This morning one of my buddy’s was complaining about the lack of investors for his small cap stock deals. I must admit to being sympathetic to his woes. Although the S&P is nearing all time highs, it is up here on Central Bank goosing, not real fundamental buying.
This Central Bank pushing up risk assets creates an incredibly unstable situation. It’s all fine and dandy when investors believe in the efficacy of quantitative easing ala 2009-2014. When there are other players investing alongside the Central Banks, the market can function somewhat normally. It isn’t ideal to have such a big buyer setting the tone, but it isn’t the end of the world because a variety of different agents are setting the price.
But as the price deviates farther from fundamental value, the list of different players setting the marginal price becomes shorter and shorter. Not only that, as Central Banks such as the Bank of Japan or the Swiss National Bank increase their monetary stimulus, they end up being a larger portion of the buying.
It is no wonder that my buddy has trouble finding buyers for his deals, prices of all risk assets are horribly expensive. Investors are increasingly sticking their hands in their pockets. I can’t tell you the number of times I have heard investors say something to the effect of “I just don’t understand the market at all anymore.” When something isn’t understood, human beings’ natural instinct is to be cautious.
To demonstrate this increasing cautiousness, I plotted the American Association of Individual Investors’ Neutral Readings for the past nine years.
There is a definite trend towards more and more investors being neutral on the market. This apathy makes perfect sense. It is difficult to short the market with Central Banks monetizing their balance sheet against financial assets, but investors have figured out that there is no value to risk assets at these prices. More and more neutral investors is a natural outcome to this situation.
Taking a punt
After giving you this long winded diatribe why the stock market is a mugs game jerked around by Central Banks, I am going to nevertheless try to trade it.
This morning one of the most dovish Fed officials returned to the late 2015 playbook of trying tighten monetary conditions through hawkish rhetoric (from the WSJ):
Fed’s Rosengren: When it comes to rate outlook, “I don’t think the financial markets have it right,” are underestimating path of hikes.
Stocks are massively overbought, pushing up at resistance, and now the Fed might be once again applying the brakes.
The short side is worth a shot up here. Most bears have long since giving up calling for an immediate decline, so I think it might be a good risk reward on the short side. I am selling S&Ps, willing to risk a spike into new highs (where I will add to the trade).
Thanks for reading,