Michael Green on inelastic markets and increased volatility

Michael Green is a staunch critic of passive investment strategies, and he has presented research to the US Fed and IMF outlining this view. In this episode of Opto Sessions, he highlights several ETFs that can help manage these heightened risks.

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Michael Green has been studying markets and their structures for almost 30 years. A graduate of the Wharton School at the University of Pennsylvania, in April 2021 Green joined Simplify Asset Management as chief strategist and portfolio manager. “One of the fastest growing and and most innovative ETF providers,” according to BusinessWire, Simplify offers 25 ETFs with a wide range of exposures.

Green’s number one rule when it comes to investing is: “Approach with your palms out, and do it slowly, letting the market sniff you before you go to pet it.”

He is known for his opposition to passive investing, a strategy whereby an investor buys and holds a diversified portfolio of securities for a long-term horizon – often in the form of an index-based ETF – rather than actively buying and selling them individually, with the goal of matching the performance of a market index, rather than trying to outperform it. Green has presented proprietary research to the US Federal Reserve and the IMF on this subject.

The rise of fundamental volatility

Green believes that markets have entered a new regime of long-term high volatility. There are two reasons for this.

Firstly, the Fed is “reacting to trailing data”, rather than looking at current prices, he says. Despite the rate of inflation falling to 6.5% in December from 7.1% a month earlier according to the US Bureau of Labor Statics, for example, the Fed continues to fiscally tighten.

Because the Fed is continuing to increase interest rates at a much faster pace than it has done historically, it is making “mistake after mistake after mistake, and that’s injecting volatility into the system”, says Green.

The second dynamic driving volatility is a generational power-shift, Green says. As baby boomers, America’s largest generational cohort, “finally age out of our economy”, millenials – people born between 1981 and 1996, according to the Pew Research Center – take over managerial positions. According to Green, “we just don’t know what the next generation is going to bring.”

Managing the risks of volatility

What concerns Green most about the growth of systematic and passive strategies is that, as those strategies gain popularity, they exercise a larger influence over the market. He believes their preponderance increases the inelasticity of the market, meaning that “small changes in supply and demand can create large changes in price”.

In an inelastic market, the level of demand for a good or service does not react significantly to changes in price. As a result, increases in the price of goods or services do not negatively impact their demand, and nor do price decreases spur demand.

As a result of the volatility typical of an inelastic market, on a relative risk-reward basis, the US stock market is getting riskier and less attractive.

According to Green: “We have increased volatility more than certainty. I am attracted to things like trend-following strategies that will let the market guide us in that direction.”

Simplify has many ETFs that contain options or managed futures, which can help manage volatility, and Green highlights several in his interview with Opto Sessions.

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