Is the Stock Market REALLY Distorted?

• Can we really say the stock market is distorted?…
• When bull markets end…
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Dear reader,

I have long argued with high confidence — along with countless others — that the stock market is a scene of vast distortion.

That is, it is the site of prodigious intervention by the Federal Reserve.

The stock market takes fright. Immediately the central bank sallies to its rescue through interest rate reductions, quantitative easing and all the market-comforting tricks at its disposal.

Thus the raging bear is put perpetually to dispiriting flight.

The pattern has repeated for years and years, menacing crisis upon menacing crisis.

The mere expectation of central bank intervention has become itself a form of intervention.

Is the Market Really Distorted?

Yet if the market endures such habitual distortion… can it truly be distorted?

• Perhaps the distorted market is simply the market.

That is the studied conclusion of market commentator Quoth the Raven. From whom:

• I’ve spent years mocking the market as distorted.
• Everyone in Austrian economics circles loves that word: distorted. Markets are distorted by central banks, distorted by artificially low interest rates, distorted by endless intervention. Distorted, distorted, distorted. 
• Fine. But at some point, if a distortion lasts long enough, survives every crisis, and becomes embedded in how markets function, is it still a distortion? Or is it just the market now?

Face the Facts

The very contemplation of the question raised above discombobulates me severely. It disconnects me from my natural settings.

That is because I harbor a stubborn and lingering belief that no distortion can permanently endure.

The ledgers must eventually square, the scales must eventually balance, truth must eventually triumph.

Yet I cannot deny that the distorted market has enjoyed a vastly extended inning. More:

• In ten years, the [Nasdaq] index (read it again, index) is up 534%… 
• And now, back to the question: “if a distortion lasts long enough, survives every crisis, and becomes embedded in how markets function, is it still a distortion?”
• That’s the uncomfortable question fundamental investors increasingly refuse to confront. We continue dragging out valuation charts that go back to 1900 as if they’re sacred scripture. We point to historical average P/E ratios and the Buffett Indicator and say things like “the market has always reverted.”
• I’ve said such things… for years.

The Triumph of Distortion

And now you are saying what, Mr. quothed Raven? That the mechanisms of distortion have permanently vanquished the mechanisms of clarity?

• The market that existed in [for example] 1952 has almost nothing in common with the one we have today. Back then there were no ETFs mechanically absorbing retirement contributions every two weeks regardless of valuation. 
• There was no passive investing machine blindly funneling trillions into the largest companies simply because they’re already the largest companies. There were no options markets large enough to create absurd gamma-driven price movements detached from fundamentals. There were no retail armies weaponizing leverage from their phones while posting rocket ship emojis.
• And there sure as hell was no widely accepted assumption that if markets fall hard enough (3%, give or take a percent?), the Federal Reserve will eventually arrive with fresh liquidity and soothing words about financial stability.

This corvid-quoting fellow is correct. None of the mechanisms listed existed in the year 1952… or in any year prior to recent years.

Yet they exist today. And so the Nasdaq Composite has leapt 534% in the space of 10 years. The Dow Jones Industrial Average and S&P 500 have rampaged with similar dynamism.

Investors Have Become Lab Rats

Please continue, sir:

• The lab rats participating in this market have learned a very simple lesson: the adults will not tolerate prolonged asset deflation…
• Markets now operate with the deeply embedded belief that liquidity will always return when things get sufficiently bad. That belief alone changes behavior. It encourages risk-taking…
• It makes traditional valuation frameworks feel increasingly obsolete because those frameworks were built during periods when markets still had to fully purge excesses. Today, excesses are often interrupted, softened, or reflated before true cleansing can occur.

And so the question comes fizzing to the surface yet again:

“If a distortion lasts long enough, survives every crisis, and becomes embedded in how markets function, is it still a distortion? Or is it just the market now?”

Stop Acting Shocked!

Here is this fellow’s frustrating and maddening conclusion:

• This forces an almost heretical conclusion I’ve been toying with for a year or two: maybe what we consider “expensive” is anchored to a market regime that no longer exists. Maybe 20x earnings is not expensive anymore because 20 years of future earnings are guaranteed in a way they weren’t 50 years ago… 
• Maybe historical comparisons to decades that lacked passive flows, algorithmic trading, derivatives-fueled volatility, trillion-dollar buybacks, and perpetual monetary intervention are becoming less useful by the year…
• If central banks keep dropping trampolines underneath the market every time gravity starts doing its job, people should stop acting shocked when assets bounce higher than historical models suggest they should.  

In further conclusion:

• If the Fed has effectively made permanent distortion the foundation of modern markets… then maybe we need to admit the obvious: the market is no longer broken. It’s functioning exactly as designed…

Just so. Yet below I offer solace for the enthusiast of the traditional stock market, the undistorted stock market with its bearish potentialities — including our dispirited author.

When Bull Markets End

There exists an old saw on Wall Street:

“Bull markets end when the last bear throws in the towel.”

Perhaps this Quoth the Raven fellow represents the last bear — if not literally then symbolically. And it appears that he has thrown his white towel into the squared circle.

He is conceding the bout. Thus, in this interpretation, you can soon expect the bull market to confront extinction.

It is a possibility even the author permits:

• Of course, now that I’ve penned and published this piece, a medieval-style return to the investing dark ages is probably right around the corner.

Perhaps a medieval-style return to the investing dark ages is indeed right around the corner. And perhaps it is not.

Perhaps the forces of distortion have permanently seized the heights that are commanding.

Yet the season is spring. It is the season of possibility, the season of hope.

I, harboring somewhat medieval sensibilities, hope for the investing dark ages’ return.

And hope, as is said, springs eternal.

Brian Maher

for Freedom Financial News