Inelastic Market Hypothesis - You Crash Markets - Explains 30% of The Market
What causes markets to crash? Well, it is YOU! But you can push the S&P 500 to 7,000 points too!!!
These are just some of the findings from professors Gabaix from Harvard and Kooijen from Chicago Booth that have developed an interesting new framework that explains market volatility called the Inelastic Markets Hypothesis.
Due to the markets being inelastic, $1 dollar going into the market, actually increases the value of the market by $5 dollars. This is mind blowing!
Markets are inelastic because pension funds and other institutions do always the same, hedge funds are small and there is thus not enough supply to cater for demand and, in a crash, not enough demand to cater for supply.
When households, i.e. you and me, withdrew just 0.5% of the market, markets crashed 50% in 2000 and 2008. Similarly, in March 2020, just 0.3% of the market was withdrawn for a 34% crash.
Thus, what will cause the next crash? You selling stocks, this group selling and panicking. On the other hand, it is also possible that we see the S&P 500 at 7,000 points soon because just a few trillions switching from bonds yielding zero to stocks, could push markets to the moon due to their inelastic nature.
Enjoy the explanation, I've done my best to make is as simple as possible and not academical!
I think that we have to account for higher volatility onward, which should be a great benefit for us value investors. Huge opportunities might be found in markets that are even less elastic than the S&P 500.
2020 has been a perfect year for explaining the inelastic market hypothesis, and especially ARK ETF's staggering 150% performance. Here is the video explaining how inflows created the performance due to inelastic stocks.