Something unexpected happened on the market's relentless trek to all time highs: the market died.
At least that is the impression one gets from walking around Wall Street's formerly busy trading desks (certainly the formerly biggest trading floor in the world, that of UBS, now hauntingly empty) where these days one can hear a pin drop. Take the Credit Suisse Prime Brokerage desk in Manhattan for example: here, as BusinessWeek reports in its 1987 anniversary issue, "the phones hardly seem to ring anymore." In fact, if one didn't know better, one could assume that instead of all time highs, the market has just experienced another spectacular crash resulting in a universal trading revulsion.
Credit Suisse's hedge fund clients don’t call about Donald Trump’s tweetstorms and the stock market or ask what to do when terrorists attack. And there was barely a whiff of panic when North Korea erupted in August. “Two rockets flew over the land mass of Japan and nothing happened,” says Mark Connors, Credit Suisse’s global head of risk advisory.
Connor's assessment, in not so many words, the market has died: “There were no calls. That’s absolutely crazy.”
Why crazy? Because traders who don't belong to the millennial generation, will recall that in addition to buyers, stocks also have sellers. But not now, unfortunately, because what goes on in Credit Suisse' prime brokerage desk does not stay in Credit Suisse' prime brokerage desk. Instead, it’s become the norm on Wall Street. "Whether it’s the threat of nuclear war, hurricanes, or Russian meddling, it seems nothing can unnerve investors bent on pushing the U.S. stock market higher and higher. Even Richard Thaler, who won a Nobel Prize last week for explaining how irrationality drives financial markets, said on Bloomberg Television he couldn’t understand why stocks keep going up now."
What is causing this unprecedented meltup? The same thing we first presented in 2010: the "Buy The [Fucking] Dip" (which subsequently became "Buy the Fucking All Time High") mentality, originally popularized by a couple of cartoon characters, which has since become the one and only "trading strategy" on Wall Street - and everywhere else - and which is also known as "don't sell anything." Because why sell in a world in which central banks have everyone's back?
"So what’s going on?" Bloomberg asks and ponders:
During most of the first 8½ years of the bull market, the mood was paradoxical. Although stocks rose, many investors scarred by the financial crisis acted as though they hated owning shares again, and every obstacle was framed as the next big meltdown (even as the underlying fundamentals remained strong). Now, everywhere you look—swelling stock valuations, hot sales of new cryptocurrencies, IPO shares with no voting rights—investors are embracing their speculative side. In the language of Wall Street, every day it’s “risk-on.”
Actually, dear Bloomberg authors - while we do realize the question is rhetorical - the answer is simple. Bubbles. Bubbles everywhere.
Back in June Citigroup's hans Lorenzen pointed out precisely what was going on in financial markets that scramble to maximize every last ounce of what central bank impulse remains, in which we get such bubbles as London real estate, bitcoin and vintage cars amid the Fed's attempts to "facilitate recovery", or as Citi puts it: "the wealth effect is stretching farther and farther afield."
And while on the upside the surge in sweet for everyone involved, it's what happens when bubbles burst - as they always inevitably do - that is the problem, a problem which the Fed clearly is not concerned about (and for Janet Yellen, in just three months it will be someone else's problem).
Unfortunately, the realization that it is a bubble provides little relief for those who careers depend on being fully invested, i.e. all of Wall Street. Which is also why goalseeked justifications and rationalizations - "the market is a bubble, but a much smaller bubble than bonds, etc." - emerge. This is also known as FOMO, or Fear of Missing Out. As a result, as Bloomberg notes, while it is an uncertain world out there, "fear invariably turns into greed, and the fear of missing out overshadows any anxiety about the next crash." That tends to quickly draw money back into the market every time it wobbles, despite legitimate worries about high valuations.
“We certainly all joke about it: Buy the dip, that’s what we’ve been conditioned to do,” says Benjamin Dunn, president of the portfolio consulting practice at Alpha Theory, which works with money management firms. “Now you kind of have to do it. It’d almost be irresponsible not to.”
A joke for some, perhaps, but in the end all that will be left are tears, of course. Until then, however, the market not only refuses to crash, it hasn't had a mere 2% drop in months.
Another way of seeing the market's unprecedented complacency: the number of days with a 1% up or down move in the S&P is below 10 so far in 2017, among the lowest on record. By comparison, the post WWII average is over 50.
In light of the above, it is not surprisng that This year, the S&P 500 index has hit records on almost four dozen different occasions, with the single biggest drop from the latest record amounting to less than 3 percent. At the same time, more than $3.2 trillion of market value has been added to U.S. equities (and $5 trillion since Trump's election as he will gladly remind his twitter followers each day) while volatility is at record lows.
And speaking of goalseeked justifications for this epic, artifical, central-bank inspired rally, that's what Bloomberg does next:
It’s easy to say it’s all about Trump and his promise of big tax cuts. His election has fueled some impressive gains (though perhaps not quite as impressive as he has often claimed and still far short of the best year for U.S. stocks during this current cycle). But for Credit Suisse’s Connors, the shift in market psychology can be traced back to a different signal event: Brexit.
