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Investment Capitalist and its founder, Peter "Pej" Hamidi, a well known trader on Wall Street, present a unique global macro perspective of financial markets, technology and the geo-political landscape affecting market movements. There is also an important "micro-structure"... More
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  • Straight Talk from a Global Macro Practitioner about Current Events 0 comments
    Aug 22, 2011 3:59 AM | about stocks: LONG

     Dear SA Readers, my apologies for what appears to be an untimely post, a posteriori, after the fact, rear view mirror analysis, but it was actually written many, many months ago. And as I've mentioned in the past, I rarely check my SA profile because I just have way too much on my plate. But I noticed this particular article wasn't published and the "Feedback" was to post it as an "Insta-Blog". So I will, since now it explains what happened rather than what is going to happen. Quite eerily accurate, even for my own taste....

    Back in May, dear Capitalists, Investment Capitalist, where one may find quite a few more articles that can lead to "actionable positions and analysis" if read by the astute, skilled market operator. I can't tell you what to short or when and at what price. I'm not a market timer, nor a big fan of technical analysis. I'm a Global Macro Operator, and I see things in a way that requires the hardest amounts of patience to learn. At least for me. When I say "table pounding bear, or bull" on the US market, I'm pretty much referring to the overall environment. Thus, someone that reads my work might think "ok, I'm going to look for stocks to sell short over the next year because we'll keep experiencing cascades then back and fill action and then again a cascade. I could start listing names, but that's like a Poker Player telling everyone at the table what he's holding. That's something unfortunately, I've learned to shy away from. It affects the position, sometimes good, sometimes bad, but Heisenberg's Uncertainty Principle, from which Soros' "Theory of Reflexivity" was derived, proves that the more eyeballs on the same trade, the greater the likelyhood of the trade becoming a part of the mainstream, and it will either make or break your trade.  On the other hand, a Global Macro "MAJOR SIGNAL", when it's made in public and for the eternal record books, like when back in May, I/We went public with an aggressively bearish pound on the table. Those of you that embrace and absorb the rare but valuable posts coming from this site, realize when I make a call of that magnitude and depth, it’s purely from a macro-fundamental position, and never ever from an analysis of charts. To suggest so is blasphemy.

    Readers were given the simplest of instructions, which had only fundamental logic behind it. However, the language used to communicate was the language of Global Macro, and NOT Technical Analysis. I can’t even imagine how an assumption of the sort could even be made. Not knowing the meaning of “get long volatility”, and how simple such a directional, highly leveraged and extreme black swan trade is deployed (as of the eventual release of this article as an Instablog vis a vis Seeking Alpha Editors, those Black Swan trades which cost pennies are now up by a real money value of 17,000% give or take) just suggests you might be in the wrong business. However, it does not mean the author is presenting technical voodoo science in order to justify his or her position. Neither the term “setting up brackets to catch a cascade sell-off or, get long volatility by buying deep out of the money puts due to extremely low readings on the VIX and significant liquidity overflowing in the system” have technical connotations. Moreover, they are extremely actionable suggestions with immediate value and potential. Finally, the cascade has thankfully been ongoing since then, and most Investment Capitalists have been riding the wave, but 'tis a pity the article was left on the cupboard for so many months.

    Does the reader want to know which options to buy, including vintage, strike, underlying, etc..? If so, then you’re not a proprietary trader but a coat-tail trader needing your hand held. Worse is when a respectable trading website requests that their authors hold the hands of their readers and misconstrues technical trading lingo for technical analysis, thus causing a wasted opportunity for their readership to get actionable advice from a valuable source.  All the analysis that went into the June call were merely observations of macro fundamental realites of the present situation in capital markets. The rules are being re-written so fast it’s hard to keep up. The government has flooded the banking machine via the Federal Reserve’s balance sheet a sum of money unequaled in real dollar terms in the history of this country. However, this money has, thus far, remained unaccounted for. Concurrently Treasury Yields hit ALL TIME LOW'S, again, not a “technical observation”. Interest rates appear to be headed in the direction of Japanese rates at this stage in their current long and drawn out, 25 year old recession.  Lastly, the most profitable industry to be in right now is what? The industry which was toxic in 2008:  Banking.  These are not technical observations and barely qualify as observations, they are truisms. The spread defining cost of capital and rate charged to borrowers is so wide the world’s largest mining tractor can drive through it.

