Global Macro Trading Journal

[Ghost of Cutten]

You're talking about the historical accuracy of average earnings estimates, whereas I am assessing the likely accuracy of current estimates for 2012 and 2013. Those are two quite different things.

Low bond yields relative to stock earnings yields means that stocks are attractive investments by comparison. Assuming earnings stay stable or better, then the odds of investment capital seeing a major shift from expensive bonds to cheap stocks, are far higher than the reverse.

A phrase like "It doesn't mean that you won't suffer a 50% drop in stock prices next year, or that significant inflation starting in five years won't completely swamp your 5% nominal gains" is completely meaningless. Every single day, there are always outlier scenarios that "could" happen (e.g. WWIII, getting run over by a bus, the stock market being nationalised by a leftist government etc) - that in no way implies that trade X or Y is a bad trade. Besides, no competent trader just fires and forgets - managing open positions, and adjusting to events as they unfold, is a key component of trading. If it looks like stocks are going into a bear market, I will exit my longs and go short. If it looks like high inflation is coming, I will load up on T-bond puts and gold etc.

As for sentiment, I don't use any of the measures you cited, and my view of current sentiment is that it's sceptical. We'll just have to disagree on that one.

You didn't address improving corporate earnings; the bullish market action; or the improving macro data and news flow. And out of the 3 of my 6 points that you addressed, with 2 of them you just effectively said "they might not be bullish", you didn't give any actual reasons why they implied a bearish view.

Quote from Specterx:

Like the others I have to disagree.

First, I expect the uselessness of forward operating earnings estimates as a valuation measure has been sufficiently demonstrated by several sources (Hussman comes to mind). And it makes perfect sense: we know analysts using this method were saying stocks were cheap in 2007 while still 'expensive' in late 2008/early 09, FOEs involve simple extrapolation of short-term trends and miss long-term cyclical or secular factors (as for instance the Shiller PE may capture), analyst estimates are invariably too optimistic even in bull runs (but not at genuine lows!), and so on.

Second, the level of bond yields doesn't imply anything about the future direction of stock prices. If you can estimate stocks' valuation and future returns, low yields may mean stocks are relatively a better investment, over a similar ten, twenty or whatever year period. It doesn't mean that you won't suffer a 50% drop in stock prices next year, or that significant inflation starting in five years won't completely swamp your 5% nominal gains. And in fact, in 100% of historical cases, secular bear markets have terminated (and bull markets begun) at valuation levels far below those seen in 2009, let alone what we see today. Even rising earnings would not necessarily mean rising prices: in the 1972-74 bear market S&P earnings actually rose from under $6 to $9, while prices crashed by over 40%.

Finally, the only sentiment indicator I'm aware of that indicates fear or pessimism is Yale's "Crash Confidence Index." AAII survey shows 45% bulls; mufu cash is near record lows; stock buybacks and insider sales are surging; Sentimentrader's indicators range from neutral to highly optimistic (Rydex inflows for instance show a record high bullish skew, comparable to 2007 top). And of course analysts are regularly hammering away with the Forward Operating Earnings model, while last month Bloomberg came out with a story titled "Global Strategists Are Abandoning Bearish Views." There's hardly a 'wall of worry' here and even if there were, the implications are decidedly short-term in nature.

 

[Ghost of Cutten]

Quote from Martinghoul:


Finally, pls permit me to ask a question of my own. How much have you read by Daniel Kahneman?

I haven't read his papers but I have read summaries of some of them (more time efficient), especially the ones that have some impact on trading. If I was a psychologist or academic then yes I'd read his stuff in the original.

As for not reading trading books - I agree that many traders don't, just like most professionals don't follow optimal practise, and slack off instead. But the better ones will, because they know it gives them an edge.

You still should know some basic global macro, even if you are an arbitrageur or a volatility trader or a Eurodollar spreader, because once every few years, a global macro event will make your market go crazy and blow out the normal relationships. Continually expanding market knowledge can only improve your performance.

Basically you are just not interested in maximising your abilities as a trader. Maybe you find markets boring, or just have a cushy niche that you are content to milk until you retire or go save the whales. But that doesn't mean trading books aren't useful - it just means that you don't have the desire to benefit from the ways in which they are useful.

 

[Daal]

Quote from Ghost of Cutten:

Not all earnings estimates are created equal. For example, estimates set after a market decline (such as we saw 6 months ago), and that get confirmed (and beaten) by the micro and macro data as time goes by, have a lot more weight than earnings that are clearly optimistic after a major bull run, and based on backward-looking data or the excesses of a credit boom.

As for my trading position - how long it lasts will depend entirely on market conditions. As long as the market keeps acting like a bull market, and does not give any clear exit signals, I will stay long. Ordinary pullbacks are normal in a bull market, and usually should be bought, not sold.

