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More Than Surviving Uncertainty (Part II of II)

The Precedents

Beyond surviving the uncertainty of our fragile financial system, capitalizing on it requires a combination of unique traits. These include a deep, experience-based understanding of how businesses are valued; an uncompromisingly skeptical mindset; and emotional acrophobia (a condition in which high and rising prices cause acute discomfort). By contrast, high-price euphoria is the prevailing emotion—at least of the moment. This is one of those uncommon times in history that will once again prove the adage that it’s easier to make money than keep it.

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The Broken Window Fallacy

Less than two months after the CDC declared COVID-19 a public health emergency on February 3, 2020, the stock market slump that followed abruptly ended and equities have rocketed upward ever since. The Wilshire 5000 Total Market Cap Index, the most comprehensive measure of the market value of publicly traded U.S. corporations, nearly doubled to record highs from the March 2020 lows, rising from $22.5 trillion to $43.3 trillion by late May 2021.

The economy proved no less resilient. On the heels of the shortest major recession on record, resurgent GDP (gross domestic product) rebounded to the December 2019 peak by the end of the first quarter of 2021, reaching $22.1 trillion. Economically and financially, the headlines telegraphed ‘All’s well.’

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The Rationality of INEPT (Investment Entertainment Pricing Theory)

This week, Edward Chancellor, our esteemed once-a-year guest writer, again digs deep into contemporary financial deceptions, “lipstick on a pig” reincarnations of past “beggar thy neighbor” scams. Because there’s a smidgen of truth in every lie and a pinch of rationality in every bubble, his forensic prism sees clearly through the fog of obfuscation. Moreover, Chancellor peels away more layers of onions we’ve dissected in earlier posts – e.g. WeWork and SPACs – taking the reader ever closer to the core.

Some claim we are seeing a rebirth of the “roaring twenties” (a.k.a., the “Age of Wonderful Nonsense”). As previous untouchables like Modern Monetary Theory (MMT) are gaining credence, the INEPT pricing theory seems almost rational.


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The Goldman Rule, 2.0

Flash back to 2007 and this excerpt from A Decade of Delusions, page 343:

…First, a combination of factors has given rise to some huge but so far largely disregarded risks in the financial services sector, as addressed in the [July 2007, Martin Capital Management] Quarterly Capital Markets. Unprecedented technology and communications developments, copious amounts of leverage made possible by sometimes fleeting liquidity, and the increased complexity in financial innovation and “tight coupling” have created a Demon of Our Own Design—Markets, Hedge Funds, and the Perils of Financial Innovation, the title of the book by Richard Bookstaber that captures poignantly the systemic nature of the risks. The reality that they are woven together informally but with an unavoidably tight interdependence among similarly constituted firms, particularly in times of crisis, can result in highly irrational behaviors. These excitable emotional responses, exacerbated by the self-perpetuating nature of informational feedback loops, can have potentially dramatic effects on the prices of those securities. The companies about which I am writing are the major investment banks on Wall Street: Goldman Sachs, Bear Stearns, Lehman Brothers, Merrill Lynch, and so forth. Unlike the portfolio insurance scheme of 1987, an unwinding of the above may not impact the security markets as a whole as they did in 1987. It’s hard for me to imagine, however, that the major players on Wall Street can avoid a body blow to their balance sheets and income statements should the system under which they are operating malfunction in unison. Should that occur, I would expect their shares to drop dramatically. [1]

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On Fragility and Avalanches

As markets rise to fresh highs, the worries of the past months, much less previous years, seem to have happily dissipated. Gone are concerns about lost consumer income, falling productivity from reshoring production, or the growing horde of highly indebted companies sustaining themselves despite rising interest rates.

With the addition of augmented unemployment benefits and direct federal payments, worries about household debt have almost evaporated. Meanwhile, that indebtedness has grown throughout the crisis. Average wages have remained flat after a bump in April 2020 as legions of low-wage workers became unemployed. Household incomes, which include government transfer payments, remain high on the back of continuing federal support. In other words, the consumer is being propped up by Washington.

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A Common Thread

As the $1.9 trillion Biden stimulus package is emerging, its immediate impact and likely knock-on effects are being vigorously debated. Well-regarded thinkers are warning of a resurgence of long-dormant consumer-price inflation or, more problematically, stagflation. Others are inclined differently. They make the case for its polar opposite, deflation, and all that might augur. Some argue that financial stimulus will drive wealth and income disparity higher as a speculative mania in the asset markets has overwhelmed investment spending as the bedrock of economic growth. Another faction similarly concerned with wealth inequality sees those same payments as a remedy to disparity. And that’s just the tip of the iceberg of economic discourse.

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