Global Macro Trading Journal

2017.08.04%20-%20Shiller%20PE_0.JPG


One can see that the PE ratio from the late 1800s and early 1900s (gold standard period) was quite low, removing that out of the sample probably pushes up the median and average PE and therefore makes the current market looks less overvalued.
Point is, backtests are quite tricky, its not as simple as getting data, running a regression and thinking you have an edge
 
Gundlach now:

https://www.bloomberg.com/news/arti...pricey-market-sets-cap-on-doubleline-s-growth

“If you’re waiting for the catalyst to show itself, you’re going to be selling at a lower price," he said in a phone interview Monday from DoubleLine’s office in Los Angeles. “This is not the time period where you say, ‘I can buy anything and not worry about the risk of it.’ The time to do that was 18 months ago.”

Gundlach 15 months ago:

https://www.businessinsider.com.au/jeff-gundlach-stock-market-outlook-2016-3

On his latest webcast discussing his view on markets and the economy, Gundlach said that after a rally in the last month, the S&P 500 probably has about 2% of upside.

And 20% of downside.

“The set-up for risk assets, from a risk reward standpoint, is really quite poor,” Gundlach said.

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Fixed income guys live in a different world, they put a lot more emphasis on defense/being conservative, which serves them great in bonds (especially bonds with some credit risk, like non-governments bonds) but in stocks, its a lot tricker, missing out a big gain can be just as bad as holding during a drop. As a matter of fact, its probably worse

There is something that I'm working on that I'm calling the "Buffett ratio", that is the total stock market gain (over a long-period of time) vs the maximum drawdown. Since 1928, US stocks returned 23,500% real (roughly), the max drawdown was -76% (monthly data on S&P composite). That's over 300 in the Buffett ratio, but ok, no long lives that long. But that essentially show how much someone would be punished by having the tendency to be bearish/sell out of stocks/be pessimistic, and the results show the punishment would be huge.

The US had a very sucessful stock market but most countries that I have looked at still have a very positive Buffett ratio, that is, they would have rewarded someone with a bullish tilt (in limited amounts) in their investing activities. As a default option, its better to be bullish than bearish because otherwise, you will be "shorting" that Buffett ratio as as time passes, its very likely that it will get larger and squeeze people out (through missing out big profits). Gundlach doesn't seem to be aware of that, he has no skin in the game (he is not benchmarked against the stock indices) so he can just talk all day long and not care if he is wrong.
If he was a stock manager, he would have the same bullish tendency that I'm talking about
 
A lot of investors hurt themselves by trying to avoid 10-30% drops and miss out giant 500%+ gains (over the long-term) as a result. Annual accounting contribute to that as people think "either the market will rise 10% or fall 10% this year", they think there is a linear relationship but there isn't.

Looking at global Buffett ratios, what they are fighting against is EXTREMELY assymetrical. Which is why I cant see how I'm wrong on the idea that stock investors need to have a bullish heuristic (a bias if you will) to them. I sent my NY SF article, talking about this bullish bias to Taleb, we will see what he says, if he respondes he will disagree I'm certain but probably because he is an 'activist' 'trying to save humanity'. Truth is, for every period where the Buffett ratio sucked a lot (say in Cuba in the 60's with the -100% loss, or Russian in 1917), there are many more where it did great, in most countries, most of the time, it will be the case.
So overall, investors are better served by having a bullish tilt to their activities (the 70% 30% mindset balance) rather than trying to be both and then missing out on a large run, or to be too much of one of the two
 
For more active forms of trading, its different. Almost anything goes, I have seen good traders that are very biased. There is one particular day and swing trader that I know that I can tell what he will say about a stock, before he is even asked about it. He is extremely negatively biased, every company is a fraud and a joke. But he is very sucessful, he does a great job shorting them and controlling for his risk at the same time. I have seen mainly bullish biased traders also do great.

