Pricing In The Future

the market is a discounting mechanism

To be honest this is something that took me a long time to understand, mainly because the words seemed impenetrable. But I am now starting to utilise this more in my trading and wanted a record of it somewhere.

how I understand it

For me, it was reading Barton Biggs, Wealth, War and Wisdom that hammered home this principle. Using WW2 for numerous examples he showed how good investors consistently priced in the events before they happened, meaning that reactions to the eventual event were often relatively subdued or counter to what Main Street thought would occur.

The reasons for these subdued or counter reactions were due to the Big Money (smart) averaging in and out of the market. They would do this either to disguise the size of their positions or simply as a tactic to manage risk; get in small then add if the position is proved correct. The problem for most small traders is they believe the lie: "Big Money is forced to average in and out of positions". No, Big Money chooses to average in and out of positions because it helps them get a better price and improves their edge by hedging spread, slippage and commission risk.

pricing in the future

My prior post is probably far better at explaining how to price in the future but I will try and explain briefly why the opposite of what is expected often happens.

Big Money is a buyer before a positive/negative event arrives (they preempt it). So when the event comes to fruition Main Street is often left surprised. What they failed to notice is the three-month rally Big Money created leading up to the event.

Not only do positive events cause relatively subdued reactions they can often mark market tops (the same is true of negative events and market bottoms). This, of course, is an illusion: it's not that the good news causes a market to crash, it's that when markets are already as long as they're going to get it will only take slightly less good news for Big Money to start taking profit and begin shorting in anticipation of a market fall.

summary

The only thing that can move the markets is Big Money, so we need to stop pretending to ourselves that we have an edge being small and fast: jumping in and out exposes you to the three constant risks of trading: commission, the spread and slippages. Start doing what Big Money does; get ahead of Main Street,  be aware of what's on the horizon, buy low (demand), sell high (supply) and average in and out of your positions as the market approaches these places.

Interpreting News, Events and Politics

Despite writing about this in the past, with the current "politically motivated" market I wanted to write a short piece for my records on how I am using news and events to plan for trades.

recap

 I like to view markets in one of two states.

1. uncertainty - in this state risk is perceived as unlimited;  causing falls.
2. stabilised uncertainty - in this state most fears are allayed; causing rises.

Each state is caused by a catalyst.

1. a negative catalyst - gives birth / creates "uncertainty".
2. a positive catalyst -  gives birth / creates "stabilised uncertainty".

When dealing with political change it's easy to get personally involved. I can't say "don't" because it's human nature to do so. What I can say is: as a trader you are trying to be a wolf and to be a wolf you need to understand what scares the sheep. If you can figure out what scares and soothes the herd then you can better plan how you're going to eat them.

The things to focus on are the catalysts/events and the run up to them. In the markets, there is always an element of uncertainty but will the upcoming event calm or agitate nerves?

Below I cover the two states and catalysts in more detail with examples.

the negative catalyst (event)

Is an event that threatens the status quo. They can occur at any time.  If they happen to coincide with an uptrend they often mark the top of a market, although the lead up to the catalyst may well mark the extreme.

One might first think Brexit but they would only be half right. Brexit was a complete surprise and the FTSE and GBP fell, but they didn't really fall on "Brexit". Instead, the fall was caused due to the lack of information in regards to how the UK government would deal with it. The only rhetoric from the government prior to Brexit was negative. As such this lack of planning and "project fear" caused the uncertainty and the ensuing drop.

uncertainty (state)

A "catalyst" (event) which the market is finding hard to quantify will cause it to drop. A negative catalyst is the birth of uncertainty. The market will then remain in this "uncertainty" state until a positive catalyst changes how markets perceive risk. 

positive catalyst (event)

a stable base to start again from

Is an event that changes how the market perceives uncertainty. They can occur at any time.  If they happen to coincide with a downtrend they often mark the bottom of a market, although the lead up to the catalyst may well mark the extreme.

Shortly before A50 was invoked, Theresa May set out how the Tory government was planning to deal with Brexit. This in itself did much to allay market fears in regards to Brexit and was a positive catalyst. A50 itself was not a catalyst but the rhetoric coming from both May and EU leaders post A50 were. Both signalled how they were planning to deal with the situation. The thing to remember here is the catalyst doesn't need to be particularly upbeat it just needs to be clear and definable so markets can digest it and adjust risk.

stabilised uncertainty (state)

Any "catalyst" (event) which helps the market quantify risk will cause it to rise. A positive catalyst is the birth of stabilised uncertainty. The market will then remain in this "stabilised uncertainty" state until a negative catalyst changes how markets perceive risk.

note on Trump

Trump was seen by many as deeply risky but markets rose on his win and inauguration, why? The fact is he was quantifiable. Before he won he had clearly stated what he was going to do: cut taxes, start fiscal spending and negotiate better trade deals. So on his win markets rallied because the event was quantifiable. His win was in effect a positive catalyst. An interesting note here is that had Clinton won, her's may have been a negative catalyst. She had a schizophrenic relationship and views on Wall Street and her policies were unclear.

