The market is made up of various agents Each of these agents has different expectations and constraints When these agents diverge, markets shift and price the differential. It is when these agents capitulate at the same time you get massive melt-ups and melt downs 🧵👇

The main agents in the system are the following: Investors (Retail and Institutional) Central Banks Firms (Corporate Executives) Households (Consumers) Policy Makers (Governments) Financial Intermediaries (Banks, Insurance Companies, Hedge Funds)

Each of these agents helps warehouse and offset risk as we move through various changes and shocks in the economic cycle. For example, the oil shock earlier this year due to Middle East tensions is something that the Fed can't control because it is on the supply side. Oil price are a direct input into inflation though which means that the more volatility and rises in crude, the greater uncertainty in the inflation outlook. Traders can come in and help smooth this volatility by providing liquidity so that the changes in price are more evenly distributed through time which creates greater stability and less uncertainty. This helps central banks on net vs massive moves in crude all the time without anyone to help smooth it.

This is an example of how two different agents can help offset each other. All of the various agents can do this in a variety of scenarios. This is part of what creates the scenario analysis for markets.

Another example: Fed (Agent 1): Cuts interest rates to stimulate borrowing and spending, aiming to boost private investment and consumer demand during a downturn. Practical Connection: Lower rates make credit cheaper, encouraging business investment and consumer spending to counteract economic slowdown. Government (Agent 2): Increases fiscal spending (e.g., infrastructure, tax cuts, stimulus checks) to directly boost demand and create jobs. Practical Connection: Government spending injects money into the economy, supporting consumer demand and job creation. Result: Fed rate cuts and government spending work together to stimulate demand and investment, helping to offset the downturn and support economic recovery.

The RISK becomes when all of these agents begin to interact together and their actions feed on each other to amplify market outcomes. The result is massive melt ups and melt downs in both the economy and market.

Scenario: Feedback Loop of Capitulation Across All Agents (Melt Down Scenario) Consumers (Agent 1): Faced with high inflation and rising interest rates, consumer confidence drops, leading to reduced spending and increased saving to protect against uncertainty. - Practical Connection: As spending slows, demand contracts, further deepening the economic slowdown. Corporates (Agent 2): With lower demand and higher borrowing costs, companies lower earnings expectations, cut back on investment, and lay off workers. - Practical Connection: Reduced corporate activity leads to higher unemployment and weaker economic growth, amplifying the consumer slowdown. Central Banks (Agent 3): In response to the slowdown, the Fed cuts rates, but fears of future inflation lead to market skepticism, causing rates to remain volatile and reducing the effectiveness of rate cuts. - Practical Connection: Uncertainty in monetary policy exacerbates market volatility, making businesses and consumers hesitant to invest or spend. Result: All agents capitulate simultaneously: consumers pull back, corporations scale down, and central banks’ actions are less effective, creating a negative feedback loop of weakened demand, lower growth, and heightened uncertainty. This deepens the economic downturn.Ask ChatGPT

Scenario: Feedback Loop of Capitulation on the Upside (Melt-Up) Consumers (Agent 1): With rising asset prices and strong economic growth, consumer confidence increases, leading to higher spending and greater consumption. - Practical Connection: Increased spending fuels demand, boosting corporate earnings and further driving economic growth. Corporates (Agent 2): As demand rises, companies increase production, expand investment, and hire more workers to meet higher demand, leading to higher profits. - Practical Connection: Corporate growth and profitability drive stock prices up, which further boosts consumer wealth and confidence. Central Banks (Agent 3): Seeing strong growth and rising asset prices, the Fed becomes more confident, keeping interest rates low or even implementing stimulus programs, encouraging more borrowing and investment. - Practical Connection: Low rates and stimulus create more liquidity, fueling further growth in equity and real estate markets. Result: All agents capitulate to the upside: consumers spend more, corporations expand rapidly, and central banks encourage liquidity, creating a positive feedback loop. This drives a melt-up, where rising demand and asset prices propel each other, resulting in a self-reinforcing cycle of growth, higher stock prices, and increased consumer spending.

Right now we are in a melt up scenario, and this is what I have been laying out for a while now:

I recorded a full video explaining how these agents connect and frame the current macro regime here. This will be critical to understand as we move into the next 3 months with extremes on the upside and downside becoming higher probabilities.