I have to admit, I do take some satisfaction in weeks like this last one. That is: Weeks when everyone acts befuddled by the price action, and the rapidity with which an equity drawdown is recouped.
There’s a quant aspect, of course, but I’ve been over that ad nauseam. The following is more philosophical.
Day traders, everyday investors and small-time fund managers spent too much time post-financial crisis buying into various narratives centered around some version of the idea that “central banks can’t hold it together forever.”
For a dozen years, the same handful of people (some you know, some you may not) spent their days arguing that central banks were the only thing preventing markets from experiencing a “grand” reset and that trillions upon trillions in liquidity and an engineered hunt for yield together explained the perpetual bid for equities and corporate credit.
In its original formulation (i.e., before it was polluted with conspiratorial thinking and laughably overwrought derision) that argument was generally true. That being the case, when central banks doubled, tripled and quadrupled down on the same policies, the rational thing to do if you really believed those policies were the proximate cause of risk asset buoyancy was obviously to double, triple and quadruple down on risk assets. And many people did.
But (too) many market participants became enthralled with the idea that “manipulated,” “artificial” markets can’t possibly hold up forever. Not realizing that the purveyors of such narratives were largely click farms, overpriced “newsletter” authors, attention-seeking fund managers or some other sort of profiteers, regular people increasingly trafficked in juvenile central bank memes and conspiracy theories and engaged in armageddon prophesying. It was (and still is), the financial market equivalent of QAnon. And just as plenty of once credible people have slipped into a kind of madness vis-à-vis US politics over the past several years, so too has many a “respected” market maven gradually succumbed to the siren song of financial propaganda.
Leaving aside the many deleterious side effects of all that, no one stopped to consider that financial markets were always “artificial” and “manipulated.” You can create an artificial river and you can manipulate a natural one, but if you leave a real river be, it’ll flow according to the various natural laws and phenomena that dictate the movement of water. Stock and bond prices, by contrast, don’t go up and down of their own accord.
There’s no such thing as a “natural” stock. Relatedly, there’s no such thing as an “unmanipulated” stock market. There are buyers and there are sellers and they “meet” to set the price of digital certificates representing ownership in another imaginary construct called a “company.” That process isn’t “price discovery,” it’s price manipulation. There’s nothing to “discover.” There is no “correct” price. The concept of “fair value” is helpful from a practical perspective, but philosophically, it’s meaningless as it relates to stocks. The price for stocks is everywhere and always what we, as a group of people participating in a game that we created, collectively decide it is. “Fair” has no meaning in that context, or least not as a reference to some “fundamental” or “inherent” value.
We assume manias and crashes represent deviations from “fair value” or from the “correct” or the “rational” price for equities. In reality, manias and crashes are just a manifestation of the collective mood at a given period in time. During the financial crisis, the mood was dour so we collectively decided to push the price of stocks lower. Stocks didn’t respond to the financial crisis, we did. Over the past year, we collectively pushed stocks higher on a variety of rationales, some of which were predicated on assumptions about policy support, both monetary and fiscal, and some of which revolved around various iterations of the greater fool theory (i.e., “I’ll buy it here, because I know somebody else will buy it higher.”)
On Tuesday, after US equities careened sharply lower over the preceding three sessions including a somewhat dramatic Monday swoon, I delivered my customary (and, I’m sure, maddeningly annoying) reminder while responding to a comment. “Stocks and bonds aren’t real,” I wrote, adding that “they’ll do whatever we decide they’ll do, precisely because they don’t exist without us.”
Fast forward to Friday and US equities notched another record. The simple figure (below), is highly amusing.
Note the reference (in the chart text) to “record” dip-buying. According to data from Vanda Research cited by Bloomberg, day-traders bought US shares at the swiftest pace ever this week.
Vanda looks at traffic on retail platforms, as well as industry order flow. During the selloff on Monday, retail bought more than $2 billion in equities, apparently (figure below). Quite a bit of that went to ETFs, including an estimated $480 million to SPY.
The linked Bloomberg piece quoted Vanda’s Ben Onatibia and Giacomo Pierantoni. “Unlike some institutional investors who might find themselves starved for new funds, most retail investors enjoy a stream of income (payroll, dividends, rentals, etc),” they said.
There was some notable color regarding the extent to which ETF buying (as opposed to individual stock purchases) may suggest “the day-trade contingent lacked the confidence to pick individual shares,” as Bloomberg’s Sam Potter put it, but for our purposes, just note that retail investors poured money into equities, helping stocks push back to record highs just a few sessions later. In other words, that flow helped manipulate the price of stocks.
