The Tide That Lifts All Boats: Why Liquidity Drives Asset Prices More Than Earnings

Macro View · Part 2. The first piece laid out the four-quadrant framework for positioning. Now we unpack the single most important landmark on that map: liquidity. It's the tide that lifts or drowns every asset.

01One: A Counter-Intuitive Fact – Earnings Are Not the Star in the Short Run

Let's start with a truth many don't want to admit: over short to medium horizons, the strongest variable determining asset prices is not corporate earnings – it's liquidity.

We've been taught that "stock prices reflect fundamentals, reflect earnings." Over the long run, that's right (remember, I keep saying the long run is a weighing machine). But over the short to medium term (months to a couple of years), the market is a voting machine, and on that ballot, liquidity's weight often crushes earnings.

The evidence is everywhere: In 2020, the economy was in recession, earnings were collapsing, but stocks hit new highs within months — because central banks unleashed unprecedented liquidity. Conversely, in 2022, many companies' earnings were still growing, but stock prices plunged — because central banks started tightening liquidity and raising rates. The same earnings get a high valuation when liquidity is abundant and a low valuation when liquidity is tight. Earnings are the cargo on the boat, but what determines how high the boat floats is the water level.

That's the power of liquidity — it's the tide that lifts or submerges all assets. When the tide rises, everything goes up with it (good and bad companies alike, which is why late-cycle bull markets see even the worst stocks soar); when it ebbs, you find out who's been swimming naked (which is why ugly assets get exposed in bear markets). Understanding liquidity means understanding when this tide is coming in and when it's going out.

02Two: The Master Gate of the Tide – The Central Bank's Balance Sheet

So who controls this tide's water level? The primary master gate is the central bank's balance sheet – and for global assets, above all the Fed's.

The mechanism can be stated plainly. Central banks have two core tools that jointly determine the ease of liquidity:

First, interest rates (the price of money). Low rates make borrowing cheap, encouraging capital to flow into risk assets (stocks, real estate). High rates make borrowing expensive, and risk-free deposits or Treasuries offer attractive yields, pulling capital back from risk assets to safe ones. Rates are the "price gate" of liquidity.

Second, balance sheet expansion or contraction (the quantity of money). By buying assets (QE, quantitative easing), central banks inject liquidity into the market, expanding their balance sheets and raising the tide. By selling or ceasing reinvestment (QT, quantitative tightening), they drain liquidity, contracting their balance sheets and lowering the tide. This is the "quantity gate" of liquidity.

Put the two gates together and you can roughly gauge the direction of the tide: Rate cuts + balance sheet expansion = massive easing, the tide surges (a tailwind for asset prices). Rate hikes + balance sheet contraction = massive tightening, the tide recedes (a headwind for asset prices). 2020-2021 was the extreme of the former (zero rates + crazy QE); 2022-2023 was the extreme of the latter (rapid hikes + QT). The dramatic difference in asset prices between those two periods is almost perfectly explained by these two gates.

So when I do macro positioning, liquidity is the first coordinate I check — I ask: Are the two gates of the central bank currently releasing water or draining it? Is the overall tide rising or falling? This judgment, more than any analysis of individual company earnings, determines the overall risk environment.

03Three: The True Meaning of 'Don't Fight the Fed'

Wall Street has an old saying: "Don't fight the Fed." It's often misunderstood as "believe whatever the Fed says." The real meaning is about liquidity — when the central bank is injecting liquidity, don't short (the tide will lift everything); when it's draining, don't be greedy (the tide will drag everything down). It means: don't bet against the direction of the liquidity tide.

The reason this saying holds is exactly what we discussed above — liquidity is the strongest force in the short run. When that force is clearly pushing in one direction, going against it with "fundamentals" will get you crushed. In 2021, many thought valuations were too high and would collapse, so they shorted growth stocks — only to be repeatedly schooled by the rising tide of liquidity. In 2022, many thought the selloff was enough and tried to catch the bottom — only to be repeatedly slapped by the receding tide. Their mistake was fighting the Fed — betting against the direction of the liquidity tide.

