Anyone who has taken Econ 101 understands the laws of supply and demand. We’ve see it at work in the fixed income market where the demand has pushed bond prices up and interest rates down to levels not seen in 60 years. But what’s going happening in the equity market? Shouldn’t we have suffered through an offsetting and equally large decline in equity prices due to the large volume of stock sales triggered by the mass exodus?

Actually, we haven’t and it’s perplexing. As frequently pointed out here, the market has been in an interminable horizontal trading range of 1025-1150 for about a year. Rather than correcting 20-25% to the 850-950 range after it’s dramatic run-up from the March 9 bottom, the market has remained relatively flat for some inexplicable reason.

Some take that as proof that the big drop is about to come but I understand it to mean that there’s been more than sufficient demand to absorb all those dumped shares. If I remember my economics correctly, price changes happen coincidentally with the trading volume, not as a result of that volume. Prices change to encourage and facilitate transactions not as a result of trading that took place sometime in the past.

I side with those who believe that some or all of the money that flowed into fixed income will, sometime in the near future, begin migrating back into equities. However, this time, those who absorbed those disposal sales by being on the buy side won’t be in such a rush to relinquish their shares. They’ll hold on and demand higher prices since there aren’t many attractive alternatives (as all those fixed income holders will soon find out).

That’s how supply and demand works. I’m not the one who’s bullish, it’s the market and it’s price action over the past year that is convincing me to be so.

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