Friday, June 29, 2012

How This Market Is Unique

I have to say, current is the most unusual market environment I've witnessed over almost 16 years of trading (sheesh, has it really been THIS long??). No, it's not algos or HFT that make it so unusual. None of those things ever influenced the method I deploy to read the market in any significant way. Here is what is so unique about it.

Normally market is in one of two states in relation to coming news. First, it has no idea about news coming its way. This is usually what we call "Genuine News" - earthquake would be a good example. So, the market trades in its own way, reacting on this and that, until unexpected comes and changes the picture. Second state is, market knows about news coming, evaluates it in advance and starts discounting it. This is the most frequently seen state of the market and the one on which whole trading methodologies are built. We called it Fleece Sheep News in that same article linked above.

What we have right now though is a weird hybrid of those two modes -  the market knows about news ahead but isn't able to factor it in effectively. It remains a matter of speculation and guesses for incredibly long time, and we are not much closer to resolution than we were two years ago. Those who thought the whole EU charade should collapse continue thinking so; those who believed it will print its way out of debt burden still believe it. This very unusual mode for such unusually long time causes very abnormal volatility and bi-polar market that soars like an eagle one day and digs the hole like a mad rabbit another. Even intraday, market acts like a frog in a football kicked by yet another headline. I suspect we will remain in this mode for a good while. Higher volatility goes hand in hand with shorter time frames. Investors turn into swing traders, swing traders become day trader, day traders become scalpers, scalpers... well, they remain scalpers I guess.

Sunday, June 10, 2012

Three Kinds of Crash, re-visited


Below is the article I have written on October 16 2011, with some forecasts about most probable scenarios in the economy and market reactions. Interesting to look at it now and compare the unfolding events with forecasts. Seems that the second scenario, one that I deemed the most probable, takes place. Market reactions are pretty much on target as well. IMO, everything remains intact, so let's re-read it. 


Look Ahead: Three Kinds of Crash

                                                  Life never gets so bad that it can't get worse" 
                                                                                            - Solomon Short

Putting together pieces of mosaic gathered over last few months by observing both news headlines and market reactions, let me offer my view on the future big picture developments. Everyone has one, why not add another voice and see how reality matches the forecast (rather set of scenarios in my case but you get the idea). Want to say from the start - this is a forecast that I will be happy to be mistaken about.

We will break it by two distinctive parts - economy and market developments. Let's start with economy.

European Union is non-viable and not-salvageable entity. Its deep underlying problem is discrepancy between various aspects of union. It's a monetary union - but not fiscal. Economic - but not political. This patchwork creates situation where decisions are difficult to make and even more difficult to implement, and solutions help one member at the expense of another. Authorities would be happy to throw more money at the problem but taxpayers of one sovereign state are not keen on bailing out another - and those taxpayers are voters. Push for collateral and austerity threatens autonomy of a debtor - and taxpayers start rioting over there too. There is no third party that could bail it all out (rumors spiking now and then about Latin America or China lending money to EU is pure nonsense and if anything, show the degree of desperation). Thus, there are only two ways forward: crash or money printing. Are these two really two? Not in my view - money printing does nothing but stretches crash in time, turning it into slow motion crash. It's fine with authorities though if they can stretch it by decades - today's decision-makers leave the office till then. So, real choice is between three options, none of which is warm and fuzzy.

First is Crash Now. No printing, no bailouts, let's rip the band-aid off, take the (admittedly huge) pain and start healing and rebuilding, with lessons learned in mind. Probability of this? Well, only if enraged taxpayers/voters find the way to force the hand of their respective governments and abandon the attempts to save the union. No politician wants to preside over collapse ("Crash?? Not on my watch!"). Thus,

Second is some printing now, masked as bank recapitalization, insurance guarantees etc etc. As we were shown by Fed, there are many ways to create money out of thin air. If Powers That Be manage to agree among themselves and push some kind of package through their respective elected bodies before people take on the street in numbers impossible to ignore, this will postpone the crash a bit. Such solution is nothing but kicking the can down the road, and reality will catch up with fantasy of salvation once again (after all, the debt remains as unsustainable as it was, and even becomes worse). At that point political will to continue on that path runs out, and we face second variation: Crash Later. How much later? Well, depends on how much is printed. Odds? Feels to me, this is the most probable option.

Finally, third option is printing gradually over extended period of time. That would be politicians preferred way if they could find the way to do it quietly and as a trivial matter, under the radar so to speak. This is Crash in Slo Mo. Pity the savers; inflation tax forever.

One more aspect of the big picture is China (and Asia overall). My feel is, it's a whole new can of worms down the road. It's not in a focus of attention much at this point since European troubles are more imminent. China's turn is to come yet, and unsustainability of economy geared to supply the West which cuts off its demand and of putting money in ghost cities to keep people working and economy humming - unsustainability of all this is going to reveal itself at some point.


Let's move to the market side of the picture. How is it going to react in each of the scenarios? In the first one, Crash Now, it's will mirror the economy and crash with it. Second - Crash Later - is what market is betting on over last couple weeks by climbing in the face of grim news. If this option materializes, market will spike first in relief, then drop quickly reflecting the part of reaction built in already by this recent climb and killing later arrivals; then new news will overtake and new worries (or lack of such) will start influence the movement. Finally, third option (Slo Mo Crash) is what market will be most happy about, staging big long term rally, quite possibly to new all time highs. After all, inflation is not only tax - it's also a wealth transfer to those who has what to invest.

There. Hope life proves me wrong and things turn more rosy.