Thought Bubbles from the Deep

[McLovin]

I think this article was quite interesting.

http://www.independent.co.uk/news/w...guage-president-president-elect-a7412186.html

Interesting. I remember watching that press conference and thinking Trump had his chest closed and looked scared.

I can imagine Trump kind of regretting what he's got himself into. It's one thing to run a campaign, send a few crazy tweets and watch the reactions. It's also easy to insult certain groups of people without actually having to face them and bear the consequence. He could have been a happy-go-lucky idiot billionaire... but now he's definitely lost a lot of that carefree-ness.

Get ready for a period when a random tweet from Trump could put specific markets in a tailspin... yes all traders should follow Trump if they aren't already.

No doubt. Trump saw it as a challenge to win and prove he's not a loser. That's why the "Trump Pivot" is in full motion now and he's reversing so many statements he made.

He'll still have a pretty big business empire, you'd expect him to act with self-interest in that regard.

 

[mcgrath111]

D/S

I always enjoy reading your input, so thought I would bump.

Any thoughts around OPEC, changes within the EU? Current rally in the DOW?


Mike,

 

[DeepState]

D/S

I always enjoy reading your input, so thought I would bump.

Any thoughts around OPEC, changes within the EU? Current rally in the DOW?


Mike,

Hi Mike

These are just observations. Have not done a pile of work into them.

OPEC: In collective interests to do so, but tragedy of the commons type setup. Who knows, but the mood is to tighten supply. Iran will be facing pressure from a Trump presidency in terms of winding back the embargo. Good for inflation and this, and food, were the primary reasons why headline inflation were declining. Central bankers had noted that long term inflation expectations seemed to be overly driven by shorter term movements in energy, so perhaps this will now reverse. If the fiscal, Keynesian, theories are correct, it implies that demand will kick in and some sort of virtuous circle will develop of the type that Japan so clearly craves.

Although rising oil prices are a form of wealth transfer between producers and consumers, the inflation expectations element can mean that growth is stimulated by higher oil prices.


EU: Government in Italy remains unworkable but Austria rejects a far-right president. Merkl is making allowance for the issues with (muslim) immigration that have caught the public ire. At the moment, the issue which is front of mind for me is the recapitalisation of Monte Dei Paschi. Will all the work on the Single Supervisory Mechanism and aversion to government bailouts be trashed at the first real challenge?

ECB taper is reasonable in the circumstances.

Dow Rally (and interest rate rises): This is on the back of increased growth expectations and also inflation expectations. Trump oriented. I think it is remarkable that this is going on when details are so scant and the gap between statement and reality are so wide...even for a reality TV star. Threats of protectionism and the promise of stimulus from tax breaks (particularly impt for corporate earnings growth expectations), together with increased job creation all point to a period of higher activity and inflation.

Is it justifiable? It's not entirely unreasonable, but the market is clearly choosing to price in the tax cuts quite well at least. Analyst estimates are not showing much change for 2017 or 2018 at present.

Just wants to go up... And interest rates with it. The sell of in bonds has been consequential. AUD 10yr at 2.8% is still virtually no premium to inflation expected. Bonds remain very expensive despite this, and are trading around levels seen only a year ago. Japanese bonds have not moved, which highlights the extent to which it is a local market captive.

 

[mcgrath111]

Thanks for that D/S

I was particularly unaware of how Monte dei Pashi fitted into the mix.

 

[DeepState]

One of the largest developments in financial markets in recent times has been the rise of ETFs. Though not necessarily passive in nature, the great majority of these are not alpha products. Their underlying index construction may be a broad market, like Russell 2000, or industry focused like S&P500 Financials, or something like High yielding Franked stocks on the ASX. What they generally do not have is a team of analysts pouring over financials to figure our whether a stock is rich or cheap - for the most part.

So, what happens to the markets as it becomes increasingly held by ETF and passive funds?

 

[kid hustlr]

Interesting point DS - what does happen? My stabs:

- Higher correlations across markets (both domestically and internationally)?
- Thinner markets as funds aren't looking for value but rather just executing in a passive nature?
- Active managers outperform as passive and herd style investing create opportunities?

Must be heaps of others

 

[DeepState]

Thanks for that D/S

I was particularly unaware of how Monte dei Pashi fitted into the mix.

