Shortest Market Take Ever

I thought this email captured my views pretty succinctly, so I decided I’d share it. Please ask questions if you have them in the @BehavioralMacro stream and I will answer them as best I can during jury breaks. Good luck.

“Hey X. Sorry again about the slow response. Still terrible with email and on top of that have been (and still am) on jury duty. I posted this on my blog back in April.

https://behavioralmacro.com/markets-in-the-medium-term/

I still think, amid all the tape bombs and geopolitical noise, that this is the operating environment until roughly end of summer. If we get into a full blown trade war, it will of course get uglier, but whether we do is still too path dependent for us to know. I have been in ‘keeping P&L mode’ more than ‘making P&L mode’ since I posted that piece. I had a ridiculously good Q1 in my Trading style and don’t want to mess it up. In my Investment style I have been waiting for us to finish the consolidation pattern to deploy more cash. Not too worried about the Fed, about overheating, or about a recession for the foreseeable future. I think EM continues to underperform until the market begins to think it has some clarity on where the Fed’s terminal rate will be and when we are likely to get there. At least this is my working hypothesis. Hope all is well out there in the Hamptons.

 

Best,

Mark”

Currency View. Right here. Right now.

Surfacing from pup training to share two words on currencies. I was prompted by a DM this morning from a sub who follows EM ccys very closely, and by the price action this morning/late last week, which to me has evolved in favor of seeing some USD softness soon. (Just look at today’s intra-day reversal in silver.)

I have posted below his question (pretty sure my assumption that the sub is a ‘he’ is correct) and my brief answer. Please feel free to follow up with questions in the stream or in DMs.

Question:

“Hi Mark, what is your best estimate of when a short USD / Long EM position is tradable? I take that this is to some extend data dependant and we probably need to see a bit more softer US data to conclude that the top is in for rates and the USD, but given the sharp corrections we have already seen in certain EMs, I am starting to getting increasingly tempted. Do you have any thoughts in terms of the timing here? Cheers!”

Answer:

Hi. So, first one has to specify if we’re talking about a trade or a position. And if you are looking to position EM ccys, you have to start with what your current weighting relative to your benchmark/mandate/risk tolerance is. I would want to be modestly overweight here from a strategic POV. So, if you are underweight EM ccy, it makes sense to add here IMO. Need to leave room in case the EM unwind goes further (easily could), but I think the levels and the dynamic warrant adding. If you are flat, you can still start here to get overweight, but, again, make sure you leave room to add. On the tactical side, makes sense IMO to take a shot here at being more aggressively short USD, but with stops in mind/in place. Yes, for a short USD position to really run the data would have to cooperate somewhat, but the positioning and psychology is at least now somewhat favorable to try short USDEM here.”

Markets in the Medium Term

This week was unusual for me in that I had three institutional investor friends come a-calling here in my sleepy little hamlet. Always great to see old friends who speak the same language. Lots of good discussion.

The upshot is that it forced me to distill my thoughts for the next six months or so. You will have already picked up on them in bits and pieces if you’ve been tracking @Behavioralmacro tweets closely over the past month or so. And I insert here the usual caveat that what I’m about to say could turn out to be totally and utterly wrong. But, all of us need a base case, so here’s what I boiled mine down to:

I call it the ascending triangle scenario.

The shock and pain of the January-February selloff forced everyone to take a deep breath and reassess the backdrop. We now need to wring out that extreme reading of euphoria, digest the rate hikes that we had been shrugging off, and recognize that growth is much more likely to have a run rate with a two and than a three handle. In short, market and growth expectations have to continue the process of coming off the January boil

In a sense, the shock created a mini disaster myopia dynamic. This process often plays out in an ascending triangle type pattern (if you can conceptualize one for growth expectations as well). And it resolves to the upside once the oscillations decline in magnitude, volatility dies down, and the January shock starts fading in our memories.

This is what an ascending triangle looks like:

 

We are entering the “bad” season for risk taking, many are licking their wounds from Q1’s volatility, and fundamental and technical consolidation referenced above needs time to play out.

The implication is while we can expect to return to the highs, it’s hard to imagine us getting anywhere meaningfully beyond them until this rough triangle plays out and risk appetite is replenished, which I’m guessing would likely be sometime this Fall.

