Let’s Dance: Buy the credentials – Forget Reality, Baitballs and Financial Ergot!

Despite Global uncertainty, rising inflation, and potential slowdown, markets remain Euphoric. All irrational markets eventually pop. How much longer can the current market mood be sustained? Longer than we think…

Blain’s Morning Porridge, 15th November 2021: Let’s Dance: Buy the credentials – Forget Reality, Baitballs and Financial Ergot!

“Where The Dance is, there you will find the Devil…”

This morning: Despite Global uncertainty, rising inflation, and potential slowdown, markets remain Euphoric. All irrational markets eventually pop. How much longer can the current market mood be sustained? Longer than we think…

One phrase pricked my confidence in markets this weekend: I listened to a distinguished market analyst describe his premier stock pick, without a trace of irony, as “you should buy, because this has all the credentials of a top meme-stock.”

Oh dear. When market pricing is determined primarily by the fashion sense of flash-mobs it’s probably time to hang up my hat and go with them… but, of course… I won’t. My spidey-senses are all-a-tingle. I sense a madness in the air, a contagion on the loose. Is it just a disease? Something wicked this way comes… and we all know what it is….

Irrational Markets…

What fuels them? Call it meme, blame it on FOMO, describe it as irrational rationality, but the basis of current price action makes little apparent sense to anyone who’s spent a career trying to read the markets’ mood. Any serious market journal will warn every single indicator is screaming overbought, citing: a looming global supply chain recession, the stagflationary threat, record PE multiples still rising despite consensus earnings have peaked, markets hitting successive peaks, short-sellers being forced to bail-out, one-way record options volumes. I could go on… we all know the tide eventually goes out, but all pretend we know when. (That’s actually a very poor market metaphor: tides are completely predicable, sell offs are not!)

What we do know is in such euphoric markets everyone gets caught up in the dance… Everyone buys – no matter how improbable, how unlikely, how bright the warning signals are flashing, or how borderline fraudulent unicorn poop smells. In this market… No one can hear you scream. It really has become a game… Keep dancing.

Who cares about the fundamentals of a company’s future earnings potential and growth outlook, profits & margins, price, accounting, management, governance and social value-added, when all that matters is how outright speculation on how any name might appeal to the behaviour of the herd? When the determinant of market success is being in tune with the mob and being able to swim with it… then who needs market sceptics like me? (Best answer to that question gets a free subscription…)

Let’s swim with the fishy metaphor a little deeper.

The market is behaving like a shoal of sardines; dodging, diving and swimming in a coordinated mass to snap up the latest trend, theme or FOMO thread. However improbable the stock, SPAC or crypto might be – the mob will swim with it. But here’s the thing… 99% of the fish that swim in the sea are bait – food for something bigger. They swim in shoals as a defence. When the bigger, hungry predators arrive they form tighter and tighter bait-balls, until suddenly some massive whale comes from down deep and swallows the whole shoal in a single gulp.. Ouch! Or it might be an Orca stunning the baitball with an unforeseen but well timed slap of its flukes.

Just how over-priced are markets? Who knows? Who can tell..? Are they about to pop? The combination of speculation, options madness, the irrationality of memes, artificially low rates and inflated asset prices have never combined to drive markets like this in my lifetime.

But, I have seen markets behave irrationally many times before. Irrational markets inevitably pop. The question is when and what triggers the tumble.

Usually, it’s a relatively small part of the overall market that succumbs when it wakes up to the madness of crowds. Often it’s the reverberations, the contagion from a collapse in say, Commercial Paper funding markets or mortgage securities valuations (2007), that then drives a cascade of consequences across the whole financial market, leading inevitably to a much wider market stumble and sell off.

This time it is different. Because what is driving the madness is well known, and pretty much understood by everyone – the distortions at the core of market pricing in interest rates. As I’ve written so many times before; “In Bond Markets there is Truth.”

It’s dead simple: If bond yields are too low then money is too cheap = inevitable financial asset price inflation (pushing up stock market prices). It really is that simple. Markets have been distorted and juiced by artificial bond rates since QE. When is the market going to wake up to that reality? When the distortion ends…

So until rates normalise the dance will continue. I am tempted to suggest the market is afflicted with something like Ergot, the rotten fungus on rye that drove crowds into ecstatic dancing madness during the Middle Ages. Extra points if you can identify the song:

“Caught in the chaos of the market square

I don’t know what, I don’t know why, but somethings wrong down there,

Their bodies twistin’ and turning in a thousand ways

The eyes all rollin’ round and round into a distant gaze

Oh, look at that crowd”

Mother please… it is just a disease..? Well maybe it is.

