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A fundamental tenet of economics is that prices are set at the margin. To the extent that economic concepts apply to equity markets (I’m not sure that they always do), it translates to the idea that the price of a tradeable item is set by the most recent buyers and sellers. We know what has been leading markets higher this year – megacap tech stocks – the question is who are the marginal buyers? Today’s lousy sentiment and inflation indicators from the University of Michigan make the question far more relevant.

When markets go up it’s easy to say, “more buyers than sellers”, but that’s not really accurate. For every buyer there is a seller, and vice versa. It depends upon who is more aggressive at that time. At any given moment there is a bid and offer on every listed security and commodity. The price doesn’t move until someone breaks the ice, so to speak. If it’s a buyer willing to pay the offer, the price goes up. If it’s a seller willing to hit the bid, the price goes down. If there is an imbalance of aggressive buyers or sellers, the prices will move up or down accordingly. The largest stocks have generally seen the most aggressive marginal buyers.

To illustrate the marginal buying, here is a quick theoretical exercise. Apple (AAPL) is currently about $172, giving it a market capitalization of over $2.7 trillion. If one share of stock trades at $172.01, the company has just gone up in value by roughly $158 million. How? There were about 15,847,000,000 shares outstanding at the end of the last quarter. If we raise the value of those shares by just a penny, lop off two zeros from the end of that number and there is our increase in market cap. In theory, it really doesn’t take much incremental buying to drastically increase the market capitalization of a given company. 

We noted yesterday that the S&P 500 Index (SPX) has been essentially treading water this quarter, while a recent rally in the NASDAQ 100 (NDX) has given that index some modest outperformance. The theme this quarter, and in fact, year-to-date, has been that the more heavily weighted the index is with megacap tech stocks, the better it has performed. Year-to-date, SPX is up just over +7% while NDX is up nearly 23%. Compare those to the Russell 2000, which contains only smaller stocks, and its drop of -1%. 

There is a fundamental dichotomy at work, not only in terms of which stocks are performing best but also in terms of market psychology. There is no shortage of professional investors and pundits who are publicly wary, if not outright bearish, about equity prices. Valuation, politics, and narrowing breadth are concerns that have been raised by many (including yours truly), yet we continue to see stasis if not improvement in stock prices nonetheless. 

As we noted at the end of the first quarter, equity markets have been Spiderman-like in their ability to climb the proverbial wall of worry. It is quite fair to assert that if portfolio managers are publicly cautious, then they are relatively underinvested. That makes the “pain trade” an upside rally. If markets remain healthy, they would be incentivized to top up their allocations to stocks, pushing the indices higher. But as of now, the narrow leadership and tight ranges do not seem to be causing a rush from nervous institutional managers.

It is tempting to assert that emboldened individual investors are presently the marginal buyers. There is certainly some truth to that notion, as the market leaders are among the most widely held names and perpetually among the most active stocks and options.  The hype surrounding artificial intelligence (AI) is certainly attractive to small investors who love a good theme.  But the type of momentum that we’ve seen recently attracts institutional traders as well. It would be unfair to say that individuals are purely the marginal buyers at the moment, even if they do deserve much of the credit for the recent market performance.

But if individuals are among the marginal buyers, it is hard to reconcile how today’s poor Michigan readings will factor into the momentum going forward. Consumer sentiment fell to 57.7 from 63.0, even as expectations were for 63.5. The 1-Year and 5-10-Year inflation expectations came in at 4.5% and 3.2% respectively, versus prior 4.4% and 2.9% readings. That adds up to stagflation, at least as far as expectations are concerned. 

If individuals are feeling gloomy about economic conditions in the present and future, it is hard to imagine them upping their stock market exposure. One reading hardly constitutes a trend, but the marginal read on consumer sentiment is unattractive. It should not come as a surprise that today we are seeing marginal sellers. Not more sellers than buyers, mind you, just more aggressive sellers than buyers today.

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