To set up for this period, I added to discounted fixed income products to increase carry, taken the overall beta of the Investment book down, and increased in selected sectors like US home builders, which, in my view got hit too hard out of overdone fears of higher rates and higher wage inflation. I also like names that have a secular growth story–to the extent one can find them and get good entry points.

I have not changed my views on EM, but I do expect it to under-perform over much of this upcoming period. In part because its relative strength is no longer a surprise to anyone, and in part because any decent USD rally would shake out EM investors who came to the party late.

Hope this is helpful. Good luck.

The Three Books

I get asked often about what books I would recommend for getting a better handle on behavioral finance, markets, macro, pattern recognition, etc.

Back in 2012 I posted The Book List that covered a lot of ground–especially on the behavioral side. But I got asked again today, and I boiled it down to three books, one on behavior, one on central banking, and one on patterns and markets. This is where I recommend someone start.

Guesses as to where we are in this correction

We’ve sold off very sharply in a short period. Many investors—probably the majority—think this is mostly technical and the basic global fundamentals have not changed. This group will be buying this dip. Others are worried that so much stimulus on a fairly full-employment economy will lead to inflation the Fed will have to stamp out, and, more concretely, fear the January Average Hourly Earnings number triggered a broader market realization of this. This group sees maybe a bounce, but more trouble ahead now that global central bank normalization is unambiguously on.

Behaviorally, after such a long, strong run, the BTD crowd is the more likely to prevail. The muscle memory is fresh. Traders like successful retests. And the overall case for this selloff being predominately technical is pretty strong. I’d cuff 75% odds that Friday was the bottom of this correction. And if that’s the case, it’s almost a certainty that we’ll be shocked at how fast market sentiment toggles back to the bull case.

Obviously, if this is wrong, the next leg down would likely be panicky and painful once investors realize it wasn’t.

However, if Friday was indeed the local bottom, my guess is that we rally back to or near the previous market highs. And it would be in the run up to those previous highs where we start looking for divergences to gauge the strength of the bounce. At least, this is the road map I am running with unless/until thing change.

For divergences, you’d want to look primarily to market internals. Advance-decline lines, new highs vs new lows, momentum indicators, these are the kinds of things you want to track. Vol needs to work it’s way lower too.

If you want to add risk here and are in a position to do so, I would recommend, as a general guideline, the sectors and names that held up best in the correction, not the ones that sold off most. It’s counter-intuitive for many of us, but strength tends to beget strength—even if constitutionally some of us are hard wired to shop for ‘laggards and bargains’.

Whatever you do, make sure you get your sizing and your stops right to manage that risk. Good luck.

Update on Bitcoin $XBT $BTC

I wanted to follow up briefly on the bitcoin post from December. 

To me it still looks like a bearish pattern has to finish playing out.  Just going by the pattern–and bitcoin has been textbook both on the way up and on the way down–it looks like there’s at least one good down-leg left.

The reason bitcoin has adhered so well to textbook stock patterns is because there are no fundamentals and the emotions run very high. Basically it gives you an exceptionally clean read on sentiment.

If you’re short, though, remember to keep your size in check because in this last bounce alone it has been oscillating between 10 and 14k. Makes it really hard to hang onto if you’re carrying any size.

Here’s the chart:

Daily chart of XBT

Good luck.

 

 

Tricks for Hanging On in a Melt Up

Human nature anchors on the high tick of mark-to-market gains. It’s virtually impossible not to. And this makes it excruciatingly hard to stay fully positioned during a melt up. Every intra-day dip, every tape bomb, every ominous indicator du jour begs us to lock in paper gains before they slip away.

Even if you are fully cognizant of this problem you can’t make this feeling disappear. But there are some modest tricks that can help you, at the margin, manage it:

For some people all of this is just too hard. It certainly is not easy for me, and I’ve been doing this for a long time. If you find yourself chronically under-invested because of a macro hair trigger, maybe passive investing or systems-based trend following is a better approach. Discretionary trading–especially in macro–is not for everyone. It’s better to go with what works best for your forma mentis. There is certainly no shame in that.