Liquidity Driven Rally

Behavior of price movement is similar - be it vegetable market or stock market. If there are more buyers than sellers (demand is more), then price rises. And if there are more sellers (be it lesser demand or panic), price falls. Correlating it to stock market - stock price movement in the short run is more a function of this demand rather than fundamental valuation. But in the long run, it is the valuation that wins and short term demand gets 'corrected'.

Table below clearly would illustrate this fact.

In India, after opening up the economy - FII's participation in the stock market is crucial. They bring in lots of money which dictate the trend.Whenever they have invested huge money, market has gone up. And whenever they have sold (withdrawn) their investment, markets have crashed. And usually they withdraw when fundamentals detoriate. After all they are hardcore investors - looking for profitable investment avenues.

• When stock prices go up rapidly, then PE of the stock rises (Price to Earnings). And stock prices go up when more investors are interested in buying the stock.
• Similarly, when people sell shares or donot buy the shares - it means demand has come down - stock prices fall. This is precisely the biggest risk of liquidity driven market. For a market to fall - investors neednot effectively sell - if they donot invest - then the demand comes down and market falls. This is very clear from the above table. Between Dec 2010 to Dec 2011, FII's didnot invest money and pulled out small portion: US$ 512 Million - and market fell by whooping 25%.

Hence if global liquidity dries up, our market may be no exception. Unless the fundamentals improves like fall in inflation, fall in fiscal deficit, fall in fuel price etc, there is little scope of sustaining at higher levels. Ideally investors can clean their portfolio of unwanted stocks and keep cash ready for investing at opportune time.