To start this week off, let’s just take a moment to admire the fact that someone paid $2.7 million to have lunch with Warren Buffett yesterday. Granted, the money will be sent to a charity as part of a larger $25 million donation raised by Buffett in this annual auction event, but still… $2.7 million for lunch? You heard it from me first, that’s where I’m headed.
On to the more important stuff:
Conor and I have been in an ongoing debate about whether or not the current moment is an appropriate time to invest in the stock market. After all, equities valuations are through the roof, the unemployment rate is maxed out at 4.4%, the Fed is trying to slow economic expansion by raising interest rates, and our domestic political landscape is compromised to say the least.
In my opinion, that should all add up to spell imminent trouble for American investors. The summation of all of those factors, and many others such as the recent UK election results, could theoretically spark a market correction that will knock shares down to a much more reasonable price point.
Quick side note: For the millennials out there who lived through the 2009 financial crash, don’t worry. When I say things like “correction” and “knock shares down,” I’m talking about a 10-15% price correction, not the entire damn financial system going to shit.
But so far, that hasn’t happened. Other than a brief upset on Friday that sent most tech shares tumbling several percentage points, the overall direction of the market continues to be straight up.
To put it simply: Conor is winning our bet. Big time.
The stock market keeps rising. Just today, there was an article in the Wall Street Journal about how firms that recently went public through an IPO (initial public offering) are now returning to the market to issue more stock in order to take advantage of the seemingly endless supply of capital flowing through the American stock market.
So my question this week is why?
Why is the market defying most conventional wisdom that would otherwise suggest trouble?
That’s obviously a very complicated question, but allow me to offer 3 potential reasons:
Money is Cheap
Even though the Fed has talked a lot about the possibility of raising interest rates in the near future, the fact remains that they haven’t really done it yet to a large degree. Sure, there have been several small hikes, the most recent of which was just a few months ago, but the Fed funds rate is still hovering around 1%.
To put that into perspective, here is a graph of historical fed funds rates:
It should be immediately clear that despite recent hikes, the current Fed funds rate is still at an unprecedented low in recent history. We haven’t even begun to recover from when they slashed it down to 0 following the financial crisis in 2009.
And until that happens, companies have essentially unlimited access to large amounts of borrowed capital at extremely low interest rates. With a deal like that, no wonder American corporations are doing so well.
The Quants Have Won
Some would argue, Conor included, that the takeover of Wall Street staged by “the quants” has fundamentally changed the landscape of the investing world, and thus the nature of the markets themselves.
For those of you who are sitting there scratching your heads like “what the hell is Kristian talking about?” :
A “quant” is someone who trades based on a computer algorithm. In fact, to say that “they trade” is probably an overestimate of what they do. “They” code, and the computer trades. The fact that more and more of the trading happening on Wall Street and around the world is based on quant algorithms is serious shit.
It has the capacity to fundamentally change the nature of the markets.
Humans make mistakes, and conduct themselves primarily based on their emotions. The mistakes that humans make cause inefficiencies in the market that can then subsequently cause large bubbles, which are generally followed by large crashes.
On the other hand, computers do exactly what they are told. Nothing more and nothing less. They follow a given strategy word for word and execute immediately. No emotional bullshit to consider. They are the perfect investors.
Thus, it can be argued that the market has become more and more efficient and that the withdrawal of humans from the investing scene has resulted in a fundamentally more stable system.
Ok but where’s the proof, hotshot?
Boom. The VIX index, which measures market volatility, is at an all time low despite global political and economic instability that *could* otherwise trigger significant volatility.
If Donald Trump and his so-admired political posse can ever paddle their way out of shit creek far enough to actually get anything done, we might theoretically see some significant tax reform for large corporations.
The “Trump Bump” that we saw last November, which has since turned into the “Trump ride on a fucking space elevator” was in large part a result of the expectation that tax reform would come under his administration. And thus, a lot of that expectation is already priced into equities valuations, which could be one reason they are so inflated.
To be fair, some tax reform has come. But it hasn’t been a lot. And certainly not as much as is likely already priced into the market.
So as far as I can tell, investors are kind of sitting around with their heads up their asses waiting for something to happen so that they can decide what they want to do with their money.
“It’s still too early to tell whether or not the tax reform is coming. Once the Russia thing is settled, it’s going to be a priority,” they’ll say.
Right. Good luck with that.
So to conclude, I remain of the mindset that a market correction is likely to come, but I am also willing to give credence to the fact that it may be less significant and further out into the future than a lot of other people are expecting due to some of the reasons I’ve laid out above.
Next week, I’ll offer some more thoughts on how to trade in market conditions like this, with a special emphasis on how to balance risk in your portfolio.
Questions or comments? What’s in your portfolio right now to prepare for any downturn that may lie ahead?
Do you think a correction is coming?
See you next week…