Copernicus could help us pick stocks.
In a sense, anyway. I’ll explain.
Now, I don’t know what’s going to happen next. We did, however, write this July 24:
Recognize this: It’s a mathematical impossibility for any meaningful rotation to occur from large caps to small caps. It’s like pouring from a bucket into a thimble.
What will happen is that large caps will stop rising, small caps will spurt, and the entire market could then tip over.
Why?
Because you can’t rest 96% of market cap atop 4% and expect the structure to hold. And if the structure starts to collapse, money rushes for the exits because it runs on models.
Look, I’m not saying that’s going to happen. But prudent people should understand the math, the risks, the structure, the mechanics. We are sharply aware of all of those.
We’ll get to what may be next for stocks. But stocks have prices, which are denominated by money, dollars in the USA. Copernicus said in 1526:
Hence arise those general and incessant complaints that gold, silver, food, the work of servants, the labor costs of artisans and everything that is in the use of men exceeds the common price, but, heedless, we do not surmise that the general high prices stem from the debasement of money. …All prices rise and fall on the quality of money.
Back then in Poland, where Nicholas Copernicus advised the king, people thought greedy merchants were gouging them. Some things never change. But the problem, Copernicus knew, was the propensity among monarchs to devalue the currency.
That is, they would replace gold coins with, say, tin coins, because they needed money for wars, pet causes, carriages, and tell everyone that the value was the same.
I’m oversimplifying but follow me. There’s a connection to a lurching stock market.
People understood that tin and gold weren’t the same, so they would keep the gold coins and spend the tin ones. We thus have come to understand Gresham’s Law to mean “bad money chases out good.”
Copernicus invented the notion, but Thomas Gresham explained it to the English monarchy in the same 16th century, and in the 19th century Scottish economist Henry Dunning MacLeod dubbed the idea Gresham’s Law.
Copernicus observed that the king was better off establishing sound, defined money (which Poland subsequently did) than, after the people complained about high prices, blaming speculators, imposing cost controls, or simply taking the gold from the people.
Governments that steal from their people don’t tend to prosper. Whether you take money from people’s bank accounts, go into their homes and pry gold from their fingers, or inflate away the value of the money, it’s all the same.
Okay, but what does that have to do with stocks?
Copernicus observed that gold coins would disappear and the economy would fill up with tin coins. Or cast in contemporary terms, people spend credit and the economy fills up with debt – bad money.
And the gold finds its way into things of value. Stocks, bonds, houses, art, cars.
Here’s the problem. People trade good money for those things as they’re rapidly rising in price. Then everyone is out of money except for what they’ve stored in the high-priced stuff like stocks. To buy anything else, they need to sell the high-priced stuff.
But everyone is out of money and can’t afford to buy it.
So prices collapse.
I joke with Karen that if the Federal Reserve had been in Holland during the Tulip Mania of the 1630s, tulip bulbs would have shot up in value, and the Fed would have cut interest rates and started quantitative easing to keep tulip bulb prices from collapsing.
Everything is inflated, overvalued, because bad money chased out good money and drove up the prices everywhere. You can’t say that higher gas prices are inflation and higher stock prices are appreciation. They’re the same thing.
Copernicus would have looked around and said, “The problem is you’ve got crap money.”
Well, something like that.
Japan inflated its stock market by devaluing its currency. Then it hiked rates and the Nikkei plunged the most since 1987. Sure, it rebounded for now. But the problem is the money.
I’m not saying this will be the bursting of the Great Pandemic Risk Asset Bubble. I’m saying that Copernicus would recognize the genesis of our sudden trouble. The stock market shuddered because cracks are showing in the Pandemic construct.
But Tim, interest rates are restrictive.
Says who? Should that not be determined by lenders? If I’ve got money to lend, would I prefer to loan it at 5% or 1%? So then why does the central bank suppose 1% is better?
For whom?
Low interest rates create bad money, which drives out good money, until everyone runs out of money and everything is overpriced, and it has to reset.
This is where we are. I don’t know what will happen next. I would prefer that our government would follow the advice that Copernicus offered to his king.
In the meantime, we have the data. We can see the bubbles, the pockets, the bets, the Demand/Supply imbalances. And we can help you, public companies and investors, navigate them.
PS – I’ll be out the next two weeks attending the Palio in Siena and in the Dolomites after, cooling off. Catch you after.
