Why the Stock Market Nearly Collapsed and How It Staged a Massive Comeback
Abraham George Market Views
Yesterday was a very ugly day in the markets. The unwinding of frothy assets reached a crescendo (of sorts) but it got better by the end of the day. For the very attuned market participants, such days offer great buying opportunities. I have been warning of such a happening for many weeks.
In less than two years, we have had a 40% growth in the money supply. I cannot remember any other time where we have had such a massive increase in such a brief span of time. This created a lot of excess money in the system chasing a relatively stable quantity of assets.
It created a lot of irrational allocation of money and inflation in all areas you can think of. Money was being pushed out of good assets into lower quality assets with no real cash flows. The fear of interest rates going up exacerbated the recent fall but we will prove from historical evidence that interest rates moving up is after all not that bad for stocks, through another report in the coming days.
Just as in the dot-com bubble and in the housing bubble, we have again seen the dynamics of irrational investments once again indirectly aided by the authorities. The time of reckoning was overdue and we are facing it now. The overly aggressive Fed and government response to the pandemic created this excessive liquidity and misappropriation of investments. The over-administration of medicine is killing the patient. Now, the change in direction of the policies (or the fear of the extent of the policy change) is ending it.
With excessive leverage in many areas of the financial markets, discussions on interest rates moving up will not be well received. It was already putting downward valuations. So, some selling yesterday turned into more selling and reached a point of forced selling as well.
However, the good news was that after the broad market selling, the markets recovered. That doesn’t mean we will not see any more selling. The recovery was mostly led by value stocks. That means the money is not running away from the stock markets. There is a significant reallocation taking place. Money is moving out of overvalued to undervalued. This obviously is a very positive sign for the markets.
Some may be thinking if there are further declines in the stock markets that may force the Fed to change its current path of monetary policy. We have precedence when the Fed made an about-turn in 2016 and 2018 due to a falling stock market. It is very unlikely the Fed would again do something like that now. Back then, the economy was weak, fragile and inflation was soft.
This time it is different. The Fed is dealing with a 5% plus growth economy and inflation already higher than 7%. The Fed is unlikely to change what they have already communicated to the markets. Markets will surely be eagerly waiting for the post FOMC press conference from the Fed Chairman. Jay Powell will most likely downplay the recent price gyrations.
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Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and multi-billion dollar portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office and a hedge fund. Currently, he is a co-founder of a new hedge fund where foreign citizens can invest in Indian growth stocks like Tanla operating in hyper-growth markets like CPaaS.