There are some lessons that you can only learn sitting on an institutional trading desk. Until you actually experience them, you would almost be hard pressed to believe that they can be true.
Most non-trader types have this quaint notion that markets are efficient. They seem to think that the moment an asset gets slightly out of line with the fundamentals, there are a myriad of other participants ready to take the other side of the trade. Nothing can be further from the truth. First of all, how do you really know the “fundamental value?” There are so many unknowns that at best all you can do is assign a range of most likely outcomes. Not only that, these outcomes are often years and maybe decades down the line. With what sort of precision can you assign a fundamental value to Tesla? A decade from now, it could be a $2,500 stock or it could be bankrupt. If you create a probability matrix for these outcomes and come up with a “fundamental value” of $300, do you really want to buy it the moment it goes from $210 down to $205? The answer is of course you wouldn’t.
Which brings me to the ugly truth of the day to day trading of these assets. Over the short run, human nature dictates much more of the day to day movement than almost anyone would ever guess. And until you have sat on an institutional desk and watched a big client buy a stock each and every day, in the process almost single handedly sending the price to the moon, you would never imagine that the price could be so arbitrarily jerked around.
I suspect that many non-trader types reading this are still skeptical. But the guys who have sat there executing these types of orders are nodding their heads in agreement. They understand what it is like to execute large orders for clients. They know the pain from trying to capture the client’s business by agreeing to short a portion of the order to get a big block trade done. Only then to find the client return day after day, after day, after day, refusing to let the stock breathe as the sell side trader desperately waits for a break to get his short back in. Institutional sell side traders have all seen big clients fall in love with stocks, and somehow convince themselves that it is acting well (even though it basically going up because they are the ones buying), and the positive price action only encourages them to buy more.
But the lesson about this type of buying is that eventually no matter how big the client, the buying dries up. And then depending on how far the client has driven up the asset, there is a big correction that CNBC types are at a loss to explain, but all the institutional traders know that Fidelity or Cap has simply finished buying.
Usually this sort of inefficiency only happens in individual stocks. But I am convinced that we are experiencing this same sort of order in the broad market today. I have no way of proving this, and I know all the bulls will tell me that stocks are going up on the great fundamentals, but I continue to call bullshit on that claim.
I contend that the main driver in this massive stock market rally of the past month is the Japanese Government Pension Investment Fund’s (GPIF) massive asset shift out of bonds into stocks. In the process they have pushed stocks up to levels where the next large “fundamental bids” are a long way down.
We are up here on air, and as long as they keep buying, everyone is patting themselves on the back convincing themselves everything is rosy.
However it is no coincidence that over the past couple of days the Yen has rallied 4 big figures, and the stock market finally took a breather. My suspicion is that the GPIF stepped away this week, giving the market a chance to settle down without their relentless Yen selling and stock buying. As soon as they did that, the Yen went from 122 to 118 in a blink of an eye, and stocks followed lower.
Yesterday morning we got a taste of what it is going to look like when the GPIF walks away. Stocks were accelerating to the downside and the Yen was screaming higher. But then at 1030am there were rumours that GPIF was back on the bid for the USDJPY rate (selling Yen) at 118. I saw the tweet from one of my FX trader types, and from then on, the Yen went down and stocks went straight back up.
I know that many will think that I am assigning too large an effect on a single entity’s order. And maybe they are right. Maybe the US stock market’s fundamentals justify a relentless two months of straight up. The fact that the recent rally was the longest rise ever to stay consistently above the 5 day moving average is completely natural. It was merely the market reflecting the improving fundamentals.
I know I shouldn’t stoop to sarcasm, but the crap that passes as explanations for why the market has exploded higher just astounds me.
Here is how I see it. In September the stock market was in the process of correcting from an overbought situation. Given the Fed’s withdrawal of QE, it makes sense that stocks sold off. But in the midst of that sell off, the Japanese government went even more all-in-er with the next wave of QE. This coincided with a large asset shift at the GPIF, which would in essence be selling their existing JGB holdings to the BoJ, and buying stocks with the proceeds. Ever since then, stocks have been relentlessly bid and the Yen has gone straight down.
I will repeat it again – we are up here on air, and the moment that the GPIF walks away, we are going to have a big correction. I have no idea how big their order is. I am not saying when it will end. But I don’t buy for one second that this is anything more than one of the largest institutional orders that the world has ever seen.
Yardeni “fundamental” indicator
I am a big fan of Ed Yardeni’s work. One of his proprietary indicators that I watch closely, he has labelled his “fundamental” indicator.
I thought I would just take a second to post an updated chart.
The indicator has been sinking fast for the past month as the stock market has exploded higher. I wouldn’t count on this divergence lasting forever…