Submitted by QTR's Fringe Finance

One of the more embarrassing habits of modern finance is its insistence on pretending the stock market has some integrity left.

Capital, we used to think, flowed to the most productive businesses. Prices reflected fundamentals. Risk was priced. The market, in the long run, separated signal from noise and rewarded cash generation over fantasy. That is the civics-class version of markets, and at this point it bears no resemblance to the one we actually trade in.

The market’s core failure right now is not simply overvaluation. Markets have always produced overvalued stocks. The deeper problem is that speculative inflation can now be mechanically converted into benchmark legitimacy and then forcibly distributed to passive investors as “diversification.”

In other words, the modern market increasingly allows stocks to get bid up through narrative, call option activity and momentum, then ratifies those bloated valuations through index inclusion, and finally pipes them directly into the retirement system through ETFs, mutual funds and model portfolios.

This is why we see ridiculous things like companies with negative earnings outperforming companies with positive earnings. “Something is broken in price discovery…” wrote Apollo’s Chief Economist about this chart last week:

He’s right. It’s not price discovery. It is a structural conveyor belt for institutionalizing air pockets and gutting the once conservative retirement and pension accounts millions of Americans depend on to be there for them in due time.

I laid this out in detail using SpaceX as an example on a recent interview I did with Adam Taggart. I used SpaceX as an example not because it’s the first company to ever do this — hell, I saw it all the time with Chinese reverse takeover scams back in the day — but because it’s the most recent…and definitely the most egregious.

The same critique people are beginning to make about SpaceX valuation applies more broadly to the public market. Narrative and scarcity can overwhelm cash economics for a very long time, especially when investors are convinced they are looking at a once-in-a-generation story.

In private markets that can happen through funding rounds, manufactured scarcity and marks that drift upward because nobody has to test them in public every day. Until, as we’re seeing in private credit, people eventually discover the “price” they were quoted doesn’t reflect reality and they rush to get their money back.

In public markets, the mechanism is different but the result rhymes: options flows, benchmark inclusion and passive ownership can all work together to preserve valuations that have floated far above what the underlying cash economics would ordinarily justify. And the rush to the exits ends the same way: there isn’t enough room for everyone to get out, all at once.

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That is the part that should make people uncomfortable, because it means the market is no longer merely tolerating excess. It is operationalizing it. The sequence is now obvious enough that it should not require euphemism.

First comes the inflation phase. A company captures the market’s imagination with a story large enough to suspend ordinary valuation discipline. Maybe it is AI. Maybe it is autonomous driving. Maybe it is space. Maybe it is simply the promise of scale, disruption and a giant total addressable market that no one will ever bother discounting back to the present. Whatever the story is, the important point is that the story arrives first and the cash generation can show up later, if at all.

Second, the options market does what it now routinely does in modern finance: it takes a speculative move and turns it into a reflexive one. Call buying forces dealer hedging. Dealer hedging forces more buying. The stock rises because the stock is rising. Price momentum becomes its own justification. “The market” appears to be voting in favor of the company, when in reality part of the move may have nothing to do with a sober reassessment of long-term cash flows and everything to do with plumbing. That alone would be enough to cheapen the credibility of price discovery. But the real damage comes from what happens next.

For the better part of the last two decades, and especially in the post-crisis era, markets have also been conditioned by a policy regime that repeatedly suppressed the cost of risk, flooded the system with liquidity and trained investors to expect intervention when things broke. The lesson absorbed by an entire generation of speculators was not that risk had disappeared, but that it had become someone else’s problem. Drawdowns were increasingly treated as temporary policy events. Volatility was an inconvenience. Valuation discipline became optional. If enough liquidity can be sprayed into the system whenever it seizes up, the market stops functioning as a mechanism for pricing risk and starts functioning as a machine for routing around it.

So by the time a stock has been inflated by story, momentum and options reflexivity, it is already trading in an environment where skepticism has been structurally disadvantaged. Then comes the canonization phase.

Third, once the market cap is bloated enough, index inclusion becomes automatic. The stock enters the benchmark not because anyone sat down and decided it was sensibly valued, but because the rules say it is now too large to ignore. At that point the character of ownership changes. Passive funds buy it because they have to. Retirement accounts buy it because they have to. Target-date funds buy it because they have to. Model portfolios buy it because they have to. Financial advisors buy it because “the index” is sold as prudence itself. What began as a valuation inflated by narrative, liquidity and options mechanics is suddenly institutionalized by passive ownership.

This is where the market stops being a market and starts looking more like a laundering operation.

A bloated valuation gets transformed into benchmark legitimacy, and benchmark legitimacy gets transformed into compulsory ownership by people who are explicitly trying not to speculate. The retiree buying an S&P 500 ETF is not making an active judgment on the most inflated companies in the index. He is trying to avoid making active judgments altogether. That is the whole point. But the system has arranged things so that his caution becomes the exit liquidity for somebody else’s euphoria.

