History Rhymes, Discipline Pays; Will Equity Markets Suffer a Setback?
Kevin Davitt | Dec 03, 2013 04:04AM ET
There is an important distinction to be made between "investing", where an individual makes decisions and allocates capital based on a longer term outlook and "trading". That is fairly self-evident, but I feel the need to clarify because for the most part, my ideas are efforts to identify potentially profitable trading (shorter term) opportunities.
For our sake, let's consider a TRADE, a position with a time frame with an expected duration of less than 1 month (30 calendar days). A TREND is a position that looks out 3+ months (at least 90 days). Whereas a TAIL or INVESTMENT is expected to be held for at least a year.
Before ANY capital is put to work, it's imperative that you consider the duration, percent of overall money dedicated to the idea, and your risk parameters. Get in the habit of asking yourself:
- Am I bullish, bearish, or neutral?
- Over what time frame?
- What percent of my capital base am I willing to lose on this idea?
The most successful people in this business are not necessarily the smartest or luckiest. They are, at least in my experience, the most disciplined.
When I started in this business (1999) the market was the place to be! Everyone was talking about it and options still had a bit of niche mystique. There were plenty of guys that just happened to be in the right place at the right time and made a bunch of money being part of a raging bull market. That happens. It's happening RIGHT NOW. Equities are up about 300% since early 2009. However you slice it..... that's a pretty good run. The major US Indices are up between 25% and 35% year to date.
However, I saw countless guys that had great years in the mid/late 90's looking for jobs by late 2000. It was ugly, but that also happens. It's how markets work - they are in a NEVER-ENDING dance between fear and greed. At the moment, Gordon Gecko's mantra is ringing out from Japan, to New York.
Greed (with some help from really cheap money) is GOOD!
There were plenty of exceptions when the dot com boom came to an end, and one in particular in my office. (I worked at a firm that had about 150 guys in Chicago and many others in NY, Philly, and San Francisco). I will never forget how well this particular guy did in 2000. Let's just say his bonus check would make most professional athletes blush. He was unequivocally the MOST DISCIPLINED guy at the firm. He was in early in the morning and stayed late. He knew his market inside and out and boy did he understand how volatility worked.
Moving on.......I feel very strongly that Equity markets may suffer a substantial setback in the coming year. This is NOT a trading idea - it's a trend > tail event. Those that read me regularly know that I often fall in the Contrarian Camp. This is no different. I would strongly encourage DE-RISKING in the coming weeks and months. I would also recommend hedges and owning "tail risk" (cheap 3+ standard deviation OTM options out in time). As a general rule of thumb, Insurance is considerably more expensive after your house is on fire.
From a TRADING standpoint, my inclination is to be SHORT PREMIUM and attempt to operate like the Insurance company. However, cheap money and long bull runs lends itself to complacency as evidence by the preponderance of optionable products trading at volatilities that are WELL BELOW multi year averages.
If you would like examples - feel free to ask. I really enjoy talking about implied vols. My wife is less enthusiastic. I digress.
Now for some facts that may or may not change your perspective:
Get The News You Want
- Recent AAII survey readings showed 47% BULLS and 28% BEARS. These readings have been more skewed in the past, but typically 70% is thought to be a potential sell signal.
- Recent Investor Intelligence survey showed 56% BULLS and 14% BEARS. This is the LOWEST Bearish sentiment EVER for this particular survey. (Going back to the late 1980s)
A handful of other sentiment barometers are flashing concern (Market Vane, Consensus Inc., Daily Market Sentiment, Hulbert). Citigroup's reading just breached the "Euphoria" zone. This measure last pushed to these levels in 2007 and 2008 as well as in 1999 (went considerably higher) and in 1987.
"Hot" retail money is pouring into the Equity markets and out of the Bond markets.
- Rydex Fund flows also indicate concentrated bullish behavior on the part of retail investors. Very low levels of cash in Rydex Money Market funds, coupled with the fact that Rydex' Levered Long fund is now 9 times the size (in terms of AUM) as the Rydex Levered Short fund.
- Margin Debt at the NYSE is at/near all time highs depending on whether you adjust for inflation.
- Corporate Insiders, who in my estimation likely have a more realistic outlook on economic prospects and consumer behavior at the margins than most Economists/Analysts continue to sell. The did so with greater conviction in the past (2007) but it's still telling, especially when you see where Insiders were buying (late 2008/early 2009 and late 2011).
- On the flip side, money is moving out of Fixed Income (US Treasuries) with considerable velocity. To be fair, this makes a lot of sense given years of low yield and the prospect of the Fed "Tapering" but when you push further and further out on the risk ladder for yield......people have a tendency to wade into waters that are too deep and incongruous with their risk profile.
- The exodus from US Treasuries began in May when Ben Bernanke insinuated that the Fed could slow their asset purchases before the end of 2013. Money has been consistently moving out of Treasuries ever since, which is unusual for the past 5-6 years. I must point out that Bonds have been in a bull market for roughly 30 years and at some point we should expect 10 year and 30 year bond yields closer to GDP growth plus expected inflation.
We work with an incredibly bright CTA with a Treasury market focus who has been growing assets over the past 12 months and, perhaps most important, the manager has unequivocally put his money where his mouth is- considering the percentage of AUM represented by his own investment. I rarely advocate for specific Commodity Trading Advisors, but I genuinely believe in Jim's trading thesis and ability to execute/perform. Feel free to send me an email if you would like to know more about Jim Daehler and Infinity Advisors Treasury Trading program.
The most recent Commitment of Traders report shows speculators with a sizable short position in the US Bond market. Current positioning (ahead of the November Non Farm Payroll data) is one of the most pessimistic in the past 5 years.
- In conclusion, I believe strongly that the nearly 5 year bull market in Equities is long in the tooth and de-risking should be a priority. At bare minimum consider hedging exposure out in time. I welcome the opportunity to speak in greater detail about my big picture outlook or some of the minutiae.
My primary focus at the firm has been on the Energy and Metals markets which have been volatile and regularly present potential entry and exit points.
- I find it interesting that Hedge Fund exposure to "Commodities" is near late 2008 lows. The CCI (Continuous Commodity Index) is clearly declining, but the Global Race to debase shows no sign of slowing. As a friend of mine is inclined to say, when Commodities go up we see inflation, but when Equities and Real Estate move 100%-300% over the course of a few years - we continue to fear deflation. Interesting.
While the Precious Metals get most of the attention as we plumb near multi year lows in Gold and Silver, the Industrial Metals have also come under substantial pressure. What does that say about growth prospects in 2014?
- Copper Commitment of Traders Report with Industrial Metals Index overlay:
Finally, a look at the Gold selloff compared to other bear markets in the barbaric relic and one time reserve currency (pre US Dollar and pre Bitcoin....smirk).
As Mark Twain said, "History doesn't repeat itself but it often rhymes".
I agree with ole Samuel Langhorne Clemens.
At some point in the coming months I expect Equities to make a meaningful top and Gold and Silver to present very attractive LONG TERM buy levels. Picking tops and bottoms is a fools errand, but being disciplined and being proactive...... that's often rewarded.
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