This guest commentary was written on 6/3/21 by Chief Market Strategist Mike O'Rourke of JonesTrading.
"I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms...So the problem here is something which looked to be a very solid edifice and, indeed, a critical pillar to market competition and free markets did break down. And I think that, as I said, shocked me. I still do not fully understand why it happened. And obviously to the extent that I figure out where it happened and why I will change my views. And if the facts change, I will change."
Adam Smith's “invisible hand” of self interest is the foundation upon which a market economy grows.
During his nearly two decades at the helm of the Federal Reserve, Alan Greenspan was an adamant believer that market participants would operate in their own self interest, thus fostering the optimal allocation of resources.
Greenspan assumed a role of traffic cop trying to stay out of the way while making sure the streets were clear so the traffic could flow.
When there was a crisis, he would step in, frequently easing monetary policy. During the Long Term Capital meltdown, the Greenspan Fed coordinated the
private market bailout of the hedge fund, describing the move as one of "enlightened self-interest." Greenspan reminded Wall Street leadership that their collective rescue and thoughtful liquidation of LTCM would prevent the asset liquidation fire sales that could place their respective institutions at risk.
It is part of the Wall Street lore that Lehman Brothers famously chose not to participate, and when it was in trouble a decade later, there was no help to be had for them.
Greenspan's quote above was made during Congressional testimony a little more than a month after Lehman's failure as the Global Financial Crisis gained momentum.
The quote references the primary cause of the financial crisis in which banks underwrote hundreds of Billions, if not Trillions, of mortgages of dubious credit quality.
Not only did the banks underwrite the mortgages, they kept enormous sums of the mortgages on the bank balance sheets jeopardizing the banks financial integrity.
As it turns out, the executives at the banks and brokers were operating in their self interest, but it was their individual self interest instead of their company's.
They failed to recognize that by placing their firm at risk, they also placed their own livelihood in jeopardy. Today, Federal Reserve policy has fostered an environment where the US equity market resembles a high stakes game of fantasy sports spetting.
AMC Entertainment is the embodiment of the insanity. Prior to this year, AMC's peak market capitalization was $1.7 Billion dollars. Today it peaked at $36.3 Billion, more than 20x its previous peak value. The company's enterprise value was approaching $50 Billion at today's peak. These readings place the company's value on par with the likes of Best Buy, Kroger, AutoZone, Southwest Airlines, Hershey's, Humana, eBay and Discover Financial.
Market capitalization comparisons are fairly common in bubbly times, but they are usually made between a new upstart technology company and a bellwether. Here we are comparing a century old capital intensive business under constant threat from digital competition.
AMC has embraced its meme status and is reaching directly out to the public to generate excitement about the company. AMC unveiled its
new "AMC Investor Connect" initiative today just for that purpose.
One of the more absurd aspects of today's rally in the shares is that the company is expected to file a proxy statement tomorrow that will "include a proposal to authorize additional shares of Class A common stock but in a quantity significantly smaller than the previous request."
That previous request was to issue “500,000,000 shares to a total of 1,024,173,073 shares of Class A common stock" outstanding. A significantly smaller number of shares is still likely to be a material amount.
At the last FOMC press conference, Chairman Powell addressed asset prices. He stated:
"So one of the areas is asset prices, and I would say some of the asset prices are high. You are seeing, seeing things in the capital markets that, that are-that are a bit frothy. That's a fact. I won't say it has nothing to do with monetary policy, but it also-it has a tremendous amount to do with vaccination and reopening of the economy. That's really what has been moving markets a lot in the last few months is this turn away from what was a pretty dark winter to now a fast-a much faster vaccination process and a faster reopening."
While AMC Entertainment is a re-opening play and clearly benefits from vaccinations, vaccinations do not propel a business to 20x its pre-pandemic peak value, excess liquidity does.
Clearly, the market mechanism is not working here, and it is hard to identify who is operating in their own self-interest. The majority of retail investors
gambling in the name are likely to get hurt in this situation.
The company has been a beneficiary, but its average sale price for its equity sold is below $10. The company has yet to retire any of its $11 Billion in debt. Institutional investors want nothing to do with the shares at this point because they have become too speculative and volatile.
This is far from an efficient allocation of capital. In the January FOMC press conference, Chairman Powell addressed the issue of using monetary policy to counter an asset bubble. Powell stated:
"We don't actually understand the tradeoff between-the sense of it is, would you-if you raise interest rates and thereby tighten financial conditions and reduce economic activity now in order to address asset bubbles and things like that, what-will that even help? Will it-will it actually cause more damage, or will it help? So I think that's unresolved."
As usual, Powell misses the obvious. No one is asking him to tighten or raise rates, they are imploring him to stop or even slow the printing to avoid blowing his bubbles even larger.
This is a Hedgeye Guest Contributor piece written by Mike O'Rourke, Chief Market Strategist of JonesTrading, where he advises institutional investors on market developments. He publishes "The Closing Print" on a daily basis in which his primary focus is identifying short term catalysts that drive daily trading activity while addressing how they fit into the “big picture.” This piece does not necessarily reflect the opinion of Hedgeye.