Bloggers and bears want it down. Punters seem to want it up. Baruch is a bit mystified when short-medium term market direction becomes an econo-bloggy subject; his invariable reaction is “how can you possibly know?” Personally, I rarely have a strong enough opinion about it for me to be willing to put it out there in public. In my job and in my blog posts, however, I do take implicit market directional positions. I have to, at times, go “all in” either as a bull or a bear, so like any punter I absolutely love a fully fledged trend in either direction. It makes my life so much easier. But I am always fully prepared to do the switcheroo and go completely the other way, and when I do I always mutter to myself “consistency, Baruch, is the hobgoblin of the small minded”.
Baruch is often confused. There are always valid-sounding arguments for what the market is about to do, many of which contradict each other. Investing is hard. What can bring clarity, however, is widespread bullshit reasoning in either direction. The more febrile and silly the arguments of one side, the more he senses weakness, a set of trapped investors, tied to one direction or another, getting increasingly desperate and likely to be imminently carried out. He may then be persuaded to back the other with his investors’ wonga.
At this point two arguments of the bears are very telling. Firstly Blodget and some bloke at Euronext fret that “real money” hasn’t joined the buying frenzy. And apparently there is a looming, mysterious “quant disaster” which seems to be a econo-bloggy undercurrent (all HT Abnormal). This makes him want to buy.
OK, every rally from a bottom starts as a “traders’ rally”. Fast money is, er, faster, and thus earlier. We should also question whether institutions actually have stayed out of the move. Hell, I work for an institution and we deployed our cash already. The big stock market rallies I have known, in my many years’ experience, have followed a fairly typical pattern: the trading hedgies and macro guys get in first, followed by the vanilla long shorts and nimbler mutual fund guys. It’s after that that the slower ones start to deploy their cash, the big institutions, then the big wealth managers, the private bankers. The typical rally might start to get a bit long in the tooth at this stage, and ideally one should start selling here, for the only ones left are the retail wealth managers, and finally the retail punters and daytraders who come out of the woodwork for their inevitable fleecing. This idea:
The real money investors are still waiting. I think they’re waiting, they’re watching. They want to make sure that what we saw in March is real. And I think once they are convinced you will know it. The market will have a totally different tone to it.
far from making me get antsy about whether I should be in or not, makes me want to buy more. We are still at the early stage of the sequence.
The Blodget argument, pace Hussman, that revulsion is needed before we can “put in a bottom”, well that sounds true to me too, but without a checklist of what constitutes an “adequate” level of revulsion, it’s just not that helpful (and the checklist, once published, wouldn’t work the second time around). Baruch felt pretty revolted at the end of February. But was it enough? It may only be possible to detect the “right” revulsion level after the fact: and might not the velocity of the reaction post the nadir of sentiment be the only guage of how much revulsion there actually was at the bottom? In which case the greater the rally the more likely it is the bottom was in? Another supposed argument for the bears is actually flippable into a pro-cyclical, bullish one.
As for the mysterious quant blowup threatening us all, we had the real quant blowup back in August 2007. Whatever happens from here simply can’t have the same impact: the quants are a shadow of their former selves in terms of market impact. Back then, I only knew there was something up with the quants from bloggers and market rumours. The directional selloff was caused by the subprime issue (and we didn’t realise how important that would be until later). As I wrote not far after it happened:
At one point small caps looked like they were outperforming large caps, which is not normal at times of risk aversion, but that was it, and it only lasted a few days. It was market neutral positions that were being liquidated, ie, for every long that was sold there was an offsetting short that was bought. Directionally. . . there was no impact from the Quant meltdown.
Unless the nature of quant investing has changed in the last 18 months, and become concentrated in a single, directional bet, I simply don’t see the relevance of this argument as a reason we should all sell stocks here.
So what are the uninvested to do? Buy it this far up, worrying that the moment we do we’ll get our faces ripped off as the bear market comes back? Or stay out and watch it go up, which is fine and free for most of those in the econo-blogosphere with no money in the game. For investment professionals, however, this latter position is a recipe for getting all your money taken away. Opportunity cost takes on concrete reality in the form of cross investors, tired of being regaled at the golf club by stories of the investment gains of their peers. If the only arguments on the other side were these silly ones, Baruch feels we should be buying the crap out of everything. Japan saw multiple 40-60% rallies during its 1990-2002 bear market, and we’ve only just managed 30% off the latest bottom.
Sadly, Baruch feels there are much more cogent bearish arguments out there, and doesn’t necessarily buy the opposite, “generational bottom” thesis, either. His worries are mostly to do with the end of inventory restocking, and longer-term, the possibility of Japanese 1990s-like deflation followed by 1970s-like stagflation. But he won’t let this stop him from making long money while he can.
After humbling years of error, he has finally worked out what works for him: he is a Caddyshack investor. He tries to “be the ball”. He rides the trend but sets a stop and if the stock or index crosses that line then he is wrong, his thesis is invalidated and he goes at least neutral, and sometimes the other way. He loses money in the transition, but if the new trend and direction sticks, and he made the transition quickly enough, he makes it all back and more. Other investors are anticipatory and try to catch that big move ahead of time: for some of them, this works great. Baruch has managed it once or twice, and it feels great too, but he has called about 10 of the 2-3 big market transitions in the past 4 years or so, lost money more often than not, and simply doesn’t trust himself to do it well.
But as the ball, even in shitty times, he knows it often will pay to be long or fully invested, just as it will sometimes pay to be out or mega short. One thing the ball will never be is perma-anything.