After another day on Thursday of stocks starting to look mildly tired – but only mildly – only to rally back to a new closing high, it hardly seems unusual anymore. I have to keep pinching myself, reminding myself that this is historically abnormal. Actually, very abnormal. If the S&P 500 Total Return Index ends this month with a gain, it will be the second time in history that has happened. The other time was in 1936, as stocks bounced back from a deep bear market (at the end of those 12 months, in March 1936, stocks were still 54% off the 1929 highs). A rally this month would also mean that stocks have gained for 19 out of the last 20 months, the longest streak with just one miss since…1936 again.

But we aren’t rebounding from ‘oversold.’ This seems to be a different situation.

What is going on is confounding the wise and the foolish alike. Every dip is bought; the measures of market constancy (noted above, for example) are at all-time highs and the measures of market volatility such as the VIX are at all-time lows. It is de rigeur at this point to sneer “what could go wrong?” and you may assume I have indeed so sneered. But I also am curious about whether there is some kind of feedback loop at work that could cause this to go on far longer than it “should.”

To be sure, it shouldn’t. By many measures, equities are at or near all time measures of richness. The ones that are not at all-time highs are still in the top decile. Buying equities (or for that matter, bonds) at these levels ought to be a recipe for a capitalistic disaster. And yet, value guys are getting carried out left and right.

Does the elimination (with extreme prejudice) of value traders have any implications?

There has been lots of research about market composition: models, for example, that examine how “noise” and “signal” traders come together to create markets that exhibit the sorts of characteristics that normal markets do. Studies of what proportion of “speculators” you need, compared to “hedgers,” to make markets efficient or to cause them to have bubbles form.

So my question is, what if the combination of “buy the dip” micro-time-frame value guys, combine with the “risk parity” guys, represents a stable system?

Suppose equity volatility starts to rise. Then the risk-parity guys will start to sell equities, which will push prices lower and tend to push volatility higher. But then the short-term value guys step in to ‘buy the dip.’ To be clear, these are not traditional value investors, but rather more like the “speculators” in the hedger/speculator formulation of the market. These are people who buy something that has gone down, because it has gone down and is, therefore, cheaper, as opposed to the people who sell something that has gone down, because the fact that it has gone down means that it is more likely to go down further. In options-land, the folks buying the dip are pursuing a short-volatility strategy while the folks selling are pursuing a long-volatility strategy.[1]