Former trader and current guy gritting his teeth and drumming his fingers on the table at the daily staff meeting, Richard Breslow, is out with his daily missive and this one revisits what we’ve called “The Wave Paradox.”
We’ve couched this in terms of investors not being able to differentiate between good decisions and decisions being good in part because you made them. But another way to explain it is to simply call it a self-fulfilling prophecy. It’s Howard Marks’ “perpetual motion machine.” The parts of that machine are:
- passive flows
- factor-based ETFs
- systematic flows
- price insensitive investors (central banks, SWFs)
- the corporate bid
Between those market “participants” (scare quotes there to denote the considerable ambiguity around whether or not it’s appropriate to call machines and mindless ETF allocators “participants”), there’s no way to tell whether you’re riding the wave, creating the wave you’re riding, or both.
This creates a one-way market and it leads directly to confusion on days like Wednesday when everyone finds themselves trying to “explain” why risk assets are declining. Sure, everyone will always try to ascribe causation, but in one-way markets that effort is less a fact-finding mission and more a desperate attempt to talk everyone who overpaid based on the “greater fool” theory of investing off the proverbial ledge.
This conversation becomes especially relevant at a time when one of the key pillars of the “buy at any price” argument (stocks are still attractive compared to bonds) is at risk. Clearly, the question is this: ok, well what happens if yields rise?
More from Breslow below…
The debate continues to rage over whether and why equities are overvalued. Ultimately, it’s a waste of time. Equities are indeed overvalued. We all know it. It’s the best example possible for quoting Justice Potter Stewart. But inflated values hasn’t been a reason not to buy stocks, nor will some nebulous metric change be a reason to sell them. Which is important to get your head around, because you don’t want to be distracted arguing academic minutiae when things do in fact change.
- It’s not just grumbling coming from fund managers when they decry the fact that value investing has become a mugs game. It has because there isn’t a lot of undiscovered value out there. Just a lot of people buying momentum, buyback, “disruptive” and sovereign-wealth fund darling shares. And one day, when there is a significant correction, certain gems will get oversold and present an old-fashioned opportunity
- But financial markets have loads of self-fulfilling prophesy about them. Quantitative models are growing by leaps and bounds. What big hedge fund or financial institution that enjoys government guarantees isn’t investing heavily in ramping up the scale of their commitment to this approach? And these machines have seen equities higher for eight years running. They mostly aren’t concerned with why. In fact, the equity wipeout in 2008 looks like a pretty clear buy- the-dip moment when factoring in really long-term time series. That may seem an irresponsible way to approach things, and it is — if you are managing institutional money. But for a sovereign, that’s exactly what they must do. Didn’t we just read that the Saudis want to double their fund?
- Can wars, trade or otherwise, be detrimental for stocks? Sure. But they have to be really bad to change things beyond the mood of the moment. What could change things a lot, and for a long time, would be a permanent change in bond yields. They remain the key to all of this. In truth, if central banks could have equities correct, sans panic, and bond yields stay super low they would be ecstatic. This is why the recent mini back-up in yields is so important to watch
- The most recent flirtation with the 2.42% level isn’t important in any economic sense. But it is from an asset-price dynamic one. And in truth the “contagion” to other sovereign yields has been modest, at best. But if the ball ever got rolling, those same models would take note as yields and equities have gone very well together for a long time. It’s not that economic theory has changed, it’s just been corrupted in the pursuit of extreme monetary policy
- The Bloomberg Commodity Index has been making a very herky-jerky, but nevertheless solid move higher since June. The last time the index was this high, 10-year Treasury yields were, well, this high. The index is up because the global economy is too. It just might be a guiding light for the next leg of bond sentiment
- The next time the S&P 500 tries to take out the 21-day moving average, ask not what news is out. Ask what bonds are doing