We are witnessing the biggest stock market shift in decades. It's critical for investors to understand the significance of this current transition from efficient markets to inelastic markets and what it portends for asset prices.
In the video clip below, Tier 1 Alpha presents a deep-dive on the contrast between these two market paradigms with Michael Green, Simplify Asset Management portfolio manager and Tier 1 senior executive advisor.
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"The efficient market hypothesis presumes that a dollar into the market – because it also represents a dollar that someone is selling – has a de minimis impact (basically 1 penny change in market cap for a dollar that tries to go into buy)," Green explains. "In inelastic markets, it's more like $5. So in other words, the inelastic market hypothesis suggests the efficient market hypothesis is mis-specified 500 to 1. That's a huge change that's revolutionary in its implications, and it's why firms like Tier 1 exist to track these flows." |
Recognizing these flows goes a long way in explaining the occasional divergence of the stock market (particularly mega cap Tech stocks) from the broader economy.
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"Most of us are bargain shoppers," Green adds. "If we see steak is on sale, we buy more of it. If we see chicken is no longer on sale, we buy less of it. Perversely, passive vehicles, particularly those weighted on a market cap basis, do the exact opposite. If the price of steak goes higher, it becomes a larger potential portion of the purchasing basket. It's presumed the price of steak is correct, and therefore you should by it in higher proportion than you would have otherwise. That's the dynamics that create this dominance of momentum, which is another symptom of inelastic markets. Prices rise, the rise doesn't lead to a reduction in demand, therefore prices rise even more. These are all characteristics and features of the market we've seen the past several years that seem to defy common sense until you actually recognize it's just an algorithm. That's just how these things are programmed to behave and again why we try to pay so much attention to it." |
This departure from market fundamentals continues to reshape the investing landscape as we know it. Green and the Tier 1 Alpha team continue to monitor the unprecedented prominence of Gamma exposure, CTA funds, Vol control funds and retirement flows in this evolving landscape.
"Somewhere north of 40% of all assets invested in the market are passively managed," Green concludes. "As a result, the market itself exhibits an incredible increase in inelasticity that has changed significantly versus where we were when my career started."
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