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Risk and Reward

The basis of any capitalist or free market system is risk analysis. Every investment, whether in time or capital or short-term inventory is made based on the potential reward for success and the potential risk of failure. Because these events happen in the future, confidence or anxiety often play a large role in the process.

Generally speaking, it’s all about the availability of the critical resource being invested. People with nothing left to lose often put their time into a project because their time is all they have. Capital markets flush with cash are often looking for places that will give them a big return. Yet in all of these cases, emotions eventually become important.

Lately, nerves are raw. Investment? You gotta be kidding.

Bad stock news requires a picture like this. Apparently, these traders still exist.

The Barataria call for a deep dive in the stock market didn’t happen quite as we called it. The net effects of interest rate jitters are still weighing on the markets, but they are overwhelmed by a long list of other risk factors. A trade war with China, and frankly just about everyone, seems to be accelerating by the day. This sparks inflation, which the Federal Reserve recently acknowledged was indeed over the 2% target already.

There’s a lot to be nervous about.

It is easy to make far too much of the stock market as a whole. In the words of Herman Miller, an elderly accountant and a witness to 1929 whom I knew in my youth, never forget that the stock market is only a market of stocks. It’s about the supply and demand of capital, or patient money, to large companies. Nothing more.

But it does give us an indication of where we are on the fear versus greed index, anxiety versus confidence. Right now, the CNN finance “Fear & Greed Index” is flashing “Extreme Fear,” a confidence of 8 out of 100.

If you need a lot of this stuff, you go to the bond market.

Large investors who move the stock market on a daily basis are not necessarily like the rest of America. They see things coming that are often poorly reported in the news, tied up in jargon and charts and other trappings of their profession. It often takes time to translate what they see into something that the rest of the nation can digest.

In 2007, the stock market peaked in October. By the time Lehman collapsed a full year later, news outlets seriously stated, “No one saw this coming!”

What is the market telling us today? The S&P500 is off a full 10% from its peak just two months ago. It probably has another 10% to give, or another 250 points. The net effects of interest rate rises have not factored into the markets completely yet, largely because the Treasury has been able to do most of its financing with short-term debt.

One big market.

In a short while, they will either sell more long-term debt, 10 year or more, or cause the yield curve to invert – charge more for short-term debt than long-term. That is the one genuine, sure sign of a recession.

The risk is everywhere. Facebook, a low capital company that seems like a hedge against risk, has liability. Tesla, the new way of manufacturing, isn’t hitting its production marks. Everything is risky, it turns out.

What really changed? Focusing on risk, or the perception of risk, is all that changed. The same deals that once looked reasonable do not any longer. And it seems that the bad news is all around you if you look at all.

Risk management should not be emotional. But it is. As such, it goes in waves. Investment cycles are easily driven by perception. Right now, the perception is that risk is everywhere, potential reward is not.

How much should we care about the stock market? Only to the extent that it tells us the general mood of fear versus greed. Right now, fear is everywhere. Put that into a herd mentality and it is a self-fulfilling prophesy.

But what else would anyone reasonably expect by starting a pointless trade war?

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