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 outlined the 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 extreme drawdowns;
  • Supply constraints, and;
  • Rationalization.

 All these conditions are currently present in the U.S. equity market.

Condition1: Consistent, Indiscriminate Buyers

There can be no debate that there have been multiple sources of consistent, indiscriminate, buyers of U.S. stocks since the Global Financial Crisis.  They include:

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

None of these buyers are concerned 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 been forced by the Fed’s interest rate suppression regime out of conservative investments and into equities;
  • Corporations have continued to buy back their own stocks 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 companies higher.

None of these actors are individually irrational, however, they are all valuation-indifferent.  Collectively, they are a monkey with a “buy button”.  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 initial recovery 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 be measured by the volatility of the S&P 500, also known as the VIX.  Volatility of the S&P 500 in the decade ending February 2009 was 21.68.  It has been 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 result of a volatility suppression regime orchestrated by the Fed, which has shifted its 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 of publicly trading stocks.  This reduction of names has helped facilitate rising prices for the remaining companies.

The reasons for this decline are numerous: the SEC has increased the regulatory burden on small firms, low interest rates have facilitated sustained M&A activity, and venture capital has turned into private equity as startups delay IPOs and raise six or seven rounds of funding before going public.

The decline in the number offirms has led to increasing industry concentration, which creates oligopolies that 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 been accompanied by a chorus of straight-faced and earnest market sycophants.  Traditionally, this seat has been occupied by empty 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 judging the success of his policies.

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

While these commenters are technically correct that a large national debt and deficit does not automatically spell doom for an economy, it does serve as a capacitor for growth (which I have explained in detail in my blog post series on MMT).  Higher levels of debt reduce the capacity for growth.  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 be deployed.  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 is not a direct buyer of U.S. equities,[9] it plays a key role in the current Participant Ponzi.  Namely, it has lowered short-term interest rates to near zero and kept them there for seven years as well as implemented multiple rounds of quantitative easing which depressed long-term interest rates and suppressed volatility.  This has forced investors into the Participant Ponzi, both in numbers of investors and the amount that each invests in the Participant Ponzi.

In normal markets there are investment alternatives which compete with the Participant Ponzi for capital.  The Federal Reserve has destroyed them.  For instance, when I started in the business in 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 in half.

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

Finally, the Federal Reserve has given the Participant Ponzi an intellectual underpinning and gravitas that it doesn’t deserve.

In my next post, I will examine how the 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

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