Too Much Reading, Not Enough Writing

intro

So last week I walked into one of those "what the fuck is going on?" headaches. I felt overwhelmed by information and uncertainty over the true macro/geopolitical driving forces.

issue

I read the FT on the weekend and MoneyWeek / ZeroHedge/ Twitter throughout the week. This may sound like a lot but honestly it's quite manageable. The FTWeekend is consumed on the couch or coffee shop, avec wife.  Money Week is my Monday - Friday 10 minute "commute read" and twitter is light entertainment when I'm taking a dump.

It's not so much the quantity of "news" I'm reading but the "news" itself that is causing the headache.
In the last two weeks I have noticed two things: One, the distinct lack of news and regurgitation of articles. Two, a plethora of opinion pieces. Both of which piss me off because repetition, by definition cannot be "new" and opinion, by definition isn't "fact", so neither are in anyway useful.

However what I believe is the main cause of my befuddlement, is not my reading sub-par articles but the lack of time I've spent writing about what I've been reading over the past few weeks, I haven't been formulating my own ideas. Of course I'm confused.

summary

Like the title says, I'm reading too much and not writing enough. To put it another way I need to make more regular visits to this blog. Admittedly there are less trades to chronicle now that I'm trading off W1 charts but that doesn't mean that there aren't ideas that need to be documented.

(rant and self flagellation over)

Where Is The Value?

Apologies to my regular readers, I have been flat during recent volatility waiting for a position trade (and reading far too much), please indulge me.

Brexit then all time highs in stocks?!

As always supply and demand are ruling the markets but whose cash is buying the "trash" and why? I'm all for Brexit but this is BS. Of course, I'm not going to fight the market however with no growth or inflation and lower earnings, stocks fundamentally shouldn't be where they are.

the twilight zone

When has buying a poorly run company with no growth prospects made you money? As far as I'm aware never, until Bernanke and the Federal Reserve dropped the best part of one trillion dollars into markets in 2009 to keep them up. Call it what you want quantitative easing /buying debt. The truth is they didn't drop it, they pushed $1T into the markets by buying bonds and shares, this created demand-pull inflation in share and bond prices because there weren't enough to buy, so the only thing that could happen was for share and bond prices to be pulled up. It's demand and supply; if there isn't enough of something the price will go up, even if it's manure. Then of course the Bank of England, Bank of Japan and ECB got the "QE" buying bug and we've had nearly eight years of bull (shit) market. GDP down, inflation none existent, wage inflation nope.

note ascending stock prices (green), despite declining growth prospects (red)

note ascending stock prices (green), despite declining earnings (red)

So what just caused the most recent spike in the S&P500 to all time highs? As per usual for the past eight years it was another bout of central bank QE.

Note the rise in Bank of Japan (red) and European Central Bank (blue) asset purchases recently.

feed the rich

The rich have got richer and the poor have got poorer and you can see why; the central banks have only put money into things the 10% and 1% own. I am a capitalist but this is not capitalism and feel I am not overstating it when I say, central bankers have stolen our democracy. There is the perception of having choices but where are they?

The young can't choose to save because there's no interest. Central brothers, sorry "central bankers" take control of private companies because they're "too big to fail", thus management can't choose to go bust or become more efficient. Their only option has been unending stock buy backs (buying shares back off investors) inflating stock prices (to seem healthy). Worse still central bankers have stolen our job choices which has contributed greatly to the recent bout of xenophobia in the US and UK.

Believe it or not an economy based only on national demand and consumer credit (western world since 2009) creates low paid jobs. So we're now battling the migrants for the jobs that we traditionally never wanted; the fact is they're not stealing our jobs, we're stealing theirs.

To me the central banker is a dictator in everything but name. We can't get rid of them, even if we do we'll just get a carbon copy in the next one because they're brainwashed by "quantitative easing" group-think. They take away our freedom of choice and impose their will on the majority. Is there not an Orwellian stench in the air?

brexit

Brexit is good, the EU is a shambles. If you hadn't noticed there's yet another banking crisis (finally) being reported in mainstream media. But don't be fooled by them it's not Italian, it's Italian, French, Portuguese, Spanish and as it turns out German.

Deutsche Bank the biggest bank in Europe has failed two stress tests in as many years, has no capital or revenue and has recommended a €150B bailout for the EU. While Italian banks are weighed down by €360B of bad debt (about a fifth of its GDP). What's more is Italy’s terrible economic performance; it is still 8% smaller than it was pre-crisis. So it's not that surprising that UniCredit, Italy's only systemic bank of importance is in trouble and is being forced to sell its good assets. There is also the serious risk of contagion. French banks are exposed to €250B of Italian debt, German banks hold €83.2B,(Deutsche Bank alone has €11.8B) and Spain €44.6B.

