Markets on a daily timeframe fluctuate somewhat randomly, but on longer charts, weekly, monthly, ‘trends’ can easily be ascertained, that last sometimes for years at a time, these are the secular bull/bear markets. What actually creates them?

It is a combination of ‘earnings’ ‘multiples’ assigned to those earnings and inflation expectations. Earnings are in part influenced by the inflation rate. Low & stable inflation in the 1%-2% range will result in gradually higher nominal earnings, and improving margins due to all economic factors.

P/E ratios will adjust, or if you like, the nominal price per share, will adjust to reflect these earnings. Gradually improving earnings at a constant P/E, will, over time result in higher stock prices, but stocks advance and fall much faster with greater volatility than that as P/E’s measure.

P/E’s adjust to earnings, but more importantly they adjust to inflation ‘expectations’. Essentially from inflation expectations that move towards price stability, or the 1%-2%, you encounter expanding P/E’s, from deflationary conditions to price stability, you encounter expanding P/E’s.

It is from ‘price stability’ to either higher inflation, or towards deflation, that the P/E’s contract, thus lowering nominal share valuations. Thus the first step is to ascertain where on the inflation scale that the market exists and second, which direction you expect the trend in inflation to take.

In 2008 we had a deflation, accordingly stocks fell. The Federal Reserve and government undertook massive inflationary measures, which, succeeded in creating inflation, that, moved the economy from a deflation back to an inflation: the direction was towards price stability, hence, stocks rose.

Currently we are slightly outside of the ideal range of inflation of price stability, that 1%-2% range, moving higher, away from price stability, thus, potentially, the market will look for lower prices to contract the P/E multiple.

The Federal Reserve and government, while seeking the ‘price stability’ have to try and guess, or predict the rate of inflation that will be engendered by their monetary stimulus and fiscal stimulus: too much, and inflation moves away from price stability, and markets fall, possibly crash, not enough and deflationary pressures move again, away from price stability.

The trick then is to use the data that the Federal Reserve relies upon to gauge the trend that has already been generated, the empirical data, and via a priori theory, understand the necessary outcomes of decisions taken, to try and predict the trend of inflationary pressure, and adjust accordingly. There will be fairly regular updates, monthly, on this ‘expectation’.

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