Sunday, April 26, 2015

The Markets Can Remain Irrational Longer Than You Can Remain Solvent

For the first 40 years or so of my life, everything I learned about finance revolved around mathematical certainty and fundamental analysis. For more than 100 years of the modern financial system in the U.S., details related to corporate financial reports, GAAP accounting, and valuation actually mattered when making investment decisions.

That all changed in 2008.

In a world of unprecedented government economic intervention, unlimited central banker QE, and the steady erosion of GAAP accounting standards and any pretense of enforcing our existing financial market regulatory laws, every financial asset class has been manipulated to the point where successful investing has required completely different approaches.

Fundamental analysis has become a relic of the past. For a while, cyclical analysis was effective. At times, traditional trend analysis has also been useful. In all cases, you would have had to suspend mathematical logic to make money in the markets over the past seven years.

While the only markets still currently trending higher are the major market indices, the foundation they rest on is more shaky than at any time in my lifetime. The problems that created the last financial crisis (systemic debt and leverage combined with currency debasement) are larger now than they were in 2008. If it even matters anymore, the fundamental underpinnings are also worse than 2008.

The last time there was a divergence this large of stock price vs U.S macroeconomic date was in 2008. How much larger will it get?

Why is the market still rising while forward earnings projections are increasingly negative?

Nothing to see here. Stocks should rise as the U.S. GDP collapses, right? I guess it's the darn weather again.

The Big Boys have been steadily unloading positions into stock market strength. What side of that trade do you want to be on?

And finally the ultimate indicator. When your banana guy starts trading stocks, you know the end of the trend is near.

Who knows, maybe the principals of finance and math have been permanently altered by governments and central banks. Maybe this time things really are different (just like they were in 2000 and 2007). Not that advanced finance degrees and certifications were ever worth anything, but maybe all those hours spent studying and taking exams was wasted. Maybe the irrational levitation of some markets and repression of other markets can continue indefinitely.

If you haven't started lightening up your exposure to stocks, you may want to consider doing so.


  1. I don't understand what large pension funds or insurance companies have been using to make pay-outs, since 2009. Don't they invest in bonds anymore? But how could they? The yield is lower than the true rate of inflation.

    Have they shifted their portfolio over to equities, instead?

  2. Pension plans used to be the large players in the markets. The major players now are central banks and high frequency trading (HFT) hedge funds operated by the big banks and sovereign funds. The major stock market indices are being propped up on low volume action, but the real stretch for yield/return, by everyone including pension funds, is in subprime markets and their associated derivatives. The leverage in the global financial system exceeds what it was pre-Lehman in 2008. The recent increase in stock market volatility could be related to a behind the scenes melt down beginning in this massive derivatives market. The next financial crisis will be led by the liquidity squeeze that occurs as these leveraged derivatives collapse in value. I'm personally using days like today to sell stock holdings into strength. We may continue higher from here and I may leave something on the table, but the odds get worse every day.

    On a seperate note, it's also disturbing to see that even with the risk being taken on by pension funds, many of them are significantly underfunded. The promises many of them made to their constituents were simply impossible from the beginning and can't be met based on any realistic return assumptions.