That's what Charles Biderman, CEO of TrimTabs Investment Research, said not long ago in a video post. Here's his reasoning:
I first started working in Wall Street in 1970 … and this is the riskiest market I've ever seen. The reason is simple: There's no money going into the market by investors. Mutual fund investors have had consistent outflows for the last several years. Hedge fund investors have not put any money into the market this year, or in the last year and a half. Pension fund investors have not put money in. And companies have been net sellers for most of last year and this year.
So there's no new money from traditional investors, yet the market is up $7 trillion … from the March 2009 low. How can that be, if no new money has gone in? We've never seen a market where no new money has gone in and the market has gone up like this. The only logical conclusion is that it's the carry traders … people who can borrow at virtually no interest rate, and take that free money and go long.
As you can see in the full video, Biderman goes on to conclude that if these carry traders "back away," the market's toast. He gives the May 6 flash crash as a precursor of what may lie ahead -- only worse. Thus, the riskiest market he's ever seen.
Terrifying.
But not convincing. I suppose it depends on whether you're a trader or an investor, but I think this kind of logic -- which, to be fair to Biderman, is rife -- is perfectly backwards.
First, you don't need a lot of new money coming in for markets to make big moves, as they have since last March. Prices are set at the margin. All you need is one buyer and one seller trading one share to set a market price. And that price can be much higher (or lower) than the previous quote. This is why market technicians (I think that's what they call themselves) urge caution when stocks surge on low-volume days.
Also, plenty of carry traders are hedge funds, so the notion that hedge funds are sitting on the sidelines while carry traders run wild contradicts itself. Lastly, individual investors may be pulling money out of mutual funds, but as I've shown, a lot of that money is simply being transferred into stock ETFs. It's a shuffling, not an exodus.
More importantly, though, the idea that markets gain risk as new money dwindles strikes me as not only as false, but also amazingly dangerous. If you follow this logic to the extreme, does a market become riskiest when you're the only buyer left, and you can practically name your own price? Conversely, does it become the safest when everyone and their cousin is buying, like tech stocks in 1999? Of course not. If you're an investor -- not a trader -- it's exactly the other way around.
Investment risk doesn't come from a lack of buyers. It comes from high valuations. It comes from buying stocks for more than the business is worth. Ram that into your skull: Risk doesn't come from market swings, but from buying a company at the wrong valuation. If you equate volatility with risk, you probably shouldn't be investing. At all.
Take a real example from Biderman's reference to the May 6 flash crash. On that insane day, Procter & Gamble (NYSE; PG) briefly dipped to $39.37 per share, its lowest price in some eight years. Did that drop make the company riskier? Did people suddenly stop buying Crest toothpaste? Of course not. The price may have blipped, but the value of P&G didn't change one iota during that 10-minute meltdown. The flash crash allowed you to buy one of the world's strongest consumer companies at perhaps the best valuation ever seen. And it didn't force anyone to sell -- you were at its mercy only to the extent you allowed yourself to be. Ditto for Philip Morris International (NYSE: PM), ADP (NYSE: ADP), and Verizon (NYSE: VZ). The flash crash created some of the safest prices these companies have ever traded at. Permanent downside risk was minimal, while upside potential was huge.
The flash crash was the opposite of risk. It was deep safety from valuations.
If you start viewing markets that way, a chart like this is probably the most valuable in measuring risk:
Source: Standard & Poor's, Yahoo! Finance, author's calculations. 2010: Q1 & Q2 actual; Q3 & Q4 S&P estimates.
To revisit Biderman's point: Was the market really safer in 2000, when there was an utter dislocation between stocks and earnings? Safer than today, when earnings have rebounded so ferociously that the dislocation is almost as strong in the other direction? If you believe the estimates, the S&P currently trades at 12 times 2011's earnings (not shown in this chart). Those estimates could be off by as much as 25%, and the index would still trade at a rather reasonable 16 times earnings.
So you can call today's market a lot of things. Uncertain. Gut-wrenching. Confusing. Annoying. I just don't know if "the riskiest ever" truly applies.
Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.
