The Stock Market’s Great Fool Theory

The current stock market is the most dangerous stock market I have seen in my 34+ year career as a financial markets professional. This includes 1987, 1999-2000 and 2007-2008. The run-up in stocks has been largely a product of momentum-chasing hedge fund algos on behalf of the large universe of sophisticated hedge funds which are desperate for performance. In the context of the obviously deteriorating economic fundamentals, the performance-chasing game has become a combination of FOMO – “fear of missing out” – and the Greater Fool Theory – praying someone else will pay more for the stock than you just paid. There’s also likely some official intervention going on as well per the chart below.

Most, if not all, of you are aware of the degree to which the Trump Administration – primarily The Donald and Larry Kudlow – are using the ongoing the trade negotiations to issue opportunistic headline statements about the progress of a potential deal at times when the market appears ready to drop off a cliff and for which Trump’s advisors know the hedge fund fund algos will respond positively. This chart shows this “positive trade war news” effect (from Northman Trader w/my edits):

The problem with relying on this device is that eventually the market will fatigue of “false-positive” news releases and revert to bona-fide price-discovery.

To see an example of the algos’ response to a headline report and the subsequent “price-discovery” action, let’s examine the release of Bed Bath and Beyond’s (BBBY – $17.99) earnings. BBBY announced its Q4 2018 earnings on Wednesday this past week after the close:

The initial headlines reported an earnings “beat.” The algos drove the stock from its $19.40 closing price to as high as $21.27 on those headlines. But in the real world, the details of BBBY’s financial statements showed that sales declined both in Q4 vs Q4 2018 and for the full-year 2018 vs 2017. Even adding back the large impairment charge which BBBY took in Q4 this year, operating income was still down 37% vs Q4 2017. The stock closed Wednesday’s extended hours trading session 18% below the headline-driven high-tick. This is what happens when reality gets its claws into the market.

The best example of the Greater Fool Theory right now is the semiconductor sector. Semiconductors are “hyper” cyclical. The companies mint money in a strong economy and come close to hemorrhaging to death in recessions. The SMH ETF has gone up 55% since the Fed/Trump began re-inflating the stock bubble. Some individual stocks have nearly doubled.

I’m sorry I missed the opportunity to get long this sector on December 26th. But, given that the move up has been in complete defiance of the actual industry fundamentals, would I have held onto a long position until today? Probably not. The momentum-junkies have been chasing the sector higher with fury based on the faith in the “second-half of 2019” recovery narrative currently preached by CEO’s who have to deliver bad results in Q1 and take a chain-saw to guidance for 2Q. But the message is: “trust me, there’s a huge recovery coming in Q3”

Semiconductor CEO’s are notorious for rose-colored forecasts for the market out in the future. Interestingly, a German wafer manufacturer issued stern, if not refreshingly honest, guidance for 2019 when it said that previous guidance was “under the condition that order intake would need to revive meaningfully in the second half of 2019.” The Company went on to explain that “because of the general economic slowdown and geopolitical uncertainties as well as ongoing inventory corrections in the whole value chain, the timing of a market rebound is not visible.”

Wafers are the building block for semiconductors and integrate circuits. Siltronic is a leading global wafer manufacturer. If Siltronic is seeing a meaningful decline in wafer orders, it means the companies that make the semiconductors and integrated circuits are flush with inventory that reflects lack of demand from companies that use chips to manufacture the end-user products.

The higher probability trade right now is to short the semiconductor sector (along with the overall stock market). Trading volume across the board is declining, standard market internals are fading and sentiment is back to extreme bullishness (Barron’s cover two weeks ago wondered, “is the bull unstoppable?”).

I can hear a bell in the distance signalling the top. I suspect a large herd of price-chasers will realize collectively all at once that there’s going to be a rush to find the next Greater Fool but the Greater Fool will be those stuck at the top.

The above commentary is an excerpt from my weekly subscription newsletter. I bought puts on a semiconductor stock today that has gone parabolic despite horrendous numbers for Q4.  I’ll be discussing that stock and a couple others this Sunday. To learn more, click on this link:  Short Seller’s Journal information

7 thoughts on “The Stock Market’s Great Fool Theory

  1. I would say that it’s the ESF, the Fed Trading desk, the Swiss Fund, and the entire Central Banking cabal that front runs the markets and makes everyone else chase the stock prices higher. It’s like they lead the pig by the nose. They have unlimited money to do what they want. It can’t crash because they have unlimited money at their disposal. The stock markets will only crash if they allow it to crash. This is the reality unfortunately.

  2. Ten long years of stealing , preparation and maximum fooling.
    We have to be close to the end , there are too many worsening signs everywhere.
    Everybody is sick of reading , listening and waiting but never give up.

  3. We will have a melt up not a melt down. As Fred pointed out
    the Central Banks have the printing press and as long as the
    “sheeple” believe that colored paper with pictures on it has
    value it is game on. Eventually the currency along with the
    equity markets will go full Zimbabwe. You never want to go
    full Zimbabwe.

  4. Looks like the Banksters are fishing for shares. 4 of my 5 mining stocks are all trading offer out 3 to 4 decimal points…..where we normal humans can’t trade….The zone for the Banksters and their ilk. Thank you CONgress for continuing to compound their ability to steal and cheat us retail investors.

  5. “They have unlimited money to do what they want. It can’t crash because they have unlimited money at their disposal. The stock markets will only crash if they allow it to crash.

    I don’t believe this. Unlimited digi-dollars doesn’t mean there can’t be massive selling. You are among those that believe in the omnipotence [ad infinitum] of the Fed et al. Worked out real well in 2008.

    1. FWIW, after 2008, Bernanke said that they learned from it and won’t let it happen again. That means unlimited money printing to buy the markets, prop them up and not let them fall that much. Also, not letting big banks fail causing a derivative meltdown.

      The Cabal is doing everything they can to stop the global economic contraction such as buying stock futures, monetizing Treasury debt, stopping QT, stopping rate hikes and then will go into reverse with lowering rates, QE, etc.

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