The symptoms of Ergot Investing include:  credulity in get-rich-quick schemes, an unjustifiable belief in easy riches, an infection in the part of the brain that quantifies risk to constrain speculation, intense paranoia other investors might be achieving better results, and a dangerous delusion zero experience is not a handicap. In other words, exactly what’s happening today.

Financial Ergot occurs when artificially low interest rates soak the market in distorted prices, triggering the fungus of financial asset inflation, and making market participants believe a serious stupid number of things each day.

Stastically gold miners never got rich. It’s the folk that sold them shovels and pans, booze and female company that did. I doubt anyone will remain rich holding HairyDog Cryptocoins, SPACS in a failed politician’s non-existent media empire, or $100 bln electric truck makers who’ve sold a couple of hundred prototypes.. but as the fervid minds of the market crowd lap it all up, the predators, from crypto-exchanges, Cyber Shucksters, Tesla Barkers, Robin Hoods and others will be milking the opportunities and making out like bandits..

And the biggest predator? The whale that’s going to swallow the  baitball of markets whole? Well that will be reality; the expectation of rising interest rates bringing back a degree of normality to markets.

Historically Ergot caused your limbs to fall off from gangrene, or you danced yourself to death. Financial Ergot is a little different – the only thing that can cure it is a sharp, painful destructive shock. Many investors sincerely believe in a mythical power called the Fed Put which immediately rescue tumbling market. Their belief system says Central Banks and Governments won’t stop the party. They won’t raise interest rates for fear of causing a taper tantrum meltdown.

Not that raising rates would help at this stage.

How would hiking rates now solve inflation? What we can most definitely say is raising rates is not going to solve Chip and Energy supply chain meltdowns, or reduce the number of ships queuing to unload at ports around the planet. Neither will a rate hike solve wage inflation which threatens to cascade through economies: give one worker a pay rise today and the plant will strike as everyone else demands more.

Nor will wage inflation be short-term.

Earlier this autumn I was talking to restaurateur chum of mine and she was close to despair. She simply can’t get staff. Experienced, trained competent staff have left the catering sector in droves – attracted by higher wages, better conditions, and more social hours from the likes of Amazon. (Same thing in the haulage sector.) It’s left my chum struggling with barely trainable school leavers and “unreliables” who she knows will repeatedly let her down at the last minute. She’s contemplating cutting service to 3 or 4 days a week.

She knows the only solution is to attract staff back to the industry with higher wages, shorter hours, social shifts and better conditions. But to put up staff wages and raise costs means higher prices – it’s called wage inflation. It’s happening across every single part of the economy… Whatever Central Bankers would have us believe about “transitory inflation” – wage inflation and price adjustments are going to have a very significant effect on the real economy.

Normalising interest rates at this stage won’t put the already uncorked inflation genie back in the bottle. All it would likely do is precipitate the inevitable end of the irrational markets dance… so central banks and governments are unlikely to run the risk… which means….

Crank up the volume, keep dancing and keep buying! Yay! (Queue Daft Punk and One More Time)

Five Things To Read This Morning

FT – Yellen says inflation will stay high until Covid is under control

FT – Hedge funds learn the hard way in bonds shock

Bberg – To Dispel the Property Crisis, Beijing has to Tame Two Types of Bad Borrower

Guardian – “Terrifying for American Democracy”: is Trump planning for a 2024 coup?

Forbes – Shares of Rivian Continue to Move Higher After Elon Mush Throws Shade

Out of time, time to do the day job…

Bill Blain,

Shard Capital

23 Comments

  1. I’ll bite! Who needs market skeptics like me…?
    Well, obviously the market does, because it’s that place where everyone gets a vote, or perhaps more precisely every dollar/sterling/euro, etc. gets a vote. As always, the market is not wrong, not now, not ever! Here we can insert the quote “the market can remain irrational longer than you can remain solvent”.
    So the market isn’t WRONG, but right now it is largely driven by unhealthy forces, forces which start with Central Banks but which also extend to the irrational disregard for basic financial metrics that we see in so many areas. The scary thing is that the longer this goes on, the more likely it won’t be “market forces” generating the needed correction, but rather a “market failure” or some sort…, compared to that, a bout of inflation really doesn’t seem so bad. But yes, we need people speaking out against the greed and speculation, because that’s one of the few healthy aspects of this market that we have left.

