Posted by Washington.
There are at least 6 theories about why the stock market has rallied some 70% off its lows a year ago, even though nothing has been done to actually reverse the financial crisis.
What The Dumb Money Believes
The dumb money believes what CNBC and their trusty stock churner … er, broker … says: that the government has fixed the economy but it just has to “kick in” (and that unemployment is just a lagging indicator, nothing important. See this, this, this and this).
Therefore, these folks believe that stocks are hugely undervalued, and that if they buy while most people are still afraid, they’ll make a killing when the market goes to the moon.
(Note: Obviously, I believe this is a bear market rally which will eventually fizzle out. If the bulls are instead right, then that will make me the dumb money. But I think it much more likely that the rally will change direction in the not-too-distant future.)
Others believe that it is the quantitative easing, low rates, bank bailouts, stimulus spending, and other portions of the “wall of money” which the feds have thrown at the economy are creating a temporary pump to the stock market.
But they think that – when the spigot is turned off – the market will tank.
The Situation is Inflation
Others believe that – regardless of continued loose monetary and fiscal policy or real stock valuations, we’re in for some serious inflation.
Stocks tend to preform well during inflationary periods.
For more on inflation versus deflation, see this.
Machines Run Amok
Tyler Durden explains that all of the stock market gains have occurred after hours when mystery buyers purchase stock futures in low volume environments (and see this).
Vincent Deluard – a strategist for TrimTabs Investment Research (25% of the top 50 hedge funds in the world use TrimTabs’ research for market timing) – said last month:
We’ve never seen this before – such a huge rally, and the little guy is out.
Some argue that it is high-frequency trading or momentum-chasing trading algorithms doing the buying, and that the market will tank when they change their game.
Others argue that the government is itself buying stock futures.
Some believe that the Feds aren’t buying, but that they have intentionally showered the big banks with money, and encouraged the banks to buy. In other words, they argue that the Feds are indirectly promoting a stock market rally.
Karl Denninger believes that the market has rallied due to the systemic, fraudulent overvaluation of assets.
As Denninger wrote yesterday:
[A reader wrote] the FDIC to ask about [allegations of fraudulent valuations]. This was their response:
That’s the value the bank had them on their books on their year-end financials, but the true value is much less. It is similar to someone in Las Vegas saying that their house is worth $300,000 because that’s what they paid for it three years ago, but the reality is, if they had to sell it in today’s market, they’d only get $250,000 for it. The FDIC has to sell assets in today’s market…
Or tomorrow’s market.
The simple fact of the matter is that there it is, right in front of you.
A raw admission that the banks are carrying these loans at dramatically above their actual value.
Yes, this means that essentially all balance sheets must now be considered fraudulent, and thus the valuations assigned by the market to them are also fraudulent.
Extending this to the stock market as a whole you now have a market that is intentionally overvalued as a direct and proximate consequence of fraud, permitted and endorsed by the government, of somewhere between 25-40%.
Now you know why the market rallied off the SPX 666 lows to where it is now. 1139 (where we are now) * .60 (a 40% haircut) = 683.40, or awfully close to that 666 bottom.
Of course this “valuation” expressed in the market can only be maintained for as long as the fraud is. If the ability to maintain that fraud is lost for any reason then values will instantly collapse back to reflect reality.
Leave a comment about why you think the stock market has rallied, and how long you think the rally will continue.
I think the Fed Futures idea is the only one that holds any water. Of all the theories, Denninger’s makes the least sense, I think. Everybody knows that the FASB-endorsed accounting is a sham, and that by itself should be “priced in” to the stock.
Tyler’s view doesn’t make that much sense either, since there’s no reason for the “Machines gone wild” to collectively have a long bias.
Dumb money doesn’t hold–as TrimTabs noted, the “dumb money” is sitting out.
Inflation is still not considered a foregone conclusion, and the inflation/deflation debate is still raging. It’d be bizarre for the markets to be so one-sided in their bet given the general uncertainty as to outcome.