OPEC is to oil what the EZ members are to banking and competition policy. The individual members stand to collectively benefit if they can maintain collective discipline, but their direct interests keep pulling this potential apart. Italy is pulling out another sovereign rescue and underwriting retail investor losses. So soon after all the fanfare of a Single Supervisory Mechanism and banking stress tests had been undertaken. It will also result in a deficit level for Italy which exceeds the allowable thresholds before punitive action is supposed to be taken.

Greece is neglecting agreements again.

Naturally, the Germans are calling foul.

It's really strange to me that so many things are happening now that spooked tha heck out of markets in recent years and seem to be totally ignored as the market marches upwards in the wake of a Trump election - which itself had been thought to be a disaster for markets. These matters include:

Chinese reserve drain;
US rates rises drawing capital from emerging markets;
Greece refinancing;
Warships in the Spratley region;
China excessive leverage;
Weak European banks;
Russian incursions in to the West (lately by cyber);

add to list according to your satisfaction...

 

[kid hustlr]

Interesting point DS - what does happen? My stabs:

- Higher correlations across markets (both domestically and internationally)?
- Thinner markets as funds aren't looking for value but rather just executing in a passive nature?
- Active managers outperform as passive and herd style investing create opportunities?

Must be heaps of others

http://www.philosophicaleconomics.com/2016/05/passive/

A quick google removes the argument about outperformance

 

[DeepState]

http://www.philosophicaleconomics.com/2016/05/passive/

A quick google removes the argument about outperformance

Interesting article. Thanks.

I'm not very sure what will happen. I think it will depend a lot on what kind of ETFs take share, the drivers for this and what happens to the nature of the remaining market for active management. What happens to the algo traders will also have a material impact.

Here's what my guess is:

Increasingly, investors will move from active managers to ETFs. In doing so, their desire for market timing is not actually diminished terribly much. They just take these active decisions out of the hands of active managers and place them in to the hands of private advisors and ETF houses rather than take a set and forget approach.

F/As, like anyone else, like more fees to less. They will find a way to do so under the guise of doing their clients a favour. Whilst many ETFs will be broad market index based, many will be style oriented in some fashion.

In general, movement in to and out of these styles will be trend like. But trends will more likely occur in baskets and less so for individual stocks as these are caused more by active investors who are stock picking.

All sorts of interesting liquidity pressures take place in this world. It swings in favour to systematic investors attuned to these things. Whilst greater opportunities for stock selectors may exist, they may also have to wait longer for their perceived mispricings to come to fruition making profitability possibly worse than currently is the case, especially so if the remaining active managers remain peer aware. Even outside of ETFs, the general trend is for many mandates to be increasingly barbelled. More assets are made index aware with low deviation from peers and indices. A smaller proportion is souped up in some way.

Overall, I like it as a trend right now. I like where I am personally positioned. Relatively small aum and capable of implementing the kinds of trades which profit from trend implementation of baskets. Blunt herd behaviour is returning, I think.

 

[DeepState]

Review on Technical Trading in FX: "Is it still beating the FX Market?"

This working paper is to be published in the Journal of International Economics. The corresponding author is a smart guy. A technically oriented trader forwarded it to me for interest. It certainly carries a provocative heading .. still beating??

When you get in to the guts of it, the authors do as follows:

Look at at technical rules pertaining to momentum, support/resistance, channel and breakout.

By varying the usual parameters, they generate over 21k different rules. Yes... 21k. These are run over a long history of currency pairs vs the USD.

Knowing that ramming this through will generate around 1k rules that will work, they take solid efforts to avoid overfitting of the data by some clever methods to reduce the indicence of false positives.

They conclude that a currency pair can be predicted by a technical rules if at least one of these rules is shown to produce a statistically valid result (value added via timing over and above a buy-hold alternative, inclusive of interest rate differentials).

About a third of developed market currency pairs have predictability which leads them to conclude that the FX market can be beaten by technical trading. I suppose they do need a catchy headline to get a publication.

Whilst a small handful of the 21k trading rules did report a positive statistical outcome (eg. 4 of 21,195 rules tried produced a result which was significant at the 10% level), the odds of choosing the right rule from this subset is hardly an endorsement of pursuing this approach.

Even with this most generous interpretation of "beat market", none of these rules succeeds in developed market prediction since 1992. I suppose this may be why we find a plethora of increasingly complex rules being applied...it is required to find something which looks decent in the last 25 years on a backtest.

