Why the Market Is Going Up: A Ludicrous Theory

A popular thesis as to why the stock market is going higher is that the massive amount of liquidity supplied by central banks needs to find a home. Money managers are using this money to chase current performance and, likely, “self-fulfilling” their own prophecy. It might not be that simple.

It is, clearly, ludicrous to overlay economic theory onto stock market price action but the market is behaving in a ludicrous manner, so let’s give it a try and examine the underpinnings of my theory.

What could be happening in the stock market is a pre-Keynesian dynamic which John Maynard himself said, still continues to underlie all orthodox economic theory: supply creates its own demand.

Money mangers are not, in fact, chasing performance they are, in reality, being drawn to it. Their need to perform does not create performance; performance creates their need. If we substitute "supply" for performance (profits) and “demand” for fund manager need (put money to work), we see the classical theory in action.

On the other hand, much of the excess liquidity is moving into bonds. That dynamic is purely Keynesian, in that; money is “demanding” safety and, consequently, driving up prices. The TIPs are making new all time highs despite the fact that the Federal Reserve has implied, in their most recent statement, that rates will remain low for a long time. Investors, generally, are proactive about safety and allocate towards it; performance will draw them to take on more risk. So, it seems that, in terms of economic theory, “fear” is “Keynesian” and “greed” is “classical.”

This explanation becomes even more convoluted (or ludicrous) when we add a second derivative to the thesis. A safe allocation would allow you to feel secure enough to take on a little risk and great performance may cause you to book some profit and seek out some safety. The markets, then, both stock and bond, are building on themselves as they engage in this great clash of economic theories. I think “fear” can beat-up “greed” but, nonetheless, this dynamic synergy is the force that is powering the markets higher. That’s my theory and I’m sticking to it.

Disclosure: I never finished reading “The General Theory of Employment, Interest and Money.”

Comments

[zagrebzagreb:]

I'm not sure this theroy is too far fetched...

A few weeks ago I was reading in the Economist that somewhere around 30% of stimulus money in China has found its way into national equities (That is, the Chinese stock market).... Not sure how the writers were able to devine that percentage, but even if it were just a faction of that, it would still be very significant. And yes, there is that absurdity of debt - paid for by taxes - that is simply used to support and rally equity or bond prices.

Nov 11 10:26 AM

[DRIx:]

ever heard of occam's razor?

Nov 11 02:57 PM

[Kimball Corson:]

I think the key idea is trending. It can often occur independently of the fundamentals. If you reasonably believe everyone else believes the market is going up, then it is perfectly reasonable to invest in stocks with falling returns because you expect their prices to go up too. And prices usually do go up in an up trending market, at least until the bears pursuade people otherwise. A trending market can become disconnected from reality, at least for a while, which can be a long time in some cases. Then make money easily available with zero interest rate and quantitative easing policies and it is no surprise we are where we are.

Nov 11 06:28 PM

[LaChic:]

when i mention liquidity driven market I'm referring to the stimulus, the spending, the printing and the fed, that is the liquidity many people speak of.....

Nov 11 07:14 PM