Quote of the Week
“Remember to be gentle with yourself and others…none can say why some fields blossom while others lay brown beneath the August sun.” – Kal Menninger
Last week the markets sold off worrying whether the Fed will soon start cutting back on their bond buying of $120 billion per month that is designed to stimulate the economy by putting more money into circulation. The sell off again was an “episodic and non-trending volatility spike.” The markets hit a high on Monday of last week, then declined sharply, then rallied back up above that Monday’s high to a new high as of Tuesday this week. It was just another blip in “climbing the wall of worry.”
There is a big economic meeting at Jackson Hole, WY, this week where Fed Chairman Powell is speaking. The meeting is being held virtually because of the rise of the Delta variant. The markets are waiting anxiously to hear what he says on inflation. Does he think inflation is a longer-term trend, or is it transitory. The word out of the Biden administration is that it is transitory.
This morning we watched our data provider’s mid-quarter update. It appears that the Biden admiration could be wrong, and that would make good fodder for the Republicans in the 2022 midterms.
In the last few months, the big headline inflation news has been the rise in new and used car prices and the rise in the cost of lumber. All of those have moderated in the last month or so. They, however, make up a tiny piece of the inflation picture. The real drivers of inflation are shelter, labor, and food. All of those have risen steadily, and the trend is strong for them to continue to rise. If they continue, the Fed will be forced to do something about it. The Fed has two mandates: control inflation and maintain full employment.
The Fed has two tools to combat inflation. They can cut back on bond buying, thus curbing the growth in the money supply, or they can raise short term interest rates. Both of these tools will tend to slow the economy, thus in theory, slow inflation. The Fed is caught in a tight spot if inflation is trending higher. Remember in Quad III growth is declining, so if the Fed acts to curb inflation by shrinking the money supply or raising interest rates, that will accelerate the slowing of growth. This dilemma is called Stagflation.
So, we economic geeks are paying close attention.
Climbing the Wall of Worry
Climbing a wall of worry is the least understood and most powerful crowd behavior of a bull market. The phrase refers to investors bidding up stocks when news comes out that some worrisome issue for markets has “huzzah!” been successfully overcome. Then tomorrow there’s another worrisome issue, see “episodic and non-trending volatility spike”, that all the talking heads are buzzing about, but soon enough “huzzah!”, there’s a resolution to that problem and markets take another leg up. Wash, rinse, repeat.
Climbing a wall of worry is like all market behaviors, a great example of Information Theory, the intellectual foundation of all of narrative research. Information Theory was invented by Claude Shannon, and here is the central insight: Information is measured by how much it changes your mind.
The hallmark of market climbing a wall of worry is that the “worries” are not widely held. They’re not Common Knowledge. They’re stories that are presented to us as worries, as in “here’s what experts think might derail this market.” As a result, it takes very little informational strength to change your opinion about the worry and decide that it’s actually not a worry at all. In more technical terms, the informational hurdle for a new and higher equilibrium view of markets is relatively low. Repeat this a couple of times, and you have a market that is “climbing a wall of worry.”
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