Geopolitics & Trading Sentiment

Over the past few months my coach (Paul Wallace) has been emphasising the importance of geo-politics. He recommended I read Barton Biggs - Wealth, War and Wisdom -  and believe it or not I'm finding that a "geopolitical framework" is starting to crystallise. What follows are my thoughts to date.

my framework

My basic concept is really very simple; the market is more or less in one of two states.

1. Uncertainty (supply): Uncertainty of course exists in all markets. What I mean by "uncertainty" is an "opaque" risk / one that is becoming increasingly difficult to define and size. These events often build progressively, think pre Brexit, the 2008 GFC or 2015 crude supply glut. 
2. Stabilised Uncertainty (demand): Uncertainty still exists but it has been stabilised by an event or action, making a "transparent" risk that is easier to measure. Think post Brexit Carney /BoE promising £150B in QE, the Fed delivering $700B in QE in March 2009, Or in January 2016 simply the news that OPEC were finally talking about reducing crude output.

What is important here is news doesn't necessarily need to be particularly uplifting or downbeat, just less bad or good than it was previously. Biggs uses the Battle of Midway as an example. Despite WWII being far from over, the US Navy defeating the Japanese Navy was better news than had came before (Pearl Harbour). This marked the lows of the US stock market and the start of its recovery during that period.

brexit example

certainty - a predictive state

My final thought on sentiment is that I think it's fair to say that markets are always moving towards some kind of climax, this I see as two kinds of certainty.

1. Certain optimism: when the market and main street get to the point of believing something is genuinely amazing, the market is often overbought/topping. (Bonds and Equities)
2. Certain pessimism: when the market and main street get to the point of believing something is completely doomed, it is often oversold/bottoming. (Crude)

When things are at their unimaginable best/worst, there's really very little room for markets to climax further. Working on the Biggs premise that you only need slightly better/worse news than previously to turn a market, you can start to preempt tops and bottoms. Such as the DotCom bubble in 2000 or oil lows in 2016.

To be clear I'm not suggesting that one would trade "certainty", I see it more as a preemptive tool to start preparing for options in the other direction, if and when they are confirmed by events and price action. Actually it was this very thought coupled with a few events and technicals that made me want to get long crude last week.

summary

To me there is a catalyst that gets everyones' knickers in a twist, causing "uncertainty"(supply), then there is a "stabiliser". This doesn't eliminate uncertainty but creates a "stabilised uncertainty"(demand) that markets can rise in. Finally as a predictive tool I believe listening and looking out for when the market/world is in "certain" optimism or pessimism is a very useful tool to start preparing for a top or bottom.

Maybe my views will change again in time but at least for now this is how I believe markets work. What I like about this is that I have always believed markets move due to supply and demand. From a technical perspective I think I have a relatively good grasp of this but on a sentiment front this has always been lacking. Identifying what supply (uncertainty) and demand (stabilised uncertainty) look or feel like has strengthened my commitment to my strategy as it is starting to flow through the market in a more holistically way.