It’s always manipulation. It can’t be otherwise because stocks, being imaginary human constructs, have no “natural” movements. We (and the algorithms we built) move them around by buying and selling and, also, by talking about them, which prompts other people to buy them and sell them. The same goes for any and all markets that reference imaginary human constructs.
The term “manipulation” has a negative connotation. In fact, in the market context, it’s often synonymous with illegality. But it’s always manipulation. We just characterize the situation differently depending on who’s doing the manipulating. Libor was “fraudulently rigged,” for example. But submissions were “false” only by comparison to rates that were arbitrary in the first place. You’ll scoff. But what natural law do we refer to when we set interest rates? They exist in the context of markets which are priced off rates set by policymakers. There isn’t anything truly “real” about any of that.
Consider the different ways in which we characterize various sorts of manipulation. When a billionaire takes a position in a stock and then unveils the thesis at a closely-watched investor conference, knowing that very act will push up the price of the position he already holds, we say something like, “Legendary hedge fund manager reveals new long in XYZ.”
When the same hedge fund manager (not literally, but metaphorically) trades on inside information, we say instead “Hedge fund legend falls from grace as trading scheme exposed.”
When a cabal of retail investors colludes in plain sight on a message board to drive a stock into the stratosphere, we say “Reddit wins one from Wall Street.”
When a movie theatre chain capitalizes on that dynamic by, among other things, selling shares with the disclaimer that investors shouldn’t buy them, we say “Reddit revolution rewrites rules for struggling companies.”
And when the day-trading masses learn to weaponize gamma to orchestrate blow-off rallies in mega-cap tech shares, we say “Robinhood crowd exploits esoteric dynamic to propel tech favorites.”
Finally, when a central bank backstops the domestic corporate credit market or becomes the largest holder of domestic equities through ETF purchases, we say policymakers have created an “artificial market.”
Each and every one of those examples constitutes manipulation by humans of an artificial market of our own creation. The only difference between them is how we choose to describe that manipulation.
Of course, within the context of another imaginary human construct, money, there’s something “real” about corporate profits. Unlike the federal government, companies can’t literally print money. Like everyone else, I force myself to pretend like all of this (stocks, bonds, money) exists, because these shared myths have such broad-based buy-in that refusing to recognize them is an exercise in futility. While I’m pretending, I rely exclusively on fundamental analysis. In some respects, that’s counterintuitive given everything said above. The problem with technical analysis, though, is that while it has some loose claim on being able to track sentiment, it has no predictive capacity at all. If, for whatever reason, we all decide to push stocks lower in unison (a pandemic comes along and shutters the global economy, for example), all of the lines technicians drew prior to our collective decision are meaningless. Fundamental analysis, on the other hand, might still prove a semblance of useful. For example, market participants recognized that some large-cap tech companies were likely to generate windfall profits from pandemic dynamics. That assumption informed investment decisions.
Even fundamental analysis doesn’t have the kind of claim on reality that we often ascribe to it. You hear, time and again, that valuations are “stretched to the breaking point.” I regularly traffic in such boilerplate copy because, again, I’m compelled to persist in our shared myths like everyone else, and if every article were like this one, most people would tune out.
But the ratios we cite in claiming that stock prices have “overshot” are totally arbitrary. There’s no natural law that dictates the “correct” or the “fair” multiple someone should pay. Hilariously, we cite the average multiple over time as though that somehow validates our assertions about “fair” prices. What are we really saying when we point out that, over the past nine decades, investors have been willing to pay, on average, 15x for a dollar of earnings? Nothing, really — we’re not saying anything. That’s just the way things turned out. There’s nothing natural or cosmic about 15 (or 17 or whatever multiple your lookback spits out). If we re-ran human history a million times, we’d only end up creating “stocks” and “stock markets” in a fraction of those re-runs — if we created them at all. And in any alternate versions of history where stocks existed, P/Es may have averaged four, 400 or anywhere in-between.
This is, at the end of the day, why I often chafe at the idea that central banks are creating “artificial” markets. Or that policymakers are suppressing the “natural” “price discovery” process.
Those assertions are meaningless. Stocks and bonds, just like central banks and the money they conjure, aren’t an empirical reality. They only exist in the context of a shared human mythos. They go where we decide to push them.
As I write these lines, it’s Saturday, which means they (stocks and bonds) aren’t going anywhere. We took the day off. So they did too. Not because they wanted to. But because without us, they’re inanimate and inert.