As for the “temporary juice” idea–why would all that money be reluctant to go to credit, but instead go to stock in highly indebted companies instead? I don’t think this really makes much sense either.
Hence, I’ll blame the Fed…
Who wrote this guest post, btw?
George Washington has a bad habit of posting without bothering with a byline. He prefers us to think it Yves until we notice the writing and advocacy style are all wrong, prompting us to scroll to the end of the post for the “posted by” note.
I apologize if there was any confusion. All of my posts say “Guest Post”, and so it never occurred to me that anyone wouldn’t realize it wasn’t Yves.
Plus, I am sick of tooting my own horn every time …
But now that you have pointed out that you don’t like it, I will start with my byline from now on.
The market rallied because in March 2009 there was nowhere left for sentiment to go but up. The symptoms of that improvement in sentiment include higher “liquidity” and an increase in the belief of the power of the Fed and government policymakers to levitate the market. These will both be revealed to be illusions in equity prices turn down again.
I think low interest rates have a lot to do with this stock market rally.
A lot of pension funds, mutual funds, and hedge funds need to make money every year. Or else the managers of these funds will get fired. And since there isn’t much income from US bonds now. Professional fund managers have probably cashed in some of their bonds and are now playing poker in the stock market with that money hoping to outsmart amateur investors and make money from them.
When fund managers play with other people’s money. And they get paid bonuses for short-term performance. Then it’s in their interest to blow financial bubbles and get paid their huge bonuses. And when the latest bubble bursts and their investors loose a lot of money, then these managers might loose their investors and their jobs. But by then these fund managers will be rich from their bonuses. And loosing their jobs won’t be any great hardship for them.
For someone who invests his own money, this kind of investment behavior doesn’t make sense. And that’s why you need to remember that the stock market is driven by fund managers who are playing with other people’s money. Their goal is to get paid those bonuses at the end of the year rather than preserve their capital for the long-term.
They are paid to take risks and profit in the short-term. And they don’t care if they loose money in the long-term. Because it’s not their money they would loose. It’s other people’s money.
There may indeed be some “fraudulent” element to the rally – and, full disclosure, I expect the S&P to get back to 800-ish before the end of 2011 on pure reversion-to-the-mean reasoning – but let’s not discount the role of reflexivity. The banks have raised well over $100 billion in equity during this rally (and other various and sundry companies have done the same) and that’s *real.* And I expect such companies to continue raising capital for as long as the market allows. All of which raises the theoretical floor to which this market *should* ultimately decline. Again, I’m quite bearish. But I can’t ignore the power of rising prices on raising capital and, thus, raising the floor for the next leg down.
Are there any facts or credible sources in this post?
I do suspect it’s a sucker’s rally, but surely we have more to go on than this.
There are two ways MM’s make money-
1. as a percentage of assets under management
The market was over sold as per the indicators, but fair value according to me in March 09.
Retail got pissed and moved their money, selling out of MF’s and moving to other MF’s. This makes money for WS, and appears to make money for the clients(who are probably still over invested in FIRE sectors).
The bagholder economy, do you have yours? I don’t.
they saw the crash coming, created a simulated crash, and are now running a simulated economy, waiting to be hooked up to the next motor, systematically shedding layers to reach the ratios required by the next motor.
like passing a baton.
Stock market valuations are based on expectations of future earnings. Most traders merely project past averages of recessionary periods on the assumption of an extrapolation of future results based on past performance. Once this catches some steam it becomes a self fulfilling prophecy because you can always look out far enough to fool yourself and everyone else. In this case, Tyler’s machines amplify the effect.
The critical error here is that past recessions have been inventory precipitated, whereas this is a credit induced recession. At this point, no one (who is invested) wants to shout out that the emperor has no clothes. So like wiley coyote, the market will defy gravity for a bit longer.
