Thursday, 27 August 2015

Here comes the stock boom!

Well, someone has to counter the sea of doom.

- Oil is up over 4%  6% wow, now 8% as I write. As stated at the beginning of the week, energy, commodities and all of the other bombed out components of recent moves need to reverse to confirm that this isn’t just a flash-in-the-pan equity bounce. This oil rally is the sign. Indeed oil  is even looking has broken its death slide trend that started in July.

- My TDI signal has just triggered. Yesterday my taxi driver said it was due to China slowdown. I wasn’t sure what was due to China as I wasn’t listening to that bit, only being triggered into awareness by the ‘due to China slowdown’ bit. Which was followed by a comment on oil prices. the Taxi Driver Indicator is a time honoured indicator of mine which has wonderfully predictive turn calling abilities and is used to confirm the 'Gone Tabloid' function, which in itself follows on from the "Armchair General Indicator' which the BBC's economic journalist Robert Peston triggered on Monday.

- Liquidity. My views on why illiquidity driven moves are as much an opportunity as trouble have been previously published here.

 -VaR. If everything told you that the bottle of whisky I was offering you was genuine and you knew that the only reason I was selling it to you for 10p rather than £18 was because I couldn’t fit it in my flight luggage due to weight restrictions, would you refuse it because the price had just moved 99% lower so was very likely to move another 99% against you? - Because that is exactly what using value at risk (VaR) models results in. Just when you want to buy value, your volatility driven model says you can only buy a tiny amount.

As a quick aside I was pondering setting up a fund with a reverse VaR function and seeing how it got on. Of course all the fund consultants and allocators would have pink kittens at the very thought of allocating to such a fund, but I have the killer reason for them to do so - diversification. Diversification has kept many an appalling performing fund alive and I bet there aren't any funds out there offering diversification of risk in risk. (Make cheques payable to....)

Data - The data coming out from western economies is pretty strong. Though the market is anticipating a massive slowdown caused by China it isn't here yet and if it is anything like predicting the Fed, any interpretation of the future will be made irrelevant by new information emerging before the event arrives.

- Equity indices are through their original dead cat bounce highs. But expectations that this is just a bounce dominate. Expectations of SPX hitting 2050 again in the next 2 weeks appear minimal (update, well they might be now).  The shake down we have just seen never had all the ingredients needed for a full scale collapse. The recovery in oil and commodities is solid and new ultra-doom calls based on China will most likely, as with Greece, need to be put back on the shelf ready to be brought down as bear food to justify any subsequent falls. China and Greece may be chronic but they are not acute.

Where are we? I don’t think the anatomy of this crash is truly crash like. Granted, we have China and commodity stories, but the part of the equation that doesn’t fit for me is the mood. Post financial crisis  the mood has been one of perpetual doom with an expectation of each subsequent crisis being observed as ‘the big one’. Yet they never are. The last few years' stock rally has been the most fought rally I have ever observed. I still find it hard to believe that we are due a really big correction until we have had the exuberance phase where exuberance has leverage in tow. If something is believed to be such a sure fire bet then it is worth mortgaging the kids for.

Yes, various sectors have seen prices pushed to levels that are hard to justify using normal metrics, but they have not been employing enormous leverage. The rally over the last few years hasn’t so much been so much one of exuberance but more of one of reluctance driven by a desperation for yield.

Here's a map which represents the classic phases of an asset price.

We can ooh and aah at it and instantly suggest that it represents the Chinese stock market pretty well

But where the Chinese and Western stock markets differ is that the Chinese market went through the mania phase with leverage being prolifically employed by the general population and many a Chinese taxi driver piling in. 

Western markets have not enjoyed the mania phase and general public leverage into the stock market is not being deployed. I have had it rightly suggested to me that the 2007/8 crash didn't see a stock mania before crashing, but it did see massive leverage unwound from society and the destruction of money in circulation. All crashes involve the unwind of leverage but there is little evidence of leverage in the stock market and I would imagine there is dramatically less after the actions of this week. 

