No Market For Reasonable People

by: Paulo Santos

As the sessions go by, it's becoming more and more obvious that this market will not allow for much rationality, at least not if someone tries to short some rationality into something.

For certain, the never ending Central Bank support is part of the reason why things are going out of control and into loony land. When the market was already quite hot back in January, the FED thought it reasonable to say that it wouldn't move rates until 2014. Then in February we had the ECB doing the LTRO2. And just two weeks ago, when again the market tried to put on a small correction, the FED brought out its mouthpiece on the WSJ saying that it would consider a "sterilized" QE3 (which is about the same as any QE, since much of the printed money always ends up in the FED being remunerated at 0.25%).

Given this backdrop, the market managed to get into a state where ANY trade that requires a short sell is bound to be stressful, no matter how irrational the long side is. The examples keep piling up and go to extremes:

  • The S&P500 stock with the best performance, up 152.8% year-to-date, trading at 40x EV/EBITDA on an industry that's lucky to do 8x - Wal-Mart (NYSE:WMT) is at 7.3x - is Sears (NASDAQ:SHLD), even as it seemingly races into never-ending losses and possible bankruptcy while selling profitable stores;
  • (NASDAQ:AMZN) manages to miss every guidance it gives, has earnings falling into a hole and is earning about the same as it earned back in 2004, yet, that's the large cap with the highest valuation (multiple-wise) in the market, trading at a forward 2012 P/E of 150x;
  • There are ETFs and ETNs trading well beyond any reasonable level, so distant are they from their intrinsic values, yet if you short any of them you get clobbered. This goes to the point where one sees an ETN like VelocityShares Daily 2x VIX ST ETN (NASDAQ:TVIX) trading at a 30% premium to intrinsic value, and has to say "wait," because it will probably trade at a higher premium in spite of it being valued at around $615 million. No surprise, it then manages to trade at a 61% premium;
  • But a 61% premium is not as crazy as it gets. The iPath Dow Jones UBS Natural Gas ETN (NYSEARCA:GAZ) managed to go as high as a 155% premium. If you had an arbitrage position on it, shall we say at a 100% premium, you'd be sweating bullets quickly, especially because even if you were just short calls, they'd keep getting exercised months ahead of their maturity.

The examples keep coming; it's a brutal and irrational market out there. Even Apple (NASDAQ:AAPL), a reasonable stock to buy given the not-too-demanding valuation it had not long ago, trades in an unnatural hyperbolic fashion - and that's when you start hearing everyone, even thousands of miles from the U.S. and completely unfamiliar with the markets, saying how good an investment Apple is, and how they bought so much and are making so much money.

Perhaps this is going according to plan, perhaps a market that behaves like this was just what the FED and the ECB wanted all along, a market where two losing days in a row seems an anomaly. But it sure feels weird.


For now, all that can be done is to take the opportunities the market gives, especially the arbitrages mentioned, and do so with a very tight risk control - meaning, using positions that can withstand even 100% moves against them. And wait. This too shall pass.

Disclosure: I am short AMZN, GAZ, SHLD.