This is a Guest Post by AK of Fallible
AK has been an analyst at long/short equity investment firms, global macro funds, and corporate economics departments. He co-founded Macro Ops and is the host of Fallible.
2018 was a rough year… so rough that for the first time, no major asset class outperformed inflation. This comes from data that goes all the way back to 1901. 93% of assets had a negative return, a crazy high number. Cash was actually king! And it only had a small 1.8% nominal return… This does not happen often. We haven’t seen it happen in the last 19 years. A big part of the reason all this happened is because of the Fed.
The first thing we gotta talk about is why interest rates even matter to the stock market. So bonds and stocks, they compete with each other for capital flows. And that means that stocks end up being valued relative to bond yields. Higher interest rates work to compress equity multiples because if interest rates are high enough then investors don’t want to mess around with stocks. They rather go buy bonds instead which are safer and still give them a good return. So higher rates basically pull liquidity (or demand) from risk assets like stocks out of the system.
This is why Stan Druckenmiller always talks about how important it is to watch the people who control the interest rates, AKA the Fed. He said:
“Earnings don’t move the overall market; it’s the Federal Reserve Board… focus on the central banks and focus on the movement of liquidity… most people in the market are looking for earnings and conventional measures. It’s liquidity that moves markets.”
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***All content, opinions, and commentary by Fallible is intended for general information and educational purposes only, NOT INVESTMENT ADVICE.