Ponzi Finance

Last week more than anything displayed exactly what is going on in the stock market. The two prior weeks before this week economic data started to actually look really good. What happened? The stock market started falling. Why? Because it meant that liquidity may have to be taken out of the system by the Fed. This week, two things happened. On Wednesday the Fed did not make any aggressive moves on the language concerning interest rates and basically said, party on. On Friday, you had bad job loss number but it was about perfect for the stock market. How can over 260,000 job losses (if you count previous revisions) be good? Because, our finance system has become a ponzi system. In a ponzi scheme, fundamentals don't matter. What matters is liquidity. For Bernie Madoff, the fundamentals never mattered. What mattered was always having new money to be able to give to investors that withdraw money. When the stock market started crashing and too many people started withdrawing their money, the scheme collapsed all around him.

Same thing with the stock market. Real numbers do not matter UNLESS it interrupts the liquidity flow. Friday's job number was absolutely perfect from a stock markets viewpoint. Temp jobs (a leading indicator) was up while job losses where basically steady from previous months so it could be argued there was a slight improvement while at the same time the headline that went out to every news source was 10.2%. While 10.2% was what everyday people saw, what does Wall St see? Dollar signs. It tells them more stimulus will be coming from Washington, more liquidity from the Fed, and that interest rates will stay really low. It was a horrific number for bears. I was texting at 7:35 central time right after the number came out with bears who were all excited about how bad the number was. My text back was "the worse the number the more bullish bc fed stays easy." If the number would have come out and surprised everyone with a 30k job gain, my guess is the market would have dropped over 2%. In fact when the number came out, I groaned. Did not surprise me at all the stock market was up.

All of that screams ponzi and screams that macro liquidity issues is what matters. Where does that leave investors? I owned IMS health at the beginning of the week. It got bought at a close to a 30% premium on Thursday and I made a lot of money. Was I lucky or was that a great call by me? I am short Amazon which I have lost even more money on that trades north of 70x earnings. Am I unlucky or am I just stupid? Everyone is feeling smart or dumb right now depending what side of the trade your on but I think on many levels it is all just pixi dust. The trade is one way.

With all ponzis, they all end but there is basically no way to make money on it. The reason is because when they end, they end almost overnight. If your long the ponzi, you feel brilliant as your making money day after day, statement after statement. Until the day you wake up and it all implodes and you have lost close to everything. If your betting against the ponzi you will have one day when it pays off. You will lose money (possibly everything) as the ponzi continues and you try to bet against it. How rich were Bernie Madoff investors in 2007. Their financial statements said they were very rich. Where they? The Dow claims it is at 10,000 today. Is it?

So what are investors to do? The answer is simple. Avoid it. There were many investors who looked at Madoff's fund and said something is not right and didn't invest with Madoff. They went elsewhere. What if elsewhere does not exist? What if there is no other option? I present you the U.S. financial system. Even many bulls would not argue that the system is not solvent today. The bulls would argue that we will be able to earn our way out of it (Whitney Tilson who is not really a bull makes this argument with Wells Fargo). Whether you buy that argument or not, what that arguments implies is a basic form of ponzi. The system is insolvent, liquidity will enable to allow the firms to keep paying people who want out (to really understand that at a deep level you really need to understand the accounting framework of a liquidity transaction, maybe at some point I will do a post on it), and at some point out in the future earnings will make the system solvent again. Not a game I really want to be apart of. Why? Because maybe it works maybe it doesn't (it usually doesn't) but the U.S. government has taken over the entire system in this matter. That means that the mom and pop shop is going to be affected by this outcome. Why I get so discouraged is because it seems that studying the financial statements and business opportunities of company x on the NYSE does not really matter. Because it has gotten unwillingly trapped in the ponzi system (the government decided to place it in the ponzi system when it took the entire system in this direction) all that matters is the outcome of system. The failure of the system means failure of company x.

It is why I thought Mark Sellers nailed it in his last letter when he said: "A weak U.S. economy is required to continue the boom in the U.S. stock market. It’s nuts." The weaker we are, the more people without jobs means the more liquidity will be there to continue the ponzi game.

So the question I have been asking myself, which has been sort of depressing, is why am I playing this game? If company x was a ponzi I would avoid company x. I would look a company y or company p or company j. The fact is the government has made every company a ponzi inherently by being part of the system. My successful investment of IMS Health would have probably been a complete failure if the ponzi system would have unraveled three weeks ago. Goes back to the question again. Was that a good investment or was that luck and actually a bad investment that was putting money in part of the ponzi scheme that I happened to be able to collect on before the ponzi unraveled?

To make matters worse from an investors standpoint, there is a second aspect to this all. The deck is heavily rigged. Goldman Sachs lost money from its prop trading desk only three days in the last two quarters (this last quarter they only lost money 1 day). Statistically in the old system that would be almost impossible. Probably be like a 10 standard deviation event or something. In today's system, it is hardly a surprise. Big competition (like Lehman and Bear Stearns) has been destroyed leaving bascially only one major player on the street. They essentially have a monopoly on which way the market will go in the short day to day trading. Completely making up numbers but if they were 20% and they are now 60% they can now push the market on any given day in whichever direction they want. So in the short term, the question is not what will the fundamentals do. The question is what does Goldman want the market to do. It is asinine. I know traders who have thrown up their hands and quit in the last three months because the markets have not followed the patterns they have traded in for 20 years. Well those patterns only depend now on what side of the bed Goldman Sachs traders wake up on.

So I come full circle. Why am I participating? If the system is a ponzi I will lose money eventually when the ponzi finally pops if I am participating in it. If I am betting against it I will lose money until it pops in which case there is no telling if I will be able to be around to collect on that bet when it pops. If you could short Bernie Madoff you would have lost a fortune betting over 10 years that the ponzi would collapse. If you were enjoying the ride investing with Madoff, it was good until the day you woke up and found out your investment was a complete zero. If your shorting a stock that Goldman has a desire to see increase for some reason or another, you will lose your shirt as Goldman decides it will make sure it will not go down.

Ever since I was around 13 I loved looking at companies and getting to know what they do. I am finding it more and more a meaningless task because more and more I come to the conclusion it does not matter. As a result, more and more I question why I am participating in a rigged game. Life is short. The ending to all of this is likely to be horrific and even if I have nailed exactly what is going on, there is no guarantee I will ever collect on it. Just thoughts bouncing around in my brain.

I think the odds are growing that this market rally thing will end on a 10% down day or 25% down month type of event.

In the short term, because the job loss number was so bad, it probably means the stock market has a decent chance of making new highs. What is really freaking amazing is that the AAII weekly survey of US retail investors was the bearish it has been since February 19th 2009. This is usually a major contrary indicator. This number just collapsed after the stock market pulled back a mere 6%. What the great bear trendline from the November 2007 highs. If we break that, there will be a rocket ship higher. Correlations seemed to have started breaking down recently so it is possible we are not headed for new highs but those odds have been falling. If we don't, I think it will have to do with U.S. financials and/or Europe. Those two is what will eventually end the Ponzi game.