Has the market stopped being a kid?
People tend to agree upon the fact that one of the greatest virtues of children is the capacity for wonder, and that those who are able to preserve it, as grownups, enjoy an enviable intellectual curiosity.
It is in this sense that I wonder if the stock market has acquired this degree of maturity, and if that is why it seems to assimilate seemingly negative news more quickly. Recently macroeconomic events appear to have had less impact on asset prices on a medium-term.
We already know how temperamental the market usually behaves, jumping between states of panic and euphoria, but it is the duration of these levels of fear that seem shorter. That is, windows of opportunity are presented, but for a shorter time span.
From the investor’s psychology perspective, risk aversion is highly regarded, and how in this eagerness the participants often make bad decisions and feed a vicious circle. It seems that lately, when negative events arise, “something” is correcting the course and lessening either the dimension or the duration of this pressure.
This question arises more specifically after the recent Brexit’s anniversary, and its apparent rapid assimilation in the stock market, taking it to historical highs despite the repercussions so discussed at the time.
Several explanations may arise in this regard, one is that ever more and more participants are acting in a rational way (as econs) and avoiding these untimely impulses to rush out without effectively determining the impacts on valuations.
Aswath Damodaran believes that if an event does not translate into an impact on future cash generation or on the discount rate, the effects on the asset value cannot be quantified correctly. Have the participants arrived at this degree of maturity to self-regulate their impulses? Sounds romantic.
Another cause could be the growing number of strategies that respond automatically to parameterized changes in asset prices based on quantitative models, better known as algorithms. This answer is beginning to make some sense, but not only is there a need for consensus in the programming of these guidelines, but also available capital for execution.
Some of the liquidity injected into the major economies, by central banks, following the financial crisis in 2008 could still be on the sidelines waiting to enter the market, regretting to have missed its comeback.
The theory dictates that prices of products and services respond to the everlasting clash of supply and demand, and that an imbalance where a greater number of applicants contrasts with a limited supply of goods results in an increase in prices or inflation. Hence, a limited supply of financial assets for an ever growing number of participants with increasing liquidity could have resulted in an inflation in the prices of financial assets, reflected in stretched valuations.
A normalization of valuations occurs when the results of the companies keep up an increasing step. Therefore, this liquidity injected into the economy could help to ease valuations if it is used in investments addressed to increase the companies’ profitability, or by the consumers, translating into income growth of the companies, which in turn would support economic growth.