Herd Mentality

This may become the most important article I’ve ever written. But whether it becomes that article or dwells in anonymity is up to you, the reader.

Investors may be trapped in a ‘greater fool theory’ in thinking they can all unwind risk at the same time. Over-regulation, shrinking bank balance sheets, and fewer market makers mean that market liquidity is challenged. Retracting Fed dollars is always far more difficult than creating them, particularly in the current environment.  The FOMC scientists have been working in their lab tweaking models to assess marginal benefits, but it is blinding them from seeing the underlying risks that are building. They openly ask what signs of troubles are evident, but the morphine drip has been in use for so long that they can’t see that the current calm may be replaced with an uncontrollable monster unleashed when the sedation fades.

"When it comes to market events, there have been no impactful black swans - the so-called unexpected 'tail events," Mark Spitznagel notes in his excellent new book, The Dao Of Capital: Austrian Investing in a Distorted World, explaining that, "what were unseen by most, were indeed highly foreseeable" by others. The Fed planted the seeds for the last financial crisis and "when you prevent the natural balancing act, you get growth that shouldn't be happening." 

The financial crisis of 2008 could have been the wake-up tall that, like the Yellowstone fires of 1988, alerted so-called managers to the dangers of trying to override the natural governors of the system. Instead, the Federal Reserve, with its head "ranger," Ben Bernanke, has deluded itself into thinldng ft has tamped down every little smolder from becoming a destructive blaze, but instead all it has done is poured the unnatural fertilizer of liquidity onto a morass of overgrown malinvestment making a even more highly flammable. One day - likely sooner than later, it will burn, and when that happens, the Fed will be sorely lackng in buckets and shovels and must succumb to the flames.

Anchoring is "our tendency to grab hold of irrelevant and often subliminal inputs in the face of uncertainty." In the absence of reliable knowledge about the future, investors have a tendency to anchor onto something – anything – to help them predict future market returns. And what better anchor to use for future market returns than prior ones? This is where the story gets more intriguing. When looking at the UK stock market in discrete 20-year blocks, the period from 1980-1999 is the only one in the last 300-years in which inflation-adjusted returns averaged between 8% and 10% per year. Investors seem to be anchoring their market predictions to recent returns of the past, therefore buying ‘the index’ expensively, inclusive of a grotesque bubble of credit. One can expect this to end in a train wreck.

So, apparently, according to Jon Hilsenrath, "QE to Infinity" is actually "finite" after all. There is no doubt that the Federal Reserve will do everything in its power to try and "talk" the markets down and "signal" policy changes well in advance of actual action.  However, that is unlikely to matter.  The problem with the financial markets today is the speed at which things occur.   High frequency trading, algorithmic programs, program trading combined with market participant's "herd mentality" is not influenced by actions but rather by perception. As stated above, with margin debt at historically high levels when the "herd" begins to turn it will not be a slow and methodical process but rather a stampede with little regard to valuation or fundamental measures. The reality is that the stock market is extremely vulnerable to a sharp correction.   Currently, complacency is near record levels and no one sees a severe market retracement as a possibility.  The common belief is that there is "no bubble" in assets and the Federal Reserve has everything under control. Of course, that is what we heard at the peak of the markets in 2000 and 2008 just before the "race for the door." This time will be no different.

By now everyone knows that POMO is the daily physical manifestation of the Fed's love for the "1%", and the trillions in underfunded pension and stock-linked entitlements, taking place (almost) every day in the hours between 10:15am and 11:00 am Eastern, when the NY Fed's trading desk injects between $1 and $6 billion in the stock market. What many may not know is that while POMO was the name of the game since 2009 (just think where the S&P would be if the "market" was only open on Thursday, during the 45 minute duration of POMO, and between 3:30 pm and 4:15 pm), it may have finally met its homophonous match, courtesy of Citigroup. So step aside POMO. Presenting.... FOMO, or Fear Of Missing Out.

One cannot see clearly while in the midst of the madness using only the cognitive tools and worldview assumptions supported and promoted by the madness.

The 2008 crash resulted from the bursting of the biggest bubble in financial history, a ‘credit super-cycle’ that spanned more than three decades. How did this happen? Some might draw comfort from the observation that bubbles are a long established aberration, arguing that the boom-and-bust cycle of recent years is nothing abnormal. Any such comfort would be misplaced, for two main reasons. First, the excesses of recent years have reached a scale which exceeds anything that has been experienced before. Second, and more disturbing still, the developments which led to the financial crisis of 2008 amounted to a process of sequential bubbles, a process in which the bursting of each bubble was followed by the immediate creation of another. Though the sequential nature of the pre-2008 process marks this as something that really is different, in order to put the 'credit cuper-cycle' in context, we must understand the vast folly of globalization, the undermining of official economic and fiscal data, and the fundamental misunderstanding of the dynamic which really drives the economy.

We already posted Howard Marks' most recent letter in its entirety previously, but it bears reposting a section from Art Cashin's daily letter which focuses on one segment of Marks' thoughts, which is especially relevant in light of today's most recent comment from one Warren Buffett - a person who very directly benefited from the government/Fed's bailout of the banking sector in 2008 - who said that "Bank Risk No Longer Threatens U.S. Economy." The same banks, incidentally, who are TBerTFer than ever. An objective assessment or merely yet another example of the "handcuff volunteerism" (not to mention crony hubris) Marks touches on? Readers can decide on their own.

Bulk (Wall Street) buyers have been receiving a lot of attention recently. It's time to take a closer look. There is little data available pertaining to bulk investors and even less meaningful analysis. Historically, Wall Street has never been active in direct ownership of single family homes, so there is no past histrory to learn from. We need to start from scratch. Anecdotally, Las Vegas is the most shocking: "... never seen a market where over half of the buyers paid cash and over 1/3 of the sales were financed via the FHA, leaving only 14% of sales in the "other" category." The herd mentality is in full control with buying increasing at all levels. How long will this feeding frenzy last? Will the bulk investors be able to generate enough returns to whet their appetite for more? Stay tuned.

More of my contrarian, yet highly accurate Apple research released free to the public, unfortunately not in time to save Rochdale's ass...

"Yellow journalism" – which seems almost the only kind we have these days dominates our newsflow, but the truth is out there. As with everything else though, it's subject to Pareto's Law. So, 80% of what's out there is crap, and 80% of what's left is merely okay. But that remaining 4% of quality, uncensored, free information flow is extremely valuable. The terminal corruption of the major news corporations and the lack of interest in seeking the truth among the general population augurs very poorly for the prospects of the US and the current world order. This creates speculative opportunities, but prospects for mainstream investments are not good. Western civilization is truly in decline and far down the slippery slope.

"The next stage in the crisis will be blatant blackmail....

With their refusal to accept money from the bailout fund to recapitalize their banks, the Spanish are not far from causing the entire system to explode. They clearly figure that the Germans will lose their nerve and agree to rehabilitate their banks for them without demanding any guarantee in return that things will take a lasting turn for the better."

Get those rotten tomatos ready

Confused by stock bubbles and furious episodes of manic market euphoria? SocGen's Dylan Grice explains it in one brief sentence: "we’re hardwired to overvalue excitement and undervalue boredom."