August 30, 2011
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The major world markets have completed significant “tops”. The implications are dire. The “break down” was meteoric, prices plunging over a few days. The consensus verdict emerged – not a correction but a resumption of a bear market, coincident with a double dip. The wall of worry now seems insurmountable, investor sentiment is panicky; normally indicators of important “sentiment” bottoms.
Does investment sentiment still matter? Do the flow of funds from High Frequency Trading
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and the huge proliferation of derivatives, especially “dumb funds” reduce or enhance the reliability of sentiment indicators? And Gold, what is that relic telling us? Things are out of sync – what’s going on?
Have the markets and the economy reversed course for an extended period – or is this the “pause that refreshes”, in a gradually improving economy and a nascent secular bull market?
Unlike a road trip, there is no GPS for the stock market. There is an unknown destination, thus no course, or time to destination. Lots of alternate routes – but that depends on where you are going.
Same for the government – thus the analogy of “driving the economy into a ditch” only applies if one knows where they are going. Driving on the left shoulder of the road to wherever it takes us is not a trip to a destination – eventually you end up driving in circles – wear and tear, fuel consumption and in a rut.
Unlike the lost motorist, the drivers of the national economy seem to believe they have an unlimited charge account with Manny, Moe and Jack and the major oil companies and that their passengers are complacent.
Before modern technology, explorers used dead reckoning to find their way. (We still do today, within sophisticated navigation systems.)
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In some sense the technical analyst is faced with a similar task; extrapolating from known data – trying to chart an investment course in an environment without clear guideposts. Technical analysts have great confidence in our navigation systems when volatility is
1 Livin' on a Prayer " is Bon Jovi's second single from their Slippery When Wet album… the single, released in late
1986, was well-received at both rock and pop radio giving the band their first #1. http://en.wikipedia.org/wiki/Livin'_on_a_Prayer
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subdued and trends well established. That lasts until we come to a “break in the road” and have to find another way to our destination. Cannot drive over a washed out bridge.
“In navigation, dead reckoning is the process of calculating one's current position by using a previously determined position, or fix, and advancing that position based upon known or estimated speeds over elapsed time, and course. By analogy with their navigational use, the words dead reckoning are also used to mean the process of estimating the value of any variable quantity by using an earlier value and adding whatever changes have occurred in the meantime. Often, this usage implies that the changes are not known accurately.
The earlier value and the changes may be measured or calculated quantities. A disadvantage of dead reckoning is that since new values are calculated solely from previous values, any errors and uncertainties of the process are cumulative, so the error and uncertainty in the value grow with time .
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There are parallels to the investment process – so how might we apply this technique in deciding our investment course? How can we know if we should predict a continued freefall to zero, or a reversal?
Merely extrapolating price trends takes us to zero in a short time. No matter how panicked, most investors acknowledge that outcome is almost impossible. And therein is a clue, historically when the number of investors who believe in the “end of the world” jumps, the market has rebounded dramatically. There is another clear sign; Gold is also be signaling rampant fear: the more people who head to the Ark, (Gold), the higher the level of fear.
Technical analysis is not limited to price and volume data in the modern era. There are many
“indicators” including a subset indentified as “sentiment indicators”. A fundamental belief of many market technicians is that the market is best understood as a creature driven by investor psychology.
The market is theoretically driven by emotion; extreme short term price volatility occurs at important turning points and is caused by how investors “feel” - either elated or dejected.
Is this belief still valid in a market that is perceived to be dominated of trading strategies that verge on the border of market manipulation?
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There is a growing belief among traditional “Mom and Pop” investors that the equity markets are corrupted by high frequency trading, dark pools, naked shorting, insider trading, and the widespread use of derivatives combined with high leverage, or a combination of all of the above. The names and details of the techniques change, but common sense informs investors that something very similar to market manipulation is occurring under the benign supervision of regulators.
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These “changes” have contributed to the extreme negative sentiment surrounding “stocks” today. Not only do we need to contend with the vagaries of the world economies and domestic policies, but also the fear induced by the volatility associated with all these investment “gimmicks”
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So, is it different this time? Does the mass of trading noise overwhelm the traditional emotional indicators – since a significant majority of trading volumes on the major exchange(s) is thought to originate from H.F.T.
