Safety Dance

Your definition of Safety is very different from the safety sought by Wall Street professionals, and this latter form is what’s propelled the stock market to new record highs over the last 32 months.

The real Flight to Safety has been on since the beginning of 2012 and it has barely let up for even a single headline or emerging threat.

When the media uses the term Flight to Safety, they are typically describing a one-day or one-week period of time during which small caps and economically sensitive stocks sell off while large cap value defensive stocks, gold and Treasury bonds rally. But this is merely a tactical flight to safety. The strategic flight to safety is the real deal – the one that actually matters most and gets the least attention.

In a strategic flight to safety, practitioners whose job it is to allocate money for their firms or clients, run to the only thing that will allow them to keep their jobs 99 percent of the time – US stocks. The only safety that matters for these folks – career safety – is the driving force behind trillions of dollars of asset flows.

Portfolio managers have learned over the years that their biggest occupational hazard is not the possibility of a temporary market drawdown (which is what the media focuses on). No, the number one risk for a money manager is to stray too far from the US equity benchmarks and have them run higher without nearly-full participation in the gains. Foreign stocks or bonds can run up without quite as much risk to the manager, but an S&P 500 rally not harnessed is practically grounds for dismissal in most corners of the industry. This explains the home bias present even in professionally managed portfolios – whereby the typical equity mix looks more like 60 to 80 percent US stocks vs the global reality in which US stocks comprise just 48% of the world’s capitalization.

It is strategic – and in their personal best interests – for money managers to run to US stocks every chance they get, especially during a bull market. And as the economy has become more financialized, with more professionals involved in the business of Other Peoples Money (OPM), equity market multiples have gradually drifted higher. This is what the CAPE Ratio adherents haven’t been able to grasp – the answer to why US stocks have been “overvalued” by historical standards 98% of the time since 1989 is a behavioral one. Good luck finding “job security” in the data.

The close cousin of this strategic flight to safety, the flight to safety happening with corporate share buybacks, is almost never far behind.

Prior to 1981, public companies were limited in terms of how much of their own stock they could buy back and how they executed it. Back then shares were bought back at a fixed price tender offer, announced in advance. President Reagan’s Securities and Exchange Commission deregulated the buyback process and ever since it’s been open season. Shrinking one’s publicly available float has gone from novelty to condition of employment in the C-Suite.

Corporate managers now face an unprecedented job security threat level in the form of activist bazillionaire hedge fund guys who demand massive buybacks – whether with cash or newly issued debt – almost as a matter of course. It’s hard to find a 13D filing that doesn’t reference the filer’s desire requirement for a share repurchase bump. According to the Shareholder Director’s Exchange, activist hedge funds now have a warchest of over $100 billion – a triple from what these operators were playing with in 2008. The average market cap of a public company being targeted by activist investors has doubled from $4 billion to $8 billion in just the last three years, the SDX tells us, and with Carl Icahn banging on Apple like a gong, every CEO in America is vulnerable.

And you wonder why companies are buying back shares like there’s no tomorrow – between $75 billion and $159 billion a quarter for the past four years – the alternative is literally being fired.

The evidence suggests that the only net buyers of US stocks thus far in 2014 are corporations executing buybacks. Participants among most other categories of investors are shown to have been net sellers, and still the S&P drifts higher.

The next time you hear the term “flight to safety” being used to describe a 2 percent correction or a quick race into cash, remind yourself that what you’re really witnessing is more like a momentary un-rally, a tactical flight driven by a handful of panicky players or over-margined hedge funds.

Because the real flight to safety is the one that is measured in months, quarters, years and decades. And the destination of this flight, in the end, is toward US stocks.

This is the only flight to safety that really matters.

And yes, of course I’m hooking you up:

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