    Either strategy rewarded the experienced market operator as the cascade sell-off picked up steam in early August. By saying “cascade sell off”, to the layman, that means a steep, multi day, rapid point drop where the market gives up in excess of 15% in a week, or a large move in a short period of time. Having gone through this sudden initial sell-off, seasoned traders, be it quant, fundamentalist, technician, astrologist, whatever, know from experience or study that a dramatic move is always followed by a consolidation. That consolidation becomes ever more obvious as volume declines, and prices continue to trade “inside” the prior day’s prices. Again, to make such an observation, not a single chart is required, and a cursory glance at prices backed by experience, knowledge and market wisdom, allows the trader to make this factual observation and understand the meaning of it. It is in the latter that the unknowing seeks solace in the accusation that the observation is just a “technical” one and therefore irrelevant. The person or entity that makes such an ignorant statement has very little knowledge of the micro and/or macro structure of the market itself. Forget behavioral, quantitative, fundamental or technical. For this exercise, only think in terms of the mechanics of what such a set-up implies.

    Because that implication is how you draw the conclusion that a “price rest” is taking place as the earlier short traders are covering some or all of their positions, while other aggressive directional funds are coming in before it’s too late. The reason we assume that this consolidation is taking place at the half-way point of the move again has absolutely nothing to do with technical analysis, even when coming up with a target. In this case, the skilled trader is extrapolating where he or she thinks prices are headed merely based on the idea that those getting involved now are going to cover their bearish bets close to or at the same percentage decline as the one which just occurred. That’s just a function of greed and how the markets are trading right now during a general lack of retail interest. This general lack is also NOT a technical assumption; it’s the truth. The retail segment got crushed in the 2008 move and had nothing left to trade the March, 2009 low or sell the June top leading itno the August crush. August has always been a terrible month “for the market”, not necessarily for the prepared trader. That sharp intraday reversal  in March 2009, which kicked off a 30 month bull market, most of which occurred in the first 60 days, was, from a 100% macro observation point, a counter-trend rally.  Market’s became “sold out” in March of ’09 and had to cover because there really was nothing left to sell. These are conclusive facts about the markets micro structure and macro memory. Huge pension funds lend stock to generate income from their massive holdings that they are not ready to sell. When they get caught in a situation of heavy losses, they call in their stock in order to liquidate, and while their brokers and clearing firms locate their stock and call it in, the pension fund is locking their position using derivatives and other tactics such that when the stock is returned, it is used to offset their derivative positions. This is a function of the market, not a function of charts.

    Today, those same retail investors are not trying to catch this move or trade it off the charts, for if they are, I guarantee you they’re getting crushed. Right now, it’s like gravity and Newtonian Physics no longer applying once you’re inside a black hole. Either Quantum Mechanics kicks in or some other form of physics which our scientists don’t yet understand.  The fact remains the same, the old rules are no longer relevant and hence, technical analysis, as the broad segment of the market has known it, is no longer relevant. Sorry.  

    You have to understand global macro dynamics to realize there’s a problem when in 2011, they are doing documentaries in Chinese about how the coming Tsunami is about to hit China’s manufacturing base because what happens in America spreads to the rest of the world. George Soros said that during normal market episodes, the United States is in the center and US Dollars are flowing to the outer rims, the emerging and frontier markets. However, when markets are out of whack, as they are now, US Dollars, with a zeal at that, reverse course and make a straight line towards the center, leaving those outer edges to figure out what to do on their own, and the countries in the middle bearing the weight of trying to keep them from collapsing because they are attached in the physical sense. Like east and west Germany re-uniting; a sudden surge of east Germans, or cheap labor, become available, knocking west Germany, or now Germany, back on its heels with a stiff consumer driven recession, but Germany has always been able to maintain a strong, fiscally disciplined economy, whether it’s the Nazi’s or the Christian Democrat’s running the show.

    When I said in 2008 that the most profitable business to be in was Banking, at a time when their stocks were freefalling, or near their all-time or multi-decade lows, it was a logical conclusion drawn from seeing the spread between the rates the banks were paying and the rates they were charging to extremely qualified borrowers, corporate or individual. Of course so called "technician's" could have justified the same idea by saying the stocks have experienced "exhaustion sell-off's", but that's an observation of the extrerior, not an understanding of what is causing the "exhaustion". The commercial paper markets had locked up and weren’t functioning, so again, the big banks became like the neighborhood thrift, getting to really know their borrower before extending any loan to them at a steep rate. A spread of 500 to 3000 basis points between their cost of capital and rates charged to borrowers suggests a severe credit scarcity at a time when the flood gates were open and fiat currency was being created in the trillions and trillions to just flood the system until it stops threatening to collapse and take out western, unregulated capitalism with it.

