Special Report

The Stock Market is a Traffic Accident Waiting to Happen




February 20, 2022

Red toy car accident

Recently, I was reading an article written by a professor of finance who had done a detailed study of “How Novelty and Narratives Drive the Stock Market: Black Swans, Animal Spirits and Scapegoats”. Behavioural finance is all the rage these days. It’s interesting stuff for students of the “market” and I am one of those ‘nerds’.

The professor studies how news narratives, ambiguity, and unscheduled events impact stock market behaviour. Consider how we behave when we encounter a traffic jam on the highway. An unscheduled event, a car accident, creates a pause in those closest to the event who slow down to look. Hopefully, everyone is fine but, in the process, the on lookers have created a narrative; there has been an accident and for everyone on the road behind, maddeningly, we are all impacted. As we in turn pass the scene of the ‘crime’, we too slow to glance over the mess and pass-on the reactive actions of those behind. This is human behaviour, and the stock market follows similar patterns.
Presently, the news events and subsequent market narratives are substantially centered upon the prospects of war, inflation, and interest rates.

On the Prospects of War

Our view is nuanced but mostly influenced by the facts. The U.S. has explicitly said they will not go to war over the Ukraine. They will punish Mr. Putin in other ways. Hoping that Mr. Putin will bargain a deal or just steal a bit of the country. That seems like the likely outcome and most investors are doing little to adjust their portfolios. They reason that who oversees Ukraine means little to the number of hamburgers sold by McDonalds or the movies watched on Disney+. We agree and suggest you follow the same strategy.

On Inflation and Interest Rates

We all want a little inflation, it’s a matter of how much and of what is inflating. If our portfolios values are inflating at a rate greater than our needs to meet our day-to-day expenses, we are thrilled. If our friend gets a raise, we are happy for them. If someone comes along and offers to buy our house at a high price we are pleased. If we walk into the store and eggs are 2x what they were the week before we must make a choice. Do we buy/need eggs? Have chickens stopped making enough eggs? For how long might chickens refuse to work and might eggs fall in price if chickens get back to work making more chickens?

Some inflation is because things are still messed up from people not working. Not putting eggs in boxes would be a good example. Some inflation is because we all bought a lot of the same things all at once. Pelotons are a fun example. For these types of inflation, prices are already falling, and it is likely to solve itself soon. We are not alone in this view.

Some inflation is because businesses need to pay people more money to work. We may find it offensive, if rich(er) people make more money but, in the end, we do nothing. But if poor people make more money? Well! Some think this is bad. Henry Ford said he wanted to pay his workers well so they could buy his cars. Henry Ford got rich doing that. Smart businesses will pay their people well and do just fine because the things their employees produce, people want to buy. These are the types of businesses you own.

Interest rates are rising because they were at zero, and that’s dumb when the economy is booming. And to be clear, regardless of what you hear about, inflation, the price of eggs, oil, Putin, Ukraine, interest rates, Covid, Trudeau, Truckers, or any other narrative in the news, the economy is booming.

On a Booming Economy

Strong economies can only exist if business is good. If business is good, good stocks do well. Booming economies do not boom for ever and usually slow down. As with everything, it is a question of how much will the economy slow? This is the narrative that most active trading investors and or commentators, story tellers really, are most focused on and is the excuse they give as to why stocks are up or down on any given day. It's a fun sport to watch. I guess.

We do not think the economy will slow, nor will inflation and or interest rates rise to a point where business will suffer materially. Then again, we didn’t predict the markets would soar last year either. Our Ouija board has been put away having given a comforting forecast.
So, what’s going on?

A lot of storytelling is being tortured into narratives as to why stocks are going up or down daily. Sure, if you need an explanation, these stories are as good as any else, but I would just put it down to a good old-fashioned bout of volatility. It happens all the time, is not a unique event and really doesn’t justify defining it more than that. More money has been lost trying to time the next recession or stock market crash.

Volatility and falling prices are an opportunity. Always have been and always will be. This is a good time to check your pockets for change, send us a check and make some investments. In the meantime, to avoid traffic accidents, take the scenic route and enjoy the drive.