CAMS Weekly View from the Corner – Week ending 6/19/2020
June 22, 2020
Board of Governors of the Federal Reserve System
June 15, 2020
Federal Reserve Board announces updates to Secondary Market Corporate Credit Facility (SMCCF), which will begin buying a broad and diversified portfolio of corporate bonds to support market liquidity and the availability of credit for large employers.
Understanding the Greater Fool Theory
If acting in accordance with the greater fool theory, an investor will purchase questionably priced securities without any regard to their quality. If the theory holds, the investor will still be able to quickly sell them off to another “greater fool,” who could also be hoping to flip them quickly. Unfortunately, speculative bubbles burst eventually, leading to a rapid depreciation in share prices. https://www.investopedia.com/terms/g/greaterfooltheory.asp
In our previous Weekly View we shared that the rally of recent weeks was beginning to look a little suspicious in terms of its strength and ability to continue upward. There were various aspects of market behavior that was beginning to stack up offering caution if not concern.
Enter this past Monday – the 15th of June – whereby the Federal Reserve – perhaps – (think highly likely) – was noticing questionable market behavior as well. Our first header excerpt above shares their new actions to “support market liquidity” as they shared in their release.
In previous announcements they offered the potential of delving into the markets to purchase corporate instruments. This occurs with more printed money. They create new dollars out of thin air (digitally, not actual printing) and then purchase said securities. Again, previously they offered they may do this.
In FED speak this is known as “jawboning” market participants. If they offer they may come into a market logically market participants get the hint if you will and begin bidding up said instruments realizing the market has a potential whale sized buyer behind it.
If said instruments get strong and continuous bids to the point that the market in question looks well supported the FED never even has to act on their announcement that they “may” be a purchaser. Hence, their jawboning efforts work whereby market participants alone create a healthier market condition with their continuous bidding up of the instruments in question.
In trading parlance this is simply known as “x” market is “well bid” meaning it has plenty of capital seeking it out and supporting it.
The FED jawboning efforts reach a problem point when economic and/or market environments turn questionable and it appears said jawboning is wearing thin on market participants.
Here then, they must act to keep credibility with participants for future jawboning efforts as well as to support said market that seems to be weakening to a level they do not want to see. Simply stated, they can ill afford to be looked at as a dog with no bite by market participants.
Run this to a logical end and you realize market participants can turn into speculators, not of the overall market or even the economic backdrop but rather of the Federal Reserve itself. They speculate on what the FED will do next and they try to front run that view by moving capital into “x” market in advance.
FED speculation then begins to be at the epicenter of collective market psychology which leads to ugly market backdrops.
Price Discovery – the true function of markets – is left in the dust as “FED Discovery” takes over. This all leads to mispriced asset categories which is known as “misallocation of capital” which leads to overvalued markets that are left ripe for notable downturns and overall volatility. (If interested more on Price Discovery click here: https://tinyurl.com/ych2lol6)
Greater Fool Theory
In our second excerpt above the Greater Fool Theory is described. When markets function freely the Price Discovery process forces collective participants to bid assets to their level of economic quality. Simply, they are priced to their economic viability as an entity or instrument.
When a whale sized buyer with a money printing apparatus behind it enters, the aforementioned “FED Discovery” replaces the disciplined Price Discovery process. This leads to the greater fool theory backdrop whereby participants lose their focus on the quality of “x” asset and merely focus on if the “whale” will be there to support it with its deep sized pockets of freshly printed money.
When a market environment reaches the Greater Fool backdrop then all economic logic exits and even the “forward looking view” of collective market participants (of which we reference consistently in our Weekly Views) becomes questionable because one cannot ascertain if they are viewing a positive economic/societal backdrop several months down the road or if they are merely discounting what they feel the FED will be doing several months down the road.
We all know that in life we can have the best of intentions with our actions and pursuits but this can still lead to negative if not disruptive outcomes. The Federal Reserve’s sub title on their website reads: “The Federal Reserve, the central bank of the United States, provides the nation with a safe, flexible, and stable monetary and financial system.”
Per the above we leave it to you as a citizen to decide if this is true or if, regardless of the best of intentions the end result of their actions and pursuits end in a wealth of additional problems and unintended consequences.
Regardless, with the additional actions taken on June 15th by the FED, we have now entered deeper into “FED Discovery” by collective market participants and as this continues will lead to a Greater Fool market backdrop which leads to even more sizeable and unexpected market moves – both up and down – which leaves a more questionable and volatile overall market landscape.
I wish you well…
Director, Market Research & Portfolio Analysis
Portfolio Manager, CAMS Spectrum Portfolio
H&UP’s is a quick summation of a rating system for SPX9 (abbreviation encompassing 9 Sectors of the S&P 500 with 107 sub-groups within those 9 sectors) that quickly references the percentage that is deemed healthy and higher (H&UP). This comes from the proprietary “V-NN” ranking system that is composed of 4 ratings which are “V-H-N-or NN”. A “V” or an “H” is a positive or constructive rank for said sector or sub-group within the sectors.
This commentary is presented only to provide perspectives on investment strategies and opportunities. The material contains opinions of the author, which are subject to markets change without notice. Statements concerning financial market trends are based on current market conditions which fluctuate. References to specific securities and issuers are for descriptive purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. There is no guarantee that any investment strategy will work under all market conditions. Each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. PERFORMANCE IS NOT GUARANTEED AND LOSSES CAN OCCUR WITH ANY INVESTMENT STRATEGY.