Sunday, August 21, 2011

Never Say Never?

Before I get into my latest comment, I want to share with you a discussion I had Saturday night with a trader called "Joe." I knew his wife back in college and ran into him last year at this time at the airport when I was leaving for Greece.

Joe is somewhat of a legend among Montreal's trading community. A proud Italian-Canadian, he started trading in his teens and never stopped. He's self-made, very successful, and he knows what he's talking about when it comes to managing money. He's one of those few guys that nobody knows about who has made a small fortune trading stocks and futures -- and he did it all on his own.

I have a lot more respect for a self-made, anonymous, and humble trader like Joe than many arrogant pricks in high finance that take themselves so seriously because of their titles. In this business, titles are bullshit. Show me what you can deliver, what you have actually accomplished on your own, not the chair you're sitting on right now which can be taken away from you at any time. When you scratch beneath the surface, a lot of people in high finance are nothing but titles, degrees, certifications and pure fluff!

Anyways, Joe and I grabbed a drink at the bar at Mythos, one of my favorite Greek restaurants in Montreal. We talked about health, family, and markets. He told me I look much better than last year and I told him all about my Liberation treatment back in March and how I decided to join a gym and put myself first once I turned 40 in late April. I'm realizing that I was worrying too much about others and not enough about myself and decided to take matters into my own hands.

The discussion on markets was interesting. Joe has taken some time off from trading to focus on building a home, but he's still plugged into the markets, trading a little on the side, and follows them very carefully. We talked a lot about high frequency trading and how that has impacted his own trading. He agrees with Marvin Schwartz and Leon Cooperman, it's not just a potential collapse of Europe, there is a high frequency trading (HFT) free-for-all going on right now, and they need to reinstate the uptick rule to halt it. Unfortunately, the SEC is busy aiding and abating the criminals on Wall Street instead of prosecuting them.

We talked about how crazy and volatile the markets have become lately. I told him that I started a blog three years ago, write a lot on markets and pensions and trade stocks on the side. I told him that I've never seen things get so crazy. Just look at the one year chart of LDK Solar, one of the solar stocks I trade. I told him that I'd be buying it here but I'm reluctant to give advice in these markets because oversold can become even more oversold, or extreme oversold. It's a fool's game to try to pick bottoms in markets dominated by super fast computer trading in nanoseconds. I also told him that the only stocks hedge funds are trading lately are the FAZ, FAS (ultra short and ultra long proshares on financials) and TVIX an VXX (to play volatility).

I told him that Q2 13-F filings are available and I've been examining what elite funds have been busy buying and selling (stay tuned). Joe told me flat out: "You got nothing to gain by recommending stocks. Most of my recommendations went south and that's all people remember. They won't remember your home runs. As long as you have more winners than losers, and make more on the winners than you lose on the losers, you come out ahead." He also added that "deleveraging will continue and even these leveraged ETFs have to deleverage. The amount of speculation in leveraged ETFs is ridiculous."

He's right, deleveraging continues and uncertainty is killing markets. The world is waiting for some long lasting resolution to the European debt crisis and all we're seeing is more political posturing. It's as if politicians and policymakers are hoping this will all go away without any intervention. It won't and time is of the essence.

If you don't think so, I invite you to read Niels Jensen's excellent comment from Absolute Return Partners on why US of AA matters and the Predictions of Michael Pettis posted on the Aleph Blog:

I learned a lot when I read the book, “The Volatility Machine.” You will too. You can buy the book here. Sorry, it is expensive, because there are few copies relative to demand.

In his weekly e-mail, he decided to highlight twelve questions where he would offer predictions. Here they are:

  1. BRICS and other developing countries have not decoupled in any meaningful sense, and once the current liquidity-driven investment boom subsides the developing world will be hit hard by the global crisis.
  2. Over the next two years Chinese household consumption will continue declining as a share of GDP.
  3. Chinese debt levels will continue to rise quickly over the rest of this year and next.
  4. Chinese growth will begin to slow sharply by 2013-14 and will hit an average of 3% well before the end of the decade.
  5. Any decline in GDP growth will disproportionately affect investment and so the demand for non-food commodities.
  6. If the PBoC resists interest rate cuts as inflation declines, China may even begin slowing in 2012.
  7. Much slower growth in China will not lead to social unrest if China meaningfully rebalances.
  8. Within three years Beijing will be seriously examining large-scale privatization as part of its adjustment policy.
  9. European politics will continue to deteriorate rapidly and the major political parties will either become increasingly radicalized or marginalized.
  10. Spain and several countries, perhaps even Italy (but probably not France) will be forced to leave the euro and restructure their debt with significant debt forgiveness.
  11. Germany will stubbornly (and foolishly) refuse to bear its share of the burden of the European adjustment, and the subsequent retaliation by the deficit countries will cause German growth to drop to zero or negative for many years.
  12. Trade protection sentiment in the US will rise inexorably and unemployment stays high for a few more years.

I agree with these, and then some. I do not fear the actions of China. In debt crises, the debtor is usually favored.

I agree with many of these predictions, especially the myth of decoupling which I wrote about three years ago, but remain hopeful that Europe will solve its debt crisis by implementing the Eurobond solution that Soros and others have been arguing for. Unfortunately Merkel isn't biting and others think this the Eurobond solution is a non-starter. As for China and the BRICs, they will slow down as the world enters another economic downturn, and this will hit commodity indexes and currencies particularly hard (ie. Canada and Australia).

Whether we like it or not, we live in an interconnected world. This means that financial and economic crises can spread like wild fires throughout the world. And while I agree with Marc Faber (see video below), and would be buying stocks over Treasuries at these levels, I worry that policy blunders will ensure a prolonged Japanese-style deflationary period in North America. This is why the Fed will continue pumping billions into the financial system and why good old bonds might still outperform every other asset class in the coming decade just like JGBs have done in Japan over last ten years. In this uncertain world, never say never.

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