But I want to add an important, often-overlooked footnote to this rule: "Don't fight the Fed" is a discipline about direction, not a license for timing.

It tells you "don't make big bets against the tide," but it cannot tell you "exactly which day the tide will turn." Because the Fed's own pivots are inherently hard to predict (they depend on equally unpredictable data like inflation and employment). If you turn this saying into "I'll precisely predict the Fed's next meeting decision and then go all-in or all-out," you're falling back into the "prediction trap" I criticized in the first piece. The correct use is to observe the current, clear direction of the tide and adjust your overall risk exposure accordingly (be more aggressive when the tide is rising, more defensive when it's falling) — not to bet on the exact timing of the next inflection.

This brings us back to the core of the series: use liquidity for positioning (is the tide currently rising or falling?), not for prediction (where will the tide be tomorrow?). Positioning lets you go with the flow and avoid getting crushed; abandoning the quest for exact timing keeps you from being burned when your bet on a precise turn goes wrong.

04Four: Beyond the Tide – Liquidity Is Not the Only Force, Just the First

After all this talk about liquidity's power, I must add a balancing note: Liquidity is the strongest force in the short run, but it is not the only force, and over the long run it can even cede primacy to fundamentals.

This is crucial, or you'll fall into the other extreme of "liquidity-only, ignoring value." I see it as layered:

• Short term (months): Liquidity dominates. The rise and fall of the tide overwhelms almost everything.
• Medium term (a year or two): Liquidity and earnings tug-of-war. The tide provides the backdrop, but earnings delivery begins to matter.
• Long term (many years): Value dominates. The influence of the tide gets smoothed out, and ultimately it's the real value created by enterprises that determines asset returns (the weighing machine).

So in my framework, liquidity occupies this place: It's the first coordinate for positioning "current risk environment," but it cannot replace judgment of value. An ideal decision is a combination of "align risk exposure with the direction of the liquidity tide" + "always hold assets with long-term value." Use liquidity to manage the size of your exposure; use value to manage what you hold.

The two most dangerous types of people: the one who only looks at value and ignores the tide — getting priced out of a bubble because "it's too expensive," or buying too early in a draining tide because "it's cheap" and getting buried (the sin of fighting the Fed). The other is the one who only watches the tide and ignores value — chasing the worst concept stocks when the tide is rising (buying the chicken when even the dogs are flying), only to see those positions exposed and suffer permanent capital losses when the tide recedes. Only by combining 'following-the-tide exposure management' with 'holding true value' can you avoid being crushed by the tide and avoid swimming naked when it ebbs.

05Five: Final Words

Liquidity is the single most important coordinate on the macro map — and the one most easily overlooked by fundamentalists.

Its importance lies in being the strongest driver of short-term asset prices — earnings are the cargo on the boat, but the water level determines how high it floats, and that water level is controlled by the central bank's two gates (rates and balance sheet). Understand the direction of the tide and you'll grasp "why prices swing wildly even when fundamentals haven't changed" and the real weight of the old saying "Don't fight the Fed."

But keep its limits in mind: liquidity can explain the short run, but it cannot explain the long run. It can tell you "is the current risk environment a tailwind or a headwind?" but it cannot predict the next turning point with precision. So its correct use, consistent with the entire Macro View series, is: use it for positioning (is the tide currently rising or falling?), and manage the size of your exposure accordingly. Don't use it for prediction (where will it be tomorrow?) and bet on precise timing.

If I leave you with just one line:

The strongest force for short-term asset prices is the tide of liquidity. Manage your exposure with its direction — don't short when the tide is rising, don't be greedy when the tide is receding. But only ever hold things that can still stand when the tide goes out. The tide determines how high you float; value determines whether you'll be swimming naked.

Next, we'll unpack the first gate of the tide — the variable that completely changed everything in 2022: interest rates. How we went, overnight, from an old world into a new regime of rates.

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Disclaimer: This is a macro framework study and does not constitute any investment advice. Markets carry risk; invest with caution.