But the tricky thing is that the longer is someone's time horizon, the more they will need a bullish tilt to their actitivities, otherwise it will be just too difficult to fight against the "current". Some exceptions might be people like Soros or Druckenmiller, they make so much when bad things happen that those profits compensate for not doing as great when good things are happening. But even then, you got to consider that they stay on those negative trades for a short period of time, they are good timers, they get their money and run. And when they run, they buy (to cover shorts), and buying is a bullish behavior. And during good times, they are long a little bit in stocks, bonds etc. They are very cautious bulls and occasionally massive bears, and they tend to time the bearishness well, that can work if you got to the timing skills. For most people, most of the time, it won't work. They need a bullish tilt to their actitivies to make things easier
 
Whats funny is that Howard Marks, a conservative fixed income guy, most sucessful investment of all time (the 20% stake on Gundlachs firm) is an equity position that paid off exponentially. All his talk and bond investments mattered very little compared to the sucess of that stock position (typical in Extremistan distributions)
I guess what I'm trying to say is that every second an investor/position trader spends not trying to find those exponential/gigantic gains, is a waste, and a bullish bias/mindset can be helpful in that search (more motivation/visualization of the result/belief that it will work). And I say to hold myself accountable, I need to spend more time in that and less time in other things
 
Daal said:
A lot of investors hurt themselves by trying to avoid 10-30% drops and miss out giant 500%+ gains (over the long-term) as a result. Annual accounting contribute to that as people think "either the market will rise 10% or fall 10% this year", they think there is a linear relationship but there isn't.

Looking at global Buffett ratios, what they are fighting against is EXTREMELY assymetrical. Which is why I cant see how I'm wrong on the idea that stock investors need to have a bullish heuristic (a bias if you will) to them. I sent my NY SF article, talking about this bullish bias to Taleb, we will see what he says, if he respondes he will disagree I'm certain but probably because he is an 'activist' 'trying to save humanity'. Truth is, for every period where the Buffett ratio sucked a lot (say in Cuba in the 60's with the -100% loss, or Russian in 1917), there are many more where it did great, in most countries, most of the time, it will be the case.
So overall, investors are better served by having a bullish tilt to their activities (the 70% 30% mindset balance) rather than trying to be both and then missing out on a large run, or to be too much of one of the two
More...

This is why I understand Ackman's decision to go with the VRX investment. People will look at the loss and say 'he is stupid, he lost 25% in one stock', but they don't realize that you can't have one without the other. He is up like what, 20x since his first fund (plus all the fees), you cant do that in stock investing without having some some unique mindsets, usually very positive and optimistic mindsets. They also have to be willing to take a fair amount of risk, so risk happy and optimistic. So if you look at only at the investment, sure, it looks bad, when you consider the entire context, it works, massively (exponentially). This is similar to Buffett's buy and hold approach, sure, he will ride down crashes and recessions and look follish when things are down a lot, but that bias/mindset ('US will always bounce back') also enables him to ride gigantic bull markets of 500%+. A more 'logical' person will ALWAYS find a reason to sell at some point, whereas the biased guy will stick with his heuristics and be right exponentially. People that never made a dime will judge people that are up exponentially

And when you are right exponentially, guess what, you don't need to be right very often to justify that decision. Its the other people that need to be right almost everytime
 
I have been hammering this for so long because it took me a long-time to realize it. I'm sure a lot of other people are/were in the same boat. For instance, one of the Market Wizards quotes that stuck with me for a long-time was Colm O'Shea quote of "Also, a problem I have with equities is that equity stories make no sense to me. Equity people often make no sense to me".
And for a long-time, I was in the same boat. I couldn't understand how that bullishness and unwillingness to see negative facts could possibly work. "They ignore bad news, that is reckless, they will get burned eventually!"

But then I learned through the real world (trial and error, experience) that NO ONE KNOWS ANYTHING. Backtests don't prove a thing (they merely suggest that things COULD be a certain way), statistics don't either. "Analysis" is extremely fragile in the real world. Financial theory is just that, theory. When I got that them I realized that in order to navigate through an uncertain world (and markets) one needs to rely on robust heuristics/mindsets NOT statistics or "analysis". The latter can only help a bit in that process, they don't produce the final say. And then I realized that top performers in the equity world do just that. They don't understand the world they live in (no one does, everybody is just guessing about what is going on), they rely/count on robust heuristics/mindsets/biases even if they will claim otherwise. And in the stock market, a more bullish posturing is more robust versus a bearish posturing. When for every bear market of -30%, there is a bull of 200-300%, quickly it becomes obvious that as a default, one needs to be optimistic. And in individual equity stories, that also can be true. When you think something has a massive potential, the biggest mistake is not buying it. Its better to err on the side of being an optimist, vs being a pessimist.

