Tail Wagging The Dog

Not sure whether I have mentioned this previously but was thinking about it this morning and figured I'd put the thought down.

Funds flow has all been into indexing and ETF vehicles over the past 3 or 4 years. ETFs are now the primary vehicle for many financial advisor and trader playbooks. This begs the question is the tail wagging the dog.

With investors hitting the ETF vehicle (sector, country, or other) before they worry about the underlying, markets are being buffetted by dull signals. Arbitrage keeps things in place, but the weight of money is coming from the macro side and it seems in keeping with the adage "shoot them all and let God sort them out."

Declaring Failure and Moving On

This is a very rough note. I think it could be fleshed out into a very meaningful article, but for right now it is just some top of mind reflections.

My underlying framework post-GFC was one where the business/investment cycles going forward was going to be more compressed (timewise) and more volatile. I was also heavily influenced by the new normal meme and how the economy was going to be stagnant as it worked through a balance sheet recession.

If I were to attribute a reason to that belief I would ascribe it to my ideological bias toward market economics and the belief that the market had not been allowed to clear properly due to significant artificial interventions. It was also heavily influenced by the recent traumatic past and the idea that modern markets/economies were more integrated, interrelated, more complex than ever before, and were consequently prone to momentum and cascade effects.

Financial marketwise this has not played out and I must declare failure and move on. I think the reason why financial markets have not reflected those beliefs is due in large part to hindsight bias and the massive trauma effected upon the psyche of market participants who endured the brutality and existential angst of a market implosion that could have gone even further. Investors have been fighting the last war. They have been overly pessimistic. They have been unwilling to give the Fed (or the govt) credit for stimulus. The market has climbed a massive wall of worry the whole way.

We are now at a point where the market is coming around to the idea that the Fed may have steered us over the canyon and to other side. The economy may be gaining sufficient strength to be self-supporting and a new cycle of more normal growth is going to ensue (even as the stimulus disappears).

That is the hope. We shall see how things pan out in practice.

More Than Just the Folly of Forecasting

"We have reached that time in the year where everyone is speculating about the prospects for equities in the year ahead.  As usual the consensus is that the market will be up 10% in 2014.  I have been an observer of strategists' estimates for half a century and I can tell you that as a group they always think the market will be up 10% in the following year whether stocks were up 20% or down 20% in the previous year."

- Byron Wien

There is something even more insidious here than just the folly of forecasting. The Mercenary Trader cuts to the chase in his breakdown of the mallady.

Think about the magnitude of what Byron Wien -- a guy who has been in markets longer than most traders have been alive -- is saying here. The collective Wall Street strategists who are bullish for the coming year are ALWAYS bullish. EVERY year. By an amount just enough to be respectable without getting them in trouble. So why should anyone care what they say or think? Their two cents isn't even worth two cents. It has negative value because it's a waste of time. They should be laughed out of town.

And why aren't consensus strategists laughed out of town? Why does the same crap get play year after year? Is there anything more irrational or lame than paying attention to utter bullshit, that has proven itself worthless, year in and year out, over and over again? Why do investors do it? Why do investors care about predictions that virtually never deviate from a standardized norm, and thus have almost zero information value?

A pet theory: It is in part because institutional investors are not the savvy, sharp group that biased product promoters and academic apologists would have us believe. To a large degree they are a group of underpaid (relative to the size of assets they manage) identikit MBAs in matching suits and ties, trying hard to avoid career risk while making decisions that don't get them fired. In the process of making those decisions, sticking close to the herd, or the established norm, is generally the safest thing -- and this "don't make waves" attitude is generally weak-minded, which leads to a weak-minded embrace of useless predictions as a pastime and a crutch. It's the same thing for establishment forecasters, by the way, which is why their predictions always cluster. The nail that sticks out gets hammered. Our general view is that, with a handful of notable and important exceptions, the supposedly high and mighty money management environs of Wall Street are actually closer to a bunch of drunks propping each other up via consensus embrace of mutually poor solutions and broadly irrational practices, not unlike the historically hidebound and sclerotic Japanese zaibatsu or Korean koretsu (big dumb corporate managements entrenching each other through cross-holdings of shares).

When You Least Expect It...Expect It

The market hasn't provided an opening for a nice buy the dip all year. It has been incessant and merciless to the uncommitted...

...and it has proven Al Funt's maxim "when you least expect it, expect it."

