An Upside-Down Market

One of my favorite financial writers is an anonymous researcher who goes by the pseudonym, Jesse Livermore. The real Jesse Livermore was a pioneer of day trading in the early 1900s, whom at one point became one of the richest men in the world but ended up taking his own life when he lost everything.

Little is known about the current writer who uses his name today. He only writes a couple pieces a year, but when he does it’s a must-read. He just released his first piece of 2020, called “Upside-Down Markets” referring to how the market continues to go up on the backdrop of declining economic news.

I was a bit taken aback when I opened it up because it’s 94 PAGES LONG, but knew I had to dig in. I’m glad I did. Every time I read one of his works, I learn something, and this time was no different. I obviously can’t condense the entire piece into a short blog, but I wanted to at least give an example of some of the things “Jesse” writes about.

So the entire writing is based on him dissecting the economy into 3 main groups (Households, Corporations, and Government) and taking a deep look at how the actions of one affects the others. These actions affect anything from corporate profits, to inflation, to the markets and so on.

One of the points at the end that I found particularly interesting was how emergency government assistance such as stimulus checks or unemployment insurance can find its way into the stock market. I’ll share his simple illustration below. (note: this is a very complex topic and some of the backdrop was in the first 80+ pages of the paper, so I’m oversimplifying a bit)

Suppose the government gives everyone $1,000 to help during the pandemic. Depending on what income bracket you’re in, you may be more likely to spend that money, or more likely to save it. For example, if one has a low income that $1,000 check may need to be spent immediately on necessities, whereas if you make plenty of money, you’re likely to just throw the check in your brokerage account. The Bureau of Labor Statistics keeps stats of each income group’s propensity to spend vs. save.

Now for those that spend the check, that money gets recirculated into the economy. For example, say someone spends that at a corporation. Much of those dollars will make their way to the employees and execs as compensation, some go down to the corporation’s profits, which can get sent out as a dividend to investors or retained by the company. This cycle keeps repeating until at some point all of those dollars are eventually saved.

About 3.4% of all income is made by the bottom 20% of people, whereas the top 20% make nearly half of all income. What this means is that as those dollars circulate through the economy, they tend to move up towards those that already have the most since those at lower incomes have a propensity to spend and those at higher incomes have a propensity to save. (as a side note: even well intentioned stimulus checks and unemployment benefits end up exacerbating the much debated income/wealth inequality we have in the U.S. since the money eventually ends up in the hands of the wealthy)

An illustration of this cycle is below:

Each row shows how different income brackets interact with that government $1,000 check. You can see in the second and third column how much of all income makes its way towards them, and how much of that money they will end up spending vs. saving. Taking this information, you can simulate how that $1,000 check cycles through the economy.

The takeaway is from the box in green on the far right. After just 4 cycles, over 70% of that $1,000 check ends up being saved. Today about 50% of all U.S. savings are held in U.S. stocks, so you can assume roughly half of that ends up in the market (in fact there are reasons to think more, but that’s a longer story.)

So when you see these giant government stimulus packages, say the $2T package being discussed in Congress, you can imagine that a large portion of that is going to make its way directly into the stock market.

This creates the upside-down market environment from the pieces title, where as the economy gets worse, fiscal stimulus will increase and potentially drive up stock prices. In short, good news can be bad news for stocks, and bad news can be good.