Last week, I was privileged to be a guest on Bloomberg’s “What Goes Up” podcast. I had a wide-ranging discussion with the hosts Michael Regan and Vildana Hajric, and monetary policy featured prominently. Around the 11:30 mark, I utilized a term that became the title of the episode — “Flight to Crap.” The podcast format didn’t allow me to fully explain the term, but this format does.
The term was actually a throwaway that I would use during frothy markets, and I’m not sure when I started using it. There were days when it seemed as though everything was going up for no apparent reason, and when someone asked why, I would throw out the comment “flight to crap.” During those sessions it was apparent that traders were gravitating to the most speculative stocks, bonds and currencies, and risk management was largely eschewed.
It was a play on the well-known phrase and phenomenon of “flight to quality.” If you are already familiar with the term, I apologize for the upcoming explanation, but the phenomenon has become rare over the past year and a half, so newer investors may not have experienced one yet. A “flight to quality” occurs when traders and investors want to reduce their portfolio risk, often in response to a significant geopolitical or economic event. It is characterized by a movement away from more volatile assets into traditional safe havens. US Treasuries tend to benefit during flights to quality, with short-term maturities benefitting more than their longer-dated counterparts. Stocks tend to sell off on those days, with defensive sectors like utilities outperforming more speculative, high-beta stocks. Emerging market stocks and currencies tend to suffer as traders in more established markets bring their money closer to home.
I unveiled the term for readers last June, in a piece entitled “We Saw a Flight to Quality. How About a Flight to Crap?” At that time we were seeing a rush by traders, newly emboldened by massive monetary and fiscal stimuli in the wake of Covid shutdowns, causing some speculative names to jump wildly during the first week of June. Interestingly, 5 of the 6 names mentioned in that article (LK, GNUS, CHK, XSPA, AAL) are lower now than they were then, despite a raging bull market in the intervening months. The exception was HTZ, which gave back all its gains before the end of the month and stayed at much lower levels for nearly a year.
The explanation I used in that article remains valid now:
“A potentially overbought market does not signify a flight to crap. If levelheaded investors can choose whether they agree with that narrative or not, and make an informed decision as to whether greed has outpaced fear in the short term, that is not the scenario that applies.
No, a flight to crap occurs when we see money piling into stocks or sectors strictly because they are going up, because speculative traders see the possibility of profit by jumping on a trend. This is momentum investment on steroids, when speculators see a trend and the only thing that matters to them is price movement. Fundamental valuations matter little, if at all.”
To be fair, despite the historically high valuations and potentially overbought conditions in global equity markets, that does not necessarily indicate that we are in the midst of a flight to crap. I reserve that comment more for the rush of money that we see into highly speculative, usually non-yielding assets. The rush into cryptocurrencies, which reminds me of high-priced internet stocks in the late ‘90s, has not only taken some dubious cryptos into wildly high valuations, but has fueled a rush into often silly NFTs. I am a believer in the commercial applications of blockchain, including NFTs, but I think only the most hardened NFT advocates would view the action in say, pudgy penguins, to be anything but froth.
This is why I am concerned about any moves by the Federal Reserve to reduce monetary stimulus. Yes, the Fed will only be taking its foot off the accelerator, not tapping the brakes, but many of the most excessive financial valuations are dependent upon an ever-increasing tide of new money. If that tide ebbs, let alone reverses, there could be many assets left ashore.
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