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and various derivatives as well as other strategies that have little or nothing to do with the economic, political or social trends?
I believe the answer is always the same to that question – it is always the same – never different. Bet on continuity in basic investment fundamentals – at some level. And I’ll tell you why – in the absence of some “driving forces” these market manipulation strategies would ultimately “arbitrage” out all volatility and the market would tend to stasis – there would be little or no movement because every possible bet would have been placed. While the physical universe and our world may be trending to entropy as are all such systems; that trend is not evident in world markets, quite the opposite seems true.
Therefore, the very presence of these extreme bursts of volatility dictates that mechanical investment strategies do not primarily account for market direction. Rather it appears that these strategies amplify the impact of sentiment change, creating the impression that economic “reality” is also very unstable.
Since the majority volume of the market is presumably “rules based”; the virtual flock of Black Swans we have witnessed recently suggests that the tail does wag the dog, that is, the small fraction of overall volume accounted for by “genuine” investment decisions is still determinative of the markets
“direction”.
One source of this volatility may rise from managed products and accounts. Regardless of whether an investment is actively or passively managed, when investors sell – shares must be liquidated. Those are emotional decisions. The difference between actively-managed investments and passively-managed investments is that there is no “vested interest” of the manager to perform well in managing the investors’ money in the “dumb fund” that mimics and index. They make no distinction among companies, if it is in the index – it is bought or sold. As a consequence, the investors make no distinction among the stocks, bonds or other underlying assets either. Indeed, the sponsors’ “vested interests” is their compensation, which is directly tied to the size and volatility of the assets being managed. A larger and more volatile investment generally does not align with the interest of the investors in the dumb fund. (Dumb fund = dumb investors)?
Gypsy Rose Lee had it right – “you gotta have a gimmick” and that, in the traditional sense requires a
“mark”. That the supposedly “best and brightest” are herding (stampeding might be more apt) investors into these “dumb funds” is oxymoronic. If they were the best and the brightest they shouldn’t be advising you to join the herd and do what everyone else is doing, surrendering the edge of independence, a key element, in my opinion, to investor success.
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I reject the current investment vogue – call it the cafeteria line approach, of a little bit of this and a little bit of that in just the right proportions as prepared by one cook or the other. I don’t frequent cafeterias
– my approach to a meal begins with the selection of the menu and obtaining high quality ingredients.
Then I prepare the meal. This is the only way to achieve a superior dining experience.
The fresh market, the butcher, the sea food monger, the bakery and the wine shop are having sales on their best merchandise. It is a gastronome’s delight and I’m planning the menu for the celebratory dinner in 2013.
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Buying ahead of time to take advantage of the sales, everything I need should keep well, even if it needs to be kept frozen in the cooler.
It should be a sumptuous treat! What is on the 2013 menu? I’m looking for multicourse extravaganza, as the opening course: enhanced domestic energy exploration and production. Followed by a main course, a rationalized tax code that raises revenue more efficiently accompanied with the side dishes of job creation in the USA and the repatriation of foreign earnings to fund this growth. This is a special meal, with additional courses: bringing runaway agencies to heel by limiting their ability to issue job killing rules and regulation; for dessert, replacing Obamacare with a more modest solution that delivers affordable, basic medicine where it is needed most.
The markets are beginning to recognize that better days are ahead for our Nation. Let’s set the table and get ready for two chickens in every pot. It will not pay to be too clever, nor is there a need. “When everything is cheap – buy the best
At this juncture, while I remain a huge fan of the energy issues, but it is time to look forward and anticipate positive changes to the outlook for finance, healthcare, defense, industrial real estate and many other sectors.
No need to buy it all now, prices will fluctuate, perhaps dramatically. Know what you want to own and at what price. If you are reasonable you should be able to make some astute purchases. A successful investor goes for the middle 70% and lets other investors attempt to pick the exact tops and bottoms.
In some cases shares seem to be near enough to support to consider purchase, in many other issues, prices have quite a bit of downside to the support.
Resident Manager
Senior Vice-President, Investments
Investment Management Consultant
Raymond James & Associates, Inc.
