This interview explains why stocks keep rising despite a bad economy. Guest Jesse Livermore says the key is direct government spending (fiscal policy), not just rate cuts. Giving people cash directly adds to their wealth, and with nowhere else to earn a return, that money flows into stocks, passively pushing prices up. He highlights the S&P 500 index fund (SPY) as a way to capture benefits from all stimulus, since it owns about 1% of every major company. He also favors value stocks like banks, which are more sensitive to an economic recovery. But he warns that if stocks get too expensive, any bad news could trigger a sharp drop.
Jesse Livermore, in his research at O'Shaughnessy Asset Management, explores the phenomenon of "upside down markets," with the core question being why the stock market is near all-time highs despite a grim economic backdrop. He analyzes in detail the driving role of fiscal and monetary policy on the
Alright, this episode of Invest Like the Best features Jesse Livermore, a research partner at O'Shaughnessy Asset Management. He introduces and explores the concept of the "inverted market," aiming to explain a core paradox: how the stock market can be near all-time highs against such a dire economic backdrop. Jesse Livermore's core judgment is that aggressive fiscal policy has fundamentally altered the relationship between the stock market and the real economy, turning "bad news" into the "good news" that drives equity markets higher.
Jesse Livermore argues that fiscal policy is the key to understanding the current "inverted market," as it directly creates private sector wealth, with an effectiveness far exceeding that of monetary policy.
Livermore points out that traditional monetary policy (e.g., rate cuts) stimulates the economy by lowering borrowing costs, but this has a critical flaw: it cannot force people to borrow and spend. Especially during a recession, individuals may be unwilling to take on debt due to impaired credit or a pessimistic outlook. This is akin to "you can lead a horse to water, but you can't make it drink."
In contrast, fiscal policy (e.g., direct cash transfers) is fundamentally different. It "directly increases private sector wealth" and represents "unconstrained spending power." Government-issued checks can be used unconditionally for any consumption, without the need to consider future repayment ability or investment returns, as loans require. This "injection" directly fills the income gap created by a "savings glut" in the economy, thereby supporting aggregate demand and corporate profits.
Livermore further explains that the smooth rollout of fiscal stimulus is due to the removal of political obstacles. After the 2008 financial crisis, the warnings of fiscal hawks (e.g., soaring inflation, skyrocketing interest rates) did not materialize, weakening their credibility. Combined with the extreme nature of the COVID-19 crisis, the incentives of the political cycle (an election year), and the absence of moral hazard (the bailout recipients were not "deserving" bankers), this created a "perfect storm" for the current massive fiscal expansion.
Jesse Livermore reveals how fiscal stimulus passively pushes up the prices of risk assets like stocks through an "asset allocation crowding out" effect.
When the government injects wealth into the private sector through deficits, this money eventually settles in investor portfolios as cash or bonds. In a near-zero interest rate environment, cash and bonds are almost equivalent to "negative-yielding assets." Livermore estimates that the approximately $7.5 trillion stimulus plan over the next two years will passively push the equity allocation ratio in the U.S. economy down from 46% at the end of 2019 to 42%.
The key question he poses is: "Are investors willing to reduce their equity allocation in this environment?" The answer is clearly no. Holding cash yields a certain negative real return, while equities are expected to provide positive returns. Therefore, investors are forced to endure this decline in allocation ratio, but psychologically unwilling, so they tend to reinvest the new cash/bonds back into the stock market. This pressure of "cash burning a hole in their pocket" provides a continuous buying support for the stock market—a passive, yet very powerful, upward force. Livermore emphasizes that this is not an active choice by investors, but a structural force catalyzed by fiscal policy.
Jesse Livermore believes that current market concerns about inflation may be exaggerated, but in the long run, excessive fiscal stimulus still carries unpredictable risks.
Livermore first distinguishes between "increased money supply" and "inflation risk." He points out that the Fed's quantitative easing (QE) primarily "swaps" assets like Treasuries for bank reserves, which does not change the net wealth of the private sector and therefore does not directly lead to the "too much money chasing too few goods" type of inflation. The real inflation risk comes from fiscal expansion itself, as it directly increases the private sector's spending power.
He argues that the current inflation risk is very low because there is substantial slack in the economy and people are unable to fully spend due to pandemic restrictions. However, he acknowledges the uncertainty: "we don't know where the tipping point is." He cites economist Hyman Minsky's theory of "stability breeds instability," warning: "If we are very confident that fiscal policy won't cause inflation, we will keep increasing stimulus until one day inflation really does break out."
