Forget about the Trump rally, the market is really in the middle of a very powerful liquidity trade that has "totally overwhelmed everything," noted economist Mohamed El-Erian told CNBC on Friday.

And if the focus doesn't turn to fundamentals, there could be trouble ahead, he warned.

The liquidity trade is "being fueled by lots of corporate cash, some of which makes it back into the marketplace, and by income inequality that puts money, the incremental dollar, in the hands of people who have a high propensity to invest," the chief economic advisor at Allianz said in an interview with "Closing Bell."

The result is very crowded trades and a buy-on-the-dips mentality, he explained.

The market was initially propelled higher after the election by investors betting on President Donald Trump's promises of pro-growth policies.

And stocks have continued to hold up despite the recent drama coming from the nation's capital, including a probe into Russia's alleged interference in the election and former FBI Director James Comey's testimony.

However, El-Erian told CNBC there is a limit on how far the market can decouple valuations from fundamentals.

"Liquidity works really well for a while but it needs to hand off to fundamentals. So if that doesn't happen, which means if we don't get the policy response that the market is hoping for, then it could be quite a marked sell-off."

While it's hard to judge just when that could happen, a policy mistake by the Trump administration would accelerate it, he added.

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