So I realized that O'Shea was lost because he didn't realize this assymetry. Whether if that was because of annual accounting, convexity/powerlaw blindness or pure internal risk aversion, I don't know. But now equity people make complete sense to me and when they ignore bad news, its because of the payoff matrix of the stock market (limited risk, exponential reward) not because they are stupid or lazy.

But of course, if you ask them, they will say they are ignoring bad news because of the Fed, the economy, this statistic, or that. Its not, the reason they are top performers is because of their heuristics/mindsets, these "facts" are just expressions of their internal mindsets/biases.
 
Let me argue a little about the other side. Here are some scenarios that I'm worried about for US stocks that could lead to huge declines (40-50% or more):

-US corporate profit margin collapse. The S&P500 price to sales is high for a good reason, profitability (profit margins) are very high. If the price to sales didn't adjust upward, the market would be such a huge bargain. Damodaran demonstrates this well with a tweek on the gordon formula in his video series. A similar thing can be said about the Shiller PE, which is backward looking and slow to adjust (and it still affected by things like the AIG earnings from 2008). But if a catalyst hits those profit margins, US equities will implode. Trump and the Republicans I believe will be good for margins because of deregulation (already under way) and tax reform. but if something were to happen that could force margins down, that would be horrific for stocks.

Thats an area I need to research more, read a few books about. To understand at the macro level what affects margins. Its tricky because Grantham was shouting at the top of his lungs many years ago how 'margins are the most mean reverting series on finance' and said that the budget deficit decline HAD TO bring down corporate profit margins because it was an 'accounting identity'. He was wrong, he learned the hard way that backtests/data/theories are fragile (but I'm sure he didn't care because he was still long 2/3 of his money in other markets and cares little about the people he talked into selling). So whatever I learn about profit margins, I got to consider that it can be wrong exponentially so its like playing with fire

-Real interest rates increasing a lot. This would provide a lot of competition for investors capital and probably hurt the stock market a great deal. This is partially the reason why I'm short fed futures and long eurodollar puts, I'm a little hedged against that.

-Nasty recession or recession+US Fiscal crisis. A recession the leads to a US fiscal crisis could probably implode equities by at least 50%. One could even argue that the next recession will be a roll in the dice on whether it leads to a fiscal crisis (as the deficit grows, people get pessimistic and start to wonder about SS and Medicare), the numbers are so monstrous ($200T in unfunded liabilities which simply cannot be delivered to the people that were promised that). So I'm concerned about that. Or even just a nasty recession could lead to problems because of personal, corporate and federal debt levels (Dalio's long-term debt cycle). If debt levels can't be increased further, perhaps that will hurt growth even more and that could impact margins? or it could lead to a cascade of defaults, either way, I don't want to be holding too much in equities in the next US recession. It could be a russian roulette type of situation. Maybe nothing happens, maybe nasty things happen, nobody knows. But its tricky because we could be 10 years away from a new recession, I'm not kidding, this easy money fed might lead to the longest US expansion in history. Its already almost there, once it breaks that record it can just keep going for a long-time. I know Scott Sumner thinks it could happen

-Something else that I cant think of now

I believe other types of catalysts will lead to simple 'liquidity rushes' in stocks that will produce limited declines of 5-20% at the most, kinda like we saw in 2015/2016 and many other years
I will try to catch some of those liquidity rushes by shorting ES/SPY (but I'm quick to let it go if the market starts to rip again), through my S&P500 put buying and I'm also protected through bonds, gold and cash positions. But if I miss out a liquidity rush short decline, its fine. These smaller drawdowns are part of life. Its the 50% drops that I don't want to be caught by surprise but I'm not seeing it one on the horizon now at this point
 
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