Upside-Down Markets

After much hype, Season 3 of Stranger Things debuted on Netflix last week. If you’re not familiar with this sleeper hit that debuted a few years ago, the first season introduced viewers to another world called “The Upside-Down,” a parallel dimension where things are not what they seem. It’s a place where the darkest evil and monsters known as Demogorgans and the Mind Flayer exist—hunting for prey while terrorizing and taking over the minds of the denizens of fictional Hawkins, Indiana (perhaps a parallel dimension of Atlanta, Georgia where the show was filmed).

In a similar vein, the markets often seem to function in their own sort of Upside-Down world where things are quite different from the rational real world with good news often sending things careening lower and bad news being the catalyst for market rallies. Why and how does this make sense?

It is no secret that markets love “cheap” money and that asset prices respond to liquidity being pumped into the system by central banks. When interest rates are low and money is easily available, speculators are more eager to take on risk. This “Risk-on” mentality is often the reason given for markets that inexplicably surge higher on some days. Central bank stimulus feeding into the markets act like steroids, amplifying returns, often regardless of what the economic datapoints might suggest. The current bull-market, which was born in the depths of the Great Recession, has had a strong tailwind from several rounds of central bank easing cycles and liquidity injections, which has no doubt contributed to the massive run in stocks from 2009 through today.

In May markets were weak as fears of a trade war escalated, sending shockwaves of uncertainty through the technology supply chain while the proverbial “Sell in May and go away” mindset likely exacerbated the negative swing. However, as the sell-off deepened, expectations of additional Fed interest rate cuts (or “an insurance cut”) took hold, helping the markets find their footing. Further, as May concluded, positive steps towards a resolution of the tariff/trade war began to take hold (or at least the headlines turned from negative to positive), easing fears and negative sentiment, while sending markets right back to their highs. In hindsight, this action, while frustrating on a short-term basis, did not seem particularly “upside-down” or from a broad market perspective.

Then last week something interesting happened and good news was suddenly treated as bad news. After several months of weaker than expected jobs reports, non-farm payroll data came in for June, showing a stronger than expected addition of 234,000 jobs (compared to 72,000 in the prior month and expectations of 160,000). Finally, some good news…or so it would seem. Apparently not. In the often twisted (and short-term) view of the markets, this positive economic data was an unwelcome development because stronger economic data could mean that the Federal Reserve will now hold off on any previously expected rate cuts. Queue the short-term traders to hit the sell button as the absence of a singular 25 basis point cut in the Fed Funds rate was suddenly all that mattered.

While jobs data is very volatile and thus a single report is not a reliable indicator of future Fed policy, the corresponding market action is a reminder that the economy and the stock market, while related, are two different entities, often moving contrary to common sense, which can cause investors to scratch their heads and lose confidence. By maintaining focus on the long-term fundamentals and avoiding the short-term noise and hysteria, investors can reduce the risk of getting caught in the noisy, irrational Upside-Down.

P.S. Season 3 of Stranger Things is great.

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