Last week, former fund manager Rich Breslow made it clear that "the only thing standing between this being full-blown panic versus the frenetic gyrations we’re seeing is the central bank put." He is, of course, correct. One glimpse at the following chart tells you all you need to know about 'trading' in these 'markets'.
However, as Breslow explains today, it's not what central banks have done that matters... but what they're about to do - and that may change the discussion dramatically...
I was reading a note warning traders to avoid focusing on what policy makers should do and concentrate their efforts on sussing out what they will do. Both are interesting questions, deserving of discussion. And they also share the trait of being equally unhelpful when trying to make money. The only reliable way to have a consistently high Sharpe ratio is to figure out what the important (read “big”) players will be up to--and then get in front of them. Get that right and what happens down the road becomes largely irrelevant.
It’s unfortunate that we’ve all come to accept the notion that it’s better to be lucky than smart. It comes from thinking that trading is largely betting on the coin flip of a number or a decision and then subjecting yourself to the vagaries of how markets will react. The real and most delectable juice is squeezed out of the market before any of those results are scheduled.
Will the ECB go big, small or nothing at all as they contemplate tapering and the like? The answer didn’t have to be known to drive the last three months of opportunities. We could sit around jawboning what they should do. We can wrangle over what they might do. Or you could have ridden the wave from about 1.13 to the dollar up to 1.20 when it became pretty clear that the market had the bit between its teeth and the discussion turned to reserve reallocation rather than the next inflation print.
It’s a lot easier to remain focused on the big picture when your P/L has a nice cushion and you aren’t constantly living hand to mouth. It’s why I’ve never cared for CFTC data. Crowded trades are perilous if your company is an amalgam of marginal players. A crowd becomes a party when you’re mixing with central banks.
The best proprietary trader I ever worked with used to run enormous positions up to an event and then be largely hedged going into the actual announcement. She figured, it works best over the long run if you keep ringing the cash register by playing the emotions of anticipation and then take a pass on the part you have no control over. I think of it as the compound interest approach to building up a big bankroll.
How many times have you been transfixed by being told that X out of the last Y Septembers, we’ve seen some asset do the following? And then been unduly influenced by that not very bankable information. Yet for years there’s been this buy the dip pattern in equities that one commentator after another is sure is being done as a direct personal affront to them. It’s true that one day it won’t work. But if you’ve cashed in on the previous one-hundred times it happened you can afford it. Thomas Bayes told you so--as would most street urchins.
It’s been a good strategy not because of some P/E ratio nonsense but because sovereign wealth fund, QE and buyback flows have consistently been deployed to contain things. And because they have a time-horizon that bears no resemblance to that of the vast majority of market participants. Should the market go down? Will the next time be different? Successful traders don’t think of it in those terms.
Breslow concludes, try this one on: sovereign bonds and equities aren’t in a trend. If you think they are, you need to justify the reasons for it to continue.
The only thing you need to debate is whether the resolute buyers, who just happen to be bigger than the private market, will keep on doing what they seem to like doing.
It’s always flow, not stock, that should guide you on your next trip.