    Out with the Ayn Rand Capitalists and in with the Joseph Schumpeter plus a little Marx. Buying banking stocks at their lows could be explained away technically, but the reason they can is why technicians exist in the first place. The key foundation of discretionary Technical Analysis is that the “why” matters not, and only the when and what is important. This is quite the lazy approach to trading, and I admit, often times appropriate in the right environments. However, the charts tell a story of what the smart money is doing, if you use the charts without knowing what the smart money is doing, you’re trading overly subjective strategies with no regression or Monte Carlo analysis, or any statistically qualified measurement to validate the strategy you are using. However, knowing and understanding the global macro picture from multiple angles; How everything correlates when the Federal Reserve acts as lender of last resort to foreign central banks in desperate need of US Dollars, or how the Treasury expands the debt ceiling by selling Treasuries which the Federal Reserve buys with newly printed currency and calls it “quantitative easing”, then the over-covered congressional debates about raising the debt ceiling and the risk of the Federal government shutting down, and whispers of a downgrade on the US Dollar become laughing points to the market generalist schooled in the ways of the global macro trader. This isn’t a discretionary trader, or one that uses charts, but rather an investor that understands the interlinked intricacies of global banking and deduces the consequences of certain events as George Soros deduced the consequences of the Mt. St. Helens erupting and what impact that would have on commodity markets worldwide. 

    The macro market thinker is focusing on the why but not on a quarter to quarter basis. The time horizon is 3 to 5 years but the trades may be much shorter as large positions are traded around during times of uncertainty or excessive euphoria. The mood of the market can be seen in the way the talking heads spew their toxic, stale feedback constantly lagging events as they unfold while they try to make sense of things. And the Technician says “I don’t care why, I can just see this is an exhaustion sell-off and I should buy.”  However, the global macro trader is looking at that fat 2500 basis point spread the banks are averaging and seeing Fed and Treasury operations buying slightly off the run bonds as a form of “tricky capital injection” into the hands of the ones they hope will quickly put it to work.  Hedge funds are borrowing at the window and although there are plenty of interesting things to buy, the rest of the world is looking at a sliding dollar and saying, “ok, that blue chip stock is now paying a 6% dividend, but with the dollar heading down God knows how much then what’s the point?” And you know what, they’re right!  Oh yes, there are many trades out there that one can make based on discretionary technical analysis, but knowing when emotions hit extremes should have nothing to do with charts and only with the traders natural sense of what’s going on in the “bigger picture”. And as far as charts are concerned, you can use them as timing tools after you’ve generated a defendable market theme. 

    The entire world knew exactly what was coming in 2008, with Lehman, Bear, AIG, Goldman, Barclays, US Bank, Merrill, Bank of America and Citigroup, but the American’s chose total Laissez Faire attitudes and when questioned at G-10 and G-20 summits by the central bankers of the world, they would respond in the high-brow manner and say “We’ve got it under control”. The fix was in. The ratings agencies went before congress and just said “our words and ratings are our opinions and nothing else. They are our opinions and if you choose to listen to them, it’s your problem”.  The same banks structuring derivative products that they were selling to deep pockets because of the boom in export dollars were also shorting those same products without even the hint of disclosure to buyers like Teacher’s Pension funds. The Chinese and Russians, I can understand leaving them holding the bag, but our own teachers? The most sacred and underpaid job in this country? How could we defraud them?  We did, and did it indiscriminately. If AIG were really so stupid as to insure the same derivatives over and over and over until no one really knew how many times a particular credit was insured, then they deserved to blow up like they did. And when they did, the world felt it, plus a few thousand workers in the US, but since Goldman’s been running the country for several Presidents’ now, the swaps which AIG sold were paid at 100 cents on the dollar. Of the $100 billion that went towards paying AIG Credit Default Swaps, $17 Billion went to Goldman. And it was Goldman that helped AIG keep creating a steady flow of credit default swaps by providing more and more credit to builders and anything that screamed “speculation”. The bailout funds were used to pay mountainous bonuses in 2008, 2009, 2010 and now 2011. Perhaps now they’re earning it, but the stock market is and has been a tool to take advantage of the greed and fear of the general public, and a macro understanding of the drivers of globalization and its effects on the mobility of capital allow what I call “blind” trades made without looking at charts; based solely on very simplistic emotional analyses of how markets are behaving. Macro traders don’t try to peg tops and bottoms, but recognize when the reflexive nature of the market and its incestuous relationship with the herd’s mentality is so out of whack that a major opportunity presents itself. Every macro trader must be a highly skilled chart reader as well, because the chart is used for timing of trades post analysis, not the other way around. Most analysts at bulge bracket banks look at charts to find a good trade, and then create a story to back that trade up in fundamental garbage. This is what that expensive MBA taught them.

