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Synthetic Valuations or the New Reality?


We have written extensively about the BTFD-Fed feedback loop that has led to valuations that seem decoupled from fundamentals. Do we ever get to the point where the synthetic liquidity insertions become the new reality and fundamentals just do not matter anymore? Since the 2008-09 financial crisis this cycle has repeated itself. Despite a backdrop of historically poor organic domestic growth, terrible developed international growth, and a hostile political and foreign policy environment the domestic equity markets have continued to rise and credit spreads to narrow. It has been somewhat unrelenting for anyone formally trained in the last fifty years. It has been a Helen Keller market where anyone who over weighted domestic equities or risky credit has done relatively well.


The last crisis was a very focused problem that was addressed with what was then unprecedented government intervention. Like all government actions they become a permanent part of the playbook if policy makers perceive them as being successful. We argue that the markets would be far healthier today if they were left to clear but that is not relevant if policy makers believe otherwise.[1] By destroying the bond market by continuously lowering rates and offering incessant liquidity to the equity markets these policies have distorted valuations. Back then the problem was far more easily defined and addressed. It was purely institutionally created and therefore more easily solved. The economic repercussions were also far easier to address and as a result they were short lived.

This current problem is societal. Pandemics are not institutionally created. The current solution is destroying the small business infrastructure. More people have become unemployed in the last month than in all recessions cumulatively since the Great Depression! Moreover, the fear being instilled throughout society as a result of the supposed solution is widespread and psychologically damaging to consumer behavior. In all scenarios we face a very different society after this thing runs its course. Our economy will be far more depressed than it has since the 1930s. That is unavoidable! With each passing day this becomes more and more clear. The damage is so systemic and widespread it is impossible to be sanguine in regard to economic growth for the foreseeable future. And yet the capital markets continue to whistle past the graveyard as if all is right in the world. What is it they are pricing into financial assets that fundamental analysts like us have difficulty understanding? What is the substantial improvement in the economy that market participants seem to see since mid-March? The S&P 500 has recovered about 50% of its previous loss for no apparent reason.

The answer is continued government intervention. Heretofore, the estimated total fiscal and monetary insertions have been about $12.5 Trillion (1013). Clearly, traders and “professional investors” believe that this is going to continue. It seems the only rational explanation to current market pricing dynamics. For us, we continuously debate the longevity and the sustainability of this level of government takeover of our economy. Politicians love it. It accumulates power to them and if the markets ignore that development and focus on the short term, then a market clearing to a much lower equilibrium is postponed. Keep feeding them with massive amounts of socialized portfolio insurance and risk asymmetry will continue.


When all the dust settles, and we have enough empirics to properly evaluate the economic consequences of the current crisis, will the markets continue to be so optimistic? That is our current debate amongst our investment team. Can this virtuous delusory cycle continue indefinitely? Or, will markets finally clear and liquidity be allowed to find its value? If this crisis does not trigger this reckoning, then we may have to join the BTFD-Government-Synthetic valuation crowd. Toss out all our doctoral degrees, graduate degrees, professional designations, and our collective century of experience. Bring out the dart board. Playing darts to dictate our investment solutions will be as tethered to fundamentals as the markets. Roulette will officially be more fundamentally sound than the capital markets. Our government will have successfully destroyed the capitalist system and it is time to recalibrate valuation fundamentals. Paradoxically, will the markets then purge to fair value?

An example of how distorted the markets have become, this morning 4.4 Million people filed for unemployment and yet, at the same time, equities traded up. The mayor of Las Vegas was quoted as wanting all casinos to open “at their own risk” meaning any subsequent health issues are the gaming industry’s problem. This perversion of leadership was apparently interpreted by the capital markets as an indication that casinos were going to open imminently and therefore gaming stocks were up over 10%. So, folks are going to go from lockdown, losing their jobs, and run off to gamble? Or perhaps the markets just figure the government is going to literally buy the entire Strip?


God Bless America. Stay safe and maintain liquidity. It will have value soon enough.

[1] See our earlier commentaries for a more detailed presentation regarding the untestable hypotheses used by policy makers to justify every decision they make.

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