How the conditions that create bull markets inevitably lead to fraud

“The fox is guarding the hen house.”

So said John McCain criticising the Securities and Exchange Commission, back in 2002.

Enron and WorldCom had been discovered to have committed accounting fraud, and it’s no coincidence that these scandals coincided with the bursting of the tech bubble.

There is a logical link between fraud, scandal, and the ending of a bull market.

In fact, the appearance of fraud and scandal is a sure-fire sign that we are well into the end zone of this particular game.

Let me explain.

The business cycle swings to and fro.

After a recession, confidence slowly returns and good times begin once more. Companies and competition have been swept away by the recession, leaving room for the survivors and new entrants to grow and gain market share.

Some get excited by this growth, and forgetting the errors of their predecessors, decide to try and grow even faster, by using debt to fuel growth, often by acquisitions.

Once one company in a competitive sector begins to leverage up and grow more quickly, others must respond, and as competition grows for new market share, profits begin to dwindle.

Perhaps one company starts delivering a slightly better product, or another starts offering lower prices.

In such a situation, a company which has taken on more and more debt, leveraged to the hilt, starts to see its growth trajectory fall.

It must grow rapidly in order to sustain itself, as the large pile of debt has a growing interest burden attached.

This is when the so-called “Minsky Moment” arrives.

When a debt burden crosses over from the sustainable, manageable level into the unsustainable level, companies begin to run out of options. Default, renegotiate, try and survive, innovate… or in some cases, lie.

Enron and WorldCom were the most widely publicised corporate scandals from the tech bubble of 2000.

But take a look at what has been going on recently, and you’ll see that conditions are ripe for greed, excess, and deceit. And people have not been sitting idly by.

Wirecard, Nikola, and WeWork are the main three, but there are others.

There’s the 1MDB scandal involving a Goldman Sachs-led fundraiser for the Malaysian state investment fund, from which billions were stolen, while Patisserie Valerie was found to have hidden overdrafts of up to $10 million in 2018.

More recently, Wirecard was a proper Ponzi scheme, with fake accounts, fake customers and fake profits that went undetected by regulators – who even had the cheek to investigate journalists who were pointing out the fraud, accusing them of potential market abuse. The company is being sold for parts.

Nikola has been shown to have overstated its current capabilities, lied in marketing material, and misled investors. It rolled a truck down a hill, and led investors to believe it was self-propelled. The CEO Trevor Milton has fled, shortly after tweeting “cowards run, leaders stay and fight”.

WeWork was a governance disaster and a valuation fraud. As soon as its prospectus entered the public domain, it became clear just how wildly overstated its $50-$100 billion valuation was.

It had to be bailed out by Masayoshi Son of Softbank, amongst others, within weeks of its cancelled IPO.

An increasing emergence of major corporate scandals and fraud is a sure-fire sign that the economy isn’t doing so well, and that financial conditions (easy money, low rates) have created the conditions for lying and fraud.

Tesla will come soon, I am sure of it, but that’s a story for another day…

Finally, it’s not a scandal, but today we found out that Arcadia, which owns Topshop and Dorothy Perkins, is in grave financial danger, threatening 13,000 British jobs.

This is just sad, obviously. But it’s also another sign that coronavirus is the ebbing tide, which will show who has been swimming naked, to reference Warren Buffett’s famous saying.

Expect more fraudulent behaviour to be discovered before this is all over.


No, that’s not a Latin motto, or secret code.

It’s another interesting thing I spotted this week!

It is the relationship between the Relative Strength Index (RSI) and the S&P 500.

The RSI is something I’ve looked at briefly but in no great depth in these pages – mainly because I don’t understand it very well, so bear in mind this next point is an observation/enquiry which has made me curious, rather than a point made with any great conviction.

The basic premise is that it measures how under or overbought an asset is, in this case the entire S&P 500.

It does this by using current prices vs recent prices.

The higher the RSI score, the more overbought the index is, in basic terms.

However, something strange happens around the two previous peaks in markets. And it’s happening again.

Can you spot it?

Source: Koyfin

The RSI actually seems to start falling before the US stock index peaks. Quite a long way before, in the case of the tech bubble bursting in 2000.

And as you can see, it clearly peaked in 2018, and has formed lower highs since then.

It’s interesting, because the RSI tends to rise and fall in line with prices. When that relationship disconnects, you need to be careful.

I have this odd, vague, meaningless belief that the current bull market ended in 2018. And that everything since then has been fake or wrong, a sleight of hand, like a coyote flapping over the edge of a cliff.

I believe that without immediate and powerful central bank support, the end-of-cycle bear market and crash would have played out in the aftermath of the crash of winter 2018.

Source: MacroTrends

This would be my number one way of showing this – the S&P 500, but priced in gold.

This shows that the S&P actually peaked in 2018, if you account for the perceived devaluation of money since then.

2018 saw the start of the gold bull market, having risen from $1,300/oz to over $2,000/oz earlier this year.

The fact that the RSI has been setting lower highs since 2018, as it did in 1996-2000 and 2006/7, adds to this since that the coyote is over the cliff, and gravity will assert its inevitable power at some point soon.

Add in the increase in high-profile scandals of Wirecard, WeWork, and Nikola, and we are building a nice portfolio of alternative evidence for a cautious approach to investing.

Regular readers will be thinking yawn, we get it, stocks are expensive.

But my belief is that the psychology of a contrarian or bearish investor is fragile, and needs a regular, balanced and varied diet of nutritional information. Something to snack on as we hibernate, waiting for the sun to melt the snow.

Otherwise watching stocks rise, when in all honesty they probably shouldn’t, can be tough, and having positioned ourselves cautiously, the worst thing we can possibly do is cave, throw in the towel and re-enter the fray at its most frenzied and elevated point.

(For reasons why, see: Isaac Newton, South Sea Bubble.)

That’s all from me today anyway.

Have a great weekend, I’ll be studying how to incorporate environmental, social and governance into traditional investment methods. Lucky me!

Kit Winder
Editor, UK Uncensored

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