    The rest is understanding the mechanics of how present day markets work, like the pin collectors at a bowling alley and how today they’re more efficient than the ones used in 80’s and 90’s.  So too is making a general, macro observation and employing tools the market offers to deploy or set-up that position. When the market fell off a cliff in early to mid-August as was expected once Treasury yields broke to new lows, many technicians ran around screaming bizarre things like “a head and shoulders told us this would happen” and so forth.  However, the truth was, $1.5 trillion worth of stimulus and continued job losses, and very recent documentaries about the coming collapse in the Chinese manufacturing sector, and one realizes; “ok, this is bad, and it’s going to get worse”. Humans have a natural tendency to be optimists, at least the majority of them.  Especially when it comes to speculating; and trading off of charts and charts alone is nothing but superstitious speculation, no matter how much you learn about formulas, patterns, measurements, waves, and theories, etc… 

    It’s only natural for prices to trend higher after a sudden swan dive, as short sellers slowly unwind their positions while the market makers slowly increase theirs.  We haven’t seen, for the present cycle, any general selling triggered by forced liquidations and the ever destructive portfolio insurance, which the major business schools teach the portfolio managers of today so they can sell at precisely the wrong moment.  Once these events take hold, because the public in general has been washed out and what remains are the advisers that manage client capital who either bought the 2009 low and watched as prices fell below those levels after being magnificently profitable on paper for a while; Or those that held for a retest of the low and now find themselves saying “perhaps it’s time to throw in the towel” to their clients. When I hear reports of that happening, I slowly begin building a line in stocks because of what I see happening in the world. Right now, the status quo has won out as always, and an Executive Branch elected on the promise of “reform” did nothing of the sort. Everyone was reappointed, positions and turf wars were solidified, the federal government, though not bigger, became much more powerful, and the intended shrinkage of the middle class once again resumed in the United States, and the rest of the world, especially the new middle class from the so called emerging stars like China, India, Brazil and North Africa.  

    Everything came together for one ugly August as expected. It's not over yet and we've seen markets tumble 10% or more in as little as a few days, so the rest of 2011 will be significant and I predict quite choppy and volatile as volatility takes a reflexive swing back in the other direction.  Remember as a general rule it’s ok not to take any risks by simply not trading. In fact, a key factor in long-term market success is not taking too much risk, and the most efficient way to do that is to not trade. An important point is that those of you reading this are the only ones either trading or monitoring the markets, because August is meant for the Hamptons. Lacking the professional’s, of course the market takes a swoon lower. Prices can fall on their own weight, but they must rise on the strength of buyers. Lacking liquidity, the obvious place to look for it is at lower and lower price levels, which is what these automated market-making algorithms do, they seek out liquidity in order to generate transaction revenue and rarely do they end up exposed significantly in either direction. If you're among the group not reading this, then I commend you for taking this time to get important rest and prepare for the outstanding months of September and October before holiday trading schedules take hold. On the other hand, if you’re trading, then you can write about how isolated and desolate the Financial District is right now to keep your mind off the market, and your hands off your keyboard. Don’t be a blind “hot key trader” that comes in at 8am to 8:30am and does his or her research for the day ahead. And try not to confuse technical, tactical trading like “getting long volatility”, with the subjective and inaccurate concept of Technical Analysis, unless of course you’re schooled in the subject of “Statistically Significant Technical Analysis”. Look on Amazon and you’ll find the book with that title.

    In the major institutional periodicals, which Financial Advisers, Money Managers, Stock Brokers and worst of all, arcade daytraders read, everywhere you look it says "consider selling 10% every X number of basis points the market falls until you can find 'emotional equilibrium'".  The term, although bizarre and for Behavioral Finance junkies, means "get to a point so you can sleep again at night" instead of making CNBC your only window into the world.

