A few thoughts on where we are
Photo by Michael Olsen on Unsplash
The past two years have been, for lack of a better word, strange times. For over 3 years now we’ve been writing about all the weird and wonderful phenomena that characterised the markets, characteristics that we have inevitably become used to.
With everything that’s happening in markets, three quarters into what has proven to be an action-packed year, there’s no better time than the present to take a step back and get some perspective on where exactly we are, as well as the road that led us to the present.
Of course, the most important thing in making sense of markets is context. We are merely putting our thoughts at this point in time in writing, but markets are extremely volatile. We are active traders so as always, please do not take any of this as investment advice.
From the seemingly endless bull market in private valuations, leading to companies remaining private for much longer, using IPOs as the final exit for private investors; to the seemingly unstoppable dominance of passive as an investment methodology; to the semantically unintuitive outcome of “derivatives” dictating the prices of their “underlying” instruments; to the unquenchable pursuit of risk, or perhaps (at least in the minds of those involved), of “yield”.
All of these market phenomena – and we use the word phenomena just because they seem to bring about occurrences which fly in the face of theoretical orthodoxy – find their origins in a single point: abundant and excessive market liquidity.
In many ways, these developments have unseated a large part of the conventional wisdom around markets. And since the beginning of this year, the unwinding of a backdrop of surplus liquidity has certainly struck hard at markets. The Fed is tightening, many other central banks are doing the same (except, perhaps, the BOE), and it would seem like the days of easy money are over.
Thinking about this even more deeply, we quickly realise that the conditions for being able to get away with printing surplus liquidity are not recurring - most important of which is persistently low inflation. Inflation, as it is, is a rate of change metric, which means that the cause of low inflation must continue to be in effect for it continuously remain low.
What were these causes? China’s industrialisation, becoming the world’s production base, supplying all across an interconnected and globalised economy, alongside huge developments in technology (particularly the internet), are probably the two biggest contributors. The problem is they can only happen once.
In contrast, we now face drivers that point us in the reverse direction: whether the ongoing reversal of globalisation trends or structural changes in behaviour post COVID leading to the balance of bargaining power moving towards labour (over capital). Populism is on the rise as the inequality brewing over the past 2 decades (arguably longer) comes to the fore.
But does this mean we automatically go back to the way things were before? The question is – before when? The unadulterated steady grind up of 2008-2019?
Probably not, unfortunately. If we do go back, we’re looking at going back to a way earlier time: the 1960s to the 1980s, perhaps, but fuelled by the technological and societal changes that are themselves hard to reverse. YOLO options trades, electronic trading, r/wallstreetbets, to name a few – these aren’t going away. The underlying state of the market may change, but the means of operating in the market remain.
The challenge is finding someone who has knowledge of trading in an environment of persistently high and sticky inflation. Some quick numbers suggest we’d need to look for a stockbroker who’s at least 77 years old and active on the floor of the NYSE in the 60s. That’s quite the challenge – if there’s anyone you know who might fit the bill, we’d definitely like to speak with them.
In the absence of that opportunity, perhaps the best guide is to take a re-read of Reminiscences of a Stock Operator.