Sunday, July 19, 2015

Now, The Most Dangerous Time to Trade


Some pseudo-sophisticate might say the most dangerous time to trade any market is when it is open for trading. For traders initiating a trade that can be costly to unwind, there is no worse time than when the market is slow, with little volume and in a long, flat pattern. The very trap of being the worse time could also be the best time for investors.

For Traders

For many years I have watched the actions of traders on various broker/dealer trading desks. At times their biggest risk is boredom. In a slow, flat market (which we have had for some time) watching their screens, reporting only minor price changes can drive these activists crazy. To create some action they find prices that they follow closely which they believe they understand better than the market and create a long position or in a minor number of cases a short position. Because the traders need to earn more than the cost of capital assigned to them they multiply the small expected moves by the use of borrowed capital in some form. A swift breakout or breakdown from the price level of their position can have a dramatic impact on the value of their positions, the bonuses, and ultimately their employment. In the current environment the trading desks staffed with portfolio managers at hedge funds play similar games as the old dealer desks, except with more modern training they are likely to use derivatives as their medium.

For Investors

Perhaps the key difference between a trader and an investor is the time to success (or failure). The trader is short-term oriented in terms of hours, days, or possibly weeks. An investor is much more concerned in terms of years, often a number of years, which is why we developed the Lipper Time Span PortfoliosTM concept. We manage money for the long-term, and in some cases beyond one’s lifetime. However, the long-term starts with now, at today’s price.

Jumping Off Point

We have written in past posts that it is somewhat natural to be in a reasonably flat stock price picture. Equity prices have raced ahead of the slow, uncertain economic factors that are producing limited gains in top line revenues. Current prices reflect largely present and expected earnings gains coming from profit margin increases due to low commodity prices, more efficient use of labor, foreign earnings translated into US dollars, and buy-backs. Without future revenue gains much of the above-earnings increase elements will eventually reverse.

Two Bullish Strategies

The strategists at Charles Schwab believe that we will enjoy a grinding higher stock market. With core inflation, excluding food and energy, growing at a current 2.3% rate, Schwab and most of the rest of the strategists are looking forward to the early stages of an interest rate rise. Also the sentiment index of home builders is rising at a faster rate than new starts.

The strategists at JP Morgan proclaim that they are global investors to some degree, escaping the geographic labeling in asset allocation. Nevertheless, they point out that for many of the normal investment measures, US stocks are priced above their ten-year averages. On the other hand they point out that the Asian Emerging Market stocks are selling below their ten year averages in terms of forward price/earnings ratios, price/book value, and price/cash flow. This Asian bias is similar to our own which favors Asia over Europe, even though a number of the funds we use are currently betting in favor of Europe.

Two Causes of Concern

The first is Moody’s has raised its forward looking ratio of default frequencies for US and Canadian High Yield issues. From an abnormally low level the expected rate increase is back in the more normal range. This could be influenced by a concern for the oil and gas High Yield paper or  too accommodative underwriting standards in the past. I tend to pay attention to the fixed income market from the perspective of an equity investor. Often the risk avoidance mechanisms of bond holders and traders act as the canary in the stock market.

The second cause for concern is much more complex and controversial. It starts with the relief rally the world stock markets delivered for the week ending July 15th  as reported by The Economist. All 44 of markets it tracks rose for the week in US dollar terms. Only 9 declined in local currency terms. As a contrarian, any time I see all of the passengers in a boat on one side I fear a collapse. Many market participants view the news of the week positive from Greece, China, and Iran. Perhaps, the US Mutual Fund and Exchange Traded Fund investors were using the relief rallies to be net redeemers of both domestic and international funds for the first time. Maybe they are right or at least raising the same questions that I do in terms of Greece, China, and Iran.

The decision to fund Greece’s place in the euro with German money in the long run, in my opinion weakens the euro and will not correct the larger than treaty permitted deficits for a number of European countries. The cost of losing Greece for awhile is much smaller than the damage in keeping it.

In many ways the current Chinese government is the most effective government in the world. This may be true due to its command structure or the skills of the present leadership learned at the party’s political school. I am afraid what has been taught is the use of socially determined bailout mechanisms. Bailouts perpetuate poor behavior and in the end prove to be more costly to the society than letting failures occur. In quick order they will be replaced by newer and sounder forces.

In terms of the agreement with Iran, my fear is that we have seen this movie before in terms of our experiences in and after WWI and the creation of WWII.

Once again we are experiencing the power and “wisdom” of an unelected woman in terms of the second Mrs. Wilson (VJ) and the lack of understanding by Neville Chamberlin (VJ and crew). The temporary avoidance of conflict comes at a much larger price of future innocent deaths.

As we have not yet raised cash, and since Gold and TIPS are not rising in price, let us hope that I am wrong.

Questions of the week:
1. How are you going to “play” the change in direction of the current market? 

Question 2: What are your long term investment worries? 
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