Markets are Irrational

And that’s not good

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By most historical standards, pandemics or major global crises, except for war, are not good for the economy. Many people wondered why the stock market kept rising as most countries began to shut down for Covid-19 regulations. No matter what seemed to happen, the stock market, after an initial decline, still ended 2020 up for most indexes. Why is this?

Markets Are Irrational

My main contention with the current state of the market is that traders are not trading rationally on fundamentals (like earnings, value, and growth); instead, they are trading merely on the “story” of the stock. The prime example of this is Tesla. The reality is that Tesla is a boutique carmaker that barely clears 100,000 units per year. Their product has major problems, including a faulty autopilot, poor fit and finish, and poor reliability. For a major automaker like GM or Ford, this would be a stock price death sentence. However, because the story of Tesla is about the future of the electric car and the potential to move transportation away from fossil fuels, the stock market price for shares of the company remains high. This is not rational behavior. 

Another example of irrational markets is what is happening around the bond markets these days. Commercial real estate bonds should have already fallen significantly, but they have not as of yet. Many companies are reducing their footprints as work from home becomes more popular. Many bars, restaurants, and other hospitality establishments have closed, leaving many commercial property owners with space. Ordinarily, this would be a problem, but they are sitting cool for now in this economy. Both of these situations are being caused by the same force: free money. 

Free Fed Money

One of the main culprits of the rise of the stock market and the lack of failure in the commercial bond market is that the federal government has made trillions available to businesses and individuals. I do not want to leave the impression that I am against the stimulus checks, the PPP program, or relief. Obviously, if the government is going to shut down large swaths of society, people need to be compensated. It was important to help people during the pandemic. The result, however, is that our usual market economics has become broken. The Federal Government has not just given out money to individuals but businesses and others. There is excess money sloshing around the American economy. This is also on top of the 2.7 Trillion Dollars that Americans saved last year and an 89 Billion Dollar reduction in consumer debt. The printing presses have been working overtime. During the pandemic, there was so little money moving that we had deflationary pressure on the dollar. I mentioned last year that everyone would be reading about Deflation, and we certainly learned a great deal. Deflation does not last forever. Money starts moving again, and often inflation can be the result. 

Inflation or Stagflation?

Every year, the Federal Reserve states its inflation goal. It is usually 2%. This means that the money supply will increase by that much each year. This also means that the spending power of the dollar decreases by that much each year. However, if wages and salaries grow due to increased economic growth, inflation is much less noticeable. Inflation, by itself, is not bad. It is only bad when it gets out of control. Right now, we are seeing an increase in the price of everything due to inflation but also to high demand and supply chains that continue to be stressed from the pandemic shutdowns. This will likely continue until 2023, at least. We also face another problem as the world gets back to work: the dreaded Stagflation. 

What I think we face now are the economy of the late 70s and early 80s. This is a problem because the period was marked by high inflation and high unemployment. In other words, the price of everything was going up, and employers were not hiring. Right now, some employers are complaining of a labor shortage. However, the economy is still not creating as many jobs as are necessary to reduce employment down to pre-pandemic levels. This is combined with a reshuffling of employment as those who worked in service industries find other jobs or get trained for new careers. 

Navigating These Times

It is tough to navigate these times as an investor. Ultimately, the market will eventually adjust back to the fundamentals. It is all fun and games until the earnings reports come in, and investors see that their favorite company isn’t doing as well as they hoped. Some stocks may be immune due to future revenue projects. This is certainly true for companies like Palantir and Tesla. However, for many other companies like Airbnb, valuations will eventually fall back to earth. The best thing to do is to invest in companies that have solid revenues and solid growth.