While in the EU: unemployment is sitting at 10% and growing, youth unemployment is at 21% for the region but is hitting far higher levels across the region (as high as 50%) and EU growth is currently 1.7%... However paraphrasing the ECB, with the UK leaving, it will likely lose 0.6% of that (my guess is it will be more) so in reality, EU growth is probably somewhere under 1%.

youth unemployment in the EU

One final point here. Let me just mention how well the EU manages its deficit offending member states when they don't obey the rules. How many debt defaults there have been in the EU since 1999? Take into account the (PIIGS) poorer countries, 20? 50? No, try 165 unpunished deficit breaches. Hardly inspires confidence.

the uk

Well the UK isn't doing that well either? Not an unreasonable statement however every UK bank has passed rigorous stress tests for two years running, unemployment is sitting at 5%, youth unemployment's at 13% and we're growing at 2% a year, all healthier than the EU. Absolutely, our growth rate might flounder in the next twenty four months as we negotiate our exit but as I've been highlighting that will really depend on central bank policy. With Carney (BoE) promising £150B in liquidity to UK banks on the 24th July and with more to come if needed, this is far from certain. However for the same reason, a weak GBP for the foreseeable future is easier to predict; starting the money press will create a glut of supply and thus lower prices/valuations.

We'll lose our trade with the EU and the world? I can't see this happening. Sure banks will need an arm in the EU but only 7% of asset managers are thinking about moving operations out of the UK. 60% of our trade is with non EU countries and the EU sells more to us than we do to them; exports to the EU are only about 13% of the UK's economy. This is precisely why most EU members are already in "informal discussions" with the UK (the power Junck-y is forbidding anything else). Australia has just offered the UK a free trade deal. While it turns out the UK is now at the front of the US queue, with the Obama administration initiating discussions with UK officials about a bilateral trade pact. A pact like this will be more focused to the UK's needs and it's hard to argue a deal within the EU would come close to this. Plus despite all that "EU trade", the average UK individual hasn't exactly got any richer in the past eight years, which is precisely the point of Brexit.

going forward

Davis (Johnson and Fox) want to move the UK into being a more international, export led economy, think China. This kind of economy would have far better potential to create stronger GDP (growth), a growing middle class, better jobs and higher wages. All of which will help fund government services and reduce our national debt. But be prepared, an export based nation prefers a weaker currency; so we might want to get used to and start embracing our weak GBP, it could well be permanent and the new sign of health.

My guess is the EU will fudge its seven month old law, that no country can be bailed out unless shareholders first take an 8% loss, This is because this would mean Italian voters would take an EU enforced loss of around €16B before the Italian referendum in October. While the Bank of Japan will likely break its own laws and buy the US Chinook, (adopt helicopter money) because America (The US Treasury and Bernanke) tells it to, Carney will probably start the sterling printing press in the BoE's August meet and this farce will continue.

UK options as I see them...

1. We reform (some form of Brexit), reinvent our economy, gain stronger growth, real inflation and reduce the roughly two trillion pounds we still owe the central banks. Then attempt to get over this mess.

2. We follow the "do nothing, the central bank will sort it out" approach of the EU and it will all eventually blow up. But only after ruining the future of several more generations of youth whose governments will no longer be able to function due to the crippling debt (think tens of trillions of pounds) they owe the central banks. All the things we love today (NHS, housing, benefits) will, if we're lucky, survive just long enough to see us out or already be privatised. While the youth won't be able to afford any of them because we will have remained a national, consumer credit driven economy with low paying jobs, tied to a "union" of countries with an atrocious history of fiscal and monetary policy.

To me it comes down to "moralism" or realism. It's easy to say what's right or wrong but it's much harder to deliver it; this is the crux of why I am a blue.

Morality is expensive to deliver and it is my unwavering belief that we'll have a better chance of doing good and delivering morality long-term, if we focus on correct fiscal & monetary policy and capitalism (even if this brings around a temporary decline). No they're not perfect but they have a far better history than the alternatives.

our money?

Believe it or not I would like to see a crash. As I've tried to explain, what has happened for the past eight years is not sustainable or real; the UK (and world) needs a crash for long-term sustainable growth. Stock, bond and property prices would return and represent true value. Companies would be forced to innovate and a low GBP would make it easier for our exporters. With Brexit deals already in the pipeline we will have the opportunity to trade with nations experiencing far faster growth than the EU (which itself is near crash levels) and this will boost our GDP, jobs and inflation. Meaning higher interest rates which is good for savers but more importantly banks who have struggled to make money for the past eight years. This would mean a more stable financial system and better paid jobs.  All of which would mean greater tax revenues for the government to spend on services and reducing our national debt.

However my fear is: you can't fight somebody on a "monetary crusade" with an unlimited supply of cash. So for the time being we should probably be good party members and do what the central banks do, we might even make a little money.

I don't know about you, I think I might buy some tulips.

sources

ft.com

moneyweek.com

zerohedge.com

tradingeconomics.com

bloomberg.com

statista.com

conservativehome.com