Instead I am suggesting that we are only at the bear trap in the 'awareness' phase of the map. We have the mania, leverage and completely stupid stock boom ahead of us.

I know that this is a pretty punchy call but the more derision it receives the more evidence I have that the market is not thinking it, let alone positioned for it. 


Anthony Gallagher said...


You raise some interesting points which I am sure you can reflect on once the market changes for real (in x years time)

Your Valuation model is like my Block Order model I came up with when day trading forex, interesting. The only difference being the smart money controlled the move as they bought + dumped in blocks.

Re: the leverage, you believe that in order for a true bull market to take hold ie as shown on your chart, we need leverage. Are you referring to all the market participants borrowing to buy stocks etc? So when they all over extend their borrowing the house of cards falls?

If so, could we say then that when all potential buyers of a stock etc are already invested in the market, thats when it collapses?

What signs / data are there that market participants are over leverged if you dont mind me asking?

Anonymous said...

Surely a model that increases exposure as the value gets better and the VaR explodes is the JBTFD model that has been so popular over the last few years? It works every time, until one day it doesn't.

Polemic said...

Anon - I d say a JBTFD model is a subset of a reverse VaR model but not all of it. You don't have to buy the dip, but you aren't constrained should you wish to. If the dip is for value reasons rather than liquidations due to other peoples VaR models then you don't have to buy.
Reverse VaR also allows you to run high volatility rallies that VaR would make tend to want you to reduce.

Eddie said...


where do you get your leverage information from ? My trusty NYSE Factbook keeps telling me that leverage is still close to all-time highs.

I have no figures for leverage in China at hand but iirc margin lending as a share of GDP was somewhere between 7% and 8%. Levels that we saw last time in 2007.

Anonymous said...

Angus said

Great piece Polemic. Appreciate comments that maintain an 'adult' and reasoned tone. Bitter experience has taught me to at least take the Funny Money outlook into consideration.

Saw this rather agressively nationalist comment in a Beijing journal. Comment is superficial ( translation worse ) but considering the source it tells you that these things are being discussed by the 'nine male engineers'- what would a free float do to your outlook ?

"If the Renminbi became free-floating, and a reserve currency, Chinese companies could demand payment in Renminbi instead of dollars, and rates on Treasury notes would be forced upwards by the decline in demand (for entities to accept dollars). Currently, China’s stock market is largely closed to outside investors, but a push to make the Renminbi a reserve currency would require that the Chinese government open it so as to provide opportunities for holders of Renminbi to invest.

Chinese five-year municipal bonds are currently yielding around 4.25%, and are perceived to be guaranteed by the central government. The bonds are likely driven upwards less by instability than by competitive pressures between municipalities (outdoing each other with new infrastructure projects, convention centres, etc.)

Once the internal Chinese market opens and the currency liberalises, opportunities with the Renminbi would make it attractive to investors, possibly the result of a push away from the US dollar as a hegemonic reserve currency, leading to a more multilateral economic map than one dominated by the United States. The Renminbi as a reserve currency would not only leave the United States with less economic clout, but also increase the cost of deficit spending".

Booger said...

I like your thinking Polemic, although I disagree with your conclusion. I think we will see a bounce, but I reckon we are more likely to have deflation in our future. There is a good chance we will have a strong counter-trend rally in commodities with oil rallying to $50+ in Sept before further resumption of the down trend.

So I will just be nibbling on this rally and looking to sell wti low 50's, Spoos 2050 and short aud.jpy if I can get it at a good price. But who knows what will happen. May be reality will turn out different to this expectation and my trading plan will have to be modified.

I agree that China is a slow melt now, but I reckon it will turn into the full monty. Has anyone heard of a 35+ year period for any economy without a recession ? It is ridiculous if you think about it. Unless they have found the economic holy grail. China is something that Greece could never have been. And it seems right about time we had an EM crisis.