DUBLIN – Oil fell below $43 yesterday. Brick-and-mortar retailers are being emptied. The auto industry – including $1.2 trillion in auto debt – is stalling.
Meanwhile, restaurants are having trouble filling their tables. Consumers aren’t buying, perhaps because their incomes have gone approximately nowhere for decades.
House ownership is at its lowest level in half a century… along with employment participation. And consumer price inflation, as measured by the Bureau of Labor Statistics, is falling. So are Treasury yields.
All of these things – and more – point in the same direction: toward a recession.
Meanwhile, in a parallel universe centered in Lower Manhattan, prices for stocks still sell near record prices.
The stock market is supposed to look ahead. It is supposed to see more than any one person. It is supposed to detect signs of trouble long before they appear to the naked eye.
But it seems to see nothing at all. The subject of today’s Diary: What is the cause of this blindness? Who’s to blame?
Wasting no time on the evidence, we collar the culprit and get out a rope.
Why can’t the stock market see what is going on in the real economy?
Because the Fed poked out its eyes. It did this, we charge, by cutting the optic nerve that connects the equity prices to sales and profits.
A stock represents a share in an operating business. Investors have many different businesses to choose from. Until recently, they spent some time getting to know them and then made a decision about which was most likely to do best.
If he anticipated a cold winter, for example, an investor might buy a company that delivered heating oil. If he saw a new product flying off the shelves, he might want to own the company that made it.
A more sophisticated investor might even take out a subscription to Value Line and check the numbers.
Today, the market is dominated by quantitative (or “quant”) hedge funds (those that use complex computer algorithms to trade in and out of stocks) and passive ETFs (stock-like funds that simply buy and hold indexes such as the S&P 500).
From a report by independent research firm 13D Research:
The rise of passive investing has been well-reported, yet the statistics remain staggering. According to Bloomberg, Vanguard [the world’s biggest provider of passive ETFs] saw net inflows of $2 billion per day during the first quarter of this year.
According to The Wall Street Journal, quantitative hedge funds are now responsible for 27% of all U.S. stock trades by investors, up from 14% in 2013. Based on a recent Bernstein Research prediction, 50% of all assets under management in the U.S. will be passively managed by early 2018.
Passive ETFs do no traditional stock research. Instead, they rely on rudimentary algorithms, or sets of rules, when it comes to which stocks they buy and sell.
No algorithm ever went to a company meeting nor took the measure of the people running the firm. Nor do they care about the industry the company is in… nor its products. Nor do they attempt to make any connection between the real world of business and commerce and the stock price.
Investor Steven Bregman, speaking at the Grant’s Interest Rate Observer conference, used the example of Exxon Mobil.
Suppose an investor, five years ago, was given advance notice of the future. He saw that the oil price would be cut in half. He knew that Exxon’s revenue, too, would be almost halved, with earnings down 75% and the dividend payout ratio at almost three times earnings.
What would he think? What would he do?
Surely, investors wouldn’t miss such a big swing in Exxon’s fortunes. The market would take in this new information and discover the right price for the stock, wouldn’t it?
But no. A share of Exxon sold for $82 five years ago. It sold for $82 yesterday.
What happened to price discovery?
How could a stock in a mature industry remain unchanged even as the price of its product (and its operating margins) have been halved? 13D Research again:
At the heart of passive “dysfunction” are two key algorithmic biases: the marginalization of price discovery and the herd effect. Because shares are not bought individually, ETFs neglect company-by-company due diligence.
This is not a problem when active managers can serve as a counterbalance. However, the more capital that floods into ETFs, the less power active managers possess to force algorithmic realignments. In fact, active managers are incentivized to join the herd – they underperform if they challenge ETF movements based on price discovery. This allows the herd to crowd assets and escalate their power without accountability to fundamentals.
The missing connection to the real economy has implications for the next stock market downturn. As they bought, so shall they sell. As prices fall, the quants, robos, algos, and passive ETFs will not trouble themselves to discover the value thus revealed.
They will simply sell.
We don’t know. But we wouldn’t want to be standing in their way when the robots decide to run for the exits.
BY CHRIS LOWE, EDITOR AT LARGE, Bonner & partners
Remember when gold charts started on the bottom left and finished on the top right?
Those days are no more…
Today’s chart is of gold bullion going back over the past four years (to the start of June 2013).
To borrow a phrase from one of Bill’s go-to gold market timing experts, Dominic Frisby, these days, gold charts start in the middle and end in the middle.
If you’d bought an ounce of gold four years ago, it would have cost you $1,403.
Today, the same ounce sells for $1,255.
– Chris Lowe
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In today’s mailbag, readers consider Bill’s classical history lesson.
Thanks much for the Caesarean history recap… Very appropriate. Very on the mark again. We can underscore that Santayana prophecy: “Those who cannot remember the past are condemned to repeat it… ” Thanks for the nudge.
– G. W.
Meanwhile, debate on whether political correctness has gone too far continues…
What an excellent article! I hear this nonsense, or read memos or in-services on a regular basis using the word “they” instead of the singular “he” or “she.” English in its correct form is no longer taught, and few seem to understand how to properly speak it. Thank you, Bill. Keep on writing.
– Lynette K.
Like you, I am an equal opportunity offender. I pick on everyone, including myself, given enough time. Secondly, back in college during the ’60s, there was a poster on my dorm wall of the Pledge of Allegiance. It ended with, “with liberty and justice for all spicks, wops, dagos, slants, slope heads, jarheads, micks, brits, hicks, kiwis, cowboys, commies, pinkos…” and it went on and on for the entire rest of the poster with one epithet after another. Sure wish I had kept it.
– Bruce B.
I applaud you for your candid comments in your Diary message on political correctness. I don’t always agree with you, but in this case I’m with you 100%. This whole business has gotten way out of hand. People need to lighten up and learn to take these things in the spirit in which they are typically intended. Get over it people and learn to laugh it off. Life is far too short and we have much more pressing things to worry about like the looming financial crisis facing our country.
– Bruce W.
I’ve heard enough from the media about everyone being offended by someone else. When will people ever learn that anyone can choose to take offense at anything? And when will they learn that it’s THEIR CHOICE to be offended? All this nonsense about “he offended me” offends me!
– Bill T.
How appropriate that today you brought up the issue of political correctness. Today, the U.S. Supreme Court decided unanimously, an 8-0 vote, in Matal v. Tam (No. 15-1293 argued Jan. 18, 2017, and decided June 19, 2017) that it’s perfectly OK to make disparaging remarks, including to use racial terms, sexist designations, and in general – hate speech of any type.
Someone should tell David Bonderman to go back to work, sit proudly in his office, take back the reigns of Uber, and tell Arianna Huffington to pack sand! The third leg of our Constitutional checks and balances has declared it so. He can call all the women on the board a gaggle of geese if he wants! For as Justice Breyer noted in a concurring opinion, “public expression of ideas may not be prohibited merely because the ideas are themselves offensive to some of their hearers.” I guess that means the Washington Redskins and Cleveland Indians get to keep their trademark and logos.
– James P.
Thank you so much for the politically incorrect article on political correctness. If David Bonderman had said: “It’s much more likely to be more chittering.” Well, now that would have been different. Everybody knows that women chitter and men blather. Therefore, there would have been something gender specific about his comment; however, David simply referred to “more talking” and that seems quite innocent to me. I can’t tell you how much I appreciate your inappropriate blathering and the fact that they can’t fire you over it.
– Chris P.