June 28, 2023

The Emperor

I’m amused.

There is a ceaseless stream of people chattering about the economy.  On TV.  On the web. In print, in digital.

Will we have a recession, a soft landing, nothing?  When will the Fed stop lifting rates and start cutting (Bank of America’s strategist said yesterday on CNBC in May 2024)? Is that good or bad for stocks? Good or bad for bonds?

And why must rates be cut at all?  It’s nice seeing money worth some return when simply pooled. Novel idea, that.  Money that’s worth something.

Illustration 125648263 © Luca Mendieta | Dreamstime.com

So why would we be betting, hoping, the Fed cuts rates?  Isn’t the point of investing money to generate a return?

We’re getting to what amuses me.  I have a distinct impression of Emperor’s Clothes.

The Hans Christian Andersen tale written in 1837 about a ruler and a couple con men is a lesson on human nature. Two tailors claim to have unparalleled textile skills and they display magnificent garments for the king.

But he doesn’t see them. He doesn’t want to admit he sees nothing.  His advisors are loath to say, “Sir, you’re naked.”

So the ruse nearly goes the full field, the emperor buying something that doesn’t exist. Then a kid says, “Why is the emperor naked?”

It feels like that.

The planet is perched precariously atop a giant pile of synthetically leveraged and tangled debt. People generally spend more than they make.  Governments promise what can’t be delivered. Cadres of bureaucrats at central banks attempt to manipulate demand and supply into some kind of halcyon artificiality.

Look, I’m no pessimist. I have permanent and lasting faith in human resilience and ingenuity.

But to conclude that this can continue is to believe the emperor is wearing new clothes.

That doesn’t mean it’s brittle.  But it does mean, to quote one of my favorites, economist Herb Stein, father of Ben, that if something cannot last forever it will stop.

We just don’t know when.

It would be better to stop doing what puts everything on a precipice before it falls over the edge. But that is decidedly in discordance with human nature.

What reminds me daily of this disconnect is the stock market. Nine of ten stock-pickers can’t match its beta, its basic return. I looked at the top 20 holders of a client of ours.  There is one stock-picker in that group, and it’s a seller, down 160,000 shares quarter over quarter.

All the money delivering beta is passive, and all the money finding alpha is in private equity, or using arbitrage strategies.  You can go long/short. The stock market is currently 49% short, down from 50% short a month ago.

You can trade ETFs versus the basket and take 40 basis points.  Over and over.

You can sit in the market taking a tenth of a penny in massive, arrayed high-performance computing environments like Citadel, and make $16 billion.

Again, the point here is to be clear-eyed.  It does nobody any good to operate with bad or incorrect data.  Particularly your Board of Directors, public companies.  If money buys you as a product and the Board doesn’t know it, your directors are ill-informed.

I think the provision of quarterly data should be streamlined and driven by key words and the deployment of shareholder capital should be buttressed by the company’s characteristics – market cap, sector, value, growth, liquidity, volatility. 

That’s the real world.  It reflects hard, objective data.

And from an investment standpoint, you can’t expect to beat the market if not one in ten managers is.  Be realistic.

Yeah but Tim.  Nvidia is up 187% this year.

NVDA trades over $20 billion of stock daily, in over 600,000 daily trades.  TSLA trades over $45 billion daily, nearly 1.9 million daily trades.

It reminds one of the economy, perched precariously. If everybody owns those two stocks, what happens when they sell?  And models can’t be that concentrated. And target-date funds must match a specified equity allocation.

You see what I mean?  The stock market depends on too few legs. Like the economy. 

Sooner or later, that’ll be a problem.  To the degree we can plan ahead, we should.  And otherwise?  Let’s not be the emperor.  Let’s keep our eyes wide open.

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