on the stock market.

-A continual rise of stock prices cannot be explained by improved conditions of production or by increased voluntary savings, but only by an inflationary credit supply.

-Extensive and lasting stock speculation by the general public thrives only on abundant credit.