Regarding how inflation would affect the stock market if it occurs, Livermore offers a counterintuitive view: If the Fed tolerates inflation without raising rates, then inflation itself is actually positive for the stock market. He believes that historically, the reason inflation suppressed P/E ratios was not inflation itself, but the rate hikes implemented by central banks to combat it. If rate hikes are off the table, then stocks, as "real assets," would be one of the best tools to hedge against inflation.
Jesse Livermore believes that in an "inverted market," market index investing (e.g., SPY) has a unique advantage due to its "economic ownership" characteristic, and that value stocks may benefit more from sustained fiscal stimulus than growth stocks.
Livermore makes a subtle point: market index funds (like SPY) are not simply market-cap weighted; they achieve "equal weighting" from the perspective of "economic ownership." Because SPY holds roughly 1% of each company's shares. This means that no matter where the trickle-down effect of fiscal stimulus flows (to Apple, Microsoft, or a small biotech company), the index investor captures 1% of that benefit. This eliminates the risk of "picking the right winner," a very valuable characteristic in the current environment.
For individual stocks and sectors, he leans toward the view that sustained fiscal stimulus is more favorable for value stocks, as they (e.g., banks) are more sensitive to economic recovery. Fiscal stimulus can strengthen the banking system and reduce credit default risk. However, he warns that if Democrats win a clean sweep and push for tax hikes, this would pose a direct threat to corporate profits, so increasing exposure to international equities could be a hedging strategy.
Finally, he reminds investors that all risks are ultimately reflected in prices. If the stock market surges significantly due to stimulus, valuations become extremely high. Then, "liquidity value" will account for a larger proportion, and the market's reliance on confidence and the liquidity network will become stronger, making the market more susceptible to sharp corrections at the slightest disturbance.
| Ticker | Guest's View | Key Data |
|---|---|---|
| S&P 500 Index / Overall Market | Not stated explicitly (bullish on structural forces, but wary of high valuation risk) | Estimates total stimulus over next two years ~$7.5 trillion; equity allocation ratio pushed from 46% to 42% |
| Value Stocks (e.g., Banks) | Leaning bullish, believes fiscal stimulus is more favorable for them | - |
| Growth Stocks (e.g., Tech) | Neutral (notes current valuations are expensive) | - |
| SPY ETF | Mentions its "economic ownership" characteristic as a tool to hedge against the uncertainty of where stimulus money flows | Holds ~1% of shares in companies like Apple, Microsoft |
| International Markets | Holding can serve as a hedge against U.S. domestic tax hike risk | - |
1. The core of the "inverted market" is that fiscal policy creates a mechanism where "bad news is good news." —— Jesse Livermore. When the economy is weak, it instead triggers more aggressive fiscal stimulus, and the benefits of the stimulus itself (e.g., wealth injection, lower rates) outweigh the negative impact of the economic weakness, thereby pushing stocks higher.
2. Fiscal policy is far more powerful than monetary policy because it directly creates private sector wealth, rather than altering borrowing costs. —— Jesse Livermore. Giving money is "giving money," while cutting rates is just "borrowing is cheaper." The effectiveness of the two in stimulating consumption and investment is vastly different.
3. Fiscal stimulus passively pushes stocks higher through the "asset allocation crowding out effect," forcing investors to reinvest new cash/bonds into the stock market. —— Jesse Livermore. In a zero-rate environment, holding cash yields a certain negative return, preventing new liquidity from remaining in cash and creating a permanent buying pressure on stocks.
4. The unique advantage of market index funds (like SPY) is that they offer "economic ownership," not "market-cap weighting." —— Jesse Livermore. No matter where the money from fiscal stimulus flows, the index investor captures the same proportion (~1%) of the benefit, eliminating stock selection risk.
5. Current inflation risk is overestimated, but the potential risk lies in a Minsky moment of "stability leading to instability." —— Jesse Livermore. QE does not directly cause inflation; the real risk comes from excessive fiscal stimulus. Since we don't know the tipping point for inflation, continued stimulus itself breeds future risk.
6. If the Fed tolerates inflation without raising rates, then inflation is actually positive for stocks, not negative. —— Jesse Livermore. Historically, the main reason inflation suppressed P/E ratios was central bank rate hikes. If that mechanism is removed, stocks as real assets become the best hedge against inflation.
7. All risks are ultimately reflected in prices. When valuations are extremely high, market confidence in the "liquidity network" becomes fragile, and any surprise can trigger a sharp correction. —— Jesse Livermore. He proposes a distinction between "intrinsic value" and "liquidity value." High valuations mean that a large portion of the market's return relies on the continued entry of other buyers, which itself is a risk.