April 25, 2016

Stock prices decoupling from real economy

Our markets are no longer controlled by passionate players who trade or invest in brilliant entrepreneurs, superior company managements and emerging growth companies. Instead, they're too often controlled by forces like gamma trading and risk-parity strategies.

So has the absence of natural price discovery in the stock market, which no longer resembles a pure reflection of the real U.S. economy.

Many of us who have made our living using natural price discovery on the long side and exploiting frauds and questionable accounting practices on the short side are growing more and more uncomfortable.

Of course, betting that ploys from the world's central bankers will eventually blow up and produce worldwide pain is one option. That outcome seems ever more likely as our monetary authorities try to defer the pain by moving "all in." But predicting when such a meltdown will occur remains difficult.

Consider yesterday's stock-market action, which was importantly influenced by speeches made by two Federal Reserve "rally boosters" during the trading day. New York Fed President William Dudley and Minneapolis Fed President Neel Kashkari both voiced support for gradualism in U.S. rate hikes.

Stocks focused on that and again ignored fundamentals like the steepest, most-consistent slide in profits since the 2008 financial crisis. Price-to-earnings ratios rose close to levels not seen in some six years, while futures are trending even higher this morning -- putting a new all-time-high for stocks in sight.

Personally, I'm disaffected with the entire market mechanism. It was once the driver of capitalism, serving as a freely floating market that was influenced by the winds of economic change. It was gently guided by central-bank policy at times, but not so muddied that its dirty water looked like a black hole of uncertainty.

Compare that to today's disproportionate role of gamma trading, risk-parity strategies and other quant activities. Amid an absence of natural price discovery, the market all too often serves as a trap for traders and investors who rely on fundamentals and technicals.

Now you might ask that if the current degree of monetary intervention is the "new normal" and an apparently healthy situation without adverse consequences, what's the problem?

Answer: This situation isn't without adverse repercussions. The market's margin of safety is disappearing and stocks are decoupling ever further from the real economy.

Instead, it seems like we're simply flying at "ludicrous speed" further and further into today's Bizarro Investment World.

Position: Long SDS (large), Short SPY

Originally on thestreet.com