I think bernanke will achieve his goal of inflating away. it will take 2 or 3 years due to devastating deflationary forces but eventually he will succeed (if banks do not start lending, i would not be surprised he gives money away by making direct deposits in checking accounts). he’s so determined. as a result, i believe stock prices won’t probably move much from current levels, earnings will grow due to inflation and P/Es will compress in anticipation of higher rates to control the inflation problem. debtors outnumber savers, and in a democracy, politicians punish savers for the sake of debtors… and themselves.
Hey George, of the above mentioned theories, some care should be given to rank relative impact.
For instance, some large institutions must be in the markets all the time. When fixed-income rallies, these funds must allocate some assets to equities.
As for the banks, they are the best movers within the indexes. You follow the banks, how could you bet against them as they rallied off their lows? They were too big to fail, they passed the silly stress tests, they were allowed to offer lousy paper at inflated prices then turn around and play the spread. How hard is that? Stocks traders just followed the liquidity.
With respect to the Fed, again it goes back to directly supporting a number of markets, then allowing banks to use suspect paper for loans at zero percent. In addition, the Fed did purchase Treasuries further out on the curve, and said so, thus again coaxing investors out of Treasuries.
The cumulative effect meant that traders, NOT investors, just followed the momentum. Their conviction is a mile wide but an inch deep, which is why many are calling this a pure traders market. The algo/quants just follow the same trends and make huge bets for a few bps.
Moves off the lows are one thing. A sustainable market is something else. The easy money has been made. The comps off disaster are in. Its not so much a question of how we got here, its where we go from here.
It looks to me like all, or at least most, of the above.
If “insiders” are considered smart money, then the smart money is not buying either. Insider selling reached a new 2010 high. And it isn’t so much that there is so much selling, it’s that there’s virtually no insider buying.
So, smart money is not buying. Dumb money is on the sidelines. And that’s why it is such a puzzle.
I do believe the government is involved in a direct or indirect way. Maybe a combination of factors can account for the rally. Algorithms, underground Fed manipulation, just plain old greed — these are not mutually exclusive factors.
It’s clearly a combination of factors:
1. First, the stock market was oversold because the fear of Great Depression 2 was rampant (and there was much uncertainty about how the Obama administration would address the problems);
2. The Dow and S&P500 are indexes of big companies. When the economy is weak, and credit is hard to come by, the stock of big companies do better.
3. Stocks looked good (for a while) compared to many other asset classes, and are seen as an inflation hedge.
4. Momentum – as stocks rose some jumped in to avoid being left behind.
5. Happy talk. Some have been lured back. This is due to trumpting (misleading) headline economic numbers like the last GDP report. No one pumps stocks like Wall Street and CNBC. Just today I heard a CNBC lead-in that went something like this: Tech stocks are at 12-month highs – should you be investing?
Now for the kicker (#6): big stocks will use their advantage to do acquisitions this year, which will tend to drive up stocks more (unless something unexpected interrupts the party).
I’m going to go out on a limb and go with…..
All of the above.
Could be due to outflows from FI/Alt asset funds creeping into equity funds. Probably also due in part to the lack of interest in real estate investment. The lack of faith in the other investment paths and a low risk free drive people into more speculative assets like equities.
It’s a bubble. Bubbles are driven by cheap money and that money is emanating from the Fed. Some big stupid slow movers, like pensions, have to be in the market. It’s a question of performance anxiety for the managers and unrealistic expected return rates for the funds. They (the funds) are going to get killed when this market goes south. When it goes south is dependent on how long the Fed is willing to keep the cheap money taps open. The big machine driven moves on light, end of the day trading have players like Goldman Sachs written all over them. An inflation hedge is just silly. Fraud is kind of redundant when discussing our current financial system of crony casino capitalism.
S&P 500 companies have about 80 bucks of operating earnings baked in the cake for 2010. Yes they could miss, but many took ALOT of pain and write downs in 2008/2009. So thats about 15 times earnings (6.5% yield) on current projections.
Further, they are sitting on record cash due to reduced CapEx spending and hiring. They are hoarding cash. Not spending or hiring.
The dividend yield (currently about 1.9% and is 2.7% among those who do give any at all) appears to potentially increase.