I would like to see the evidence that those estimates are more reliable. As far the 2nd point goes, if ES tanks 4% on monday you promise you are not selling?I see a lot of people who want to ride momentum and try to spin the 'fundamentals' in their favor to feel good about holding the position. I hope thats not what you are doing

 

[Specterx]

Quote from Ghost of Cutten:

You're talking about the historical accuracy of average earnings estimates, whereas I am assessing the likely accuracy of current estimates for 2012 and 2013. Those are two quite different things.

Low bond yields relative to stock earnings yields means that stocks are attractive investments by comparison. Assuming earnings stay stable or better, then the odds of investment capital seeing a major shift from expensive bonds to cheap stocks, are far higher than the reverse.

A phrase like "It doesn't mean that you won't suffer a 50% drop in stock prices next year, or that significant inflation starting in five years won't completely swamp your 5% nominal gains" is completely meaningless. Every single day, there are always outlier scenarios that "could" happen (e.g. WWIII, getting run over by a bus, the stock market being nationalised by a leftist government etc) - that in no way implies that trade X or Y is a bad trade. Besides, no competent trader just fires and forgets - managing open positions, and adjusting to events as they unfold, is a key component of trading. If it looks like stocks are going into a bear market, I will exit my longs and go short. If it looks like high inflation is coming, I will load up on T-bond puts and gold etc.

As for sentiment, I don't use any of the measures you cited, and my view of current sentiment is that it's sceptical. We'll just have to disagree on that one.

You didn't address improving corporate earnings; the bullish market action; or the improving macro data and news flow. And out of the 3 of my 6 points that you addressed, with 2 of them you just effectively said "they might not be bullish", you didn't give any actual reasons why they implied a bearish view.

Perhaps just a difference in timeframes and outlook here. One of my goals is to identify excellent long-term investments based on valuation and other secular fundamentals which can be held for many years, with minimal supervision and attention to short-term developments or market action. These economize on my time, reduce the required number of decisions I have to make i.e. opportunities to screw up, and smooth out the regular ups and downs that otherwise occur in trading. My point is merely that such an opportunity does not in my opinion exist in U.S. stock indices at the moment.

From a short-term trading perspective - weeks to months - there is no question that the market action does support the bullish case while Greece's problems appear priced in. Frankly though I do not see bond yields, earnings results or the continuing bearish sentiment of a handful of commentators, bloggers and ETers as particularly relevant factors here, given the strong market advance since December. Since market expectations on earnings and macro data tend to ratchet up in response to recent positive news, the flow of 'positive surprises' seems likely to taper off (this cyclicality can be seen in e.g. the Citi economic surprise index).

Maybe it's not a universal view, but it seems to me the only macro or fundamental development which 'matters' to stock prices at the moment is the ECB liquidity operation. Now that this has been completed, if history repeats we will see a grind to marginal new highs for a few more days, weeks or months, followed by a crash which wipes out the bulk of any gains in a couple of weeks and offers very little opportunity to get out. To the extent you perceive skepticism or fear, this actually aggravates the problem as everyone will rush for the exits en masse at the first sign of trouble, while the few remaining ultra-conservative players are holding out for much lower prices. For these reasons I imagine I trade this bull grind on a much shorter timeframe, and with tighter risk parameters than you do.

 

[macroman]

are you sure you guys include in your calcs US companies operating outside US ? They are making big bucks globally and are cool in all the fast growing places. accounting reporting is manupulated up or down, depending on agenda but is undeniable their strength.

 

[Martinghoul]

Quote from darkhorse:
For what it's worth: Drobny's books, and the handful of trading books I have most appreciated over the years, are nothing like this at all. Process, ideas and insights are the drivers, not bullshit machismo.

If anything the "fearless BSD" mentality -- a cartoon caricature in and of itself -- would be mocked and laughed at by true high caliber professionals. The guy who wants to bet it all on black can get his jollies in a casino.

Sure thing... I will read it and see if Drobny manages to restore my faith in humanity .

 

[Martinghoul]

Quote from Ghost of Cutten:
I haven't read his papers but I have read summaries of some of them (more time efficient), especially the ones that have some impact on trading. If I was a psychologist or academic then yes I'd read his stuff in the original.

Well, you see, GoC, as I have said before, we're just going to continue to disagree on this.

To me, Kahneman's papers and books of that sort (generally classified as works on behavioural economics/finance) actually have a lot more to do with trading than many "trading books". I, for one, am very interested in understanding how people, including myself, make trading decisions and approach risk.

As for not reading trading books - I agree that many traders don't, just like most professionals don't follow optimal practise, and slack off instead. But the better ones will, because they know it gives them an edge.

Actually, funnily enough, the best traders I know actually don't read trading books. It's the mediocre ones that do and those haven't survived in the long run.

You still should know some basic global macro, even if you are an arbitrageur or a volatility trader or a Eurodollar spreader, because once every few years, a global macro event will make your market go crazy and blow out the normal relationships. Continually expanding market knowledge can only improve your performance.

