On August 4th, the Wall Street Journal carried a breathless tale of how a handful of obscure oilfield suppliers were striking immense riches in the sand dunes of Wisconsin. Owing to the “shale revolution”, the stock price of an outfit that had originated in the stagnating business of supplying sand traps to golf courses, and which had been at death's door as recently as 2011, had gone parabolic.
Emerge Energy Services (EMES) presently traded at $145 per share, reflecting a red hot gain of 8.5X over its $17 IPO price fifteen months earlier. In a literal sense, Silicon Valley had come to the silicon dunes of Lake Michigan, as reflected in EMES' valuation at 43X its LTM earnings.
EMES data by YCharts
Given the fact that EMES' share price had most recently risen by $100 or $2.5 billion of market cap just since January 2014, the “momo” story was self-evidently all about upside growth, not current profits or cash flow. In fact, during its 14 quarters as a public filer, EMES had generated negative $50 million of operating cash flow after CapEx. So at a total enterprise value of $3.7 billion, the punters chasing the stock straight up the parabolic curve would seemingly have anticipated some stupendous growth indeed.
Except … except they had no idea about EMES' sustainable growth potential and didn't care because the buyers were robots, day traders and flavor-of-the-month hedge funds. They were piling into the stock of a company selling a form (white sand) of the second most abundant low-value commodity on planet earth for no other reason than Emerge Energy Services was another momo play on steroids. The “price action” was the investment thesis.
Yet this typical momo “rip” had occurred not out of the natural elements of human greed and capitalist enterprise, but because the stock market has been destroyed by the Fed. That is, the combination of ZIRP and wealth effects “puts” have eviscerated all of the checks and balances that contain and modulate speculation in honest free markets.
On the one hand, Fed policy has massively subsidized momo speculators in two powerful ways. First, most of them operate through the options markets or employ other forms of heavy, short-term position leverage.
Accordingly, their “carry” cost is close to zero, and their position leverage can be continuously rolled-over without risk. That's because the Fed's foolish commitment to “transparency” in pegging its policy rate means that speculators are in the catbird seat.
In effect, the Fed is committed to sending its interest rate change messages by pony express to speculators who operate in the nano-second based cybersphere of modern trading technology. It's not even a contest; its a bad joke which showers the 1% with stupendous windfalls.
Secondly, even the friskiest day traders who intend to survive need to take out market insurance against their momo bets. That is, they buy puts on the S&P 500 to protect against a market wide downdraft.
Yet owing to the Fed's drastic financial repression and market manipulation, this downside insurance is dirt cheap—meaning that the net returns on momo-chasing are inordinately high due to the Fed's implicit subsidy of their cost of doing business (i.e. hedging). Supernormal returns, in turn, attract ever greater sums of speculative capital, thereby providing even greater buying power to the momo trades.
There is no secret as to why downside insurance is so heavily subsidized by the central banking branch of the state and is therefore so cheaply available to speculators. The absurd doctrine of “wealth effects” and the implicit Greenspan/Bernanke/Yellen “put” has generated a toxic deformation in the risk asset markets. Namely, the “buy-the-dips” reflex which has purged volatility from the broad market index almost entirely.
