Friday, March 3, 2017

Markets not in equilibrium

"The downtrodden are the great creators of slang.'
‑Anthony Burgess (English, 1917-1993)
Word for the day
Malfeasance (n)
The performance by a public official of an act that is legally unjustified, harmful, or contrary to law; wrongdoing
Malice towards none
Many "intellectuals" who are frequently visible on TV and social media, do not appear to be much intelligent.
Wisdom is something, that has not even touched them.
First random thought this morning
The government has shown remarkable resolve in sustaining the dismantling of control of transportation fuel and cooking gas. The highest ever single rise in LPG prices, when the UP elections are in critical phase, clearly demonstrate this.
Why economists like former Prime Minister Manmohan Singh and Amartya Sen; and politicians like P Chidambaram fail to mention it when they criticize the government on economic failure. This prejudice and partisanship is making even their valid criticism incredulous.


Markets not in equilibrium

In my view, a combination of following six factors determines the movement of stock markets, under any given circumstance.
1.    Macro outlook
2.    Earnings outlook
3.    The quality and quantum of flows (liquidity)
4.    Valuations
5.    Positioning vis-à-vis alternatives like debt, real estate, gold etc.
6.    Market technical (demand and supply equilibrium)
In the state of equilibrium of these six factors, the markets are calm; and average returns are closure to nominal GDP growth, usually higher than the risk free rate.
In this state usually the premium for alpha generation (outperformance of individual stock return over average return) is not great, as stable macro conditions, adequate liquidity, steady flows, reasonable valuations, and balanced market technical allow most businesses to grow in tandem and there is little case for unusually premium valuations of some businesses over most others.
On the contrary, when these key factors are not in equilibrium, i.e., one or more factors are far away from the mean position, the divergence in stock performance is significant and thus the premium for alpha generation is much higher.
From this viewpoint, if I analyze the market performance of past couple of years, it is clear that the divergence in performance of stocks is unusually high. Especially, many small and midsized companies have outperformed their large size peers massively. The premium for alpha generation has been accordingly significant.
Historically, whenever, the key factors impacting the stock markets have remained in the state of inequilibrium for longer period, the corrections needed to revert to the state of equilibrium have been sharper, deeper and painful.
If the correction occurs from bottom to mean, the pain occurs from missing the move. If the correction occurs from the top to mean, the severe erosion in prices causes the pain.
This makes me conclude two things:
(a)   The phenomenal rise in the assets under management of institutional investors like mutual funds, pension funds and portfolio managers may be related to the premium for alpha generation. This becomes even more clear, if we consider the stupendous rise in the asset under management of portfolio managers who invest in broader markets.
(b)   The key factors that impact the market are not in equilibrium. This essentially implies that we shall soon see the correction - this time top to mean, via bottom.

1 comment:

  1. You actually make it look so easy with your performance but I find this matter to be actually something which I think I would never comprehend. It seems too complicated and extremely broad for me. I'm looking forward for your next post, I’ll try to get the hang of it! forex sygnały

    ReplyDelete