Weekly Update

Reminder: The Market Is All About Supply and Demand, Nothing Else

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Published February 5, 2021

That’s right folks, any market: stocks, bonds, commodities, milk, diapers, et al. is ONLY about supply and demand. Sure, we try to make ourselves feel better by assigning formulas and trying to figure out some “fair value” based on historical data. But it’s a complete wild west guess, right? Take the price-earnings ratio, so frequently used to peg the stock market as being “expensive” or “cheap”. This ratio has run anywhere from 10 to 100, settling in a typical range of 15-20 or so. Still, it’s a bell(ish) curve with a very wide range of possible values. That typical range does not say anything about the investing or economic environment of the times. We are living in an age of unprecedented interest rates, where money is practically free to borrow. Why wouldn’t asset prices be going “to the moon!” every day in that scenario, with the greater fool theory very much alive and well. The chart below shows the range of the price-earnings ratio with the 15-20 range noted with the dotted lines. We can see that the market spends more time OUT of this range than in it. So, then, how useful is this market metric?

Price-earnings ratio

Commodity prices are the perfect example, where supply and demand (plus raw investor emotion) pushes prices around wildly at times, with only a hint of fundamental data underpinning their value. Take the chart below of silver as an example of the extreme price volatility for a commodity.

Silver extreme price volatility

Bitcoin has been the latest “asset” to act like a commodity. The cryptocurrencies have no value other than what people are willing to buy and sell them for. They have virtually no role in the day-to-day economy and have no intrinsic value. Yet, demand for them has sent their value soaring some days, crashing others (chart below with % price changes noted).

Bitcoin acting like a commodity

Same for the recent mania around Gamestop and other stocks with heavy short interest. Here, at least, there was a well-known market mechanism at play – where investors who had taken short positions were, by definition, vulnerable to a pack of hungry buyers running them OUT of those short positions. But that trade had almost nothing to do with the fair value of those stocks; everything to do with raw supply and demand. As with the bitcoin example, prices shot higher and came crashing down. They remain well above what almost anyone would say is fair value for these company’s assets. Indeed, little fundamentally changed about the company throughout this run in the shares

Gamestop heavy short interest

Our proprietary models do not incorporate any fundamental economic, market, or company data. We recognize that the stock market is an emotion-driven pricing machine, swinging widely at times. We simply attempt to uncover the market’s primary trend, up or down, and profit from it.


Market Update

After posting slim losses for the month of January, stocks pushed higher every day in the first week of February. Monday saw a sharp +1.6% gain for the broad market with strength in big-cap tech/consumer shares leading the way. Silver got the day trader treatment, soaring almost +10% while last week’s quick-trade favorite, GameStop (GME), saw shares slump -31%. Another solid +1.4% session Tuesday ahead of earnings announcements from Amazon (AMZN) and Alphabet (GOOG). Those earnings did not disappoint. However, only Alphabet’s shares won the day Wednesday, with the advertising/search powerhouse popping +7%. But the day overall was flat for the broad market as investors continue awaiting news of a fresh relief package from Congress. Another +1% day for stocks Thursday with fintech firm PayPal (PYPL) zooming higher on earnings. Banks zipped upward as yields on the 30-year Treasury bond surpassed 1.90% for the first time in a year. A +0.4% rise Friday made it a perfect 5-for-5 week for the stock market. A tepid monthly jobs report fueled optimism for a hefty stimulus package. Oil prices leapt +8% on the week, reflecting expectations for a stronger global economy as supply remains reduced. And that soaring silver on Monday? It was a one-day wonder, back down the very next day and unchanged on the week.

Stock investors got their hoped-for pullback last week and bought it like mad. The S&P 500 (SPY) kicked off February with a +4.77% rise to new highs. The Nasdaq 100 (QQQ) joined in with a +5.34% tally. Smallcap shares (IWM) resumed their leadership with a +7.83% run.

Warm wishes and until next week.