They are as it were a hyperreal layer. A constructed dimension of values, rules and norms for behavior. The trick ultimately is remembering not only that they are constructed and not some sort of divine manifestation of some God of the Market but that we constructed them to do something and that doing something is the important part. One could argue equally well I think that the current state represents near perfect success and failure, failure to drive productive investment and success at enriching the wealthy.
You are firing on all cylinders.
Hope your WS and financial world expose/autobiography is going well.
Your style reminds me of Bianca Bosker.
“There’s no such thing as a “natural” stock. ” Correct! Economies (and the market) are not “natural” like biological ecosystems. They are not “discoveries”, they are “engineered”, like nuclear power plants. You can’t let either of them “run free” to find their natural equilibrium because neither is natural.
As arbitrary as the financial markets are, our success at navigating then may determine whether we are living in a nice house in retirement, or under a bridge.
Yes, this financial markets are shared delusion, as is money itself, but it’s hard to see how you can ignore them.
The bullishness is now at mania levels. Traders last week were ready to sell their mothers in order to buy more stonk. The delusion can and has become ridiculous.
H
You are becoming quite philosophical, if not downright Platonic, in your “old” age. While I would agree with much of what you said, I would argue that at least on a cash basis, profits are as real as anything can be. My side gigs always involved cash. People gave me cash for services rendered I gave others cash for resources used. When I got more than I gave I made a profit. While the fake GAAP and non-GAAP income reported by companies these days does not necessarily represent cash exchanges in the reporting period, those exchanges took place, never the less. If more came in than went out the company made a profit.
Of course, there is always a finite chance that even we humans are not “real.”
Central banks are criticized for manipulating the market because they change the rules of the game at crucial moments (usually when a large redistribution of wealth is about to happen). The game is rigged and eventually, after enough iterations of rule changing, people will refuse to play. They will seek out or create a new game with more stable rules. Crypto is one such attempt. That’s the gist of “central banks can’t hold it together forever” arguments. A game where a BTFD strategy is winning for everyone all the time is not interesting and can’t last.
—“The game is rigged and eventually, after enough iterations of rule changing, people will refuse to play.”
Retail participation has never, ever been higher across equities and options.
—“They will seek out or create a new game with more stable rules. Crypto is one such attempt.”
Crypto’s realized volatility is on par with Flubber. Crypto is the antithesis of “stable.” And there are no “rules.” Elon Musk can tank your entire position with three tweets at three in the morning.
—“A game where a BTFD strategy is winning for everyone all the time is not interesting and can’t last.”
A game where people make money constantly is always interesting.
Also, wasn’t it you who claimed, just a few months back, that the basis trade in Bitcoin was infallible? Remember how I tried to gently tell you that was a silly thing to say? Well, I asked a few people active in that market and they both said you were unequivocally wrong. A few days later, this: https://www.bloomberg.com/news/articles/2021-06-22/bitcoin-s-money-printing-machine-breaks-down-as-futures-collapse
You also applauded Pat Toomey last year when I criticized him vis-a-vis the Fed. Remember that?
Well, guess what Pat’s been up to? https://www.barrons.com/articles/sen-pat-toomey-bitcoin-ethereum-51625763320
What’s that? Oh, it’s just a sitting US Senator who criticized the Fed for influencing markets last year buying crypto right after he maybe/allegedly/kinda, sorta used his legislative clout to push for less crypto regulation.
Gee, that sure seems like trying to “change the rules of the game at a critical moment,” doesn’t it? Namely, the “critical moment” before you buy something and you can use your Senate seat to maybe/kinda sorta help your investment along.
If I were you, I’d quit while you’re ahead. Although it’s too late now.
Nobody should take these replies the wrong way. I’ve been doing this long enough to know when someone’s sole purpose for commenting is to push a certain narrative, and this commenter’s remarks lean pro-crypto/anti-Fed. I’m somewhat allergic to that combination, not necessarily on the merits, but rather because in my experience, it often goes hand-in-hand with other narratives and world views I don’t generally care for. So, I respond accordingly. Not hostile, but with enough snark to make my point.
Please continue to administer appropriate dosages of snark.
