A World of Speculation
Bull markets may be thought of as a state of mind. The ability, indeed the desire, to believe that taking a risk will not only pay off but pay off well requires a healthy optimism. Or sometimes merely a suspension of doubt.
On the latter score, consider the case of a fledgling broker aiming to go public that, while not based in Lake Wobegon, might as well be. That is the mythical hamlet in Minnesota conjured by Garrison Keillor, “where all the women are strong, all the men are good looking, and all the children are above average.”
Which would be an ideal place for Sidoti & Co., a small brokerage firm that resists the cynicism that is an immutable strand of the DNA of its actual domicile, New York City. For, as our colleagues at The Wall Street Journal reported last week, Sidoti research analysts would indeed be home on the range, where never is heard a discouraging word. That’s because the firm issues only Buy or Neutral recommendations, never one to sell a stock.
The company, citing the so-called quiet period before its planned $35 million initial public offering, declined to comment on the matter, but the offering documents stated, “Because we do not have a ‘sell’ or ‘negative’ rating, there is the potential for investor confusion,” the Journal said. A former employee’s whistle-blower complaint to the Securities and Exchange Commission contends that Sidoti’s incentive structure rewards analysts’ marketing efforts, according to people familiar with the claims cited in the story.
Who’s to say that shares of all of Sidoti’s worthies weren’t deserving to be bought if, as with the kids of Lake Wobegon, they were indeed all above average? Anyhow, a bull market is like grading on a curve where everybody gets bumped up, so everybody wins, right?
But, as those Lotto ads used to say, you’ve got to be in it to win it. And in China, it seems, everybody is in the game. So much so, in fact, that ordinary folks appear to be playing the market more than working.
In a fascinating video package from CNBC, the locals have caught stock market fever, even in rural western China, away from the coastal metropolises. “It’s easier to make money from stocks than farm work,” according to the translation of a farmer being interviewed.
Farmers there don’t tend to their fields while the stock market is open, the report adds. And there they call a local grocer, who the piece says parlayed an $820 investment into $33,000, the “stock market goddess.”All the while, these denizens of the heartland of China monitor their stocks and trade with current-generation smartphones.
None of which comes as a shock, given the well-advertised burgeoning of new retail brokerage accounts in China. But the image of small-size stock punters has been that they were an urban species, from the shoe-shine guys proffering stock tips in the Roaring ’20s to day-trading taxi drivers in the
dot.com delirium of the ’90s.
It shouldn’t be too surprising, however, that today’s smartphone technology extends the reach of market mania into northern Shaanxi province. And that has helped lift the Shenzhen exchange to the fifth-largest stock market in the world, surpassing Hong Kong and ahead of Australia, Germany, and Canada. Only the New York Stock Exchange, Nasdaq, Shanghai, and Japan are bigger.
And while there’s no connection to the evident speculative froth in parts of China’s stock market, MSCI’s decision to delay inclusion of Chinese A-shares in its global emerging-market benchmarks seems prudent. By some estimates, including A-shares would eventually have directed some $400 billion into that sector by funds that track MSCI indexes.
The recent episode of Hanergy Thin Film Power Group shows why the choice of what to include in an index is important (“TAN or Burned,” Up & Down Wall Street, May 25). Despite questions about its valuation and business model, the Chinese company soared, then lost $15 billion in value in less than half an hour. In the meantime, Hanergy had become a major holding of a number of U.S. exchange-traded funds, after the stock got picked up by relevant indexes, including Guggenheim Solar (ticker: TAN), simply because of its bloated market capitalization. The experience ought to serve as a cautionary tale of the danger of mindless, mechanical index investing.
Americans’ financial boats also have been among those lifted by the rising stock market tide. According to the latest Federal Reserve Financial Accounts (what used to be called the Flow of Funds), U.S. households’ net worth increased some $1.6 trillion in the first quarter, to a record $84.9 trillion, mainly on gains in the equity market, as well as the recovery in residential real estate.