As to global macro, I daresay I know some basics and yes, I agree that global macro events can and do make my market go crazy. I have survived a few such events. My point here is not that expanding mkt knowledge is a bad thing. I am only suggesting that ever increasing understanding of global macro offers diminishing relative returns to someone like myself, an emphatically non-macro trader. I go to extraordinary lengths to make sure to minimize my outright macro biases, precisely because there's minimal relative edge to be had in macro.

Basically you are just not interested in maximising your abilities as a trader. Maybe you find markets boring, or just have a cushy niche that you are content to milk until you retire or go save the whales. But that doesn't mean trading books aren't useful - it just means that you don't have the desire to benefit from the ways in which they are useful.

No, not at all. This is an incorrect interpretation. As I am sure you will agree, there's an infinite number of things out there that can, in theory, benefit and be useful. One must perforce make a choice and concentrate on things that offer the highest marginal benefit to oneself, sometimes to the exclusion of other, less useful things. That is what I do and, more importantly, that is also what you do. I choose Kahneman and behavioral economics over trading books, while you choose the opposite. I can respect your choice and I see no need to accuse you of being lazy, unmotivated etc etc. So I would suggest that you keep an open mind and allow that there are people out there who disagree with you. It's generally a good thing for traders to do this.

 

[Butterball]

Quote from Ghost of Cutten:

Low bond yields relative to stock earnings yields means that stocks are attractive investments by comparison.

Apples to oranges comparison. Government and corporate bond yields represent - bar defaults - very predictable recurring cash-flows until maturity. Equity earnings using a snapshot of the price/earnings ratio do not.

Especially not at historically high corporate margins.

 

[gmst]

Quote from Martinghoul:

I go to extraordinary lengths to make sure to minimize my outright macro biases, precisely because there's minimal relative edge to be had in macro.

I firmly side with GoC as far as utility of trading books is concerned especially of the sort like Drobny, Market Wizards etc. Do you know that Market Wizards has interview with SAC founder and DEShaw - these guys didn't get lucky by putting size on a few trades. I won't get into that discussion, however, I would like to put a qualifier on your statement that macro offers minimal relative.

I submit that - the edge offered by macro depends on the timeframe. On a short time frame like intraday to few months, spread trading/basis trading/dispersion/vol arb/inside info etc. will all beat macro trades by a wide margin on both absolute return and risk weighted return basis.

However, on a truly long timeframe (multiple years to multiple decades), the edge, the R:R you can get playing a good macro theme will eclipse every other type of trading, by a wide margin.

Example are typical Buffet/Jim Rogers and entrepreneurs like Bill Gates kind of trades - you buy China/Cocacola/Microsoft and keep adding to your position and keep the position for 20-50 years. You can move as much size you want - yes you can hold a trillion dollar worth of exposure and the edge will not diminish. How much size can you move doing a eurodollar curve play or trading JPY swaptions for example ?- a few hundred millions maybe. You do any larger size and the tiny edge will be lost.

 

[Martinghoul]

Quote from gmst:
I firmly side with GoC as far as utility of trading books is concerned especially of the sort like Drobny, Market Wizards etc. Do you know that Market Wizards has interview with SAC founder and DEShaw - these guys didn't get lucky by putting size on a few trades. I won't get into that discussion, however, I would like to put a qualifier on your statement that macro offers minimal relative.

I submit that - the edge offered by macro depends on the timeframe. On a short time frame like intraday to few months, spread trading/basis trading/dispersion/vol arb/inside info etc. will all beat macro trades by a wide margin on both absolute return and risk weighted return basis.

However, on a truly long timeframe (multiple years to multiple decades), the edge, the R:R you can get playing a good macro theme will eclipse every other type of trading, by a wide margin.

Example are typical Buffet/Jim Rogers and entrepreneurs like Bill Gates kind of trades - you buy China/Cocacola/Microsoft and keep adding to your position and keep the position for 20-50 years. You can move as much size you want - yes you can hold a trillion dollar worth of exposure and the edge will not diminish. How much size can you move doing a eurodollar curve play or trading JPY swaptions for example ?- a few hundred millions maybe. You do any larger size and the tiny edge will be lost.

Well, firstly, I agree with you, in general. To each their own and I have said this a number of times. If you're a macro guy, I can see how trading books can be of help. I can also appreciate the fact that it's very timeframe-dependent, as you suggest. Moreover, I completely agree that macro strategies are probably the least capacity and liquidity-constrained (which is why Bridgewater can be the size it is).

However, in my professional capacity I simply cannot operate on a multiple decade timeframes. Even my PA macro punts hardly ever last more than a couple of years. Therefore, I confine myself to strategies that operate on a shorter timescale and offer risk-adjusted returns far superior to macro, especially during periods of high macroeconomic uncertainty. Again, very much in line with what you have stated above. So the point that I am making is that, for me, trading books offer a very small marginal bang for the time spent. I realize that I have also been disparaging of the whole genre, but that's just because I think quality is rare.