September 14, 2022

Inflation

Well, that answers that question. 

The question?

If over 50% of volume in the S&P 500 is short for the first time ever and investment declines 3% despite a 5% rise for stocks the week ended Sep 9 driven by trading machines, could the market implode?

By the way, the ModernIR team is hosting a webinar for clients Monday Sep 19 at noon ET (copy this link to your calendar at that time) titled Incorporating Market Structure Into Daily IR Activities. It features two IROs in panel format. We’re opening it to the public.

I don’t think it would have mattered if Consumer Price Index data had been better rather than worse.  The market would have tanked and the pundits would have said, “Investors fear the Fed will kill the economy.”

As it was, they said, “Inflation is killing the economy.”

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The economy and the stock market are not the same things.  In fact, the fundamentals of investing and how the stock market works are not the same thing. 

The stock market is 100% electronic, about 97% algorithmic and dominated by computerized models. Over half of all trading has an investment horizon of a day or less – and that behavior drove stocks up but shorted them too.

Investors with horizons of about 400 milliseconds were prepared for the market to tip over.  Everybody else was not.

Supply/Demand imbalances have the same effect in the stock market that they do in any market.  Weak demand, high supply, prices fall. They go on sale, like when a store overstocks goods and brays that “everything must go!”

Inflation reflects one thing: Overstocked dollars. Inflation means your money buys less. Inflation causes consumption to decline. It’s a mathematical fact.

So, it’s fatuous twaddle for Federal Reserve officials to claim they need to “slow the economy down” to stop inflation.  No, inflation slows an economy down. 

The Fed does not need to stop people from buying houses and cars and fuel and groceries. That won’t solve inflation.

Inflation will fall when dollars are removed from circulation.

That’s what higher interest rates do.  Paul Volcker in the 1970s lifted rates near 20% to induce people like my grandparents to buy laddered certificates of deposit paying 15-18% from banks.

Consumers sucked the supply of dollars out of the market. Prices came down.  Savers had something to show for it.

The trouble now is that businesses have been induced to pay sharply more for labor at the same time that the Fed needs to sharply increase the cost of capital.

What happens if the cost of people and the cost of money rise at the same time?  Businesses either go broke or have to suddenly slash output or employment, or both.

Businesses first cut output, hoping higher prices will offset higher costs.

And that slams headlong into the very thing the Fed claims to be trying to tamp down by discouraging consumption, which inflation is already doing.

The Hebrew words for “without form” and “void” in the biblical book of Genesis chapter 1 verse 2 are “tohu” and “bohu.”

I would describe Fed policy as tohu and bohu. I’m for higher rates. But not lower rates in the first place. That was the disaster. It’s too late to fix it without big pain.

Surprisingly, the stock market is not without form or void.  It’s got behaviors and rules, which combine to produce prices.  The behaviors are measurable, the rules are knowable.

And thus, so are prices.  If we measure prices according to the time-horizons setting them, in context of rules, the market’s behavior makes sense.

But listening to CNBC pundits trying to describe how stocks trading at 17 times earnings are fairly valued and ones trading at 30 times are not reflects no comprehension of how the stock market works.

That would be true if most of the money was motivated by multiples of earnings.  Statistically, there’s a one-in-ten chance that your stock, public companies, is priced by that motivation.

And no, it’s not true over time. Prices are set by whoever buys and sells.

(EDITORIAL NOTE: I’m speaking to the AGA IR Workshop in New York Sep 19 on what really prices stocks – hope to see you there.)

I mentioned in the August 24 blog that a study (by BNY Mellon and Accenture covering 9,000 respondents) found that people think cryptocurrencies are less complicated than stocks and bonds.

Flabbergasting. Whose fault do you suppose that is?

I’d be utterly confused too if my understanding of the stock market – and I have about 85,000 professional hours dedicated to it, 60,000 of those aimed at market structure – derived from the view of pundits.

We need a basic grasp of economics, so we’re not fooled by inflation (or economists).  Money is the foundation of commerce.

And investors and public companies should understand the stock market. That does NOT mean how businesses are valued – cash flows, sum of the parts, comparables.  That works in PRIVATE equity.

Those don’t determine the preponderance of prices in the stock market. If anything, relative value does.  It’s what made Ken Griffin and Jeff Yass rich, among a host of other fast-trading folks. And they invest in PRIVATE equity.

If you want to know more about the stock market, put this link in the noon ET block on your calendar Sep 19.

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