Given, as you say, that “retail participation has never, ever, been higher across equities and options”, and that we are in “a game where people make money constantly”, is there a real chance then that this very set of circumstances is contributing to the labor shortage? I have thought for quite a while now that if the benefits of rising asset prices were to become much more widespread (not necessarily ubiquitous) then that could add an ingredient to the recipe for wage inflation that had not been seen before. I understand that, from an historical perspective, gains in the stock and/or options markets don’t represent the kind of security that income that is derived from employment does, but that perspective may be changing. The perception among the retail investor/trader that over the intermediate and long term that you just can’t help but make good money is becoming ingrained in their mindset. That’s what having the Federal Funds Rate at 1% or lower for 10 of the last 12 years, and putting $8+ trillion on the balance sheet will do. We now have the audacious apes of Robinhood forming their own little cabals, searching for prey in the stock market, and then pouncing like a flash mob and gang buying the living crap out of their prey until they have, at times, turned over that stock’s entire float 10x, 20x, or more in a single trading session! Perhaps Chamath Palihapitiya’s dream will come true, and every “little guy” out there will be set for retirement on a year’s worth of trades with no real downside to worry about. Of course, if that were to ever come to fruition, then how would you get someone to work a service job? You wouldn’t. The Fed’s implicit message in all of this is: “Don’t worry, be profitable”, and ‘if there’s a bustle in the economy’s hedgerow, don’t be alarmed now. The Fed will be the May queen.’ And, by May queen I mean that they will be much more than the backstop that they were originally designed to be. They will be the susbsidizer of risk in chief.
So what? Market pricing has always been a matter of contrivance. Fed accommodation is just another layer of contrivance. This would seem to be the point of your article. I would respond by saying that before the GFC almost all of the money that was fueling the rise in the stock and bond markets was coming from some real economic activity. Since the GFC, a very significant part of that is being fueled by credits created by the Fed from nothing. So the market is to a significant degree getting its ‘ money from nothing, and its risk for free’. I suppose that this is fine as long as you be believe Ben Bernanke when he says that “the Fed can never be compelled to reduce its balance sheet”. (Which he did say back in 2015). I believe that he was closer to the truth when, at the announcement of the reduction of asset purchases on 12/18/13 he made this statement: “There are risks to having a balance sheet this large. Some of those risks we don’t even know what they are”. (His grammar, not mine). Some of those unknown risks may be playing out now. If the Chamath Palihapitiya market were to become a reality as a result of the Fed’s chronic massive accommodation, then the Fed might be compelled to withdraw that accommodation much more quickly than they would prefer. This would test the market’s ability to adjust to a much higher risk factor. The market would almost certainly fail that test. When you subsidize risk with trillions in asset purchases and 10+ years of ZIRP and NIRP, you end up with a market that, on its own, has almost no risk tolerance. It has a hell of an appetite for TAKING risk with fed having their back, but it will be severely disabled if it ever had to find a bottom without it. The market, for the most part, found a bottom on its own after the tech bubble burst in 2000. The Fed didn’t swoop in and by trillions of dollars of assets. Yes, the Bush administration created a phony boom based on reckless deregulation in the financial sector, but the money that was used to make those ill-advised purchases of multiple McMansions came from real economic activity. We’re not in that reality anymore. (We’re not in Kansas anymore?)
Raghuram Rajan asked a question at a meeting of the World Bank in Washington D.C. back in 2010. That question was: “Are we, with these policies, preventing adjustments which should be taking place?” I think that the implicit response from the Fed, the ECB, the BOJ, and perhaps the PBOC is a resounding “We don’t need no stinking adjustments”. (Think “Sideways”). My response would be: “Are you sure about that?”
Nice post.
It all “sort of ” works to determine a value, and it finds a bid-offer spread, until all the offers go away.
Sure, investing is a game played by humans and therefore it reflects all our foibles and virtues. Originally I expected the players to be small and large investors with skin in the game intent on making money using various approaches, largely focused on profitable enterprises. Speaking to the matter of Central Bank intervention, the point seems to be that we now have an overwhelmingly force, that is not an investor as such, that has changed the rules of the game, especially over the last 10 years. Whether that makes the market synthetic or not, is likely immaterial – one still needs to adapt accordingly, even if it is all an elaborate illusion.
Of all the markets out there, which one is the most delusional?
Equities, real-estate, bonds, forex, or commodities?
They are all delusional, but I think perhaps forex is the most delusional. With all the central banks printing money, it’s just a question of which one is printing money the fastest. The nice thing about trading forex is that there’s never any belief that anything is real. Perhaps, psychologically, that can help you as a trader.
For example, with equities, someone could always make the argument that fair value is the discounted value of future free cash flows. And that, right there, is where you can go wrong as a trader. You might, for example, feel for a moment that something is real.
It seems as if the game is always a shifting one. Today, the idea is to understand which of the many competing narratives is likely to believed by the most people. There is no actual “truth” it is just story telling and if you understand that then you might just end up riding the right wave. Of course, that does not mean that there cannot be unexpected events which skewer the narrative and catch markets offside, creating crashes.