David.Lerner@RaymondJames.com
Dadeland Branch 3DB
(305) 670-6611
(800) 709-1793
(866) 208-0567 Fax i
High frequency trading (HFT) is the use of sophisticated technological tools to trade securities like stocks, and is typically characterized by several distinguishing features
[1]
:
• HFT is highly quantitative, employing computerized algorithms to analyze incoming market data and implement proprietary trading strategies;
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• HFT usually implies a firm holds an investment position only for very brief periods of time - even just seconds - and rapidly trades into and out of those positions, sometimes thousands or tens of thousands of
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• times a day;
HFT firms typically end a trading day with no net investment position in the securities they trade;
HFT operations are usually found in proprietary firms or on proprietary trading desks in larger, diversified firms;
HFT strategies are usually very sensitive to the processing speed of markets and of their own access to the market. http://en.wikipedia.org/wiki/High-frequency_trading ii While traditional methods of dead reckoning are no longer considered primary means of navigation, modern inertial navigation systems, which also depend upon dead reckoning, are very widely used. http://en.wikipedia.org/wiki/Dead_reckoning iii Market manipulation describes a deliberate attempt to interfere with the free and fair operation of the market and create artificial, false or misleading appearances with respect to the price of, or market for, a security, commodity or currency.
Market manipulation is prohibited in the United States under Section 9(a)(2)
[2]
of the
Securities Exchange Act of 1934,
Examples
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Pools: "Agreements, often written, among a group of traders to delegate authority to a single manager to trade in a specific stock for a specific period of time and then to share in the resulting profits or losses."
Churning: "When a trader places both buy and sell orders at about the same price. The increase in activity is intended to attract additional investors, and increase the price." …
Runs: "When a group of traders create activity or rumors in order to drive the price of a security up." …
Ramping (the market): "Actions designed to artificially raise the market price of listed securities and to give the impression of voluminous trading, in order to make a quick profit
Wash trade: "Selling and repurchasing the same or substantially the same security for the purpose of generating activity and increasing the price"
Bear raid: "Attempting to push the price of a stock down by heavy selling or short selling.” http://en.wikipedia.org/wiki/Market_manipulation iv
The secondary market for U.S.-listed equities has changed dramatically in recent years. In large part, the change reflects the culmination of a decades-long trend from a market structure with primarily manual trading to a market structure with primarily automated trading... the current market structure can be described as dispersed and complex: (1) trading volume is dispersed among many highly automated trading centers that compete for order flow in the same stocks; and (2) trading centers offer a wide range of services that are designed to attract different types of market participants with varying trading needs. . The foregoing statistics for NYSE-listed stocks are intended solely to illustrate the sweeping changes that are characteristic of trading in all U.S.-listed equities, including NASDAQ-listed stocks and other equities. They are not intended to indicate whether these changes have led to a market structure that is better or worse for long-term investors – an important issue on which comment is requested … (emphasis added) http://www.sec.gov/rules/concept/2010/34-61358.pdf
v In marketing, product gimmicks are sometimes considered mere novelties, and not really that relevant to the product's functioning, sometimes even earning negative connotations. However, some seemingly trivial gimmicks
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of the past have evolved into useful, permanent features. According to the OED, the word is first attested in 1926, defined in the Wise-Crack Dictionary by Main and Grant as "a device used for making a fair game crooked".
Finding a successful gimmick for an otherwise mundane product is often an important part of the marketing process. http://en.wikipedia.org/wiki/Gimmick vi
By 2010 High Frequency Trading accounted for over 70% of equity trades taking place in the US and was rapidly growing in popularity in Europe and Asia. Aiming to capture just a fraction of a penny per share or currency unit on every trade, high-frequency traders move in and out of such short-term positions several times each day http://en.wikipedia.org/wiki/High-frequency_trading vii
In “real time”, short and intermediate term volatility always disrupts theoretically linear and efficient markets. Yet, there are also persistent price trends that last for months and years, hardly random in retrospect. An investor can add performance in this environment of disruptions and persistent trends.
Many of these opportunities repeat over time – and this knowledge along with a long term, macroeconomic view are, I believe, keys to success.
http://www.raymondjames.com/AdvisorSitesFiles/PublicSites/davidlerner/files/The_Lerner_Investmen t_Philosophy.pdf
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