To anyone who has studied economic data recently, the vast array of dire data points that include a -15% nowcast GDP print, a record-high loan delinquency rate, and a rising basket of consumer prices makes you wonder why the stock market has continued on its miraculous climb, not just after a global pandemic, but over the past few decades.
Since the 21st-century began, the attitude of the major market players has changed. Before, when we had a real economy, big financial institutions managing over 90% of global assets used leading economic data to dictate where markets moved. Now, as Stanley Druckenmiller, the asset manager who turned a profit every year, said in a recent interview, the Fed has made predicting the stock market a near-impossible task.
Ever since the U.S central bank has started to financially engineer the global economy into perpetual zombification, the big players have adapted their style. Today, they front-run the Federal Reserve, not leading economic data nor economic reality. As the Fed has injected trillions into the system, short-sellers keep capitulating, jumping onto the ever-growing “Fed Put” bandwagon. They have reduced their short positions and have fled to other assets — U.S Treasuries, TIPS, gold, defensives— to express their bearish views.
A narrative, a simple thesis, has become the accepted rationale for going long the stock market. Take everything you understand about rationality and turn it upside down. Because, right now, “stonks” just go up.
It’s a coordinated effort by the “Machine”: hedge funds, rating agencies, insurance companies, pension funds, governments, and central banks, to keep the system, which they govern, running smoothly. They couldn’t care less if GDP, economic sentiment, and consumer confidence fell while credit card rates, oil prices, and food prices rose simultaneously. All that matters is maintaining the status quo. If they can achieve that, the outcome, to them, becomes irrelevant. If the opposite were true and falling prices benefited the elites, they would, without hesitation, short the living crap out of the four tech stocks (Apple, Facebook, Microsoft, and Google) supporting the latest stock market rally — right as the markets open on Monday morning.
But with rising asset prices, each constituent of the Machine gets paid. Hedge fund traders and investment bankers reach their performance targets and earn their bonuses. Pension funds achieve their 7% target and can payout to whom they wish. Fed officials, who all have large stock portfolios, see their net worth rise. Rating agencies get their cheques from their clients: the banks and the corporates who help issue financial assets to investors. This, of course, would be fine if the economy was booming, inequality was nonexistent, and the standard of living was rising. But for the guy on the street, this ain’t happening. The Fed chooses which patients to support, and unfortunately, those are the biggest, most influential, and most powerful institutions on the planet.
The elites will do anything to keep the system operational even if that means propping up worthless assets that would go to zero if the Fed ripped off the band-aid and let the free market function. If they were to reignite capitalism, picture a wedding-planner knocking over the champagne tower, a pallbearer dropping his coffin, a waiter dropping his drinks tray. In these scenarios, think about how the people who caused these accidents would feel. Then, multiply that by an entire country. As that’s the brunt the elites will have to bear, there’s no way any President or central banker will allow an economic depression to occur on their watch. And they will use any liquidity available to prevent that from happening.
Take credit-default swaps (CDS). They demonstrate how the Machine props up the finance industry's latest “WMDs”. These Wall Street securities have become increasingly popular in recent years, not because they ooze quality, but because they allow Wall Street to keep the profit machine churning. For example, a profitless company approaches a pension fund to raise capital. However, there’s a problem: the profitless company has triple CCC rated bonds, and by law, pension funds must hold assets with a rating of BBB (Triple-B) or higher. To bypass this, the pension fund calls up an insurance firm that issues credit default swaps with a juicy triple-A rating. Voila! A junk asset posing as an “investment grade” CDS is born.
But the situation gets crazier. Here’s where the stock market comes into play. A hedge fund decides to make money from the profitless company and buys $100 million of triple-A CDS from the insurance company. After that, not only can the hedge fund use the CDS to buy stocks, but it can approach a big bank and use the $100 million of CDS as collateral for a loan of, say, $500 million. That’s $500 million the hedge fund can now put to work. This money “has to go somewhere,” so why not the stock market.
A well-oiled, financially-engineered machine allows these transactions to exist and coexist. But the icing on the cake is how the rating agencies operate. As they profit from assigning higher-than-reality ratings to their client’s securities, they turn a blind eye to all the financial tomfoolery that goes on behind the scenes. It’s only in their interest to mark these assets below “investment grade” (destroying every security in the chain of liabilities) when the Machine enters full panic mode.
It’s this crazy world of financial engineering that makes economic fundamentals so insignificant in stock markets today. Abandoning logic, reason, and rationality has flipped trading psychology on its head. Previously, traders worried about the economy overheating and stocks falling when economic data had peaked. Presently, traders worry about the Fed going on vacation or that the economy recovers causing the central bank to reduce liquidity so much that markets tumble once again.
From what we've seen recently, though, bulls don’t need to worry. When you see the market’s big players and retail investors shrug off a global pandemic, a lockdown, and a complete economic shutdown, that tells you everything you need to know about how phony the stock market has become. A significant black or white swan event isn't enough. For markets to suffer a sustained decline, something must disrupt the Machine’s system of propping up asset prices.
But don't expect that to happen any time soon. When you understand the dire consequences of letting markets function correctly, you’ll understand why the Machine will try anything to keep asset prices rising and crony capitalism alive. Contrary to popular belief, this time, the elites are not asleep at the wheel. They are very much wide awake, bumbling, and buffooning around trying to save the farcical modern-day financial system, which they helped conceive, from its inevitable collapse.