"THE MARKET IS ALWAYS RIGHT !"... Well, yes... and no



ref :- "Reflation trade losses pile up for hedge funds in July", The Financial Times, Companies and Markets


The mantra about the market always being right is probably the most quoted of all. That's fair enough... it represents a truth that every new investor needs to get his or her head around pretty sharpish. It's utterly self-delusional to rail against the injustice of market prices moving against you because you believe that the price does not represent the fundamentals (as you interpret them). History is littered with examples of bankrupt investors still insisting that they were right all along, it was everyone else who was wrong.


Prices of stocks, bonds, commodities... of just about anything in fact... are influenced by a host of factors beyond basic bullish and bearish fundamentals. We see them in action the whole time, often casually lumped together under the banner of "market dynamics": market positioning for example, liquidity issues, or perhaps the undue weight exerted by popular trading systems (think "algorithmic"). But if you're talking fundamentals, the price is the most fundamental of all. It's the level at which buyers and sellers are coming together to transact business at any particular time. It's there for all to see, and is an inescapable truth.


So, in that sense, the market is indeed always right... it's fact of life, whether the prevailing price is to an investor's liking or not. But that's not at all the same thing as saying that one can't take a view as to whether the current price will prove to have been too cheap or too expensive at some point in the future. People invest money into markets for any number of reasons. Indeed some institutions (e.g. pension funds etc) are obliged to do so, but if you took away those taking a directional view as opposed to locking in a return through dividend or coupon payments say, it's hard to imagine what markets might look like, or how they would function.


The stellar rise of both stock and bond markets has been driven by a number things, but to mention just a few: vast government stimulus programmes (and accompanying ultra-easy monetary policies); the weight of money in search of some sort of return, however meagre it may seem by historical standards; FOMO - the Fear of Missing Out; momentum-driven trading programmes. Some would argue that these factors have inflated asset prices way beyond their fundamental worth, but if they've been thinking that way for a while and backing their view with their money, then some of them might just be shaking their fists at the sky by now, chuntering on about the apparent disconnect between markets and reality.


To be fair, it's hard to imagine any investors not having a few anxieties with markets at these heady levels, and hopefully they will have put some strategies in place to mitigate the pain of a reversal if and when it comes. But the fact is that those factors mentioned above are some of the new fundamentals that have to be taken into account, and are every bit as valid as the old fundamentals that held sway in simpler times.


We were prompted to muse in this way by the words of Fed Chair Jay Powell, quoted in this piece in the FT. To be honest, the article only tangentially touches upon what we've been wittering on about. It focusses on the losses incurred by bond fund managers due to the reversal of the "Reflation Trade", which of course hinged on the expectation that continuing sharp upward growth readings would stoke inflation fears, leading to a tightening of Fed policy and higher bond yields. Those participating in the Reflation Trade positioned themselves short of US Treasuries in order to profit from lower prices as yields rise.


We've discussed the Reflation Trade reversal more than once. The unwelcome arrival of the Delta variant and resulting fears that growth and inflation may have already topped out has handed a number of high-profile fund managers a bloody nose, as yields fell once again from close to 1.80% to a low of 1.14%, and prices rose accordingly. What caught our eye was Mr Powell's admission that there was "no real consensus" on what was moving markets, and the FT tells us that Mr Powell was "calling out investors who had pointed to technical factors, which is where you put things you can't quite explain."


In a slightly weird way, it's vaguely reassuring to hear that neither the Chairman of the Fed, nor in his view a good number of investors, can truly explain the movements of the market. These days the Fed has a responsibility for maintaining orderly markets (though it's not strictly part of their mandate), but price levels are not their domain. That being so, his metaphorical shrug of the shoulders in response to recent price action is not a concern, but does indicate that he feels that market movements, in the short-term at least, can often bear little resemblance to the bigger picture.


Which, we guess, is what started us off on this track in the first place. The price will be what it will be, whether it seems entirely logical or not. If it's out of line, all any investor should hope for is that at some point it will get back to what he or she believes is fair value... and of course that they haven't been blown out of their position in the meantime.

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