A little different format for the update this week as I want to cover a few topics I think
are important and relevant. First, a very abbreviated market recap. Stocks were mostly
up last week as the market breathed a sigh of relief on possibly seeing peak inflation. The
market has run really hard the past few months and it wouldn't surprise me to see it take a
bit of a breather as we near the 200 day moving average on the S&P 500. Today the 200
day moving average sits at 4,327. As of this writing we are about 29 points below this.
resistance when it is trading below. Sort of like a floor or a ceiling. We can (and probably
will at some point this quarter) break through the ceiling. However, these levels are often
tested several times before they crack. I would love to see the market goes straight up from
here, but being practical, it isn't likely. But, the market does what it wants and loves to prove
as many wrong as it possibly can.
Moving averages have become more relevant over time due to algorithmic trading. These
levels are programmed into the machines and when the market gets there, WHAM, a bunch
of computerized orders are triggered. These numbers and levels only have merit because
people believe they have merit. In reality, they are just numbers. But, it works because
everyone believes it works and so it becomes a kind of self fulfilling prophecy.
This brings me to the first of two points I want to briefly cover today. Cognitive bias. Look
at the balls below. At first glance, they appear to be three different colors. In reality, the balls
are all the same color, but our brains see them as different colors. The stripes covering them
are what makes them appear different colors. Our brain expects them to be one way, so that is
how our lyin' eyes interpret them.
we tend to fit data we come across to match our opinion. We don't do it consciously, our brain
does all of this work behind the scenes. Just like you didn't choose to see the wrong color for
the balls, you may not realize your cognitive bias. I have learned over time that religion doesn't
fit well in investing. What I mean by that is one can't always subscribe to one way of thinking.
One must be agnostic and believe what the data is telling them. If there is a religion to investing
it would be discipline. The discipline to not over invest in one area just because it is doing well
now, the discipline to not cash out when things get a little rough or any other number of emotion
based decisions one can choose from.
By the way, cognitive bias is involved in a lot more things than investing. A simple example is
let's say you buy a new blue truck. Suddenly, as you're driving to and fro you begin to notice how
many other blue vehicles exist. Well, blue didn't suddenly become the most popular color vehicle,
you just happen to be thinking more about blue so you may notice it more. (Actually blue is the 6th
most popular color, white is number 1. You can thank me when you're driving around noticing car
colors and keeping tabs.) But, this isn't meant to be psychology lesson. Early in the year, inflation
numbers were ripping higher and that meant higher interest rates. The cognitive bias of the market
looked at the inflation of the 1970s and early 80's Volcker era Fed and thought interest rates must go
up exponentially and crush asset values along the way. I don't have a crystal ball, but I do have access
to data and the data says, at least for the time being, we have seen peak inflation.
This leads me to the second and final point I wanted to cover today. Inflation. Inflation is driving
stock prices this year. Earnings should always drive stock prices, but we don't live in a perfect world.
Earnings, by the way, were overall pretty good this past quarter. You don't hear that on TV because it
doesn't sell ads. The consumer price index (CPI or measure of inflation) lags real-time data by 3-4
months. Leading indicators for inflation have shown the underlying trend in inflation was substantially
lower than the “hard” data (CPI, PCE or PPI reports). Notice how many leading indicators of inflation,
including surveys, show as vast improvement. July CPI (reported in August) is the first CPI print that
was not “hot." Notice the trend below.
If hard data (“CPI”) lags soft data…Intuitively, Fed is not only watching “hard” data. The above
shows that “hard” CPI reports lag even the surveys by 2 months. If this is the case, realized inflation
could be falling for 3-4 months and CPI report won’t show this for two additional months. You get
the picture, We don’t think the Fed is primarily watching CPI alone. Since inflation is driving the
investment bus, moves in inflation are going to create moves in the market. Thus if inflation begins
to fall the market could rally further. One month doesn't make a trend, but commodity prices continue
to fall along with other indicators we follow.
forth and historically (there we go with our cognitive bias) August - October are generally the worst months
of the year. So, there may be a headwind or two, but if inflation declines and the Fed doesn't lose their minds
and push rates up a lot higher than they need to be markets will improve.
THIS WEEK'S UPDATE
August 16, 2022|