This post is sure to piss off some of my fellow ursine pals. I understand all the reasons why stocks should be going down. Whether it is their warnings about “sell in May” or dire forecasts about plunging corporate profits, I get it. There is no need to offer up compelling research pieces about stock market over valuation, I have seen it all. Not only that, I happen to agree. Stocks are stupidly priced.
I recently stumbled upon a tweet by a reasonable finance fellow that said something to the effect of “in my 30 years of watching markets, there has never been a time where stocks were more susceptible for a market crash.” Again, I can’t say I disagree with this comment. Stocks are precariously perched at asinine valuations.
But where I differ from most others is my belief about the origins of this latest bubble. Whereas most investors look at risk assets and proclaim them to be egregiously over priced, I am more inclined to see the problem lying with Central Banks that have gone completely wild.
What is the right price for an equity when the risk free rate is below zero? Try sticking negative rates into all the fancy equity pricing models. It doesn’t work. Our financial system was never designed for this sort of absurdity.
What about the fact that Central Banks are actively monetizing their balance sheets by buying equities? Do you think the Swiss National Bank or the Bank of Japan are checking valuations before they pull the trigger on their gargantuan buy programs? Not a chance. They are lifting offers, desperately trying to get it in.
Central Banks have made a mockery of financial markets. Was it really just an unlucky coincidence we had the largest decline in the history of stocks to start a calendar year, but that by quarter end, the decline had been completely erased? Central Banks have pushed all asset prices to levels where the underlying fundamental bid is so much lower, the moment they walk away, prices collapse. When they rush back, stocks go rocketing back up.
These markets are no longer proper reflections of fundamental conditions. There have been other times in history when prices have divorced from reality, but it was usually the result of the madness of crowds. This time, it is the madness of a select few Central Bank chiefs. Prices are being jerked around like tickets for dinner with George Clooney at a hedge fund charity auction where the booze has been flowing a little too freely.
There is no fundamental analysis occurring. Well maybe that is an exaggeration. Market participants try to conduct fundamental analysis, but it is pointless. It has long stopped making sense. Even technicals no longer work as stocks go from massively oversold to incessantly bid a the whim of some bureaucrat.
It is understandable that many investors are scared in this environment. How do you invest in these sorts of conditions? Buying with the idea of selling to the greater fool is a mugs game. And as investors retreat to the safety of cash, Central Banks only get more aggressive with their financial repression.
So I am understandably sympathetic to bears who think this madness has to end. And for those forecasting the next big crash, I can’t say this isn’t a realistic possibility.
But where I differ is that I believe there is also a decent possibility of prices exploding upward. Sure stocks are massively overbought, but who cares? No one is buying because stocks are cheap. Buying is happening because there is no alternative. These Central Banker jokers are desperately trying to reflate the financial system. They keep pumping more and more stimulus into the global economy.
At one point during the Japanese bubble, the 3.4 square kilometers that makes up the Emperor Palace Grounds in Tokyo was worth more than all the real estate in the state of California!.
Did that make any sense? Not a f’ng chance. Surely as that bubble was being blown there were tons of bears arguing it would end in disaster. But it kept going. It was probably ridiculous when it worth a quarter of all the California real estate, but it still doubled, and then doubled again from that level.
Why then does everyone think stock valuations matter anymore? This time the Central Banks are monetizing directly in risky assets, and yet investors are mistakenly believing fundamentals actually mean something.
We have become numb to the mind boggling amount of monetary stimulus shoved into the system. Investors have mistakenly assumed any stimulus will be met with a corresponding decline in the velocity of money, keeping the system relatively balanced. This is definitely one potential outcome.
Yet another outcome almost no one is talking about is a painful face ripping rally in risk assets. The amazing amount of monetary stimulus could ignite at any moment. If that were the case, it could make the DotCom final blow off rally look like a warm up.
Usually stock market option skews have an Elvis Presley smirk (reverse skew).
Investors pay more for out of the money puts than the equally out of the money calls because all the big displacements have been to the downside. I can’t believe I am saying this, but I almost think the smile should now be even.
It is just as likely we get a massive upward blow off explosion as a crash. Now don’t get me wrong and somehow think I am arguing you should buy stocks on this greater fool theory. Far from it. I just don’t think you should go anywhere near the short side of the ledger. Too many traders are trying to top tick this financial monstrosity.
If you want to bet on something eventually cracking, I would bet against sovereign bonds. Japan, Germany, France, even US yields - they are all too low. Eventually Central Banks will push this trade too far, and they will lose control of the bond market. In the mean time, as they monetize everything that isn’t bolted down, be careful with the pink tickets.
Thanks for reading,