And then the distortion deepens further, because overvalued names do not merely sit inside the index. They become the index, as we discussed in my above interview.

This is the part the passive revolution would rather not talk about. The benchmark is supposed to be the antidote to individual-stock insanity. You may not know which company is overhyped, fraudulent, or structurally unsound, but the index protects you because you own everything. Diversification is the defense. Except diversification stops working the way people imagine it does when the same overvalued names swell large enough to dominate the benchmark itself. At that point the index is no longer neutralizing the bubble. It is warehousing it.

And because this process is mediated through “passive” products, it becomes almost invisible. There is no dramatic moment when someone rings a bell and announces that the benchmark now contains a giant blister of overvaluation at its center. No one says the quiet part out loud: that a stock whose valuation was inflated by options flows and euphoric liquidity is now being preserved by forced passive ownership, and that this is happening inside the very products sold to the public as the safest, most diversified entrance into markets. Instead, the distortion gets laundered into respectability. Once a company sits inside the index, skepticism begins to sound unserious. If it’s in everyone’s retirement account, how crazy can it be?

Quite crazy, actually. Because if options, liquidity and narrative can help create the inflation, and index inclusion can help preserve it, then the crash mechanism is not exactly difficult to imagine. Once the story breaks, or liquidity tightens, or the options reflex flips, the same structure that held the valuation aloft can produce an air pocket on the way down. Passive ownership does not eliminate volatility. It can concentrate it. A stock that has become a major index weight does not just fall as an individual company. It drags on the benchmark itself. The “safe” diversified vehicle becomes the transmission mechanism through which the excess is spread to everyone, which is why I argued days ago that SpaceX could become “systemic”.

Quick note: this is why I own equal weighted ETFs for the S&P and not market cap weighted ETFs. In RSP (instead of SPY), every company carries approximately the same weighting.

That single structural difference dramatically changes the risk profile. Technology falls to around 18.27% of the fund instead of nearly 36%. Industrials become a much larger piece at 14.69%, financial services rise to 14.41%, and healthcare accounts for roughly 10.91%.

Instead of being overwhelmingly dependent on AI enthusiasm and mega-cap growth, RSP spreads exposure across the broader American economy. When I decided to completely stop trading and turn my last portfolio over to advisors, I requested SPY be excluded in favor of RSP for future recurring buys, as I expect it will plunge less than SPY if the market starts to tank.

The incentive is obvious. If a company can get its valuation high enough, through narrative, momentum, options activity and a market environment conditioned to treat risk as a rounding error, it can cross into a different category of ownership altogether. If executive compensation is based on milestones tied to market cap, revenue and KPIs and not actual profitability, you can become a trillionaire on three companies that have cumulatively made barely $50 billion in profit.

It no longer needs every marginal buyer to make a fresh, disciplined case for the business. It gets absorbed into the benchmark. From there, a portion of demand becomes automatic. Valuation no longer has to be defended in the old-fashioned way, through cash flows, margins and capital discipline, because the market structure itself begins doing part of the work.

That is the scandal. Not that some stocks are expensive. Not that markets occasionally get excited. Not that manias happen. The scandal is that the architecture of the modern market increasingly allows valuations to be inflated by reflexive mechanics, ratified by index rules and then distributed into the retirement system under the label of prudence.

At some point, we should be able to ask whether this still deserves to be called a market in the traditional sense. Markets are supposed to allocate capital, price risk and reward productive enterprise over fantasy. But what do you call a system in which cash-losing companies can outrun cash-generating ones for years, where options flows can overwhelm fundamental analysis, where a long era of monetary excess has dulled the fear of downside to the point that risk itself starts to feel optional, and where the benchmark products sold as prudent long-term investing become the vessel through which concentrated valuation distortions are transmitted to the public?

You call it structurally broken. OK, or, at a minimum, you stop pretending not to notice, for f*ck’s sake.

Because the most absurd part of this entire arrangement is not the distortion itself. It is the refusal to ask serious questions about it. We are now far enough into this cycle of options-driven inflation, passive absorption and index concentration that the mechanism is visible in plain sight. It is not some fringe theory. It is a description of how modern market plumbing interacts with investor behavior, monetary excess and benchmark design.

So the real question is no longer whether the market can keep getting weirder. Of course it can. The real question is when we stop treating these distortions as amusing side effects and start treating them as evidence that the structure itself is rotten. When do we stop calling it diversification when the same overvalued names are swelling at the center of every index? When do we stop pretending that forced passive ownership is a neutral outcome rather than a way of institutionalizing euphoria? When do we stop nodding along as options-driven inflation gets converted into benchmark legitimacy and then into retirement-account exposure?

And when, exactly, do we admit that a market which can be gamed this way is not merely overheated, but fundamentally unserious? Sadly, I know the answer. After the wreckage and the crash, when it’s too late.

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