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Mistakes Made -- (Part 2) The Fallacy Of Focus On The Wrong Inputs To Drive Intermediate Term Market Movements.

Mar. 21, 2015 3:06 PM ET38 Comments
Robert Duval profile picture
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I find I learn best through mistakes made and realized.

Markets continue as a humbling mechanism.

I have been down this path before but feel the need to reiterate the following summary of what I believe is and is not important in making investment decisions, as I will through this brief post.

It is critical to focus not on what I think rationally markets Should focus on to Value asset prices, but what they are focused on.

Note me that my comments apply to the intermediate term time frame of investing, mainly, and should be received in that context.

Summary.

1. Central Banks far and away remain the overwhelming #1 input for price discovery for intermediate term price movements. This has been proven again, and again, and trumps geopolitics, organic growth trends, economic data, and even earnings trends. This is not to say such fundamentals don't matter -- but central bank policy rules.

Perhaps it always has, and I have not seen enough cycles. But one would have to admit we are in somewhat uncharted territory.

Rather than attempt to defend this thesis, one chart proves it: the German DAX over the last year. Simply breathtaking. To those who doubt Central Banks are not the dominant factor, I simply ask, what else has changed in Germany?

^GDAXI Chart

^GDAXI data by YCharts

2. This will last, simply until it doesn't. Not fully and completely embracing this fact has been one of my great investment mistakes over the past 6 years. I have been solidly profitable as a trader through that time, and am seeing steadily improving results, but fighting this factor through index or individual short sale trades has mainly been an exercise in frustration and stress, even when profitable.

3. Bond markets lead, and will lead. We are in a world willing to lend to high risk countries like Italy or Spain for 10 years at under 1.5%, due to QE programs. Many yields are negative. In this environment, debating market or stock valuations are nearly always a fools errand. Without fixed income competition, TINA rules and money will be forced into stocks, even those with high risk or valuations.

4. To the above -- valuation alone is neither a market or stock timing tool for short selling or top calling. There must be a catalyst above and beyond valuation measurements, and usually a loud, powerful one. Even overwhelming short thesis trades, like many in commodity stocks, are "hard" trades, requiring great patience.

Those shorting internet stocks in 1999, got carried from the building.

5. Overthinking potential future macro developments, especially of a negative nature, more often than not, anti- productive.

Now some commentary on my thoughts and position changes post - FOMC. Hopefully this will be of some help to others as it is to me to reflect on.

The below are copied from comments I made to past blogs, and reposted here.

For my time period which is intermediate, in a world where there is no competition from safe yielding assets --- which should be the defining issue -- what is the competition -- valuation is a total red herring.

I have been, overall mistaken to attempt valuation shorts in an environment where investors are willing to lend money to Italy and Spain at 1.5% for 10 years, and to Coke for the same yield, even though many shorts had a substantially profitable outcome.

Looking at a list of the best valuation short candidates that have occurred, CAT has grinded lower from 100 to the 80 area, during a period of collapsing sales, management issues, FOSL about the same -- while their business in under huge threat from the APPL watch. Even oil stocks, with oil making new lows, won't easily go down.

Thinking this through -- if investors are willing to lend cheaply to Italy, why not Exxon -- or weaker oil stocks? Therefore -- they continue to exist in a healthy fashion that would be quite different in a tighter credit market.

Shorting a stagnant economy due to valuation, again, also makes little sense, barring complete collapse. Even then, US QE would return in a flash.

All in all, it's just not worth it, considering one pays the borrowing fee and dividend. Shorts will only be truly productive if and when rates spike due to inflation, and that doesn't seem on the radar. A good rule -- would be shorting may be more productive once there is no QE, anywhere in the world, as QE dollars move around the globe. And that doesn't seem likely near term, either.

My recent posted shorts included such names as BABA, MU, and several oil names. Brief comments for clarity.

In no way do I see the fundamental risks involving these companies as diminished, and I think they are all highly risky buys for reasons I have commented in detail on.

However one of the hard lessons I continue to relearn as a trader is just because I see a stock as an overvalued, highly risky purchase, doesn't mean it's a wise short candidate. There is a middle ground and the extraordinary liquidity from the world's central banks means valuing stocks and risk by traditional means for evaluating short candidates is extremely risky, even dangerous and stressful --- and wrong.

There are those with extraordinarily deep pockets, patience and vision to ride through this period, who may be short various assets today. I realize I do not have the willingness to ride such positions to a different credit period, and cannot foresee when this tidal wave of liquidity will end with implications for valuations.

I expect on balance of probabilities the oil stocks, Micron, and Alibaba are likely to continue to under perform their benchmarks, and the dollar to continue higher.

I also think, taken as a whole, short positions in all three, (barring a violent collapse in oil / further massive dollar spike for the oil stocks) are likely not worth it from a risk / reward / stress point of view, either long or short, compared to alternatively using capital in productive long positions, established hopefully on dips.

Here are a few charts reflecting this / comparative to their major index or ETF and (Shanghai for BABA) -- quite dramatic to see a 50% collapse in a stock while its benchmark soars!

Oil stocks // SPX, Micron / QQQ, Alibaba / ASHS (Shanghai)

LINE Chart

LINE data by YCharts

RIG data by YCharts

MU Chart

MU data by YCharts

ASHR Chart

ASHR data by YCharts

I hold a number of core long positions including in emerging market countries that greatly benefit from lower oil prices. I would be better served focusing on these ideas instead, or on infrastructure, US housing, and solar, all where I remain long term constructive.

Thanks all for following, and I look forward to your comments!

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