As Billie Holliday crooned, “Them that’s got shall have.” The equity-market gains accrue mainly to the richest 10% who own about 80% of stocks. As for “them that’s not shall lose,” more than 15% of homeowners were still underwater—that is, owing more than their houses are worth—at the end of the first quarter, according to Zillow, despite the comeback in residential real estate. While that’s an improvement from 16.9% at the end of 2014, it still leaves some four million homeowners still 20% underwater while they wait for the housing recovery to bail them out.
Meanwhile, according to an article in Investment News, brokerage firms are pushing securities-backed loans through independent investment advisors. For years, the big-name wire houses have marketed these loans to their own customers with the pitch that they’re a cheap source of credit to fund big purchases, such as yachts or houses, without disturbing their investment portfolios.
Of course, the firms get to make money on the loans and keep the assets from leaving the building, not a trivial consideration when asset size instead of transactions increasingly drives brokers’ compensation. As for the customers, Josh Brown of Ritholtz Wealth Management was quoted as calling these loans the “rich man’s subprime.”
The economist Hyman Minsky described three phases of borrowing: hedge borrowing, in which cash flow from the investments pay off the loan; speculative borrowing, where earnings cover the debt service but have to be rolled over; and Ponzi borrowing, which depends on selling an asset at a high enough price to repay the debt.
If we’re not at the speculative stage entirely, it would appear we’re headed in that direction, with margin debt at a record and small brokers touting small stocks that are only buys. (Anybody remember Bob Brennan promoting penny stocks from his helicopter in the 1980s bull market?) Elsewhere, as in China, they’re parlaying their cash like the pimply-faced office guy in the 1990s who exhorted his boss to “light this candle” to day-trade in a memorable online brokerage ad of the time. Or like the house-flippers of the past decade who followed cable-TV gurus’ advice to become real estate moguls with no money down.
So what could go wrong? That question tends not to intrude on a bull-market mind-set.
In that CNBC video on rural Chinese investors, the aforementioned stock market goddess suggested that her followers keep an eye on economic policy. Good advice, given that the 100%-plus rise in the Shanghai market since late last year has come in the wake of officials applying repeated monetary stimulus to counter the slowdown in the real economy.
And Lombard Street Research’s Diana Choyleva writes, Beijing probably wants to keep the rally going for two reasons: to allow rebalancing in the banking system, and for domestic social stability. A property destabilizes because only the rich with assets can play. But even rural residents with a few yuan and a smartphone can get in on the stock market. Be that as it may, U.S. fund investors showed signs of skittishness as they yanked the most money from emerging markets in seven years, withdrawing nearly $8 billion from Asian equities in the past week.
Policy makers around the globe also have taken greater interest in markets recently—mainly currencies—which affects everything else, including interest rates and equities. President Barack Obama early in the week disputed reports that he complained to his fellow Group of Seven heads of state that the dollar was too strong. Similarly, German Chancellor Angela Merkel backed off reported comments that a higher euro is unhelpful to the weaker members of the currency union that have to carry out reforms. Meanwhile, New Zealand and South Korea cut interest rates last week to bolster growth and curb their currencies.
With politicians focused on monetary matters, the Federal Open Market Committee meets this week amid intense scrutiny about the timing of the liftoff in its federal-funds target. Nothing will happen at this confab, but the key will be revisions in the panel’s economic forecasts and guesses about the funds rate embodied in the “dot plot” charts. The consensus among Fed watchers continues to be a September hike, although the fed-funds futures suggest that December is more likely.
While the Standard & Poor’s 500 eked out a gain barely detectable with the naked eye, all of 0.06%, it did manage to break a two-week losing streak. But it ended the week on a decided downbeat, slumping some 0.7% on Friday amid an array of worries, including the never-ending Greek drama. Markets may not be looking for the Fed to do anything, but they will be waiting on tenterhooks for what Yellen & Co. have to say this week.