Friday, June 9, 2017

This Week's Message: The Age of the Machine Has NOT Risen -- OR -- The Effects of Little League Games and Piano Recitals

I need to preface the following with the acknowledgement that, as with virtually everything else in life, future market prices are undeniably uncertain. Stocks can fall out of bed at anytime for any reason -- whether they've enjoyed an uptrend lasting 8 years, 8 months, 8 weeks, 8 days or 8 minutes. They can fall from what some construe as great heights, they can fall from any number above zero... 5,000 was considered a great height when the Dow reached that milestone back in November 1995:

Acting on that sentiment, however, would've cost one dearly. Here's the rest of that decade:

And while the index sits today at a level nearly twice that of December 1999 -- and quadruple that of November 1995 -- it mounted and tumbled from what turned out to be some lofty heights along the way:

While it's tempting to layer on moving averages, economic data, etc., to explain why one might've been inspired to get cautious leading into those past large drawdowns -- and why one might not today -- I'll instead direct you to the home page and have you watch a few of the recent videos; if, that is, you haven't been tuning in of late.

Some like to complain that today's market is run by computers trading zillions of shares by the second, per the algorithms devised by a few genius quants (or quantitative traders; the guys and gals who do the input) -- well, unequivocally no! The age of the machine has not risen; not at least in a machine-does-the-thinking sense.

Rishi K. Narang, in his reveling book Inside the Black Box: The Simple Truth About Quantitative Trading spells it out clearly:
Despite this talk of automation and systematization, people conduct the research and decide what the strategies will be, people select the universe of securities for the system to trade, and people choose what data to procure and how to clean those data for use in a systematic context, among a great many other things. These people, the ones behind quant trading strategies, are commonly referred to as quants or quant traders.
And make no mistake, "these people" -- all of their brains and backtesting notwithstanding -- make mistakes. They, like everybody else, grew up in imperfect settings. They had the trials and tribulations of little league games and/or piano recitals. Their egos have been forged by their own real worlds. And, thus, they see today's world through filters they likely don't even know they have. Hence, their supposedly (I haven't done my own study) high failure rate.

From an article titled Why Most Quantitative Investment and Trading Systems Fail by Baijnath Ramraika, CFA, and Prashant Trivedi, CFA:
The underlying cause of eventual failure of most quantitative investing and trading strategies has to do with how the factors are identified.
"Identified" by fallible humans.  

Two reasons I decided to touch on quants this week. One, I get asked on occasion about the validity of going entirely mechanical (which is, per the above, impossible) and, two, I'll grab every opportunity I can to illustrate the uncertainty of markets and the fallibility of market "experts" (read reality!)

In closing, I'd like to share two instructive email conversations from this morning. These gents are ironically named Charlie 1 and Charlie 2:
Charlie 1: I have a question. I see that the bond market isn't buying into the rally in the stock market. The volatility index is hitting record lows. I was wondering who's right. Those bond market guys are some smart guys and I'm thinking they're right. Just curious what you think.
Me: Hey Charlie 1, we were pondering the same thing in the office this week.
I sympathize, although I generally put it: those bond market guys are more careful. But, of course, they're still opportunists. 
And while various yield and CDS spreads (let me know if you need specifics), in particular, are not showing heightened stress (denoting a low financial risk environment) bond prices are still catching a bid. The contradiction there is that, for example, CDS players are the definition of careful (and they're smart) -- yet they're presently quite sanguine (i.e., they appear to be buying into the stock market rally).
I'm guessing the bond market's present resiliency is a lot about event risk and stubbornly low inflation. Plus, for example, China recently announced a planned increase in treasury buying. Opportunistic traders would want to get in front of that.
Ten year note futures traders were back to net long in a big way going into this week (for obvious event reason I'm guessing). GB's election result creates anything but certainty. 
The next few months will be interesting as the fed begins allowing its balance sheet to roll off a bit and attempts to build a little ammunition for the next recession (read raise rates).
Gotta stop here for now.

Charlie 2: Marty:
This guy is a little scary. Is he a typical gloom and doom character?
Best, Charlie 2
Me: Hi Charlie 2,
As a rule I no longer click into these articles. Okay, maybe on rare occasion.
I know Jim Rogers well (not personally of course). I've read his book on commodities and had followed his commentary for years. He's an incredibly smart guy, but he has a dangerously high opinion of his own opinions, and he's typically all about commodities.
He was George Soros's (I know you love him!) partner in the incredibly successful hedge fund, the Quantum Fund, back in the 70s and 80s. In Soros's excellent 1994 book "The Alchemy of Finance" (where he doesn't get political at all), he wrote briefly about his partner. Soros said that he and his partner loved shorting the stocks the Wall Street darlings were touting. The difference between them being that Soros also constantly doubted his own logic, while his partner actually thought they were geniuses who were always right. The partner (Rogers) is, therefore, someone to keep at a distance!
Rogers has been touting that we all should be farmers (read buy ag commodities) for years (although I haven't given him much attention the past couple, so he could've changed his tune). If he's still there, he's gotta be frustrated out of his mind as he's been left behind by the modern world of late. 
In summary; yes, he's been a hater of U.S. stocks in particular for years. Which brings to mind all the times I remember him saying he's long foreign stocks and either short, or not in, the U.S. This is while for seven years U.S. equities outperformed virtually everything foreign. That, as I've been reporting, is finally not the case of late. 
Lastly, he doesn't believe in technical analysis, which puts him, in my view, at a huge disadvantage these days. His opinions are his hunches, and this market has to take a bath for him to make a little money... it behooves him to predict doom and gloom. Of course, in the long-run, he's absolutely right (we'll have a bear market), although the "Crash of a Lifetime", unless he's talking to newborns, I dunno???
Have a nice weekend!

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