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.