Current “risk free” rates are about 3.8% on the 10 year.
3.8% in Treasuries, or (6.5% + 2%) in the stock market based on current valuations? or 0% in cash? The uncertainty of Emerging Markets? Europe? China with its lack of transparency? Gold? Corporate debt has some deals, but remains inaccessible to many in the general public.
See what I’m getting at?
It may surprise some people that there are actually American companies with solid balance sheets, good management, that MAKE and SELL things. Weird, I know. So applying the fraudulent balance sheet antics of the Financials to the broader market is a dicey strategy. Don’t pick a fight with the wrong balance sheet guys.
But yes, current policies are driving investors into riskier assets. Many no doubt would be holding cash if it paid anything, but the Fed in its infinite wisdom crushes that plan.
I’m not saying the Stock market is a wild buy, but it most likely isn’t wildly overvalued. There certainly appears to be a lack of viable competition for the US stock market. Its a race to the bottom and we are in last… or first depending on your point of view…
How about foreign buyers?
The hallmark of a Japan (zombification) policy is lack of real asset appreciation over time. No one has made money in a buy and hold sense in the US since 1999.
The bigs have figured out how to trigger waves on various temporal scales in the markets; by riding the waves and hedging they think they can make money.
Turns out they need to steal from my babies too, but I guess that’s just too bad. For somebody.
Why has there been a stock market rally?
The perception that the market is being willingly supported by the government, or specifically by the Fed, and the perception that there is a recovery from the economic crisis.
It doesn’t matter whether the perception reflects reality.
I think it is portfolio management in a low bond yield world combined with an essentially never tapped out liquidity source, all this combined to the fact that there are very few solvent real borrowers… so all the dollars are chasing paper assets and nothing will land in actual credit. The only “outlet” for all the liquidity is stocks! Hence the rallye. When will it end? When Bailout Mania ends, and that is when the bond market will force fiscal restraint on large economies. I don’t know when that will happen, but watch the 10 year yield daily…
Then your looking at the wrong yield. They would LOVE the 10 year yield to rise as it would mean economic recovery.
Your talking about a short yields, those are the ones to watch. If they start wanting big yield increases to buy treasuries in those short yields, will the liquidity dry up.
Your inability to understand that is amazing. The fact is, it wouldn’t cause fiscal restraint at all as tax revenues would crash from the next recession. Even as spending was cut, deficits would rise and rise further as the spending cut dampens demand. All sources of wealth would vanish, small businesses would be extinct and the plutocracy would still be quite intact. It is the gentiles who they fear and why they won’t risk another collapse creating anti-capitalist movements again.
It’s simple really – more people want to buy stocks than sell them at current price levels. This will continue for quite some time. You don’t need any tinfoil-hat theories. With interest rates at unprecedented low rates, stocks are attractive (tons of liquidity driving markets). Because of insolvency issues (tons of deleveraging in the face of excessive and unservicable debt) inflation is a non-starter. Therefore, we are in the sweet spot for equities. It won’t last for ever, but it does have legs.
high unemployment is putting lid on labor costs, helping corporate profits. higher corporate profits mean higher share prices.
When the Fed pumps, the market jumps. :)
I think all the reasons have some sense but there is something in common for those practices and it is that this time nobody has gone to jail , has been prosecuted. SEC allows banks to rise money with fraudulent statements, banks are flooded with money to make bets so moral hazard is a joke, FED controls the fed fund rates, the only one which is not priced in a free market taking out 30 billions from savers to banks last year, regulatory framework is a fake and so on.
balance sheet feedback is a major factor. the more assets rally, the more everyone looks solvent again, the more higher valuations seem justified.
also, short time horizons play a big part in inflating asset bubbles. i would hazard a guess that banks had a strong incentive to pump up valuations ahead of the latest bonus round. as soon as the bonuses were locked in, we saw a big selloff and the greece crisis. but it turned out this was not enough to burst the bubble, and so we are back to inflating it again..