An awesome question came in this week. After reading my latest post: Jobs, Robots, Inflation, and Yield Curves, a client wrote, “If the room reads persistent inflation and deficit, why is the equity market celebrating?”

That one made me laugh. In a former life, when I was just the CIO and not the CEO, the CEO I worked with would ask me the same thing almost daily. “Why is the market up today?” And I had the perfect answer. Mostly because it drove him crazy. “Because there are more buyers than sellers.” That response earned me a look that said, “I pay you for that?” But it’s true. Markets rise when there are more buyers than sellers… and they fall when the opposite happens. Everything else is just the narrative we attach to it afterward.

But the client’s question this week deserves more than the simple answer. Yesterday, in conversation with the ever-intelligent Jarrod Latshaw, CEO of a CPA firm in Richmond, Latshaw and MCCown, he asked if I was familiar with the “inelastic market hypothesis” … a phrase I hadn’t heard before, or didn’t recall on the spot at least, but a concept I was quite familiar with. As he described it, though, it reminded me of something I’ve written about before in Circularity … reflexivity … a concept first introduced to me through The Alchemy of Finance by George Soros. He then sent me an article from the Financial Times summarizing the view of investor and physicist Jean-Philippe Bouchaud, who argues that much of the recent market strength has been driven not by fundamentals … but by the simple influx of money into the system itself. (Financial Times)

Gosh Darn … and I’m not even a physicist.

Curious, I ran the idea through Google’s AI overview, which summarized reflexivity like this:

“It’s a self-reinforcing feedback loop where market perception and fundamentals influence each other in a circular way.

Positive beliefs lead to buying, which pushes prices higher. Those higher prices validate the belief, attract more buyers, and drive the cycle further. Eventually the loop becomes unsustainable and reverses, often violently.”

That last line is the one none of us like to read… the one most of us fear… and the one all of us tend to ignore at our own peril. Markets can celebrate while risk quietly builds beneath the surface. They can look healthy even as they become fragile. That’s why we keep our focus not just on what’s moving… but why… and on how prepared we are when the reflexive loop breaks. That’s our job… to stay grounded when everyone else is celebrating.

For those that might want a refresher:

In simple terms, as we use it here, elasticity measures how much prices move when money flows in or out… so if markets are inelastic, even small inflows can move prices a lot — and small outflows can hurt just as much.

Key Point The inelastic market hypothesis argues markets are more sensitive to flows than to fundamentals, meaning what we’re really seeing is an influx of money, and that matters.

But don’t get carried away….

A Few Caveats to Keep in Mind :

• The inelastic market hypothesis, nor reflexivity claim, that fundamentals are irrelevant. It says that in aggregate markets, flows matter more than traditional models assume, especially when elasticity is low.
• It’s more robust at the macro-market level (aggregate market) than necessarily at the level of a single stock or industry. Gabaix & Koijen focus on aggregate equity markets. Cowles Foundation+1
• Liquidity constraints and order-flow dynamics (Bouchaud’s focus) mean the mechanism is somewhat technical: “inelastic” doesn’t just mean “sticky” but means small net flows produce large price impacts when supply/demand isn’t responsive. arXiv
• Because of that, it implies additional risk: if flows reverse (outflows), price impact could amplify downside as well.

So thank you to our client for the question and the provoking thought on elasticity (Jarrod). Have a good week.

My afterthought…

All good and maybe the rest of this for another day – but all this elasticity thought got me thinking about gold and crypto:

Here’s how that same principle, market inelasticity, applies to both:

Crypto:
The crypto market is one of the most inelastic asset classes out there. There’s limited real float (most coins are held long-term or locked up), fragmented liquidity, and relatively few large, consistent market-makers compared to traditional equities. That means even modest inflows; say, new ETF demand or institutional allocations can push prices up dramatically.

On the flip side, when sentiment shifts or outflows accelerate, there’s not much liquidity to absorb selling. Prices can drop just as fast. That’s why crypto often behaves like a leveraged expression of market psychology, small shifts in demand create big swings in price.

Gold:
Gold, while far more established and liquid than crypto, also exhibits periods of inelastic behavior; particularly when demand is driven by macro fear (inflation hedging, currency devaluation, or geopolitical risk). There’s a finite, slow-moving supply response, and investors tend to buy and hold rather than trade frequently. When flows move into gold ETFs or central banks start accumulating, prices can rise rapidly because new supply can’t adjust overnight.

Similarly, if those flows reverse (for example, if real yields rise or inflation fears cool), prices can decline sharply because sellers outnumber buyers in a relatively short window.

In Brief….

This is why assets like crypto and gold can look unstoppable on the way up and bottomless on the way down. Their markets are mostly inelastic where small changes in flows may cause big changes in price because there simply aren’t enough active participants adjusting supply and demand in real time.

In other news our own Stu Caplan was recently quoted in Bloomberg discussing the New York Mayoral Election. We’re honored to contribute to such a respected publication.

Reference / Citation
Gabaix, Xavier & Koijen, Ralph S.J. (2021). In Search of the Origins of Financial Fluctuations: The Inelastic Markets Hypothesis. NBER Working Paper No. 28967. Cambridge, MA: National Bureau of Economic Research. NBER+2Cowles Foundation+2
Bouchaud, Jean-Philippe. (2021). The Inelastic Market Hypothesis: A Microstructural Interpretation. SSRN+1

The next cycle will come, as it always does. What matters is whether your plan can bend without breaking. Let’s make sure it can.

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About the Author

Dane Czaplicki, CFA®

Dane Czaplicki is CEO of Members’ Wealth, a boutique wealth management firm that offers a comprehensive approach to serving individuals, families, business owners, and institutions. The firm’s goal is to preserve and grow its clients’ wealth to endure over time, while thoughtfully evolving its strategy to suit an ever-changing world. With over 20 years of wealth management experience, Dane and the Members' Wealth team thrive on bringing clarity and confidence to clients' unique situations. He believes everyone needs sound financial advice from someone whose interests are aligned with theirs, and is determined to put service before all else.

Dane received his MBA from The Wharton School of Business at the University of Pennsylvania and his bachelor’s degree from Bloomsburg University. Outside work, he enjoys spending time with his wife and kids, hiking and camping, reading, running, and playing with his dog. To learn more about Dane, connect with him on LinkedIn.

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