Market Avalanches by Jim Sogi

Great analogy

Avalanche prediction requires the study of the snowpack both historically and how the snow structure has metamorphosed over time. One of the prime causes of avalanches are weak layers and slab formation. Weak layers in the snow pack are layers in the snow that cause the snow on top of it to slide off it and down the hill causing an avalanche. Weak layers can be low density snow or an ice layer or hoar frost flakes. Slab avalanches are created when higher density snow bonds together then slides on a weak on steep hill. Avalanches can kill.
Avalanches remind me of markets. You can study market structure historically by looking at the number of trades at a price. Over time the density may change. Market order depth structure is not available in full but could be inferred to some degree. Some parties have access to full book.
The theory is there are weak layers in the market structure that might cause a market avalanche or rapid rise. There may also be dense layers in the market structure. An example is a long bar with big price change but low number if trades. Time may change the number of trades at the prices or depth of orders might affect the reactivity of the bar. And a gap is also an example of a weak layer.

Backfire

Taken from a SeekingAlpha article:

This phenomena is called 'backfire', and has been studied extensively by behavioral psychologists. The basic premise is that when confronted with facts that prove them wrong, opinionated individuals react very differently from the uninformed. Basically, instead of changing their minds and acknowledging the correct facts, they entrench themselves even deeper into their existing view.

Turn Off The Noise

Great advice from Charlie Munger:

"For decades I read almost all of The Wall Street Journal each day—and considerable portions of both The New York Times and The Los Angeles Times. I listened to the news on my ride to and from work, and at least a few times a week caught the national news on TV. By most common measures, I was clearly informed. But I was no wiser from it. All my wisdom came from my life experiences, my on-the-job observations, and the many books I started to read. Our job as investors is not merely to know what’s happening. We need to have appropriate context and perspective to understand the implications of what’s happening in order to make sensible choices."

Why The Market Pays Up for Growth

Great comment from Jason Cohen.

"The market rewards growth over profit ONLY WHEN the market also believes there's a lot more growth ahead of the company AND when the other mechanics in the company are sound, eg. good gross profit margin and high long term value: CAC. Once a company is large and simple market expansion isn't how it will grow, they're betting on the development of stronger business models. This is the current bet on FB, P & TWTR."

I had always intuited this and so liked when I saw it articulated. Not rocket science, but sometimes stating the obvious is good. 

Philosophy - Existentialism

Existentialism

- the fundamental difference between phenomenology and existentialism is whether the stress is placed upon existence or essence.

- existentialists accord precedence to existence.

Christian existentialists or neo-orthodox = Karl Barth, Paul Tillich, Rudolf Bultmann, Heinrich Emil Brunner, Rheinhold Niebuhr, Martin Buber

Soren Kierkegaard (1813-1855) - three stages of life   1.) aesthetic   2.) ethical   3.) religious

Aesthetic stage: hedonist in search of pleasure or an intellectual interested in abstract philosophical speculation.

The emptiness of ennui is an enigmatic inexplicable spiritual ailment which brings man to the abyss of nothingness, entirely discontent with his existence.

Genuine self-hood is not found in externals, but within, in passion, freedom, decision and commitment, that is, in subjectivity.

The chief distinguishing feature of the inwardness of the religious life is suffering and faith

existence precedes essence

Christ is the Absolute Paradox (God incarnate)

Kierkegaardian philosophy is fundamentally in direct antithesis to Hegelianism.

For the existential individual all is in the state of :Becoming.

Martin Heidegger (1889-     ) - dasein (being there, human Being)

- the basic mood of man is dread (anxiety), and the fundamental structure of man is care (concern).

- anxiety is caused by man’s encountering indefinable nothingness, evidence of his finitude

Jean-Paul Sartre (1905-    ) - dealt with dualism between subjective consciousness and objective Being

Man lacks Being because there is no God to create Being.

- man’s essence is freedom

“God is dead” therefore we must rely on ourselves alone.

- man is a useless passion vainly striving in a universe without purpose

Man seeks to become more than Being-for-itself, he also desires to be Being-in-itself.

- the fundamental project of man is determined by his desire to be God.

Philosophy - Neo-Scholasticism

Neo-Scholasticism, Neo-Thomism

- most contemporary Neo-Thomist philosophers are :Catholic

- constitutes one of the largest philosophical schools in the world (administered usually under Jesuit or Dominican orders)

Jacques Maritain (1882-    ) - existence without essence would be impossible.

Humanism secularizes by deifying man without admitting the necessity of God; it portrays evil as an imperfect stage which will be overcome in the evolutionary process.

Weltanschaaung - Christian worldview

Etienne Gilson - the revealed truths of the Christian bible agree with Greek rational thought

Christianity is an optimistic not pessimistic philosophy: instead of denying the existence of evil it sets out to regulate ,combat and destroy evil because the universe at its base is good not evil.