Doug Kass: The Threat to the Market No One Is Talking About
You will rarely read or hear about the ramifications of today's perilous market structure.
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The point of my Monday morning opening missive, "It's Not Supposed to Be Easy...Anyone Who Finds It Easy Is Stupid" and the purpose of my Daily Diary on TheStreet Pro is to offer up contrarian analyses and observations that you will not regularly see from Wall Street sell-side research or in the business media.
After all, investors and traders are force fed (on a silver plater) optimism on Fin TV and from Wall Street. This makes sense as over 95% of investors are "long only."
To read my Diary, which often comprises a non-consensus view, I think has value in that it can be incorporated in your investment decision-making process.
Case in point my near 50 columns entitled "More Tales From Nvidia." These columns, especially when Nvidia NVDA and other generational compounders spurt higher, are criticized by some of our subscribers (e.g. JeffI and Masterhedge) — and this is their privilege and right as subs. But they miss the point, in my view. I serve up these columns to provide an alternative view from the spoon-fed and perma-bullish cabal on Wall Street and in the business media. I believe this is value-added.
Despite the protestations of some, I would point out since I launched this series NVDA's share price is flat against an S&P 500 Index that has risen by over +5%.
Coincidentally, I would also note a skeptical and recently published New York Times article on AI, in which a serious analyst (Jim Covello, Head of Research at Goldman Sachs) provides a downbeat outlook for AI, touching on many of the concerns I have expressed in my columns on Nvidia in my Diary.
Monday's opening column dealt with the poor quality of reported S&P EPS. Today's entails a brief discussion of the threat of market structure (which is also rarely discussed in the business media).
My view is that the markets have increasingly become unhinged (both on the down and up sides). As a result, price moves are exaggerated and some very weird stock outliers have populated our markets (think: GameStop GME, AMC Entertainment AMC and most of Cathie Woods' ARKK portfolio (!)).
Importantly, for those that have a solid sense of "intrinsic values" (as I believe my hedge fund, Seabreeze Partners, has), the ramifications and inefficiencies of market structure provides an opportunity for dispassionate investors.
The Threat of Market Structure
Inefficiencies, sharply exaggerated stock action/movement and investing pain and gain are the byproducts of today's perilous market structure:
1. Passive Domination: As noted in my Diary for a decade, the swift transition from active money management to passive money management has been profound. According to several academic studies, passive products/strategies account for about 75% of trading volume every day.
Active managers are generally fundamentalists, passive managers generally know everything about price and nothing about value. The quantitatively based risk-parity fund knows absolutely nothing about Nvidia's fundamental outlook but everything about its price momentum (and worship at the altar of price).
Today many traders and investors (like quant funds) worship at the altar of price momentum — often forcing participation from market participants (who sometimes put themselves in an unsafe position).
And never discussed is that passive strategies are often dramatically leveraged products — holding obvious risk when momentum changes and everyone is on the same side of the (long) investing boat. Risk parity, for example, can be 5x to 10x leveraged.
The jury is still out on what the dominance of passive investing means to a rational investing process, the proper allocation of capital/resources and even for our society.
2. Increased Crazy: Social media, meme stocks (read: Paramount Global PARA (which rose to over $100/share during the Bill Hwang era), GME and AMC) message boards, etc. have served up some weird/crazy price action (more often than not producing more losses than gains). So convinced are meme traders that they facilitate non understandable capital allocation (i.e. money is raised on the extraordinary moves higher). The notion that a small group of traders think they are smarter than the overall population of investors never ends well. And this sort of phenomenon (read: reckless gambling) continues to sprout up.
3. Option Speculation Has Intensified: The proliferation of 0DTE (zero days to expiration) options — which now account for the majority of options trading (and may somewhat be viewed as a product of #2 above) — is another market structure risk. To be kind, 0DTE is the manifestation of a YOLO ("you only live once") trading. To think that nearly 55% of total trading activity has a term of under one day is astonishing... and frightening.
4. Other Technological Advances Raise More Risks: The dominance of passive products (#1) has now been embraced by brokerage firms and investment advisors. Computer-generated investing strategies, intended to create a sense of safety for retail investors, have often backfired in market history.
5. Heightened Risks of Expanded Transparency: Today's transparency has an upside— it provides instantaneous information to the masses (which in the past was restricted to the privileged, wealthy, to those financial institutions that produced the most commissions and "positioned"). The problem with transparency, though, is that some of it is inaccurate, which has many investing and political ramifications.
At the time of publication, Kass had no positions in any securities mentioned.
This commentary was originally posted Monday, September 24, in Doug's Daily Diary on TheStreet Pro.
