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Newton’s First Law of Markets

By:

Chief Strategist at Interactive Brokers

For those of you who are vague on high school physics, it may be time for a reminder about Newton’s Laws of Motion, particularly the first one:

“An object at rest remains at rest, and an object in motion remains in motion at constant speed and in a straight line unless acted on by an unbalanced force.”

My reason for this reminder is that it may be particularly applicable to market movements for the rest of this calendar year.  Since Monday afternoon, the path of motion has been higher, and there are few unbalanced forces that are likely to act upon it prior to year-end.

Simply put:

  • the long-term trend of the market has been relentlessly higher for the past 21 months;
  • there are hordes of institutional investors and corporate executives who are incentivized to have a wide range of stocks close at or near their highs
  • we are in a period of seasonally light volume
  • there are few “known unknowns” that are likely to affect the prior 3 items

That seems like a very good setup for a market that grinds higher into year end. 

We had a rocky week last week, but remember that it came just one week after a new closing high of the S&P 500 Index (SPX) was reached.  This week got off to a rocky start, with worries about the spread of Omicron Covid and the apparent demise of the Build Back Better stimulus bill.  Those knocked major indices about 2% lower on Monday morning, before they recovered about half their losses in the afternoon.  Markets reassessed the situation yesterday and zoomed higher. 

Traders took some encouragement from the notion that Omicron may not be as virulent as feared, and that Senator Manchin said he would support a $1.75 trillion bill, just not the $2 trillion that is proposed.  Enthusiasm over the latter point seems valid.  During my years as a market maker, a trading spread of 1 ¾ – 2 was rarely an impediment to trading.  We don’t know yet if the enthusiasm over Omicron is valid, however.  The virus is spreading rapidly, and hospitalizations are not accelerating at the same pace.  That’s great.  But the biggest hotspots are in places where vaccination rates are high, so scientists are having a difficult time figuring out whether the vaccine or the virus itself is keeping serious case rates in check.  While the early evidence is favorable, we probably won’t really know the full effects until sometime after New Year’s, when people return home to less vaccinated regions after holiday vacations elsewhere. 

The prior sentence sums up the idea behind today’s premise.  Markets have decided that the virus isn’t a major problem right now, and won’t know for sure until after the calendar turns.  Exogenous events can always crop up, but in their absence there are few catalysts for volatility or reasons to expect a sharp selloff.   As we scan the horizon for the “unbalanced forces” that could deter stocks from their upward path for the next week and a half, there are few, if any.   

Looking ahead, of course there are numerous potential catalysts looming on the horizon.  Central bank tightening, inflation, and geopolitical concerns over Ukraine and Taiwan are just a few.  And we’ve already discussed Covid.  But after tomorrow morning’s release of the Federal Reserve’s preferred inflation measure, the PCE deflator, we can largely remove the first two from the market’s mindset for the next two weeks.  The market in motion is likely to remain in motion. As for Sir Isaac Newton, his genius remains revered even centuries later.  But his investing experience offers a cautionary tale.  Newton made a highly profitable investment in the South Sea Company, only to lose three times that amount as the shares fell.  It is not clear which unbalanced force caused that bubble to pop, but the great scientist learned a nasty lesson that markets don’t always follow real-world principles.

Disclosure: Interactive Brokers

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