Over the past week (or two or three) market participants latched onto a narrative about liquidity and the impact of an apparent upturn in global M2 on equities.

The overarching thesis is simple enough. Liquidity injections are tantamount to easing and liquidity is fungible, so if, on net, liquidity is expanding, it’d be naive to overlook that as a potential explanation for any concurrent rally in risk assets.

As discussed here at some length early this week, I’m the very last person to dispute such an assessment. I was trained to everywhere and always attribute buoyant equity prices and tight spreads to liquidity provision in the post-Lehman world. That’s a deeply ingrained predisposition and nothing will ever dislodge it.

But, just as we should be careful to avoid overcorrecting when we rush to explain market outcomes by way of geopolitical developments after decades of pretending geopolitics doesn’t matter, we should similarly avoid resorting to the liquidity provision explanation to explain a vexing equity market rally if the only reason for doing so is that we feel like we have to conjure a “why.”

That latter bit is what concerns me about the liquidity tsunami narrative for 2023’s stock rally which, I should note, may be in the process of unwinding anyway. There were a number of other explanations for the “mystery” of resilient equities, not least of which involved the simple proposition that as stocks ran higher, under-positioned funds were compelled to chase.

Additionally, some investors might’ve simply interpreted good economic news out of the US and Europe as good news (as opposed to the “good news is bad news” regime) particularly set against assumptions about a re-opening revival in China.

And yet, as Morgan Stanley’s Mike Wilson wondered, “if the economy and earnings data were about to turn higher, why would the growth segment of the market be outperforming deep cyclicals as rates have risen?” That’s a good question, and one answer is the liquidity argument.

The chart from Wilson shows that, over time, the ebb and flow of M2 growth does map pretty well with 12-month rolling stock returns.

“Over the past few years, this relationship appears to have gotten tighter and may explain part of last year’s decline in stock prices,” Wilson said, adding that if “we assume global M2 flattens out over the next six months,” it’s possible the liquidity backdrop could continue to be favorable for equities.

However, if a persistently hawkish Fed puts a floor under the dollar and the BoJ, under new leadership, abandons yield-curve control, the “cancelling out” / “offsetting” effect (i.e., positive net liquidity impulse) could fade, and with it, a key support pillar for stocks.

Ultimately, Morgan Stanley’s bearish view hinges on earnings, though, and specifically on the yawning disparity between one of the bank’s leading indicators and consensus, as illustrated rather poignantly below.

As you can see, the mathematical relationship appears to be fairly robust.

If anything gives me pause about that it’s the sheer magnitude of the disconnect, which Morgan Stanley’s equities team would argue is precisely the point. That is: It won’t be a disconnect anymore once consensus comes around.

For that to happen, management has to throw in the towel. If you’re Wilson, it’s not worth hanging around until the last possible minute. The next guide down, he suggested, is just a matter of time.