I’m still looking for an explanation for current share market valuations. Robots get us closer, but there’s still big gaps.
So yesterday I was looking at the herd-dynamics driving the market. I showed you why some people think it’s the mindless momentum of the herd that has taken the share market to all time highs on the back of the worst economic data in history.
And it is true that the market is looking a little ‘sheepy’.
But it’s not the only theory I find interesting right now. The other theory I find interesting is that this is a robot market.
This is the idea that the market is being driven by the cold calculating mind of trading algorithms, and current valuations are, in a sense, entirely rational.
Now share markets have been around long enough now that we have a pretty good idea of how these cycles play out. The Advanced Finance text-book would say that it looks something like this:
· You get a stock market blowoff followed by a bust.
· Corporate debt prices start to fall, and yields increase.
· USD gets safe haven flows and bonds are bid.
· There’s a flight to quality in stocks.
· You get government/central bank intervention.
· Stocks bounce off the lows.
· Momentum trades kick in, driving the stock market higher.
· Bonds start to sell, USD safe haven unwinds.
· There’s a rotation to value and cyclical stocks as the recovery unfolds.
· Bond yields rise further, usually due to inflation.
And around and around we go.
Now, this is interesting to think about in a game-theory framework.
So the question is, if the market is going to follow this well-worn path, how do you make money? How do you use the knowledge of these cycles to your advantage?
Well, very basically, you can make money off each phase in the cycle by positioning yourself for that phase before it happens.
E.g. You make money off the stock rebound by buying stocks before that happens.
So you want to be one phase ahead of the cycle.
But now what happens if every investor is armed with that knowledge?
Well, if every investor is in the pre-rebound phase, then every investor is buying, and the re-bound phase is actually on top of you already.
So you need to move to the phase before. But every investor knows that too, and so they move to the phase before as well, which brings that phase forward as well.
As so you go to the phase before that, and so does every other investor, and so you go to the phase before that one…
This goes on an on until you pull the entire cycle forward.
And that’s why a lot of people are saying that we’ve seen a full share market cycle – something that normally takes 3 years to play out – we’ve seen a full cycle in just three months.
To me, this seems kind of plausible. Especially when you remember how much of the market is driven by robots and algorithms, throwing massive computing power at just trying to get ahead of the cycle.
If every robot is doing that, and the market is made up almost entirely of robots, that has the power to pull the cycle forward, and crunch it down into an incredibly short cycle.
And maybe that’s why we’ve got stocks rebounding to all time highs, even before the dust of Corona has had a chance to settle.
The robots have seen through it all, and are just spitting out ‘buy’.
But it’s a ‘dumb intelligence’. That’s what big-data AI is. It’s doesn’t understand the reasoning and cause and effect.
It only knows that, historically, when X happens, Y happens. It doesn’t even care why.
And I think there’s a big question about how we’ll go this time round. Because X isn’t just a share market dip. X is a synchronised global pandemic.
And that’s never happened before.
I not sure the robots know what’s coming.