The Smart Bird: Not a Trader’s Market

How it happened

The market opened higher following the rally in China and Japan that was induced by China’s “stimulus”. As we have mentioned in the past, Asian stimulus includes government directed buying of stocks and futures to give the appearance that everything is fine. Then the global computer algorithms take over and the rest of the global markets follow suit.

Intraday on 9 September, the S&P 500 hit the same level as the 28 August close (1st bounce peak) then reversed sharply lower. That is now an overhead resistance level. But we are not trying to trade the daily noise, staying focused on the longer term signals that are less impacted by the daily news and interventions.

Daily trading in an era dominated by price & loss insensitive traders (central governments and corporate buybacks) with markets driven by front-running interconnected computer algorithms is not advised. Unless, of course, you are the first and fastest front-running computer.  But then it is not trading – it is High Frequency Skimming and evidenced by Virtu Celebrates Another Year Without a Single Day of Losses.


I realize my perspectives on what is driving the markets are not “main stream” so I think it is important to provide a simple review of my overall perspective. But before I do, it is also important to understand that my market timing models are based on objective measures and not these “opinions”.

My perspective is the economic sphere (the real economy) and financial sphere (the financial markets) should be viewed separately and are only loosely correlated in the long run. The magnitude of the market cycles the last twenty years are not explained by the underlying growth rate of the economy, but instead by the magnitude of the cycle in the global credit markets fostered by ultra-loose and competitive monetary policies of central bankers whose stated economic goals are not always their primary goals.

These perspectives enable me to wrestle with the concept as to why the best market valuation models that are highly correlated to actual future long term returns are showing that we can expect zero annualized returns in the 7 – 10 year timeframe. And since we know the markets cycle (bull and bear markets), a historical frame of reference keeps us alert to the probability the market will lose 50% in this timeframe even as many mainstream commentators keep telling us the US economy is just awesome.

Although these same commentators do not explain why if the economy is so strong and the future is so bright we are still employing “emergency” monetary policy in the US, Europe, Japan and now China six years after the last market meltdown. And why the IMF warns Fed should delay rate hike until 2016 and Larry “the hawk” Summer says it is No Time for an Interest Rate Hike.

Panic and Turmoil

The World Bank chief economist goes a step further and warns the Fed to delay the rate rise stating…

 … the US Federal Reserve risks triggering “panic and turmoil” in emerging markets… due to rising uncertainty over growth in China and its impact on the global economy… he also made the point that “fear capital” could leave emerging economies even though the rate hike has been “well-advertised”.

Well its true the rate hike has been “well-advertised” to be imminent in the very very very near future many many times during the last few years. With the same explanation that just as soon as the desired unemployment target (down from 6.5% in 2012 to 5.1% today) is hit again and again. Of course, all-the-while being very “transparent” and not trying to induce any uncertainty into the very uncertain markets.

But what is “fear capital”? Could this be the same as the “greed capital” but in reverse? Could it be the same highly leveraged and speculative capital that was borrowed in another currency at low low low rates and invested in higher yielding emerging markets to earn profits with some else’s money. And could it be that these highly leveraged plays will turn highly fearful if currency rate expectations buckle requiring rapid reversals at the first sign of the cycle turning. If so, it is too late and the cycle has turned.

All speculative investments are greed, fear or dumb capital not just the leveraged global currency carry trade. The stock market operates on fear and greed and can move drastically when levels of fear and greed are elevated. But today the markets are being moved around by another kind of fear – government fear and central bank fear of losing control (or allusion of control) along with diminishing confidence in the monetary system that is the foundation of all things financial, economic and ultimately social.  And these players are price and loss insensitive.

Need a real world example

Let’s try to determine what might have caused a 5% reversal in China’s stock market yesterday to close 2% higher and Japan’s to have the largest single day gain ever of 7.7% that in turn triggered a rally in US futures overnight.  First we will take a look at the economic sphere to see if awesome economic news caused this sudden reversal and spike on 8 September in the Asian markets.

China August trade slumps in latest setback

“Exports fell 5.5 percent year-on-year in August significantly less than the median forecast of a 6.6 percent decline in a survey of economists by Bloomberg News. Imports fell 13.8 percent year-on-year to $136.6 billion, customs said, attributing the decline to widespread commodity price falls. It was the 10th consecutive monthly fall in import values, and worse than both the Bloomberg survey’s projection of a 7.9 percent decline, and July’s 8.1 percent drop.”

Citigroup Sees 55% Risk of a Global Recession Made in China

Standard & Poor’s cut its growth forecasts for Asian economies, citing “abysmal” trade data and fears about China’s market stability, a day after Moody’s Investors Service made a similar reduction.

While the news in the economic sphere explains the deep morning slump in Asian stocks, it does not explain the massive and abrupt reversals.  Let’s take a look at the financial sphere to see what might have happened:

Here we find the Guardian reported that the Asian and European stock markets rally on stimulus hopes. Enough said. More stimulus and of course more China directed buying of stocks as Goldman Sacs explained China’s Stock-Rescue Tab Surges to $236 Billion in the month of August all to support the Central Bank directed fact that China’s Stock-Market Rout Is Almost Over.

So how does this effect the old-school market timers?

After years developing his reputation as one of the better long term market timers Dennis Gartman in the last year has become the poster child for contrary analysis. If you do the exact opposite of what he says on national TV the next day, you will make money. So how did our intrepid Dennis Gartman handle the rapid reversal of the stock market based on Asian government directed market spike.

On 8 September Gartman was extremely bearish on the stock market was short the market, but on 9 September he was buying in order to cover his shorts stating “we were short in rampaging bullish move…” Of course, after being force to buy to cover his shorts on the morning of 9 September, the market once again reversed and headed down leaving Gartman spinning.

But Dennis Gartman has a lot of company and was not the only one shorting the market on Tuesday and forced to buy back on Wednesday as the governments manipulated the markets higher explaining why Japan’s Nikkei 225 Rises 7.7% for Biggest Gain Since October 2008.

“Short-selling accounted for 41.2 percent of trades on Tokyo’s exchange Tuesday, close to the record 41.6 percent reached last week. Hedge funds that shorted index futures on Tuesday afternoon pushed Japan shares higher Wednesday as they closed out positions, Yoshihisa Okamoto, Tokyo-based head of equity research at Mizuho Asset Management, said by phone.”

Real traders are slowly stepping back from the markets and leaving it to the computers trading computers. But like everything else it has happened faster in China.  You see China Just Killed the World’s Biggest Stock-Index Futures Market in short order. Volume on China’s futures market has dropped 99% thanks to all of the government’s recent “interventions”.  One nice thing about a no-volume future’s market is that it is easy to push higher.  On the other hand, it also pushed back many years when China’s markets will be considered the markets of a world financial leader.

National Objectives

My professional education included discussions on the elements of national power.  The US economy was listed along side of the US military, but the weapons of the economic element of national power were rarely discussed.  They would predominantly fall into the financial sphere.

With China’s navy operating off the coast of Alaska for the first time, the recent massive cyber attacks coming out of China, and China’s launching of a world bank equivalent to the protest of the US,  I have to wonder if a large dose of “panic and turmoil” in the emerging markets (led by China) would be welcome by the US national security council.  If so, don’t expect a new high in the markets any time soon.

What to Do

The Smart Bird will not buy-the-dip here and continue to stick to the long view and avoid large market corrections and bear markets while trying to capture as much of the market gains when the level of risk in the stock market is much lower than it is today.  Invest smart.


Categories: Perspectives, The Smart Bird

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