EC We’re Not In Kansas Anymore

We’re not in Kansas anymore. The S&P 500 racked up another fine quarter with an 8.55% return, which brought the first half of the year to 15.25%. It has been easy to fill in the blanks with apparent reasons for the continued appreciation: Strong economic growth, easy financial conditions, the receding threat of COVID-19, etc. Still, it is hard to imagine the abyss the market was staring into just sixteen months ago.

Up, Down, Graph, Arrow, Market, Figure


This paradoxical combination of frightening crashes and eye-watering rebounds has come to dominate market behavior over the last several years. This pattern also differs noticeably from the past when markets traced out the business cycle more closely. The challenge for investors is to find a mental model that can help navigate this unfamiliar territory.


We’re Not In Kansas Anymore

As value investors are well aware, valuation does not make an excellent timing tool. Still, it is closely associated with future returns and therefore has proved helpful for long-term positioning. Since the financial crisis, however, not only has value underperformed consistently, but other investment tools have lost effectiveness as well. John Hussman recently described:

“In market cycles across a century of market history, there was always a ‘limit’ to speculation. The points where overvalued, overbought, overbullish syndromes were so extreme that an air pocket, or panic, or crash would regularly follow. However, quantitative easing made those ‘limits’ utterly unreliable.”

So, if past guidelines to theoretical limits have become ineffective, what guidelines should investors turn to? As it turns out, authors Tim Lee, Jamie Lee, and Kevin Coldiron pursued a similar course of inquiry in their book, The Rise of Carry: The Dangerous Consequences of Volatility Suppression and the New Financial Order of Decaying Growth and Recurring Crisis. For example, they wanted to know.

“Why have stock markets, over the past 25 years, experienced huge rises and crashes? Why did the US stock market, in particular, quadruple over the years following the 2007–2009 global financial crisis even though US economic performance was at best so-so?”

The Rise Of Carry

These are excellent questions indeed. The answer that best fits the evidence is the market has become one giant carry trade. To appreciate that conclusion and understand the implications. First, however, it helps to be clear about what a carry trade is.

“Carry trades make money when ‘nothing happens.’ In other words, they are financial transactions that produce a regular stream of income or accounting profits. Still, they subject the owner to the risk of a sudden loss when a particular event occurs or when underlying asset values change substantially. The ‘carry’ is the income stream or accounting profits the trader earns over the transaction’s life. In this sense, carry trades are closely related to selling insurance, an activity that provides a steady premium income but exposes the seller to occasional large losses.”

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Alpha Stockman 2 months ago Member's comment

Excellent read, thank you.

Norman Mogil 2 months ago Contributor's comment

How does a market crash lead to inflation?

Lance Roberts 2 months ago Author's comment

David Robertson's point, the author of the article, is that the CARRY REGIME ends from a rise of inflation.