I’m currently reading The Black Swan by Nassim Taleb. I’m enjoying reading the book with one eye while watching the stock market with the other eye.
Taleb spends a lot of time discussing our need for a narrative to explain the world around us. This creation of a narrative causes us to see past events as more predictable, more expected, and less random than they actually were.
Every day the newspapers feel compelled to explain the cause of whatever event they’re commenting on. Taleb uses an example of the moment when Saddam Hussein was caught in 2003 leading to two different headlines on Bloomberg.
Bond yields initially rose then subsequently fell following his capture, and two headlines said both the rise and the fall were due to his capture. Which was correct? Or were they both wrong?
The current market rally is now getting a lot of airplay on TV and in the papers. Bullish commentators are now the ones getting the interviews rather than the bears. If the stock market sells off then the bears will be given an interview to explain why the stock market is going down…but don’t expect them to give the bears any airtime before it happens.
And every person that talks about the share market on TV (apart from Marcus Padley I have to say) acts like they knew the past was going to play out as it did. They’re an expert so of course they knew.
If we all accepted that not one person on this earth can predict the future consistently over an extended period of time then a lot of the financial media would probably be shut down.
If you read Money Morning on a regular basis you’ll know that the manipulation of interest rates by central bankers is the cause of this huge rally in high yielding stocks. Fundamentals aren’t coming into play at all as far as I’m concerned. Most companies currently see their revenues and earnings under pressure, so the rising stock market is causing P/E (price-to-earnings) expansion.
That can’t continue indefinitely without earnings starting to pick back up and the fact is, there is no sign of that on the horizon.
But if you believed the mainstream media at the moment you’d think that the world is fixed and we are about to boom. Europe’s economic crisis is apparently over, China’s economy is flying high and the US economy has averted the fiscal cliff.
The other reason given for the market rally is that the ‘great rotation’ out of bonds and into equities is about to take place. I’ve read this comment at least 50 times in the past few weeks. But does reading it fifty times make it true?
David Rosenberg, the chief economist of money manager Gluskin Sheff & Associates, doesn’t think so. According to an article on Marketwatch:
‘The 10-year note yield rising to 2% is yet another in a series of “hiccups” that bond bulls have seen since yields peaked in the summer of 2007, Rosenberg said.‘Each one did not last long and presented a gift of a buying opportunity for patient investors who have an ability to see the forest past the trees,” Rosenberg added. He wouldn’t be surprised to see the 10-year Treasury yield hit 2.3% before retracing its steps.
‘As Rosenberg put it: “The mantra of the day is ‘we don’t see much value in bonds’ or ‘yields have only one way to go and that’s up.’ I’ve heard that for years now, especially at the beginning of every year, and each call is typically off course.”
‘Under the circumstances, Rosenberg on Tuesday invoked Bob Farrell’s Rule No. 9: “When all the experts and forecasters agree – something else is going to happen.” Farrell was for many years a respected market strategist at Merrill Lynch (Rosenberg’s former employer).
‘”I’m not saying the grounds for the recent last leg of this rally are totally without foundation even though I remain skeptical,” Rosenberg said. He credits the Federal Reserve’s money-printing press for lifting stocks, not to a tectonic shift among individual investors to equities from bonds.
‘The Fed’s easy-money policy “creates illusory wealth and buys time,” Rosenberg noted, adding: “I do not believe that the U.S. or global economy is poised for escape velocity. But that seems to be a view the masses are adopting.’
What are you to believe when every day you are given different opinions and different reasons for the same event?
(That’s happening right now in our office. I’ve got Alex on one side of me saying China is about to boom, and Greg on the other saying China is a basket case. Who do you trust? Or are they both right…or both wrong?)
What happens is that most people believe the person who agrees with the current direction of the stock market. If the market has been going up for a few months then they believe the bulls and laugh at the bears. If the share market falls over then the opposite occurs.
Of course this results in everyone buying at the top and selling at the bottom. The eternal cycle of investors making decisions at exactly the wrong time will continue forever.
So, what questions do we need to ask ourselves if we want to step outside this insanity?
Perhaps the first thing to accept is that we don’t actually know the future. If we accept that we don’t know the future then the way we approach investing will be very different. Rather than focusing on how much money we’ll make when our view is proven right, we’ll focus on where we are proven wrong.
Also when we enter the market to trade or invest we won’t get so caught up in the desire to be proven right. Any one trade is of little consequence. If I accept that I don’t know the future then I’ll only trade where I believe I have a good chance of being right, or where I’ll quickly know if I’m wrong. My job is just to allow the probabilities to play themselves out over time.
This approach may seem boring, but I assure you it’s a whole lot less stressful than the dartboard approach, and it can reap some very large rewards over time. That’s especially so when combined with strict money management and the sensible use of leverage.
By now I think you know that I’ve been incredibly bearish over the past three years. And I’ve been right to be bearish for most of that time. But in the last six months this huge rally has caught me off guard.
I attempted trading the stock market from the short side in October and November last year and took a few losses due to the shift in the long term trend. But I had a line in the sand where I knew I would be proven wrong (remember my comment above about knowing quickly when I’m wrong).
Once the stock market broke out above the highs made in October last year I knew I was probably wrong and I exited all of our short positions.
This means that the incredible rally since December hasn’t caused any damage and the remaining long positions in the portfolio are adding value.
In share trading, remaining stubborn in your view is a death wish because the stock market can do anything. As the old saying goes, ‘Both bulls and bears can make money in the markets but pigs get slaughtered.’
There will always come a time in the markets when you are shown to be completely wrong in your view. The view isn’t really the thing that matters. What matters is how you behave in the marketplace. It’s what you do that matters. Not what you say.
Murray Dawes,
Editor, Slipstream Trader
From the Port Phillip Publishing Library
Special Report: The Big Money Secret of Ironstone Mountain
Daily Reckoning: The Unbalancing Act Happening in China’s Economy
Money Morning: Buy Silver – the War Against the China Bears Begins
Pursuit of Happiness: How Social Media Can Wreck Your Life