After the U.K. voted to leave the European Union in June 2016, $2.6 trillion was wiped off the value of equities worldwide in just three days. Many were calling it one of the most dramatic and shocking turns of events in modern British history. Among investors, the panic was palpable, and some were paralyzed with fear. But almost as quickly, the markets roared back and jolted investors out of their crisis-era fatalism.
Since then, naysayers selling into any weakness have looked like suckers. In the aftermath of other post-crisis upheavals, “we got a lot of incoming client calls,” Connors said. “But that all ended with Brexit. Now, even though the events seem dire, volume is low and and reversals are sharp. People are looking through to things that keep them long. Buy-the-dip is in place.”
None other than JPMorgan's Marco Kolanovic quantified this effect, showing that starting with the August 2015 ETFlash crash, and passing through the Brexit, Trump and ultimately Italian vote, the BTFD rebound has been shorter and shorter, shrinking from 65 days to just a few hours. This is what Kolanovic wrote last December:
It appears that the time horizon of macro traders has shortened, likely as a result of increased participation of machines and algorithms that are quicker to adjust to significant events and can eliminate trading activity of slower investors. Consider for example the US elections - traders in Japan registered a 5.4% Nikkei drop on the 9th, followed by a 6.7% rally on the 10th, while S&P 500 investors did not register a significant close-to-close move over the election (due to market hours difference). These two days were enough to shift the volatility regime (usually calculated from closing returns) for the whole of 2016 for the Japanese equity market, and leave it unchanged for S&P 500 (e.g. think of rebalancing needs of a hypothetical risk parity fund, or a short volatility strategy based on Nikkei vs. one based on S&P 500). We also noticed that for a number of significant catalysts this year (Brexit, US Election, Italy Referendum) broad expectations were wrong both on the outcome and the directionally forecasted impact. It is possible that the lack of market reaction (or a reaction that went against the accepted narrative) was in part driven by investors’ reluctance to transact (“two negatives equal a positive”).
Whether central banks are involved in some capacity in these dramatic rebounds remains to be seen: so far all that has been publicly documented is that both the BOJ and SNB, as well as various sovereign wealth funds, have been aggressive in purchasing and accumulating stocks come rain or shine, with zero regard for price. Why would retail investors and algos not piggyback?
And piggybacking is precisely what retail investors are doing, hopeful to profit during the upcoming melt up phase, as Ed Yardeni found out just a few days ago.
The former chief economist for Deutsche Bank was in Texas recently, visiting clients. In hurricane-ravaged Houston, locals were still dealing with the aftermath of Harvey, and two clients couldn’t meet because of damaged buildings.
Yet there was one thing on everyone’s mind. “They wanted to talk about the potential for a stock market melt-up,” he says. A melt-up is a last-gasp surge like the one in 1999, when the Nasdaq doubled—just before it crashed. Nothing like it has happened in this bull market. To the extent 2017 has a precedent, the current backdrop is closer to 1995 or 2013, when the S&P 500 gained 30 percent or more with barely a peep of turbulence.
So there's the self-fulfilling prophecy of a "melt up", there is also the sense that investors have become invincibly, riding on the coattails of $14 trillion in central bank liquidity and not realizing it:
According to Wedbush Securities Inc.’s Ian Winer, all the things underpinning the gains, from robust earnings and the Federal Reserve’s low interest rate policy to the falling dollar and the retreat of sellers, has created a sense of invincibility. “Is the risk priced into the market appropriate to what the real risk is?” says Winer, the firm’s director of equities. “To me, it isn’t. People have grown more complacent and certainly more speculative, and it’s a little bit frightening.”
Of course, knowing it's a bubble is meaningless, unless one also knows when it will burst. And it is this that is the problem, as Bloomberg points out:
it’s far from obvious what will trigger the next downturn or when investors should get out. The hazards of market timing were illustrated by a Bank of America Corp. study last year, which showed that missing the very end of a bull market often means missing a quarter of its gains. What’s more, anyone who owned stocks just before they crashed in the worst bear market since the Great Depression would still have doubled their money as long as they had the fortitude—and enough of a financial cushion—not to bail.
Meanwhile, and most ironically, the biggest losers even as the zombie market, in which nobody bothers to sell any more hits all time highs, are professional, active investors, who have become a dying breed, among the biggest active to ETF, or passive, asset allocation shift in history.
Among the very few who are happy with the current "dead" market, is the Vanguard Group, whose trillions of dollars in low-cost and index-tracking funds have been credited and blamed for the current market mood, as so many retail investors have decided just to buy a diversified fund and forget about it—the new mindset is a sign of a job well done.
“To see people not trading wildly on political news is optimistic,” says Fran Kinniry, a principal in Vanguard’s investment strategy group. “Investors are acting in a very positive way, how a professional investor should be investing. Have an asset allocation and rebalance it, and do your best to differentiate between the noise vs. reality.”
Still, one can't help but wonder just how professionally these investors will be acting during the next, perhaps last, ETFlash crash, one which will make the August 24, 2015 market break, ETF and VIX freeze seem like a walk in the park. One thing that is certain: the market will simply shut down that day. The question is for how long, and will it ever reopen.