A Changed Market

In my last post I argued that it was a great time to short the market. My timing ended up being wrong. Stock prices have risen further, making them even more overvalued now (and therefore better to short). I'm not alone in having made this mistake. We have seen dozens of fund managers (publicly and privately) make the similar predictions in the past year and losing money. The worse aspect of this situation is that high-quality blue chips are not moving much while low-quality speculative growth stocks (such as the "cloud computing" sector, Netflix and Chipotle) are soaring and most overvalued. This looks a bit like the 1999 bubble, just not as extreme.

The market is also more difficult to decipher. Increasingly dominated by high-frequency trading, momentum chasers and Fed stimulus, the very nature of this market has changed. When one examines the market's internal structure, a disturbing but unsurprising conclusion emerges: big banks getting favors from government and the government itself are dominating. Many great fund managers have complained and elaborated on this point in recent months. We have seen various hedge funds and trading operations close their doors recently (big ones, small ones, profitable ones, money-losing ones) because they simply cannot figure out the market. Previously reliable patterns - both technical and fundamental - are breaking down.

This is very hard to take because Wall Street has historically rewarded the talented. Now it rewards the well-connected. In this annoying situation, the right thing to do is stand aside and let others do battle with each other. Taking myself as an example: I find myself unable to short stocks in any significant size - not because I doubt that they're ridiculously overvalued but because my previous methods for recognizing markets peaks have stopped working

But Hope Is Not Lost...

I am still optimistic. I believe that the patterns will return one day and that methods previously used by talented people will work, for two reasons: (1) I believe that real capitalism will eventually prevail, that the government will stop its policy of boosting stock prices and that big banks will lose their unfair advantage. (2) I believe that when the government bond bubble bursts, anything that depends on this bubble will collapse too, including the stock market. This means that I predict that interest rates will rise, we will enter a new recession and stocks & bonds will decline.

In summary, I am on the sidelines and watching developments in the U.S. treasury market. When the U.S. starts having trouble financing their deficit, it'll be time to short stocks.