Why do stocks ever go down? I remember asking my father that years and years and years ago. I was trying to learn about the stock market and I couldn’t figure out why stocks did nothing but go up. If they are such terrific investments, why do they seem to go down a lot?
Pop had some simple answers. People sell because sometimes stocks are too high. I would then ask who decides that they are too high? Does someone just say “stocks are too high, or this or that stock is too high and that’s it?”
Sure enough, on multiple occasions, he would say that’s pretty much it. And on other occasions he would say sometimes business is just awful and stocks go down because of that.
Looking back, I truly wonder whether Pop was on to something, but missed a bigger picture. Stocks can go up or down, depending on the underlying companies. However, the truth is that this age, stocks go up or down because of the overall economy and the individual company’s prospects are often lost in the shuffle.
And what, for the most part, determines what the economy is going to do? What’s the great predictor?
It’s not stocks. Not at all. It’s bonds. It’s why we need the bond report. It’s why you need to check where rates are every day.
The bond market, as I always tell you, is much larger than the stock market. Bonds go up and down like stocks. When they go up, the yield they give you shrinks. When they go down the yield gets bigger.
That’s all well and good. What we need to know, what Pop didn’t know, is bonds tell you if stocks are overpriced. They are the tells, so to speak and you have to respect them.
Which brings me to today’s session. You can’t tell from the averages, but for many stocks today was hideous, just horrendous.
At the same time it was a glorious day for bonds, as they rallied again, cutting the yield even more dramatically. There’s an issue here, though, that’s bugging everyone, I mean everyone, because the great teller of truth is telling us something we don’t understand. There are discordant voices out there and they all seem to admit that the bond market isn’t functioning as a predictor the way it should, because rates should be going up, not down, because we all know that inflation is raging. Worse, many people feel that the Federal Reserve Chairman, after two days of testimony on the Hill, is simply out of touch and unaware with this rap about how inflation is transitory, because everything’s going up in price, especially labor.
So, if bonds are supposed to be accurate, who is right? And what does it mean for stocks if they are right?
First, I know knot to disagree with the bond market. I take what it says loud and clear, because when I go against it, I often, not always, but often find myself losing money.
Right now, though there is a real conundrum, and it’s causing many stocks to go down on their own rate, especially the speculative, high growth stocks.
Let’s go over the theories behind what bonds are doing. Don’t worry, I will make it as exciting as bonds can be without yelling about them or arguing politics about them. What matters is trying to figure out, without ideology, what the heck is going on.
One, it is possible that interest rates are going simply because our bonds offer a higher yield than pretty much anywhere around the world. That’s important, as trillions of dollars are sent around the world seeking the highest quality, most liquid, and highest yielding paper, as it is called, and that’s our Treasurys. You can go in and out of billions of dollars a day – that’s liquidity– so it is entirely possible that the bond market is signaling absolutely nothing. The repercussion to stocks? Higher yielding stocks should be going higher. Lower yielding stocks, no impact.
Two, bonds may be going up in price and down in yield because Jay Powell is absolutely right: We are going to have a transitory period of inflation. The key components of inflation, used cars, foodstuff, energy, may all be collapsing at once and wages might be on the verge of declining after benefits run out. That would be a truly positive scenario for stocks. Oddly, if that’s true though we wouldn’t have such a decline in so many growth stocks, which do better with low to no inflation. Stocks are saying this view is wrong.
Third, there’s the possibility that rates are going down, because we are about to have a slowdown in the economy. Given that employment claims were the lowest since the pandemic began, that’s hard to believe. Unless, of course, the new delta variant is going to slow the economy more than we realize and it will hit everything. I do not want to believe this. I do not want to believe we could be on the verge of putting masks back on, because of the spread of the new COVID variant, and supply chains will be interrupted again. Unfortunately, this is a possibility and it could explain why so many stocks that do well with economic growth, especially small cap growth stocks are being slaughtered.
Those really are the three possibilities. I can tell you right now my job is not to say which is right, even as I believe it’s the second one, meaning inflation is peaking and Powell will be right. My job is to figure out what big stock sellers are thinking based on this information.
This brings me full circle to Pop’s point of view. Pop’s analysis, remember, was simple enough, which is that many stocks just got too high and now they are going down. We know that they aren’t going down because of business itself. We have had almost a full week of earnings now and they are almost uniformly fabulous.
But we have a lot of speculation in the system in part because the government has given away so much money and in part, because there is a whole new cohort of stock buyers, younger people who borrow money and buy everything from bitcoin, which is being crushed, to all sorts of high growth stocks they don’t even know. Younger investors seem to be drawn to technology and biotech and crypto and meme stocks, the unfortunate name for the stocks of companies that have become playthings for some who are trying to game a legally ungameable stock system.
I think what you are seeing is the beginning of them being blown out after a prolonged period where they had an amazing run. In some ways this market mirrors crypto currencies as well as the stocks of AMC (AMC) , the movie chain and Gamestop (GME) , the video game chain and a whole bunch of little stocks that are part of massive pump and dump schemes. At the same time, we have so many new stocks that the amount of new supply is overwhelming demand, because the big money managers don’t want the stocks and the smaller investor doesn’t even now what they do.
In that scenario, stocks don’t languish. They go down. Especially the speculative, the commodity-oriented stocks, and the new issues that nobody knows and nobody cares about.
So now, let me answer the question that I posed at the start of this screed: Why do stocks go down? Most people think the answer lies in the yield curve, what bonds are doing and I get that, that’s the way I was taught.
But right now, there is an answer that can jibe with number one – bonds are going down in yield because of worldwide demand and they are signaling nothing about stocks. Stocks are coming down because there is not enough money around to buy all the junk that’s been created, all the second-rate tech and biotech and something or other as a service. Stocks are going down because just like merchandise is a store, they are being marked down, with the speculative ones always the first to go. If the spigot doesn’t turn off, if more and more keeps getting pumped out, it doesn’t matter what bonds do. Stocks are going to fall on their own weight – the smaller ones first. That’s why FAANG was the last to go. The solution? If we get a respite of underwritings and continued good earnings we will be fine. But the new supply must stop. Hence the answer: Stocks are going down because people need to sell. They don’t want to lose money. There, that’s the answer you have been looking for.
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