The case for emerging markets is more promising. There appears to be more support of technical trading rules there. Even still, the outcomes are not the sort of thing to encourage a dive in to these markets using these methods.

---

The headline caught my attention. The details do not endorse the initial reaction.

Despite a clear bias to finding rules that work in this paper, it appears that the longtitudinal class of technical trading has not been successful in a way which would be encouraging to a trader. This is in line with my prior understanding in relation to finding rules to apply on individual currency pairs.

For those seeking to make money, that leaves finding different kinds of approaches to the baseline methods...all 21k of them...which actually make sense and have a chance of extracting profit ongoing.

Very simple stuff actually does work well in FX. It's just different from this stuff and has attaching rationale which, in my view, is more convincing. Of course, highly parameterised approaches can be forced to work as well....

I also use price based approaches in my methods. So this is not to say that matters other than fundamentals have no value in my view. However, the basic methods and their 21k cousins don't seem to cut it...even when the authors are trying to force an outcome in that direction.

 

[DeepState]

GBP Flash Crash Report released by BIS. FT Article attached.

This stuff makes putting stops on very expensive in this market....or could represent a great opportunity for a reversion trader who keeps very close track on the market and is happy to trade with discretion.

 

[Valued]

Review on Technical Trading in FX: "Is it still beating the FX Market?"
.

It seems easier to learn some macroeconomics to be honest. You could jump from system to system trying to find the one that works and chasing the holy grail but it seems a bit farfetched for an individual. Sorry guys, you might have to learn about bond yields and interest rates (boring stuff, I know).

 

[DeepState]

Word of the day:
“kakistocracy”: government of the least-qualified. (From the FT, in relation to the Trump Administation, in case that wasn't clear)

 

[skc]

One of the largest developments in financial markets in recent times has been the rise of ETFs. Though not necessarily passive in nature, the great majority of these are not alpha products. Their underlying index construction may be a broad market, like Russell 2000, or industry focused like S&P500 Financials, or something like High yielding Franked stocks on the ASX. What they generally do not have is a team of analysts pouring over financials to figure our whether a stock is rich or cheap - for the most part.

So, what happens to the markets as it becomes increasingly held by ETF and passive funds?

Here's a view on ETF that I agree with.

Perhaps the most distinctive point he makes at least that finance geeks will appreciate is what he says is the irony that investors now "have gotten excited about market-hugging index funds and exchange traded funds (ETFs) that mimic various market or sector indices."

He says he sees big trouble ahead in this area or at least the potential for investors in individual stocks to profit.

"One of the perverse effects of increased indexing and ETF activity is that it will tend to 'lock in' today's relative valuations between securities," Klarman wrote.

"When money flows into an index fund or index-related ETF, the manager generally buys into the securities in an index in proportion to their current market capitalisation (often to the capitalisation of only their public float, which interestingly adds a layer of distortion, disfavouring companies with large insider, strategic, or state ownership)," he wrote. "Thus today's high-multiple companies are likely to also be tomorrow's, regardless of merit, with less capital in the hands of active managers to potentially correct any mispricings."


Read more: http://www.afr.com/markets/a-quiet-...ghs-in-on-trump-20170207-gu7frk#ixzz4XzvOdxsp
Follow us: @FinancialReview on Twitter | financialreview on Facebook

ETF is dump money, and retail money is dump money. The growth of ETF is dump money squared. Forget about market fundamentals... dominance of ETF equals dominance of flow over substance. I just can't see that being a great development.

 

[Value Hunter]

I think what you guys are saying is only partially true. Even if we take an extreme example and say that 90% of investors used index funds instead of managed funds or individual stock picking, corporations and private equity act as a backstop.

For example if a stock stays greatly undervalued for an extended period of time, the company might do a share-buyback, the founding shareholders and or management team might decide to take it private again through a takeover bid or private equity or one of their competitors might do a takeover bid. Any of these things are likely to result in the share price rising.

The converse is also true. If a company's share persist being greatly overvalued for an extended period of time, the company may issue shares (e.g. rights issue) to acquire other listed or private competitors that are trading at a lower p.e. multiple. This would then increase the supply of shares and may cause the p.e. ratio to normalize somewhat over time. Also if a company's (or sectors) shares trade on a high p.e. multiple for an extended period of time new floats of similar companies will come to the market looking to cash in on investor enthusiasm. The greater choice of similar types of companies will diffuse the demand somewhat and over time cause p.e. or p.b. ratios to normalize.