    We've been heading down this slippery slope for a while and what happens at the end of slippery slopes? The slope ends and you hit terminal velocity as you fall. The market fell off the slope and at this point, it's no longer about the individual retail investors looking at their shrinking portfolios and throwing in the towels. No way. That happened in 2008. Those bruised and battered retail investors have not re-entered equities. Especially when real estate is crumbling, unemployment is rising, hedge funds lost 70% of their numbers, and it seemed like the world was coming to an end as early as last year. Retail and Institutional memories are long. They don't forget what happened 2 or 3 years ago, especially if there was severe pain involved, which we know there was. Whenever significant capital is sucked out of the system rapidly, there is a tremendous amount of pain associated with it. Even if the Government attempts to offset that liquidity shrinkage, it will be a while before it makes a difference. Now, commission based retail advisers are finally puking and telling their clients, what few they have left, "ok, get the hell out of everything" after having preached the "if we just hold on" gospel far too long.

    No more blabbing. We tend to get carried away with articulating simple points. That simple point is thus:

    One, there's a floor down there somewhere. But when we hit it, it's not going to be like the March ’09 1000 point drop followed by a 70% retracement within 2 hours. It's going to be more like a basketball with too little air hitting the ground: A dull "thud" and nasty whipsaw action to follow.

    Two, the only strategy that continues to work is that of absolute return, or Alpha capture trading. Those that are actually long Alpha and short-biased on their overall books, even heavily short Beta, are deploying Absolute Return strategies. If you know how to put together a semi-neutral portfolio with those characteristics, then you know what you're doing and don't need my input. Those of you that don't know what the heck I'm talking about, count the number of years you've been trading. If it's less than 7, turn the lights off no matter how much in the hole you are this month or this quarter. Wait for the ideal time and like the US Supreme Court said about Pornography, you’ll know it when you see it, except we’re applying that wisdom to the herd and inflection points in the market as events unfold counter to the policies implemented by governments around the world. In other words, if we’re in a free fall and the central banks are meeting to prevent anther lock-up, then consider getting in there and taking on some risk, or a lot. It’s up to you, but the timing is perception based, not based on what the 15 or 60 minute chart looks like, or even the daily chart. Remember, charts are for post analysis timing when you’ve already got your ideas and need to leg in at opportune price points to control risk.

    Get smart, get neutral, or get out. And remember the market leaders. Those are the ones at the top of your buy list, not the ones sitting at the bottom of their 10 year lows. If you need me to name them, that's a cue to cash out for now.

    On a completely different note, since we have actually sold off quite an enormous amount, to the point where Chairman Bernanke is overriding the "wisdom of the FOMC" and instead implementing instant liquidity and available credit at affordable rates by buying long-term bonds and selling an equal amount of short term notes. This will "twist" the yield curve by lowering long term rates and pushing up those thin margins you're earning in a money market account (hopefully).  I said in '08 and now it's obvious, in the middle of the storm, I realized Banking was the most profitable industry at that moment. Because call rates were 7% to 8% while money markets were paying .25%.  TWENTY-FIVE BASIS POINTS. That's ridiculous. The spread is so large you could (well, I'll leave the cliche out).  

    So, I'm actually starting to eliminate or offset those bearish bets which were the most leveraged and hence had the highest Beta against my portfolio, but at the same time, I'm starting to set up trades in the "other direction". Did you get that readers?  In the OTHER DIRECTION. which means LONG.  I'm not telling you to get Long, and I'm not telling you what to buy, I'm telling you the end of the ugly Swan is near, the reeling in of the short lines will be gradual and the setting up of long positions is starting off with the lowest of leverage positions as well as playing MM on the short side to some instruments including both stocks, indices and options. Sorry, it's not likely I'll give you the exact details of what I'm trading, but the market's big enough for the skilled practitioner to do the same if they so wish.

    Several of my "General's" have hit some important levels, primarily signified by a downside reversal count as well as Parabolic SAR price points. Right behind are a "twisting" of MA's and right in front appears to be a very large canyon for a retracement of any magnitude, even a 23% 1st level Fib. retracement. There are reasons to begin considering methodical and tactical accumulation. Yet there remain ENORMOUS reasons to also be completely bearish against US Stocks. Therefore, the conundrum is addressed by market neutral, absolute return trading. Now if anyone wants me to tell them how to set one of those up, HA! Learn to cook and become a short-order chef.

    Cheers, Mwiz



    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Additional disclosure: Thank you for the feedback. The article has been completely re-written to express my personal views about discretionary technical analysis, such that if there are readers that follow my work, they know my opinion on the subject as well as current global, geo-political and macro-economic events.
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