Global Macro Trading Journal

Quote from Specterx:


Absolutely would not be long stocks here, except GDX (described the bull case for that a while back and it's only weakly correlated with SPX; it's actually up a decent amount today) and Greece deep-value.
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Agree we've got a game-changer now; the pro-stocks, anti-gold case was based on a normalization meme and slow-but-steady U.S. recovery.

Flip that around and gold looks attractive again... at long-term weekly support lows GDXJ looks intriguing here for a trade (big relative outperformance amidst the carnage).
 
Ok, let's talk about trading technique here. When you have a prior uptrend that has lasted for quite a long time, and then you get the first meaningful pullback for a while, what is the correct approach? If it's simply a bull market pullback, being flat here is a mistake and being short is disastrous. If it's the start of a trading range, then being short here is a mistake, and being moderately long is probably the ideal position. If it's the start of a serious correction or bear market, being short here is a marginal trade. So, without even assessing the odds that this is the start of something bad or not, shorting here is not the way to bet.

There is a good reason you should not short the first down move in what you think might be a correction or bear market - the market has not yet confirmed a change of trend. Vic Sperandeo explained this well in his first book - to have a confirmed trend change, you need the following conditions:

i) a meaningful pullback (we have this now)
ii) a failed attempt to resume the trend i.e. a rally back, retracing part or all of the recent selloff (not had this yet), but no sustained breakout to significant new highs
iii) a sustained break below the lows of the first pullback.

So, if you are seriously bearish, the correct approach would be to wait for the first rally back - at least a 50% retracement of the down move (that would mean 1385+). Then, to short in small size or buy puts (preferred) from say 1395-1415, with a stop at say 1445. And only to move up to normal or large trading size once the market breaks clearly below the lows of this pullback - assuming a rally from here, that would be 1352...so you'd want to see something like a close below 1330 before shorting more.

That's totally ignoring any discussing of the probabilities that this is a pullback in an ongoing bull market, or the start of a spring/summer trading range, versus the start of a serious correction or bear market. I'll discuss that in the next post.
 
Ok, so what are the chances this is the start of a serious correction, or even a bear market, rather than a typical bull market pullback, or move into a sideways trading range for the summer?

Firstly, we should assess the potentially bearish macro themes. What is their likelihood of developing, how likely are they to spook the market, what would be their impact on US corporate earnings, and how badly would the market react? I'll address the main ones that darkhorse mentioned (not because he mentioned them, but because they are the main 4 being thought about in the markets).

China: even if China has a huge recession, this will be hardly a blip on the US economy. In fact, it might be a bull point as it will reduce prices for China imports and manufacturing costs, which are a major overhead for much of the S&P 500. It will also make commodity prices fall, further boosting the bottom line of US industry. The only impact a China bust will likely have is to scare people for a few weeks.

Europe: old news. At most it will scare the weak longs for a few days or weeks. It will not have the impact it had in 2011, which was a few months correction. So, maybe down 5-10% from the highs, but unlikely to be more. We're already off almost 5%, so not much upside for shorting here. Also, even if Europe implodes, this is highly unlikely to cause a US recession. The US generally does not have recessions due to foreign countries going into recession - trade is about 10% of GDP. If the UK, with half of GDP being trade, does not go into recession due to Europe wobbles, why would the US, which has 1/5th of the UK's dependence on external trade? This is why people blew that recession call in 2011.

Contracting margins. This one is easy. You sell *when there is evidence of it happening*. Not on arm-waving that it might, at some indefinable point in the future, possibly happen. In 2005, it was 99% certain that housing would blow up. The market still went up for another 2 years until housing *actually started to blow up*. And contraction of margins is not a 99% racing certainty like the housing bust was. Sell when something starts happening, not years in advance of it.

Federal Reserve 'fails'. This one is also easy. If they want, the Fed can print money. Bernanke clearly 'wants' to avoid any deflation, he's shown it by words and repeated actions. So, it won't happen unless he is replaced as Fed chairman. The Fed has unlimited 'firepower' so there is no way they can fail to create as much inflation as they want. Besides, this is another silly 'what if?' scenario. If deflation takes hold and starts ravaging corporate profits and asset values, you will have plenty of warning because companies will start missing earnings estimates and suffering large write-downs. Clearly it's better to wait for evidence that it's starting to happen, rather than just gambling that it might one day happen.

Another one:

Iran: this could definitely cause a hefty correction, say 10-15%, maybe 20%. But, it's like any 'grey swan' - you don't bet on it until you see that it's actually started to happen. If Iran kicks off, just exit and get short on the day of the news.

There are always potential bear scenarios in the markets. To get an actual bear market though, you need the scenario to start happening, AND for it to have enough impact to justify a bear market in prices. It is rare to find both. Usually what happens is that many of the scenarios don't happen at all, thus providing dips to buy; and that the ones that do happen, usually don't have the impact that people were scared of. There are only a few scenarios that do have genuinely bearish impact - things that massively reduce corporate profitability and solvency i.e. domestic recessions, banking panics, wars that credibly threaten national survival, communist revolutions, soaring inflation etc. None of those are anything other than outlier possibilities at present.
 
So, all we really have left on the bear side is that the markets might get a bit more scared of one of these macro themes, and go down a bit more. A 10% (or smaller) pullback on a macro scare is pretty commonplace in long-term bull markets. With the pullback already in the 4-5% range, you are shooting for 4-5% profit, and your risk if wrong is about 5-6%. What are your odds - definitely not much better than a coin-flip. So, the trade sucks - being short the stock market here is marginal at best.

On the bull side, things are different. For example, if nothing in particular happens for the next 12 months, stocks should be about 10% higher, simply on accumulated corporate profits for the year, plus inflation. I.e. if the bear case is right, stocks fall 5%. If it's neutral, stocks rise 10%. If the bull case is right, stocks return 15-20%. Those don't look like a good set of scenarios for being short.

