What Moves the Market

The stock market is a complicated place. Thousands of companies are all trying to grow their earnings while juggling a hundred balls: Motivating employees. Keeping customers happy. Minding the competition. Building products and services. Making sure bills get paid and that payments are received. Determining which projects to fund. It’s a long list that has no end.

And then they have to communicate with their investors. Thousands, in some cases much more than that, who try to determine what the price should be for these companies 390 minutes a day for 250 days of the year.

And for these investors, it’s not enough to just learn about these businesses and their competitors and the overall industry landscape. You have to understand which way the macro winds are blowing. Some years you can hardly feel anything, and other years you have to batten down the hatches because the winds can blow your company away. And all of this is to say nothing of the unforeseen storm that blows up all of your previous assumptions and models. Like Covid for example.

The stock market is a complicated place.

I like to say that even if you knew the news ahead of time, you couldn’t possibly predict how the market would react. The market responds to a million variables, not just one. But some variables are more important than others. If you knew where inflation would be a year from now, you would have an edge over everyone else who didn’t.

This chart shows you the returns of the S&P 500 when inflation is higher or lower than it was one year ago.

They might look the same at first glance, but they’re very different. Going back to 1950, the S&P 500 has an average annual return of 6.3% when inflation is higher than it was a year ago, and 11.8% when it’s lower than it was a year ago.

The thing that is causing such a wide gap in the data set is that there are way more negative years when inflation is up y/o/y; 33% of the time versus just 17% of the time when it’s down y/o/y.

Ben and I covered this and much more on the latest episode of Animal Spirits.