The Tyranny of the Non-Economic Market Players

Anyone paying attention has by now noticed that these are not your father’s markets.  Stocks go one way, up.  Commodities swing wildly up and down as the “stock guys” wax and wane over their love of this or that market (for the second time this year it is Ag markets – after all everyone knows you just have to own Ag).  Metrics that people have used for years are at values that are hard to believe.  Technical analysis of markets is futile because nothing works any longer.  Why is this?  Largely it is because there are at least three classes of players massively active, in bond, stock and commodity markets in decreasing order, whose agendas make them relatively insensitive to price.  As a result, prices go places that do not make sense.  Bubbles form and collapse.  Price signals, the mother’s milk of capitalism, become noise rather than signal and fail to allow for the proper alignment of incentives that make for the creation of real lasting widespread wealth rather than temporary wealth that accrues mostly to those closest to these players.

The 3 players are Central Banks, Sovereign Wealth Funds and Corporations themselves.  Central banks are engaged in massive pushes of liquidity into the banking systems of the world, ostensibly with the goal of spurring growth and hiring in a world that needs to deleverage its balance sheets.  The problem is that liquidity has not been a constraint for at least 4 or 5 years.  The means they usually choose is the buying of sovereign and sometimes corporate bonds and mortgage backed securities in the secondary market.  The massive size of these purchases by a buyer who either doesn’t care about the price of the bonds, the rate they bear, or may be purposely trying to lower the rate they bear, drives yields to levels below what the market itself would likely realize.  The effects are many.  It means investors must look to other assets, like high yield bonds and equities, to get yields consistent with their mandates or needs.  It also means savers face insufficient yields to incentivize saving.  In most cases, nominal yields are below the rate of inflation and so real yields are negative.  The Central Banks think this means the cost of financing business activity declines and will therefore result in more activity.  What they often fail to realize is that providers of capital will simply not provide it because they are not adequately compensated for either risk or inflation.  This is called financial repression.  It also means that the governments who are operating on persistent deficits and racking up debts of historically unprecedented proportions, are able to continue to borrow and operate while keeping interest expense within seemingly tolerable limits.  To the extent the repression of savers enriches speculators, increasing the divide between the rich and everyone else as financial market asset bubbles accrue more wealth to those with the most wealth already and the facilitation of irresponsible spending by governments allows the further buildup of debt to be paid by future generations, these policies are both immoral and unconscionable.   Lately the Bank of Japan has jumped the monetary shark, and will buy not just all of the bonds issued by the Japanese Government, but will also buy hundreds of billions of dollars of domestic and international stocks directly, alongside Japan’s giant pension authority which will also be buying stocks.  I just read today that the Swiss Central Bank has also been in the market for small company stocks in the US and I know that the Bank of Israel also buys stocks (their Chief recently joined the Fed as Vice Chair!).

The second major player is Sovereign Wealth Funds.  Collectively the funds of countries such as Norway, Saudi Arabia and other Middle Eastern oil powers like Kuwait, Abu Dhabi and Qatar, China and Singapore control Trillions of dollars which they are investing in all kinds of assets, but mainly bonds and stocks.  Such funds typically have a very long-term view of markets and so are willing buyers not just on pullbacks but all the time and hence represent a consistent bid under markets.

Finally, the prime mover in the current equity bubble taking place in the US, and yes it is a bubble, are Corporations themselves.  This effect is massively insidious.  Rather than spend earnings on productive investment, company managements, with the approval of activist shareholders like Carl Icahn, have spent something like 91% of after-tax cash flow on buying back stock in the last several years.  This explains why the stock market is at record highs while the real economy is in the doldrums.  Fewer shares outstanding means any earnings are shared among fewer holders and so the per share price rises.  Managements love this because they get a huge part of their compensation in stock options.  If the price rises their options go into the money and they get rich.  So price is completely irrelevant to them.  In fact their incentive is to overpay as the higher the price on the market, the better the outcome for their stock option grants!  I recently read that JP Morgan has estimated that 80% of the rise of stock markets in the US since the 2009 low has been because of corporate buybacks (that is 160% of the 200% runup so far).  These hundreds of billions go directly to a relative few wealthy corporate managers while doing nothing for workers or the real economy.  It doesn’t flow down at all.  This is a disaster for the economy made possible because the corporations can borrow for nothing thanks to the Fed’s ZIRP policy and its flooding of the banking system with reserves through QE.  The Fed makes this rape of the economy possible and is yet another reason the Fed is about the most immoral institution in America and deserves to be ended for these reasons.  Of course shareholders love the rise in prices made possible by the corporate borrowing binge to buy back shares.  And the government and the Fed love the rise in prices because it makes 401ks look better and provides the illusion that retirement funds are available to support the baby boom as it retires.

The net effect of all this activity by price insensitive market participants is that markets give the appearance that all is well while underneath the foundations of the real capital economy continue to rot.  It is a form of can-kicking to avoid taking responsibility for actually fixing the underlying problems with the economy that will cause major dislocations to be worse than they would have been in the fullness of time.  And of course the destruction of price signals means that capital will be misallocated to a degree unprecedented in history which will eventually make the entire economy poorer.  Hedge Fund manager Paul Singer recently published a rant where he talked about the fakeness of all around us and the reprehensible abuse of their duties by lawmakers that has perpetuated this Potemkin state of affairs.  He is right.

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