On the Nature of Markets

I cheat my boys every chance I get. I want to make ’em sharp. I trade with the boys and skin ’em and I just beat them every time I can.

William Rockefeller, father of John D. Rockefeller

I hold that, in the financial markets, if something oughtta happen it will. Just a question of when.

A bull market is a natural phenomemon arising from the common desire to get rich without working. The affair starts slowly, with caution and care. As it ages, the scary uncertainty of it gives way to confidence and, later, to absurd conviction, which is when the majority of investors get involved.

At market tops, healthy skepticism and proper due dilligence give way to hubris, which is a warning sign the crowd ignores, preferring the delusion that two and two don’t just make four anymore. It is a very good time for crooks and wise guys. When the crowd is bent on getting rich the easy way, sociopaths can take liberties with aplomb.

I know of no location more prone to sociopathic behavior than Wall Street. The culture on The Street is about getting rich by ruthlessly eviscerating the other guy. Very unsettling to the uninitiated. Among the denizens, when a trader makes a successful trade, he is understood to have ripped the face off the sucker that took the other side.

Rogue brokers are busy at tops, heartlessly defrauding gullible investors by foisting investments on them that have no benefit beyond the commissions they generate. Investment bankers shovel the most dubious offerings out the door and it’s buyer beware just when buyers are not so inclined.

To top it off, the so-called regulators of the industry are bought off with promises of jobs in banking if they do a good job of not doing their job. Those banking jobs, of course, are obscenely remunerative because, with all the self-dealing and fraud, the banks are obscenely profitable for the bankers until the banks fail, at which time a long-ago bought off government steps in and bails out the banks. At the top of a bull market the whole smarmy business sucks.

A bear market is the natural response to the sick environment brought on by the preceding mania. It follows a predictable pattern. A first leg down reveals the vulnerability of an overpriced market and uncovers the shenanigans of the financiers. A relief rally follows, during which the outrage of the losers is muted by the hope of recovery. The second, more devastating crash gets underway when investors are finally witting to the fact that nothing has changed, there is still no value in the market and the wise guys are still on top. This is when the anger persists long enough for a significant redress of grievances.

So, you’re thinking that what oughtta happen is that during the next leg down the banksters are held accountable and have to pay for skinning the suckers, right? Oh sure, a few headlines, maybe. A perp walk or two, some fines, a little jail time for a few of them, and some after-the-fact legislation to prevent what has already happened. But that’s just collateral damage in the great game of the capital markets, where players who know what they’re doing rip the faces off the suckers who naively flock in during bull markets.

The wise guys are players. There is no reason for them to change. They’ll pay their fines, do their time, and get ready to have another go at playing the game when the markets heat up again.

My view is that the more important functions of a bear market are restoring value and educating the inexperienced crowd. Newby hedge fund guys, naive late-arrival advisors and their clients comprise this cohort. They will get the financial ass-kicking of their lives, lose most of their money, and learn the primary lesson of the capital markets: Investing is a zero sum game in which the players take money at will from inexperienced investors.

This is a brutal experience, but it is the only way to learn about investing. Every successful investor I know lost his stake one or more times before figuring out the game. Most people will be so shocked by the losses they will get out and never come back. That’s OK, they will be replaced by more newbies over time. P.T.Barnum was right about suckers.

What’s really gonna happen is that a very few brave suckers will lick their  wounds, pay attention to the process, figure it out, and become the players in the next bull market. That is the nature of markets.

 Observations

 The  drop from May 1 into the June 4 low traced out a clean five wave impulse wave. The ragged rally since then has been a series of three wave moves that are corrective in nature. The correction appears to be ending now. The next drop should be the most severe to date. Class will soon be in session.

Cheers,

Rod

No one should consider any part of this essay as a recommendation to buy or sell any stocks whatsoever

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