Everyone Is In The Pool, More Buyers Needed

At the halfway point of January, the market has struggled to hold onto its gains. This is surprising given the recent passage of a $900 billion stimulus bill and Biden’s proposal for another $1.9 trillion on Thursday. With another $2.8 trillion in stimulus hitting the economy, inducing the Fed to do more QE, markets were seemingly unimpressed.

For the first two weeks of January, the market is up by 0.32% YTD.

As we discussed recently in “There Is No Cash On The Sidelines,”  the markets are driven by buyers’ and sellers’ supply and demand.

In the current bull market advance, few people are willing to sell, so buyers must keep bidding up prices to attract a seller to make a transaction. As long as this remains the case, and exuberance exceeds logic, buyers will continue to pay higher prices to get into the positions they want to own.”

Such is also the definition of the “Greater Fool Theory:”

“The greater fool theory states that it is possible to make money by buying securities, whether or not they are overvalued, by selling them for a profit at a later date. This is because there will always be someone (i.e. a bigger or greater fool) who is willing to pay a higher price.”

The problem comes when buyers are no longer willing to pay a higher price. When sellers realize the change, there will be a rush to sell to a diminishing pool of buyers. Eventually, sellers begin to “panic sell” as buyers evaporate and prices plunge.

3 Risks In 2021

As we will discuss in a moment, there is ample evidence that “everyone is currently in the pool.”  Such leaves the market vulnerable to three risks we debated over the past week:

  1. More stimulus and direct checks into the economy lead to an inflationary spike that causes the Fed to discuss hiking rates and tapering QE.
  2. The current rise in interest rates continues over higher inflation concerns until it impacts a debt-laden economy causing the Fed to implement “yield curve control.” 
  3. The dollar, which has an enormous net-short position against it, reverses moves higher, pulling in foreign reserves, causing a short-squeeze on the dollar. 

The reality is that both a rise in the dollar, with higher yields, is likely to start attracting reserves from countries faced with economic weakness and negative-yielding debt. Such would quickly reverse the tailwinds that have supported the equity rally since March.

The following video covers the current market exuberance and the importance of the dollar.

The Problem With Monetary Policy

There is also the problem of monetary policy. As discussed in “Moral Hazard,” investors are chasing risk assets higher because they believe they have an insurance policy against losses, a.k.a. the Fed.

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