The Relentless Bid Theory, or RBT for short, was recently proposed by Josh Brown in his TRB blog. It appears that RBT is an inference to best explanation for the current state of the market and possibly beyond. In this article I propose a mechanism that supports this theory, which is evident from serial correlation charts.
In his article, The Relentless Bid, Explained, Josh Brown offers an explanation of prevailing stock market dynamics that in my opinion is the best one available due to its simplicity and impeccable logic:
“Whereas yesterday’s brokers were principally concerned with keeping money in motion and generating activity each month, today’s brokers – who call themselves wealth managers by the way – are principally concerned with making client retirement accounts stretch out over decades. Stocks are increasingly the answer to this puzzle. Bonds, with their fixed rate of income, by definition cannot get the job done. This means a bias toward buying equities everyday and almost never selling. It means adding to stocks sheepishly on up days and voraciously on the (rarely occurring) down ones… In short, it means a relentless bid as the torrent of assets comes flowing in every day, week and month of the year.”
I believe that RBT offers a unique perspective into the current market state that has very important ramifications for economics and the way economists, whether neoclassical, new classical or heterodox (yes, this mess exists in economics, it is ridiculous and in my opinion irreversible) view the connection between asset prices and the state of the economy. Maybe the new paradigm is the generation of, an otherwise, false sense of growth by inflating asset prices instead of real-estate prices. Of course, this cannot go on forever, it just buys time because as we may see from the charts below, the 1960s and 1970s were marked by a high positive autocorrelation of daily S&P 500 returns whereas recent autocorrelation, especially after 2009, has been persistently negative, indicating a mean-reverting tendency, which is dampened by occasional price boots, or what I call the Market Boost Theory, or MBT.
On the above chart of daily S&P 500 Index prices since 1960 we may see in the first indicator pane that the autocorrelation of 250-day returns decreased persistently over time from its highs in the early 1970s and, by 1997, it has completely vanished. One explanation that I have offered before is that the autocorrelation was arbitraged out by fast traders using algos and computers, taking to the cleaners naive chartists and other technical analysis types who were following visual rules and techniques developed in the beginning of the 20th century. This implies that the autocorrelation was present in the first place due to the actions of participants relying on methods that required autocorrelation and, as a result of a self-fulfilling prophecy, autocorrelation was present. When the autocorrelation vanished, the market started exhibiting strong mean-reverting tendency and we had two major tops with wide swings in the order of 50% or more, i.e. an erratic behavior. Since the top of 2007, the autocorrelation is persistently negative, indicating a mean-reverting tendency but the market is on a very strong uptrend. The question, in the context on RBT, is how this can happen, or in other words, what is the mechanism of this behavior. Below I will try to explain this mechanism I call MBT (Market Boost Theory):
The first chart was zoomed to display prices after 2008 and on it I have marked with circles periods during which the market was boosted with clusters of high daily returns. Note that these clusters, especially the first three, came during periods of high uncertainty and corrections, in 2010, 2011 and 2012. In the context of the RBT of Josh Brown, these boosts offered a sense of an impeccable market that could only go up. The boosts were accomplished by relentless bids from large houses with large reserves of capital. After a period of 4 years of negative correlation, these boosts managed to cause a short period of positive autocorrelation in the start of last year that, however, faded fast.
But as it is shown on the chart, the cluster size has decreased substantially during the last year because even those who have instigated them know that this cannot go on forever without significant help from central banks. Therefore, they are afraid of the moment liquidity dries up and a cascade effect. At the same time, this must go on forever because if there is a sell-off, where will the money go? If the money goes to the real economy, inflation will ignite. Therefore, the market rise serves several purposes of: (1) creating a (false) sense of economic prosperity, (b) acting as an inflation buffer and (c) alleviating the need of a direct real-estate bubble.
In other words, RBT says that there is plenty of money now to bid prices up and there are not enough traders to counteract this because the modern broker is the private wealth manager with a long investment horizon. Then MBT says that essentially this is a more of a mean-reverting market but occasional high boosts predicted by RBT dampen reversals and elevate the upside target.
Evidently Josh Brown’s RBT is an inference to best explanation that challenges not only the way most of us view the markets but also shakes hard the foundations of finance and economics to the point that these discipline start appearing like a farce.
Disclosure: no relevant positions.
Charting program: Amibroker