Peter Bernstein - Economics & Portfolio Strategy
LET’S DON’T WAIT TIL THE WATER RUNS DRY*
Liquidity: the ability to buy or sell an asset quickly and in large volume without
substantially affecting the asset’s price.
Barron’s Dictionary of Finance and Investment Terms, 1995.
The liquidity available in financial markets over the last five years is unlikely to
persist over the next five. The degree of ease Liquidity has been abundant where we expect it
– in stocks and bonds – and has been flowing in places we might not – in structured credit
products and pre-sold Florida condominium developments. Liquidity in the capital markets
has been increasing for so long that we have difficulty in remembering what happens when
markets distinguish between assets that are in fact liquid from those that are not.
If we apply to liquidity the theory of environmental change Peter Bernstein introduced
last month, we will see a dark cloud on our previously sunny skies. As we have come to
understand why the world is awash in liquidity, perhaps we are on the cusp of a new regime
where we no longer are so lucky. The Greenspan put, debt financing, credit derivatives, and
Asian growth all played a role in fueling liquidity. In the event the water runs dry, and the
spigot has dialed down since May, we should remember that in more normal times, liquidity
is usually uneven across investment securities or asset classes. In times of crisis, liquidity
disappears when we need it most.