  2. Most people don’t profit much from financial asset price inflation because they remain long, they never sell.
    If I run my own business and every year someone tells me it’s worth twice as much (think market price) my profits remain the same.
    I value skeptics like you, thanks.

  4. The S&P is at 21.1x estimates for 2022 earnings – so there is no room for error when it comes to evaluating future earnings power. However, we don’t care if the Fed raises rates 4 times next year and 10-year Treasuries end up yielding 3.0 percent. If S&P earnings end up at +$240/share in 2022 (i.e., 10 pct above current estimates), none of that will likely matter much to stock prices. Just look at this year for proof that earnings can trump pretty much anything else. My point, the market may not be as irrational as portrayed, when analysts are behind the curve.

    • Basically you are arguing that the rise in corporate earnings will more than compensate for higher bond yields.
      However, I don’t think that really links with the way in which artificially low interest rates have inflated equity prices – as investors have gone for yield. Its a relatively thing – when rates are very low, you buy stocks to make returns. As stock valuations become more risky due to the perception they are overvalued, the the relative risk-weighted attractions of higher bond yeilds come into play…
      Its complex… consequences.. always consequences…

      • “The “Live” P/E , capitilization weighted, (non-earners ascribed stock price as P/E), is 50.8x. From demeadville.com

  5. You identify correctly the cause of distorted markets in the “Whatever it takes” policies of Central Banks and “Whatever it costs” policies of governments. People also are loath to “fight the Fed”. What remains totally incomprehensible to me (and that you do not mention) are the possible dire consequences of a renewed pandemic scare in Europe (despite the high vaccination rates) and the renewed immigration tensions not only on the Belaruss border but also in the Chanel. These are leading to growing intra EU tensions with the advocacy for “taking control” and “repatriating sovereignty” growing fast. This leads to a third risk that you overlook: the desintegration of the € and the EU, the fear of which should scare any rational investor to heed your very welcome skeptical remarks.

  6. Bill, someone has to keep on shining the torch of rationality into the murky recesses of manipulated markets! The lyrics are from Moribund The Burgermeister on Peter Gabriel’s Car album (1977). The last track Here Comes The Flood is scarily prescient.

  7. Great article, Bill – thank you! I particularly liked your baitball analogy, and the thought of ‘Ergot Investing’.

    Why do we need sceptics? In my opinion, to help support the long-term investor. The sceptic tried to tell things like they are, and this helps the long-term investor to understand the risks. Some (maybe many) market participants will dismiss the sceptic’s thoughts, but investors (in the proper sense of that word) will absorb some different perspective, and perhaps some wisdom.

  9. They say that even a broken clock is correct twice in the day. When you are a reveler in this party getting high on the manna of a utopian future, one simply assumes the clock is broken, only to realize later that it isn’t.

    We need folks like you Bill because you are the envoy for the big whale, Reality. Your notes are a harbinger for its arrival and when it comes, the ocean will be emptied of the shoals.

  11. You can expand “Wage Inflation” to “COST PUSH INFLATION” cause dats what it’s goin to be!
    -Steve Sands

  13. My answer to your question

    “When the determinant of market success is being in tune with the mob and being able to swim with it… then who needs market sceptics like me?”

    is:

    In today’s markets, and indeed since 2008, it has been rational to be irrational in following and staying invested in the market. To have failed to have participated would have meant 12 or 13 lost years. And once you stop investing and trying to give it a go you lose your nerve and once your investing nerve is lost it is very difficult to regain. Therefore investors should have ignored your prognostications of doom and kept going with the optimists, for the optimists nearly always win..

    But your market scepticism serves a very useful purpose. You are like the slave whispering into the ear of the emperor as he enjoys his triumph, “Remember you must die”. We investors know neither the hour nor day of the reckoning but only that as time passes the reckoning must get nearer. And the longer it takes to arrive, the worse it will be. So Bill, carry on whispering in our ear. We might be lucky and get out just in time, we might, having listened, be willing to take the first and kindest cut or we might, having heard your whisper, just more readily accept the fate that is handed to us when our time is up.

  14. >Who needs market skeptics like me…?
    we need to get out of boom and bust cycles
    we don’t need anyone to tell us we’re inside one

  16. “Who needs market skeptics like you?” … answer is: Mr. Blain, you are desperately needed because you are not an Elongated Musk.

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