Over the past couple of days I have found myself in the unusual position of arguing that things weren’t that bad. Usually I am the guy warning that the stock market is setting up to disappoint. Too often I am the one talking about how it will all end in tears.
But this week I have found my usual pessimistic position much too crowded. Whereas a month ago everyone was extrapolating the bull market into infinity, now they are all extending downtrend lines to zero. It is shocking how quickly everyone has jumped from one side of the boat to the other.
Maybe I am being too cute by fading the recent sell off. Maybe the stock market went up way more than I would have ever guessed, and now it is going to do down way more than I would ever imagine. Maybe all these new found bears with visions of 2008 dancing in their dreams will be correct.
However I am going to listen to that great trader Yogi Berra who knew enough to avoid crowded trades. Although I believe we will eventually have a big sell off in the equity market, I don’t think this is it. All of these guys puking out their positions 150 S&P handles lower than last month’s high are panicking.
The credit crisis of 2008 left quite a scar on the investing public. I know that I made the mistake of getting bullish too early. Coming into the decline, I had set up bearishly, covered it into the swoon, and then made the mistake of going long at what I thought were panic lows. Of course we all know the decline kept going, and going, and going.
Today as I write this, I am aware that I might be making the exact same mistake. But the fact that everyone expects a repeat of 2008 is exactly why it isn’t likely to happen.
In the 1990s I worked as the institutional equity index trader for Canada’s largest bank. I was the upstairs guy that traded with the institutional clients, but my partner was down on the Toronto Futures Exchange floor executing the futures portion of our book. My partner was a great guy. He came from a family of 10 or 12 or something like that. Most of them were firemen or had some other noble careers, but a couple of them had wandered over to Bay street to scratch out a living trading. He was the kind of guy you wanted in the fox hole with you. One day I was down on the floor for some reason or other, and I was watching him trade. I noticed that one of the locals would not execute any orders with him. I asked if somehow he had somehow pissed that guy off (which I thought highly unlikely as my partner was pretty well loved by all).
“No, not at all – we get along great,” he replied.
“Then why won’t he trade with you?” I asked.
“Oh that…” my partner paused and then continued, “he keeps track of every trade he does and then does analysis of each trade’s profitability. He told me that over the past couple of years his trades with me have consistently lost him money… Lots of it. So he doesn’t trade with me anymore.”
Now some of the reason he lost money trading with us was because we had better information. We knew the big upstairs flows and could lean against them.
But the real reason he lost money was because most of the time we were simply executing index arbitrage. When the futures were pushed up to elevated levels, we sold the futures and bought the cash. Or vice versa. Either way, we were providing liquidity when the pit was demanding it. Here comes the real important part. We used to sell the high or buy the low of the day all the time. In those days stock indexes did not go straight up or straight down, but instead chopped around. So when locals got all bulled up they often made the highs, or when they were the most bearish, they puked into the lows.
During the last decade that has all gone away. Now we get all these unnatural straight up or straight down days without a pause. The stock market has trended like some stupid currency. It has taken all the fun out of the game… I know I sound like some old man yelling at the kids to get off his lawn.
I think most of it has to do with this dumb QE. There are other factors as well, but this whole risk off / risk on mentality has dominated trading for too long.
I don’t know if I am being foolish, but I really believe that QE is not coming back, and that markets are going to return to a more normal up and down trading.
If I am right, then dips are going to be buying opportunities and rips are going to be the opposite. Either way, the idea of just chasing momentum either way is going to punish you.
Most guys you read on the internet are usually always bullish or bearish, so how smart they seem will just be a function of the market’s action over the last couple of weeks. But I try to follow the guys who will actually change their views. During the last couple of weeks, these guys have all turned universally bearish. Some of them were smart enough to have pushed their luck a couple of weeks ago, and they have been rewarded handsomely. However, over the last day or two, they have gotten really beared up. There are all sorts of 1987 analogies in my research stream. I have read more articles about why the big bounce a couple of days ago was not the bottom than anything else. In fact, in terms of trading pieces, no one is willing to proclaim this decline is over.
I don’t know for sure if the bottom is in. But I do know that shorting down here is like the futures local that sold into program levels. Maybe it works every now and then when the selling snowballs on itself, but over the long run, it is a losing trade.
Wait for a chance to sell it. Wait for guys to tell you with certainty that the bottom is in – that is the time you should be getting out the pink tickets.
We are not getting more QE!
Many market pundits keep talking about QE4. Stop and think about this for a second. The Fed Funds rate is basically zero. Yet JOLTS are hitting new highs and initial jobless claims just ticked at 14 year lows. The idea that we are going to get more QE because stocks have fallen 8% is absurd. I know inflation is not meeting target, but that is why the Fed is going to be slow raising rates. Don’t forget that QE was supposed to be an emergency measure. It is not something that will be trotted out every time the stock market dips.
Yesterday’s initial jobless claims shows that the American economy is doing just fine.
In fact, it is better than fine. The Fed needs to let go of the training wheels and let the economy ride on its own. And they cannot be held hostage to Wall Street. If the leverage trades come off and risk assets back up, so be it. Wall Street is doing a shitty job pricing risk anyway.
Yesterday Fed member James Bullard panicked and said that the Fed should think about pausing the tapering. I sure hope that the grown ups put him back in his seat and tell him to shut up. The Fed needs to follow through with the elimination of the QE program. They cannot be seen to be wavering to Wall Street’s tantrums. They have a plan and they should stick to it.
If they do panic and pause the tapering, it will only cause the ultimate withdrawal to be all the worse.
This month of Fed bungling has shown that they really don’t have a plan. The famed “dots” don’t mean squat. They are flying by the seat of their pants and the market is waking up to this fact. They don’t need to lose any more credibility by pausing the taper.
Today Fed Chairwoman Yellen speaks. It will be the first time since the sell off accelerated. Let’s hope she stays the course and doesn’t panic. We need a steady hand on the wheel right now, not jerks based on the squiggles of Wall Street.