WHY DOES THE MARKET KEEP GOING UP?
Courtesy of The Pragmatic Capitalist
This is a question that confounds those on the sidelines and aggravates the bears to no end. Many attribute it to some sort of bank or government engineered conspiracy theory. Others say it is simply performance chasing by large money managers. Personally, I find the answer in the psychological. When you break market transactions down to their simplest point it really all comes down to psychology. The transaction price point occurs at an agreed upon price where one party succumbs to the demands of the other (to oversimplify things). In other words, one party has a greater need to achieve a certain price on the buy side or sell side. This is all due to psychology.
This was best seen during the last year. 12 months ago sellers were desperate to get out of stocks. The buyers were in an obvious position of power where they could actually drop their bids or hold out altogether. Today’s market environment is very much the opposite. The sellers are in a position of power because there is no great need to sell. The buyers on the other hand, are in a position of fear caused by the idea that they might miss out on future price appreciation. There is no dire reason to sell therefore the buyers simply overpower the sellers on a daily basis and this drives prices higher.
This is all being compounded by the fact that we are coming off such a massive psychological imbalance earlier this year. This is classic overshooting in a mean reversion process. The following image represents price action around the business cycle. The blue line represents the mean. As the economy expands investors tend to overshoot to the upside. The inverse occurs in a recession. What we saw in March was a classic case of panic fear that resulted in a massive overshoot to the downside. My March 8th bottom call had very little to do with changing fundamentals and everything to do with a panic overshoot. Admittedly, the timing was remarkably lucky, but the approach was not. I was simply playing off the idea that stocks and emotions had overshot far too much to the downside.
So where do we sit today? Today’s market is characterized by a lack of negative psychological catalysts that can change the current market dynamic where buyers overpower sellers. That means we are likely to continue seeing the buyers overpower the sellers until a negative catalyst catches hold of the sellers in the market and instills enough fear to grab the reins backs from the buyers. Until that occurs, psychology is likely to remain positive (but not yet euphoric) and price action will likely follow.
