Financial crises seem to happen fairly regularly so they shouldn’t be unexpected. But no-one seems particularly concerned about our current financial system, at the moment our attention is controlled by other threats.
I’m concerned that a lot of money has been injected into the money supply but we haven’t seen any inflation. And I am concerned that the price of stocks is no longer related to the value created by the company but instead by macro economics.
It’s a terrible time to be a value investor. This should be an alarming statement. Value investing should always be a decent way to make money unless markets are broken. If the price of something doesn’t represent its value then a correction is inevitable.
Interest rates are really low at the moment so if you have spare money and you want to make it work for you then where do you put it? Not into a bank account, because interest rates are low1, and not into government debt, because the yield is so low. It has to be stocks if you want the value of your investments to increase meaningfully.
But everyone is doing this which drives the price up, and because their price is increasing they increase even further.
I think that the main reason for concern is super low interest rates and massive increases in the money supply, but there are a couple of other factors that are also contributing.
It’s easier than ever for retail investors to participate in the stock market, and this seems like a good idea. Democratization. However if retail investors have influence to effect prices, and they themselves can be manipulated or influenced regarding what or when they buy or sell, then that is likely a new kind of threat to financial stability. We’ve never seen social media combined with quick, cheap investment services for amateurs before.
Index funds are also more popular than ever2 - the efficacy of index investing relative to traditional funds that use stock pickers is very high over medium or long time horizons because index funds are much cheaper. But if index funds become too large then they end up influencing the market in predictable and rigid ways.
Index funds cannot choose what they buy or how much they buy - they just track the index. If a company’s stock crosses certain thresholds, their stock has to be bought or sold. It seems like its possible to create feedback loops where funds have to buy more of a rising stock, which increases its scarcity and price, which then requires index funds to purchase more of the same stock.
If the price of something doesn’t represent its value, then a correction is inevitable.
- Why are interest rates low? Because confidence in the economy is low, so central bankers have to lower interest rates to make it 1. Cheaper for a business to borrow money to invest in their business and therefore easier for a business investments to be profitable, and 2. So that its more attractive for investors to use their capital to invest in a business (which grows the economy) relative to depositing spare cash in a bank account (which is safer but a less efficient way to deploy capital). Interest rates affect the relative risk-reward ratios of different investment strategies ↩
- Index Funds Are the New Kings of Wall Street ↩
- statista ↩
- in2013dollars.com ↩