FWIW # 55 - Old Signals - New Signals

The investment markets are confirming changes have taken place in market dynamics that are not fully understood by all participants. Here are some important issues.

OLD SIGNALS: There was a time when the US stock market was dominated by individual investors, professionals managing retirement accounts for individuals, wealthy families, and foundations / endowment funds that had a long-term viewpoint. When the stock market became too volatile or extended in value, many of these participants would sell their stocks and place the money in other areas, usually ultra-safe fixed-income securities. There was some rotation from “growth” speculation to “value” investing. Usually this rotation was based on the economic outlook; however, a significant amount of money exited the stock market, causing all stocks to decline in price, even the good ones.

It was not easy, but an analyst could study the psychological mood of the market participants and obtain an idea of whether the sentiment was setting up for a decline or an advance. This study of market psychology is the basis of technical analysis or chart reading. Charting is the study of supply and demand. If not taken in a literal sense, it was very helpful for gaining perspective on an individual stock, a sector, or the market’s probable direction. A company’s fundamental financial position was important and revolved around its sustainability, or its ability to maintain and increase its sales and profits over time. When the next recession or market decline took place, excess valuations returned to value levels as many participants had left the market. Over time, trust in the future of the country and the stock market returned and the cycle began again.

NEW SIGNALS: Over the last 25 years, two factors in the stock market dynamics changed. First, money in the stock market gradually shifted into the hands of professional speculators focused on momentum, the current direction of a stock due to its demand among other speculators, rather than fundamental value. And second, there’s the globalization of money committed to stocks, no matter where the exchanges are or where the money is owned.

There is a third factor that is much more difficult to prove, but over the last 10–12 years, market action appears to evidence an easier ability of transnational crime organizations to bring their profits into the legitimate financial arena, thus adding to the amount of available speculative demand for securities. The amount of money controlled by very large and aggressive speculators is huge and growing. These market participants also use leverage by borrowing from banks and other sources that are not pledged to any specific security or account.

A fourth factor is also in play: Exchange-traded derivatives and market-maker-created derivatives allow speculators to control large positions in individual companies and market indices without committing large capital amounts.

All four of these factors have distorted the stock market in this country more than in other places because of the size and liquidity in our marketplace. Wall Street is raking in profits from these changes in market dynamics. The selling that has continued since February 6 is indicative of these changes. Large daily price changes are becoming the norm. The crowding into and out of individual stocks or indices as the psychology shifts based on sudden and immediate changes in geopolitical and economic issues is illogical, but it’s the result of the prior 12 years of momentum-speculating based on far-fetched and dreamy scenarios about profits years in the future.

            Having seen what can happen to good companies fundamentally (such as MSFT and GE) and to the market (2008–09 and 2021), it’s important to build a certain amount of insulation from the volatility. Buying the dips is not the answer. Knowing a good and fair value for a company and demanding an annual reaffirmation of management’s abilities through a dividend should be an investor’s perspective.

            This week has given a signal that is potentially disturbing. The stock market continues lower with relentless selling. Ten-year US Treasury yields have fallen from 4.29% to 4.06%. That yield decline does indicate substantial money going into Treasuries. Likely, some of the money being liquidated in the stock market may be finding its way into the 10-year Treasury. On the scale it takes to move Treasury yields, this yield change appears to signal a brewing problem. Be aware and know what you own.