This Week Markets Took a Pause

In 1996, the then US Federal Reserve Chairman Alan Greenspan coined the term ‘irrational exuberance’ after using it during a televised speech.

As he said (emphasis added):

Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?

Greenspan thought the markets were too hot, and wanted to cool them.

The plan worked. The Tokyo Stock Exchange, which was open at the time of the speech, fell 3%. Other world markets followed.

But the effect was short-lived. Stocks quickly rebounded. It wasn’t until four years later in 2000, with the dotcom bubble, that the market collapsed.

That, as you know, was followed by the more spectacular property bubble, which burst in 2008.

Since the bust of 2008, markets have once again soared, aided by long-term low interest rates and quantitative easing.

Even through a once-in-a-century pandemic the S&P 500 and the NASDAQ are trading at new highs.

This week though markets took a pause…

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You’ve surely heard…

You’ve surely heard of the biggest story making the rounds in the financial world. The one where a Reddit message board takes on the hedge funds.

In case you haven’t, a forum on Reddit called WallStreetBets executed a short squeeze. That’s when a stock boosts up, forcing people who have bet that the price of the stock would fall to buy it in order to prevent more losses…which pushes the stock higher.

WallStreetBets’ ‘army’ of retail investors went on to buy one of the most shorted companies in the market, GameStop Corp [NYSE:GME], a video game company that at the beginning of the year was trading at around US$17. Millions flocked into GameStop, pushing the share price to US$483 in only a couple of days.

The move put hedge fund Melvin Capital against the ropes. The fund had shorted the stock and confirmed this week they’ve had to close out the stock after taking a huge loss, and that Citadel and Point72 ended up pumping US$3 billion into the hedge fund to boost its finances.

It’s turned the whole system on its head, and put Wall Street on edge.

Since, the share price for GameStop has plummeted. Robinhood and other exchanges have stopped buy trades on GameStop and other stocks that have rallied like AMC and Nokia…something that has prompted plenty of criticism.

And the whole thing is nowhere near over.

The US Senate Committee on Banking, Housing and Urban Affairs said they would be holding a hearing on the state of the stock market after saying:

People on Wall Street only care about the rules when they’re the ones getting hurt. American workers have known for years the Wall Street system is broken – they’ve been paying the price. It’s time for the SEC and Congress to make the economy work for everyone not just Wall Street.

There’s no doubt in my mind we are in a moment of ‘irrational exuberance’, there’s a complete disconnect between the stock market, property and the economy. But things have been irrational for a while.

Usually in a crisis liquidity drains from the system but there’s plenty of liquidity around. Central banks have flooded the system with money to stave off the pandemic but have been doing so for years.

There’s a lot of money around, but not much prosperity. All the money printing and low for long interest rates has distorted things, it’s pushed asset prices up, but much of the population hasn’t benefitted from that.

Gone are the days when people could steadily and safely grow their savings into an account. Instead, they are pumping their money into the stock market banking on the central bank to keep propping the system.

I mean that’s what happens when you distort the system.

One of the big questions in my mind is when will it pop…whether it’s tomorrow, in four years or ever. There’s no way of knowing that.

What we do know is that all this liquidity is coming from central banks, whose policies have continued to support asset prices. If central banks stopped support, it’s likely asset prices would collapse. So, this could continue for a while.

The other question in my head is: What are the long-term trends that could benefit from this type of policy, even when the irrationality ends?

In my mind, that trend is the clean energy transition.

It’s a trend that’s not only benefitting from cheap debt to build infrastructure, but there’s also a push in government policy, public opinion and the technology is getting cheaper.

Of course it’s risky, and there will be plenty of losers, but it’s a long-term trend that could continue well into the future.


Selva Freigedo Signature

Selva Freigedo,
For The Rum Rebellion

Selva Freigedo is a research analyst for The Rum Rebellion.

Born in Argentina, her passion for economic analysis started at a young age. Her father was an economist for the Argentinean governments and the family used to discuss politics and economics at the dinner table.

Argentina is a country with an unusual economic history. Growing up there gave Selva first-hand experience on different economic phenomena such as hyperinflation, devaluation and debt default.

Selva has also lived in Brazil, Spain and the USA.

Back in 2000 she was living in the US as the dot com bubble popped…
And in 2008 she was in Spain as the property market exploded and then collapsed…

She has seen first-hand what happens when bubbles burst.

Selva joined Fat Tail Investment Research’s team in 2016, as an analyst. She now writes from her vantage point in Australia, where she settled in 2015.

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