THE KEY ROLE OF THE STOCK MARKET IN THE INFLATION/DEFLATION DEBATE AND THE PARABLE OF THE BLIND MEN AND THE ELEPHANT.

The creation of inflation and deflation is caused by the actions of the US government, the Federal Reserve Bank and the stock market. Simply put, if demand is greater than supply the result is inflation, and should supply be greater than demand it causes deflation. In every industrial sector, prices tend to adjust until they reach an approximate equilibrium between the two, as we are witnessing in the price rises in the oil industry, and falling prices in the lumber and copper industries.

These combined results, because of their organic natures, appear and disappear in the Producer Price Index (PPI), the Consumer Price Index (CPI), and impact positions in the money and bond markets, until their equilibriums are reached.

The stock market plays a key role in the economy as a proxy regulator of the money supply, all the more so today, since the S&P 500 Index is significantly inflated, because the stock market has mopped up large swathes of the liquidity caused by the government’s stimulus programs.

If indeed a point is reached when investors are convinced that the market is very overpriced relative to earnings growth expectations, - at the moment EPS growth of the S&P 500 companies is 66% - the market may fall sharply into a correction mode, or worse. This will cause astute investors to cash-in their profits swiftly, while others delay their exits perhaps only to end up making losses.

The net of these profits and losses are transferred into the real economy, which will add to the prevailing inflationary or deflationary trends, caused by the respective price disequilibriums coming from any and all industrial sectors?- much like the waves that are produced when a stone is thrown into a pond - until a satisfactory equilibrium in the economy is reached. ?

Two very influential investors, Cathie Wood, CEO of Ark Investment Management, and Ray Dario Co-CEO of Bridgewater Associates, are currently arguing disparate views of deflation and inflation outcomes. My view is that they are both right, whereby the economy will oscillate wave after wave between the two scenarios until eventually an aggregate equilibrium is reached.

This poem, in allegorical terms only, seems to illustrate why differing views often fail to reach agreement, namely because they do not see the full picture unfolding over time, and is emblematic of our bias-driven perceptions, instead of stopping, standing back and rethinking everything; just like Grail does.

Adapted by John Henry Smith from John Godfrey Saxe's (1816-1887) version of the famous Indian legend.?

The Parable

The Parable

There were six men in a far-off land

To learning much inclined,

Went to see the Elephant,

Though all of them were blind.

That each by observation

Might satisfy his mind.

The Legislator was slow of mind

With this problem to grope.

So the only thing that he could find

That fell within his scope,

Was the tail hanging at its behind,

And concluded the elephant was a rope.

The Regulator, filled with pride,

Stumbling, broke his fall

Against a broad and sturdy hide.

In relief, he began to bawl

That the Elephant at his side

Is like the law’s protective wall.

The Investment Banker stroked the ear,

And therewith grasped its plan.

To survive in comfort it had to hear

That making credits without a ban

Would spread its risks far and near.

So this Elephant is undoubtedly a fan.

The Stockbroker, who felt the tusk,

Cried out, “What have we here!

It’s round and smooth and very pointed

To easily hunt my prey, that’s clear,

Cos cheap money me thus appointed,

So yes, the Elephant is like a spear!”

The Housing Agent, by chance did take

The squirming trunk that made him feel

With careful handling he could make

Good profits from this slimy deal,

Because this Elephant is like a snake.

The Financial Advisor reached out his hand,

And felt about the knee.

“Its strength and girth will bears withstand

Is the essential thing for me.

It’s clear enough the Elephant

Is very like a tree!”

The Moral

And so these men in this far-off land

Disputed loud and long,

Each in his own opinion

Exceeding stiff and strong.

Though each was partly in the right,

All of them were wrong!

So oft in a financial predicament,

The disputants, I do glean,

Rave on although each one ignorant

Of what the others mean,

And prattle on about an Elephant

Not one of them has seen!