One of the worst things when you are trading is to say, “I was right”. The point isn’t to be right. The point is to make money. The QQQ was up, the SPY was down on Monday, so no Black Monday.
The bears will be disappointed but there is hope for them if they have a lot of confirmation bias, which is also a terrible thing to have when you are trading. Instead of being objective you look for and notice things that tell you that you are right. See the first paragraph about being right.
On cue, my friend Keith sent me a link to an article in Monday’s WSJ about the next Black Monday being around the corner. The two gentlemen who wrote it are Johns Hopkins economics professors. I will give them their space, but they are incorrect in the way they are looking at things.
First, remember this. When you see a professor of economics write an opinion piece, the first thing you need to know is what sort of lens they are viewing the world to have that opinion. In this case, both macroeconomics are neo-Keynesians. Hence, they put a lot of emphasis on the government inputs into the economy.
A classical economist would put those same inputs at 0, or close to 0. Sometimes, even negative given opportunity costs.
Here is their fatal error. They are looking at M2. M2 is a measure of money supply. It is defined as: Beginning May 2020, M2 consists of M1 plus (1) small-denomination time deposits (time deposits in amounts of less than $100,000) less IRA and Keogh balances at depository institutions; and (2) balances in retail MMFs less IRA and Keogh balances at MMFs. Seasonally adjusted M2 is constructed by summing savings deposits (before May 2020), small-denomination time deposits, and retail MMFs, each seasonally adjusted separately, and adding this result to seasonally adjusted M1. Here is the chart of M2 since 1959. As the US economy grows, the volume of M2 grows too. This is a good thing. Gold bugs won’t agree.
The dear professors, bless their hearts, are sounding the alarm because M2 has declined from Covid levels, which were artificially high to begin with. Additionally, the learned professors cite the statistics of commercial bank securities. Banks are holding less. That’s because loan volume is down which makes total sense since interest rates are significantly higher.
When the Fed raises rates, this is exactly what should happen. Loans and business activity should decrease which should slow the economy allowing inflation to ease. Business and consumers need to adjust to the higher cost of money. Imagine being a CFO at a business. You have a cash flow positive business and you are sitting on cash.
you can allocate your capital to safe US Treasuries and get a guaranteed return
you can allocate some capital to commercial paper and get a higher, but more risky return
you can pay a dividend to equity shareholders
you can pay down debt that you have incurred
you can raise the salaries of employees
you can buyback stock
you can invest in your business and build more capacity
Certainly, with uncertainty you will not pay a dividend. You also won’t pay down debt since it’s probably financed at a rate lower than today’s rates. You will raise your employee salaries some and you might look at ways to buy software or machines that can do things more efficiently so your employees are more productive.
However, the hurdle rates you use internally changed a bunch in the last year with the rise in rates. You might put any investment in the business off.
Buying back stock might make sense depending on where your stock is trading relative to your book value.
That leaves buying US Treasuries and commercial paper. That’s what businesses and individuals are doing these days.
Do not look to academic economists to predict the next Black Monday. Odds are really good it won’t happen again. This is especially true because of all the circuit breakers that are built into markets that slow their decline.
Certainly, we will have some really bad days in the market at some point. Something crazy that you don’t see will set it off. Who saw Covid coming besides some people in Congress?
If we look back, who saw Long Term Capital Management falling apart? Who saw the Flash Crash? No one really saw the mortgage crisis coming and it was tough to take advantage of anyway.
The 1987 crash was caused not only by high interest rates as cited by the professors but trade data. The ten year went from 7% to 10%. Our trade deficit was ballooning and it was hot news.
If the ten year were to go to 10%, certainly, that would be a factor but not the only one. As a matter of fact I just read on the same editorial page that our economy is in great shape by one Alan Blinder. He is a Keynesian too. You shouldn’t believe him.
Crash events are wildly addictive. Movement is fast and furious. But the native progression of the market is upwards. Fight that to your peril (which I have some good experience at).
This time may be different. Sure seems like a possibility. Indexes look primed for a look down and possible extension move. Wars everywhere. Banks stink, big tech strong as an ox. Lots of SP500 stocks printing massive monthly downtrends. UAW doing their best to become the commie superstars of the world. Make your bets boys and girls. If anything good happens, watch out if short.
Always enjoy your posts, thanks.
History repeats itself. We're seeing it again in real time.