An engineer’s unfiltered take on the stock market

Asset Classes

  • Equities — basically stocks
  • Bonds — IOU issued by governments and companies when they want to borrow money from investors. Fixed interest and percentage return is based on risk, and they usually have a fixed timeframe of return
  • Property — commercial or residential. Real Estate baby
  • Commodities — Oil, Gas, Metals, traded primarily on the Chicago Mercantile Exchange. Futures set the price of these commodities.
  • Cash — Rock hard, stone-cold cash. Liquid AF. Slosh baby slosh

Inflation

Why don’t people just save cash, why stocks or property? Well, your money has a decay rate. Every year in our society prices of goods and services inflate at a certain rate. This rate is targeted by the Fed to be 2% (Fed or the federal reserve is the central bank of the United States that controls the monetary policy). That means your 100 dollars this year can buy ~98 dollars worth of stuff last year.

Bank of Banks

The Fed can be thought of as a bank of banks. It can loan money to the banks us normal people use like Wells Fargo, Bank of America, Chase. Just like our banks lend us money when we need to buy a house or a car. The Fed lends money to these banks in the form of credit. And when you take a loan you have to pay interest on the loan. The same is true for the banks, and this interest rate is set by the Fed.

Interest Rates

For us mortals, our interest rate is set by a number of variables heavily weighted by our credit score. If our credit score is high, we make a lot of money and we pay our loans back on time, the bank will want to lend us more money at a lower interest rate. If our credit is poor we can get abysmal interest rates because I’m a riskier investment.

RISK/RETURN

Normally there’s a risk associated with this. See if I invest in equities and commodities, I usually get a higher return but I also get greater volatility or swing in the prices. Over the long-run, I’ll probably make money and beat inflation but in the short term, I might gain and lose tremendous amounts of money. Again as long as I make the interest payments, I’m good. But again this is rated to be a risky investment because there are no guarantees.

A crude seesaw of price, interest rates, and bond yield

Quantitative Easing

As you can imagine after a depression, people stop spending and start saving more. They need money in their accounts for a rainy day. This leads to a vicious cycle of deflation (opposite of inflation). Remember the Fed wants people to spend their money. What if they decrease interest rates all the way to zero like after the 2008 financial crisis? What other tool do they have at their disposal to restart spending? How about just printing money?

Inflation?

But wait how about inflation, doesn’t this raise inflation. Well, son, stocks and certain asset classes (the ones banks invest in) aren’t counted in the CPI. People still relatively bought the same amount of soda and food. It was more than elastic and inelastic goods. Different asset and sub-asset classes had different inflation rates. This is well known. So duh inflation wouldn’t show up in CPI. The assets that were inflating weren’t being measured in the inflation index, how shocking.

Money Printer goes Brrrrr…..

The Fed acted swiftly, lowered its interest rates to zero, and started a bond repurchase program. But that wasn’t enough. For the first time, the Fed floated the idea of corporate bond buybacks. This was unprecedented, companies would now directly be financed by the fed (but again this wasn’t really an increase in value because swapping one asset for another right? *sarcasm*). Then the government started giving cash directly to the people of the United States as well as to companies and banks. How was the government going to finance this? By selling bonds to the Fed. It was unprecedented and truly insane. Trillions of dollars just added to the money supply effectively in a couple of months. But it reversed the down-turn. There were some immediate second-order effects.

--

--

Get the Medium app

A button that says 'Download on the App Store', and if clicked it will lead you to the iOS App store
A button that says 'Get it on, Google Play', and if clicked it will lead you to the Google Play store