The Participant Ponzi and the Basilisk Eye of the Fed

The Fed has shifted its basilisk gaze from the economic cycle to the credit cycle.

In my first post, I introduced the concept of the Participant Ponzi.  In this post, I will show how the current Participant Ponzi in the U.S. stock market has come to exist.

TheParticipant Ponzi in Practice

In my previous post, I outlinedthe necessary conditions for a Participant Ponzi to exist.  They include:

  • One or more sources of consistent, indiscriminate(value indifferent) buyers;
  • Steadily rising prices with no sustained or extremedrawdowns;
  • Supply constraints, and;
  • Rationalization.

 All these conditions are currently present inthe U.S. equity market.

Condition1: Consistent, Indiscriminate Buyers

There can be no debate that therehave been multiple sources of consistent, indiscriminate, buyers of U.S. stockssince the Global Financial Crisis.  Theyinclude:

  • Individuals: buying on dips and also buying systematically through 401(k) Plans andother dollar cost averaging programs, and reallocating out of bonds and cashand into equities;
  • Corporations: buying back their own stock in recordamounts, many effectively financing the purchases with newly issued debt,[1] and;
  • Index Investors: buying market cap weighted indexes.

None of these buyers areconcerned about valuation:

  • 401(k) investors use a “set it and forget it”strategy automatically buying stocks in their retirement accounts.  In their non-retirement accounts, they have beenforced by the Fed’s interest rate suppression regime out of conservativeinvestments and into equities;
  • Corporations have continued to buy back their ownstocks at higher and higher prices, many of them effectively on “margin”, and;
  • Index investors have created a self-reinforcing,momentum-based, feedback loop that continues to push the biggest companieshigher.

None of these actors are individuallyirrational, however, they are all valuation-indifferent.  Collectively, they are a monkey with a “buybutton”.  Stocks going up? Buy more.  Stocks going down? Buy more.

Condition2: Steadily Rising Prices/Low Volatility

Since February 2009, the S&P500 has been in a very narrow upward band, with low volatility.

Chart 1:  S&P 500 Price Index from February 27, 2009 through April 25, 2019[2]

bantam inc jack duval MFO UHNW New York City Manhattan - chart SPX log chart since 2.27.09

Remarkably, after the initialrecovery from the February 2009 lows, the Relative Strength of the S&P 500never dipped below 44.  The RelativeStrength is plotted in the bottom pane of the chart above.

This smooth glide path up can bemeasured by the volatility of the S&P 500, also known as the VIX.  Volatility of the S&P 500 in the decadeending February 2009 was 21.68.  It hasbeen 17.23 since then, 26 percent less.

Chart 2: Volatility of S&P 500 in Decade ending February 2009 versus Thereafter[3]

bantam inc jack duval MFO UHNW New York City Manhattan - chart VIX 99-09
bantam inc jack duval MFO UHNW New York City Manhattan - chart 09-19

The low volatility is the resultof a volatility suppression regime orchestrated by the Fed, which has shiftedits basilisk gaze from the economic cycle to the credit cycle.

Chart 3: Move Index[4]

bantam inc jack duval MFO UHNW multi-family office New York City Manhattan - Move Index Chart

Condition3: Supply Constraints

On July 31, 1998 there were 7,562stocks in the Wilshire 5000 Index, on June 30, 2018, there were 3,486.[5]  That’s a 54 percent decline in the number ofpublicly trading stocks.  This reduction of names has helped facilitaterising prices for the remaining companies.

The reasons for this decline arenumerous: the SEC has increased the regulatory burden on small firms, lowinterest rates have facilitated sustained M&A activity, and venture capitalhas turned into private equity as startups delay IPOs and raise six or sevenrounds of funding before going public.

The decline in the number offirms has led to increasing industry concentration, which creates oligopoliesthat can tacitly cooperate without colluding. Industry concentration can be measured with the Herfindahl-HirschmanIndex.

Chart 3: Herfindahl-Hirschman Index for Selected Industries[6]

bantam inc jack duval MFO UHNW multi-family office New York City Manhattan - Move Index Chart Industry Concentration

Condition4: Rationalization/Cheerleading

The post-GFC bull market has beenaccompanied by a chorus of straight-faced and earnest market sycophants.  Traditionally, this seat has been occupied byempty heads on CNBC, but perhaps no one embodies this more now thanDonald Trump, who has come to use the stock market as a key metric for judgingthe success of his policies.

The primary rationalization inthis cycle is that the national debt and deficits don’t matter.  This belief has been taken up by many seriouseconomists, policy makers, and investors, including Warren Buffett in his 2018shareholder letter.[7]

While these commenters aretechnically correct that a large national debt and deficit does notautomatically spell doom for an economy, it does serve as a capacitor forgrowth (which I have explained in detail in my blog post series on MMT).  Higher levels of debt reduce the capacity forgrowth.  This has been true for Japan,the U.S., and now China.

Also, I notice that BerkshireHathaway is sitting on $112 billion in cash. If the debt and deficits didn’t matter, that money would bedeployed.  But it does matter, and UncleWarren can’t find any growth opportunities worth the risk.

Chart 4: China GDP Growth Y/Y and Total Debt[8]

bantam inc jack duval MFO multi-family office New York City manhattan UHNW - china gdp growth and total debt chart

The Role of the Federal Reserve

Although the Federal Reserve isnot a direct buyer of U.S. equities,[9] it plays a key role in thecurrent Participant Ponzi.  Namely, it haslowered short-term interest rates to near zero and kept them there for sevenyears as well as implemented multiple rounds of quantitative easing which depressedlong-term interest rates and suppressed volatility.  This has forced investors into the ParticipantPonzi, both in numbers of investorsand the amount that each invests inthe Participant Ponzi.

In normal markets there are investmentalternatives which compete with the Participant Ponzi for capital.  The Federal Reserve has destroyed them.  For instance, when I started in the businessin 1994, investors could get four to six percent from money market funds.  That was stiff competitions for 10 to 12percent offered by the stock market, where your investment could get cut inhalf.

Today, many investors, especiallyretirees, are invested with excessively high equity allocations due to theFederal Reserve’s manipulations.

Finally, the Federal Reserve hasgiven the Participant Ponzi an intellectual underpinning and gravitas that itdoesn’t deserve.

In my next post, I will examine howthe current Participant Ponzi will end.


[1]      I know that many firms have paid for stock buybacks out of their cash flow.  However, if they are at the same time borrowing to fund CAPEX and other expenses, they are effectively financing their buybacks.

[2]      Source: Bloomberg.

[3]      Source: Bloomberg.

[4]      Source: Bloomberg.  The Move Index measures the volatility of U.S. Treasuries across the curve.

[5]      Global Financial Data; Available at:; Accessed April 26, 2019.

[6]      The Hamilton Project; Available at:; Accessed April 26, 2019.

[7]      Berkshire Hathaway 2018 Shareholder Letter.  Available at:; Accessed May 16, 2019.

[8]      Source: Bloomberg.

[9]      The mere utterance of this phrase would have caused laughter 10 years ago, but Central Banks in Japan and Switzerland, among others, have come to be significant holders of equities.  For instance, the Bank of Japan now owns 77.5 percent of Japan’s ETF market, equivalent to 23 trillion yen of equity holdings.  See


Jack Duval

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