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Thinking Inside the Black Box of Corruption

By:Tim Knight

Our resident technician opines on the unseen forces influencing stock prices, corporate buybacks and corporate bailouts

  • The idea of corruption is evolving.
  • Young people growing up amid corruption accept it as the norm.
  • The incentives to perpetuate corruption are too effective to go away.

If you had asked me a week ago what the word “corruption” means, I would have said it’s things like bribing a government official. In other words, it’s a way to bend the rules in your favor by doing someone a favor or handing them a payoff.

But in the past few days my notion of corruption has broadened—or at least changed. Now, I think of it as what is going on inside a black box. In a normal system, if “A” goes into the box, and you can expect “B” to come out, then “B’ usually emerges. However, if the box spits out “X” instead of “B,” something foul is afoot inside. It isn’t operating as expected. The innards of this hypothetical box are ... corrupted. The outcome does not comport with the expectation.

Such a characterization would easily include the earlier example of bribery. In a well-functioning state, people follow the rules because the rules are there for a reason. In a corrupt state—like, oh, let’s just say, Russiaonly President Putin and few other villains know what will come out the other side of the box. We don’t know what favors, threats or bribes are taking place behind the scenes.

New corruption perpetuated Russian poverty

Failing to realize that caused me to make an error in my younger days. I excitedly anticipated Russia’s future when the USSR fell to pieces. I essentially “projected” the free enterprise system of the United States onto the newly liberated people of Russia and assumed it was like the birth of a nation. My perception was that free markets had “won” and that it was the end of history. Conflict would largely end because capitalism would save us all.

Nope. Not even close. The corrupt Soviet system was simply replaced with the even-more-corrupt Russian Federation, and you wound up with a handful of oligarchs. They were essentially murderous thieves who kept the vast majority of the population mostly impoverished.

Of course, cultures tend to be persistent and deeply rooted. Ten years from now, I would fully expect Denmark to be as free of corruption as it is today. Likewise, I would expect Somalia to be every bit as corrupt then as it is today—if not worse. Young people growing up in a corrupt environment accept it as the norm.

Ya gotta pay to play,” as they say. It’s a tragedy because every human comes into this world as an innocent. But their surroundings poison them and fully prepare them for an adulthood of perpetuating the problem, even if it’s against their will.

Equity market corruption

This ties into equity markets, which I consider deeply corrupt now compared to the 1970s. The corruption comes mostly from exogenous sources. (I’m looking at you, Yellen!) But, off the top of my head, what constitutes this “corruption” is:

  • Limitless corporate buybacks of one’s own stock;
  • Endless bailouts by the Federal Reserve for any company or fund that has trouble;
  • Trillions of dollars in asset purchases by the Fed, which flows into equities;
  • The direct purchase of exchange-traded funds (ETFs) by the federl government;
  • The willingness to go into debt ($33 trillion) to create the simulacrum of prosperity.

The result has been that the best strategy is to just to keep throwing cash into stocks willy-nilly because, over time, it is virtually guaranteed to be worth a lot more. That has worked with few interruptions for the past 40 years.

It does tend to diminish the value of analysis, however. The methods from earlier times focused on management, products, growth, profits, the competition, and other elements of a corporate enterprise and its prospect for positive cash flow.

Understanding the plumbing

These days, it’s all about the “plumbing.” That is to say, the extraordinarily complex data flows pertaining to topics like reverse repo, fed assets, QE/QT, the BTFP program and so forth.

I have tried countless times to study and attempt to comprehend all these waterworks, and I haven’t been able to get my head around it. This has caused me distress because I figure I’m too block-headed to figure it out, but I’m comforted by the fact that I’ve read more than once that people who have been deep in the trenches with this stuff find it challenging as well. Indeed, my desire to untangle this mess is what compelled me to create Chart Lab in the first place.

So, will the “black box” of the stock market ever go back to an uncorrupted “A in, B out model as opposed to what we have now? I don’t think so. The incentives to perpetuate this curious situation simply seem too effective, and I’m not sure what would ever break it or compel the system the change. It’s simply too important to keep the show going.

However, the bumps along the way are going to be increasingly swift, shocking and violent. If you compare the COVID crash, which took only one single month from peak to trough, to the Great Financial Crisis, which took 18 times as long to play out, you can see what I mean. So, when the next shock comes, the “solution” will be even more modifications to the system that make the corruption even worse. The workings of the black box will become even more inscrutable and its output even more unpredictable.

Tim Knight, a charting analyst with 35 years of trading experience, hosts Trading Charts, a tastylive segment airing Monday-Friday. He founded slopeofhope.com in 2005 and uses it as the basis of his technical charting and analysis. Knight authors The Technician column for Luckbox magazine. 

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