 

[skc]

ETF is dumb money, and retail money is dumb money. The growth of ETF is dumb money squared. Forget about market fundamentals... dominance of ETF equals dominance of flow over substance. I just can't see that being a great development.

Dumb, not dump

I think what you guys are saying is only partially true. Even if we take an extreme example and say that 90% of investors used index funds instead of managed funds or individual stock picking, corporations and private equity act as a backstop.

What you have described is the way how it's supposed to work. However, for that to happen, the clout between the different perspectives / proponents has to be somewhat comparable. If the ETF's are indeed punching with 90% of the money, the remaining 10% will struggle to make a dent against the weight of money directed by the ETF. That is the concern imo.

 

[skyQuake]

I reckon it'll be self correcting. If too much money flows into passive funds, the active players can start playing games.
Buy up any old thing and get it over the index eligibility criteria and sell to forced demand.

Alternatively borrow from the very same index funds (who all compete to lend out stock to boost their returns) and short the crap out of a good profitable co till it falls out of the index (eg. SGH ) and buy back cheap stock!

 

[skc]

I reckon it'll be self correcting. If too much money flows into passive funds, the active players can start playing games.
Buy up any old thing and get it over the index eligibility criteria and sell to forced demand.

I am pretty sure they already do that.... something like 1PG comes to mind.

 

[Trembling Hand]

I am pretty sure they

They! Ha as in you two!!

 

[DeepState]

The Trumput: Some Perspectives

Donald Trump appears to have underwritten the equity market. Promises of tax cuts, deregulation, protectionism and infrastructure development have set the markets alight and given breathe to the animal spirits. It can’t last….so goes the usual instinct.



The S&P has climbed relentlessly since his surprise election, producing a return of over 10% since the election in early November. Too much too soon?

As Seth Klarman, the legend of Baupost Capital, said in his recent letter to investors, “Trump is high volatility”. And yet, the VIX is trading as if market volatility has been solved. The Trump Put is in place. If he manages to unwind the Volcker Rule, it really might be that the US public purse will once again serve as a backstop to the banks, who remain too big to fail. Meanwhile, the market is running on what appears to be highly productive Tweetpower.

Perhaps the market is complacent? Yet, take a look at the longer term trend line for the equity market since the GFC. Nothing really special in the most recent period…just a bit of catch-up from a lull between late 2014 and early 2016 when Fed support was being unwound in terms of quantitative measures and companies were no longer generating earnings growth via buy-backs en masse and cash accumulation on balance sheets levelled off. There were also various issues with China, oil, concerns about global growth as well of course. Just the usual swings and roundabouts of markets washing out?



Additionally, the reflation trade is definitely being priced in to expectations. The SP500 earnings in this chart relate to the forecast over the coming 12 months. The yield of 10 year bonds is also shown, along with the forward looking PE ratio.



Maybe the rally is actually reasonable? It’s not like forward looking PE ratios are so elevated relative to where they were for much of 2015/16 or, indeed what would have been reasonable in much of the 2000s were interest rates a little lower..and there is heaps of spare capacity to bump up profits without a stack of capex.

Suddenly it’s not exactly obvious to me that this rally is nuts and must be reversed in the blink of a stray Tweet. The economic outlooks around the world are being revised upwards for the first time in a long time. In light of expectations, this looks alright.

However, is it truly plausible that President Trump can engender such confidence and for this confidence to be fulfilled? $USD 2tr in capitalisation gains on the S&P500 alone, let alone the flow through to other markets? That’s more than the Australian economic output for 18 months. Are we worth so little that alternative facts can create more value that nearly $25million Australians create in 18 months?

Maybe this is a form of collective madness or a game of chicken.

Professor Read Montague of Virginia Tech gave an interesting public lecture late last year at University of Melbourne. He was talking to this paper:



People will create bubbles in markets seeking to outperform each other in a zero sum game where the ending value is known to be a dud. As Professor Read notes, eventually those who made the most money seem to wake up to themselves [activation of Anterior Insula Cortex] and the show ends.

Hmmm.