Most mysterious market

It seems that JPM is totally bullish on equities.

We are certainly in a very strange world. A pandemic has trashed many visible parts of the economy: airlines, restaurants, hotels: i.e. mainly services. It has left most manufacturing, and large scale retailing (especially Amazon) not only unscathed, but in a much stronger competitive position. People have been denied the opportunity to spend money on “frivolous” services like holidays and drinks out. So they’ve spent money on stocks, Bitcoin, houses and electronic gadgets. So the stockmarket is experiencing huge gains.

I’ve said myself, many times, that the stock market is not the economy. It’s the expected net present value of future cash flows from the securities in it. Thus, it depends on two radical sources of uncertainty. Looking at dividends, for valuing stocks, it depends on future profits, which is a function of pricing power and the cost of all factors of production. It also depends on future real non-equity funding costs.

All this stuff is very hard to get a hand on, although the last item should follow from a look at government bond prices, which strip out credit risk and economic risk. It looks as though funding costs will remain very low, and so this should drive stocks higher. But gearing isn’t really going up much, because more and more equity has to be issued to feed the hunger of the C-suite. Shares are bought back, but only to the extent that exec. comp. is diluting the equity.

We are now deeply into the zone where interest rates alone are enough to move the needle on economic activity, to really affect people’s willingness (‘propensity’) to save. Governments are having the bulk of their bond issuance purchased by central banks. Some politicians are making noises about sound money, but everyone is reading books about MMT. We’ve undershot inflation targets for so long, it seems inconceivable that even current monetizing of debt will dent the trend. So, taxes won’t rise, but debt will, and foreigners will (at least by us in the UK and US) be expected to accept it in exchange for imports.

Herb Stein said, a very long time ago, that if something cannot go on forever, it will have to stop. But Keynes said that things can go on for so long, the fact that will stop one day might well be of no interest to practical men. And central bankers and politicians don’t have to look ahead very far. And the bond bulls have been saying that monetary conditions are too tight for a long time. So maybe in five years time, I’ll still be saying that inflation is coming, either here, or to my grandchildren, or on my gravestone.

We seem to be stuck in a permanent risk on world, for certain assets, like equities. But a risk off world for others, like BTC. Normally when related markets get out of line there is some market neutral trade that can be put on which will take advantage of the inevitable mean reversion. Which I guess would be gold vs FAANG, or TIPS vs Long Bond, or value factor equities vs momentum factor ones. Or emerging market equities vs SPX. But the argument for these trades has been present a long time, and these trades would have lost money for a long time. So, we have no option but to wait.