![]() ![]() Now, Wall Street makes money by lending securities and arbitraging indexes. It used to be that Wall Street would make money by executing trades and providing research on stocks. In other words, the widespread adoption of passive funds at the expense of actively managed ones has significantly changed the way the market works. Transactions focused on buying or selling all stocks and profitability derived from index arbitrage (again, both futures and the creation/redemption process of ETFs) rather than security selection have irrevocably changed the incentive structure on Wall Street." "As we have repeatedly discussed, the widespread transition to index products (both futures and passive mutual funds/ETFs) has changed the behavior of markets. He sums it all up in his piece, Talking Your Book About Value, Part 3, by saying, "it's all about flows". A key element in looking for the cause of the problem is to consider sources other than the Fed. Recent research by Mike Green of Logica Funds provides some extremely useful insights into these issues. What we want to know is when it will end. What we seem to be observing is speculative fervor run amok. These questions can be distilled down into more specific ones. What should investors make of this? What does it imply for investment strategy? The idea is that stocks have become untethered from reality because central banks have hijacked the capital markets. Asset prices are disconnected from economic reality. The economy is weaker than people believe. On the other side of the spectrum, high profile hedge funds continued to close down, further highlighting how troublesome the environment has become.Ĭriticisms abound and revolve around the same points. Retail trading picked up significantly and focused much more on "story" stocks than fundamentals. Other phenomena have corroborated these observations. Everybody's bought everybody else with low-cost debt". has become massive." Upon leaving ValueAct Capital, the hedge fund he founded, Jeff Ubben declared, "Finance is, like, done. the disconnect between financial assets, equity markets and the real economy. Nomi Prins exclaimed, “I call this a ‘Permanent Distortion.’ I have not used this term in prior books, but I am using it because. Jeffrey Gundlach chimed in saying, "There's no price-discovery mechanism". Michael Every from Rabobank proclaimed, "Markets are, across the board, totally divorced from reality. As markets continued bounding despite evidence of a relatively weak economic recovery, commentators have tried to capture the growing disconnect. Not only did stocks rebound, but they seemed to be completely reinvigorated. In addition, it kept rolling out new policies throughout the second quarter in order to quell any remaining doubt as to its intent. In a set of measures that were mind boggling both in terms of magnitude and breadth, the Fed sent a strong signal of its commitment to support markets. In a pattern to which investors have become all too accustomed, the Fed pounced into action soon after stocks fell precipitously in March. The key to managing through this is understanding what has happened and why. While overwhelming policy responses to the Covid-19 related lockdowns certainly affected the markets, the Fed didn't force anybody to do anything either. There is no doubt that public policy is part of the equation. What is open for question is whether the first or the second quarter is a better portent for the foreseeable future. After a record drawdown in the first quarter and a record rebound in the second quarter, no one is disputing that the first half of 2020 has been memorable. ![]()
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