Finally, even if the bear case is right, the timing is wrong - you are shorting a pullback in a confirmed bull market. Wait for a 2nd attempt at the old highs before thinking of shorting. If you want to play some theme like a China or Europe blowup, then the way to do that is to short specific names and then hedge out your overall market exposure with some long ES or NQ (or, ideally, some of the market leading stocks that are acting resilient in this selloff) not to make an outright bearish market bet too.
 
Instead of rationalizing your bias, what about putting the cards on the table and telling us how much of your total net worth you have in your long equities trade. What good is three pages full of arguments to double down on your longs if you only bet a fraction of your assets on the trade?

Net worth = value of all trading/investing accounts + net equity in real estate + whatever else you own that is a comparable asset net of debt

I just ran my numbers. 90% of my total net worth is long equities. 120% long, about 30% short. Down from about 130% net long in mid March. For every further drop of 5% I'll take off another 15% or so in net long exposure, rinse and repeat. I never go net short.
 
I couldn't disagree more with the idea that Europe can only cause a 10% decline from the highs in US equities. It doesn't have to trigger a recession at all
 
US trendline growth appears to be closer to 2%, maybe 2.5% right now compared with 4-4.5% in 1998. Those who use the Asian currency crisis as a blueprint to gauge the impact of a European recession on US GDP are missing that. The US economy is much more vulnerable to an external trade shock now than in 1998.

45% of SP500 sales are from international trade, approx. a third of them from Europe.
 
Even going beyond the 'fundamentals' there should be an impact. A large default in Spain and/or Italy should trigger global risk aversion, the last few days were small examples of that. Even if the S&P500 profits weren't affected people will still put a lower multiple on stocks due fear

Russia default triggered a 20% decline in stocks during a stock bubble and good economic times. I don't think US exports or profits were impacted meaningfully(Certainty nothing like by 20%)

I believe the book animal spirits by Shiller talks about the fact that the volatility of economic variables is something like 1/10th(don't quote me on that number) of the stock market. Essentially stocks fluctuate like crazy even though reality isn't

Its all about expectations and moods, Europe can put people in a terrible mood and get them to sell for all kinds of silly reasons. If you are a long-term investor that is irrelevant but if you want to trade the market this year and next, it matters a lot
 
"We should wish for IMB's stock to languish throughout the next 5 years." - Warren Buffett from his recent annual letter. Buffett wins because he understands this concept from the core of his being. I'm trying my best, but it's really quite tough.

If you own good companies over a long time frame, you should hope and pray that Europe goes in the toilet and stocks in the States take a hit. It just means the billions spent on buybacks and dividends (automatically reinvested through DRIP) get more bang for the buck. WMT (or TUP or MSFT or XOM or BP or a bunch of others) at $70 this year, and $80 the next will be great for my ego. WMT at $50 for the next 5 years will be far greater for my bank account.
 
Quote from Ghost of Cutten:

So, all we really have left on the bear side is that the markets might get a bit more scared of one of these macro themes, and go down a bit more. A 10% (or smaller) pullback on a macro scare is pretty commonplace in long-term bull markets. With the pullback already in the 4-5% range, you are shooting for 4-5% profit, and your risk if wrong is about 5-6%. What are your odds - definitely not much better than a coin-flip. So, the trade sucks - being short the stock market here is marginal at best.

On the bull side, things are different. For example, if nothing in particular happens for the next 12 months, stocks should be about 10% higher, simply on accumulated corporate profits for the year, plus inflation. I.e. if the bear case is right, stocks fall 5%. If it's neutral, stocks rise 10%. If the bull case is right, stocks return 15-20%. Those don't look like a good set of scenarios for being short.

Finally, even if the bear case is right, the timing is wrong - you are shorting a pullback in a confirmed bull market. Wait for a 2nd attempt at the old highs before thinking of shorting. If you want to play some theme like a China or Europe blowup, then the way to do that is to short specific names and then hedge out your overall market exposure with some long ES or NQ (or, ideally, some of the market leading stocks that are acting resilient in this selloff) not to make an outright bearish market bet too.
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Agree with almost everything you've stated!

I do have a bullish bias for the US stock markets for this year too, generally for these reasons (influenced mainly by Ken Fisher's thinking):
- bull markets usually last around 4 years (2009-??), the 3rd year's (2011) "down a little"/flattish performance keeps people fearful,which typically would lead to a good 4th year.
- this is the last year of an election cycle, historically a good year for the market
- investor psychology is still neutral/slightly bullish at best, everyone's anticipating the next "correction", stating that the market has gone up too much too fast, which is always usually the case for a bull year. We haven't seen the excessive bullishness that we typically see at the end of the bull market -> using AAPL as an example, it's not until almost 99% of the analysts have a buy on the stock that we have to start worrying.

What I'd do after today's action would be to wait-and-see. How the market performs the next day after a big down day would give us a better read on what the good risk/reward trade would be.

To note is that the daily ranges are starting to widen again (volatility, which usually accompanies a change in trend), the stock closed at the bottom of its range with abnormally large volume, so we'd have to see the "follow-through" whether demand is enough to overwhelm the supply at this level:
- if there's a large up day with a large daily range (which would force short sellers to cover), and then start trending down again, then I'd change my short term stance to bearish.
- if market starts trending up with no excessive ranges and no excessive volumes, I'd maintain my bullish stance and trade a risk reversal at zero cost by buying some OTM calls + short some OTM puts, which would give me additional comfort in case the market still has room to go on the downside, but still preserves my upside.

would welcome any thoughts, feedback on my view.. any holes to poke in my reasoning?
 
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