All that is gold does not glitter,
Not all those who wander are lost;
The old that is strong does not wither,
Deep roots are not reached by the frost.
— J.R.R. Tolkien
I lifted this poem from Tolkien’s “Fellowship of the Ring” – the first volume of voluminous and the now-ubiquitous “Lord of the Rings” Trilogy. But as has been consistent with the protocols of this forum, I have this rather startling and embarrassing confession to make. I’ve never read Tolkien, not even the Trilogy’s widely-considered-more-accessible prequel: “The Hobbit”. And no, I’ve never seen any portion of the film sequence. Not one minute of it.
In the days of my youth, Rings was all the rage. I even knew a couple of particularly erudite brothers who were part of a Tolkien Club, which analyzed and re-enacted scenes, etc. In solidarity with my betters, I bought these books, but could not get through them. Then Tolkien disappeared from the scene for about a generation, but was resurrected, around the turn of the Millennium, in (it must be said) glittering, fashion by those crazy kids in Hollywood. JRRT had been dead for about a generation by then, but boy oh boy, had he lived, would he have been happy. And rich. The Rings Trilogy not only copped an astonishing 17 out of the 31 Oscars for which it was nominated, but generated a box office gross that places all 3 in the top 50 takes of all time.
So clearly there must be something there, and our little poem, which appears twice in the text of “Fellowship”, reinforces this notion. But the glitter/gold thing does not originate with Tolkien. Indeed, it had been used, in various forms, by stone cold ballers ranging from Chaucer to Shakespeare. And even them guys took poetic liberties. Some references in literary history trace the glittering gold reference all the way back to Aesop, who did most of his writing about 600 years before the birth of Jesus.
So, while that more famous line does not strictly belong to Tolkien, it should be noted to his credit that he cleverly inverted it, advising his readers that all that is gold does not glitter. Moreover, the next phrase in the sequence, the elegant, thought-provoking observation that not all who wander are lost, appears to belong entirely to him. However, it strikes me that this phrase also lends itself to inversion, as it may very well be the case that all who are lost do not wander.
I can cite my own experience in support of the foregoing. Though I have often felt lost, perhaps out of laziness, I seldom wander.
And I’m not alone in this practice. To wit, it can be argued that the inverted version of the phrase applies to current market conditions. Consider, for instance, our equity indices, which we observe as being in single-direction motion, namely upward. Their refusal to diverge from their set course takes various forms, but let’s consider a just this one. As of Friday’s close, the SPX achieved a record set of consecutive sessions (241) during which the index has failed to yield as much as 3% of valuation ground.
A determined march in an identifiable direction is arguably the antithesis of wandering. If my theme has merit, though, this doesn’t mean they aren’t lost. So are they?
A lot of smart folks with whom I deal would answer in the affirmative. They observe in frustrated awe the unfolding rocket ride of our equity complex, click their collective tongues, and darkly suggest that wherever Mr. Spoo and General Dow, Captain Naz and Admiral Russ are headed: a) they will be unaware of their precise coordinates; and b) they may be impelled to reverse course when the reality of a) hits them.
Unfortunately, I’m not in a strong position to predict with certainty whether or when these darker hewn prognostications will come to pass. However, I can state with some confidence that if they do, then the equity complex, though not wandering, would fairly be described as being lost.
Further, if said complex is in fact missing, it might be due to a trend illustrated in this handy little graph making its way across my Linkedin feed over the last few days:
Now, I’m not sure the source of these time series, but the numbers appear to be approximately correct. And if so, the solution to our problems is obvious: the markets need more hedge funds! Maybe lots more! I mean, if there are only now two fund platforms available to hunt down each listed equity security, then how are we supposed to find the little buggers? Perhaps, if the ratio increased to, say 3:1 or even 4:1, we’d stand a better chance.
But setting aside the troubling flatness of the hedge fund growth curve over much of this decade, one might do well to train one’s eye on the disturbingly diminished number of listed equities available to buy and sell – a figure that has dropped by nearly half over the last couple of decades. This trend reinforces one of the main themes of my most recent written rants: an increasingly alarming imbalance between the supply of, and demand for, marketable securities.
For me, the problem begins in the bond markets, with the persistence of global QE serving to catalyze the hoovering up of all govies – immediately upon issue (if not beforehand). As such, if you wanna trade something, it’s almost gotta be equities. But with low borrowing costs and miniscule yields that have characterized the debt markets for several years, the appropriate response – particularly for large conglomerates has been to borrow, acquire and bury incremental available float inside corporate treasuries.
I will stake some proprietary claim on this hypothesis, and, if pushed, can back it up with evidence, but the idea is catching on. Over the weekend, I read something pithy by some hedge fund dude which points out that stock buybacks account for 40% of post-crash earnings growth, and that in 2015 and 2016, public corporations spent more than their entire aggregate operating income buying their own stock and issuing dividends.
If I’m making myself less than clear, perhaps the following chart will reinforce the point:
There’s some other stuff in this note that I found less than compelling, but I don’t think one can misinterpret the implications of reduced of supply on equity prices.
I foresee no imminent end to this technical imbalance, but clearly, it cannot go on forever. On the other hand, it could continue for quite a spell, and, as long as it persists, I believe that so too will the rather perverse immunization of equity securities (and, for that matter, bonds of all forms) from price effects created by risk-enhancing or downright negative news flow.
This past week’s annoyingly predictable climb to yet again another set of all-time record valuation levels was catalyzed in part by the custodians of our government policy. Surprisingly, and again against the consensus smart thinking, the members of the World’s Greatest Deliberative Bodies managed to actually come close to passing a budget framework. In turn, or (so the thinking goes) this sets the table for that swell tax cut we’ve been promised by the ruling party.
The mere hint of these tidings caused equity investors to swoon with delight, and then buy up every available share of every stock in sight on Friday. Consider, for example, the case of General Electric Corporation, the stock of which has been perhaps the hottest dumpster fire of this improbable year (it’s underperforming the SPX by nearly 40% this year: down 25% vs. up 13% for the index). On Friday morning, newly anointed CEO John Flannery strode grimly to the podium to announce the Company-that-Never-Misses’s first earnings disappointment in 10 quarters, along with plans to divest of some $20B in business lines. For a brief moment, investors showed their ire, actually selling of the stock down by a little more than 1%. By mid-morning, however, they had returned to their senses, and GE actually closed up by an equivalent amount.
And as for those tax cuts, well, I reckon we’ll see. I suspect that the Pachyderms will indeed push something through, especially with their increasingly alarming election prospects now looming just one short year on the horizon. But we’ve seen these guys soil themselves before, and come what may, I expect the final product – if we ever get there – to look much different than and diluted from what is being described to us. Good luck with that removal of mortgage interest deduction kids, and (while we’re at it) with the elimination of the state and local income tax offsets.
In the meantime, next week marks the busiest section of the Q3 earnings sequence, with nearly 200 companies reporting. On Friday, we’ll also get our first glimpse at that mulligan inducing GDP print. I don’t see any of this knocking the indices off of their determined path.
But I will admit to remaining a bit lost. This is nothing new to me, but it is getting increasingly bothersome. Perhaps I should knuckle down and read some Tolkien. Or at least dial up the movies. But given the length of these writings and film Hollywood Blockbusters, this could keep me distracted for months, if not years.
Let me know how you make out.
TIMSHEL