Again With the Discounting Mechanism

One of the biggest ism’s on the Street that has been pounded to death by any and all financial sites is the fact that the stock market is the greatest discounting mechanism in finance and is always looking out 6 to 12 months. This may seem rational to all you EMH’ers out there and there is of course evidence that can be pointed out supporting the markets’ abilities to discount for future events. Feel free to scour the web for all data pertaining to this notion.

I’m not going to get into the facts and fiction of the mechanism. I just want to provide a little reminder that the forward looking ability of the markets gets a bit fuzzy at the extremes. Whether it’s is an epic crash, a normal correction, or a bottom-ticking nadir; at the extremes the markets don’t exactly send the clearest message. Have a look at the S&P 500 since 2009.


You can see that the Flash Crash came out of left field for a lot of speculators in 2010. That strong uptrend wasn’t giving anybody any kind of forward guidance regarding what was about to happen in May 2010. How about the end of QE 2 in 2011? The last “real” correction this market has seen. It too had a nice positive uptrend going before pulling the rug out in the summer. Sure the normal seasonal platitudes could have been rested on, but nobody saw the blowout in August coming. And finally, look at the choppy action in 2012. It was difficult to get a bead on how to allocate, because everyone was busy worrying if the Fed would keep the punch bowl spiked and the dj dropping the base.

Did that choppy action of 2012 tell you that 2013 was going to be a mega-homerun year for people who simply invested long? Hardly. Even though the Fed announced to the world that it would provide unparalleled levels of liquidity to market players, many a professional was caught off guard at the strength of the move.

The S&P 500 is setting new highs here and the NASDAQ is fast approaching its highs off the 2009 lows. One can paint any picture they see fit with any sets of data they choose. In the end, it’s about your experience and gut in combination with robust data. Not going into a bearish spiel, again I’m just reminding that at extremes the markets can be less than reliable discounters. Consider all the world events simply being shrugged off by investors:

1. Ukraine civil war – label it anyway you want but that sure looks like civil war to me
2. ISIS taking over a fair chunk of Iraq with US deployments to the Persian Gulf
3. Chinese Commodity Financing Deals (“CCFD”) and the budding re-hypothecation scandal
4. The approach of no quantitative easing – seriously think about that for a second – NO QE if the Fed follows through on their word; a full taper is most definitely not being discounted.
5. Potential liquidation fees imposed by The Fed at bond funds to “prevent” bond runs

We’ll just leave it at that. For good measure though I’ll present you with a snapshot of the Financial Times cover from Tuesday June 10th, 2014.


This has been bandied about all over the web as the “Contrarian Indicator of the Year”, with the FT extolling the virtues of Central Bankers’ abilities to remove volatility from the investment picture. I’m not here to debate the efficacy of the Magazine/Newspaper Cover Indicator. If, however, this cover proves to indicate a bottom in volatility in 2014, did the markets discount that?

Hardest Time in History to Speculate

One of the themes I continue to hit on is the importance behind attempting to fill one’s noggin with as much knowledge as possible, so as to attempt to speculate as intelligently as possible. No easy task considering the quantity and depth of material that exists. I wanted to provide a couple of recent examples of what the average amateur speculator is up against from the world of professionals. Keep in mind that these example-providers aren’t billionaire fund managers; just investment professionals who operate successful businesses and publish outstanding investment blogs.

The first example is from In my previous post I touched on an idea regarding the Baltic Dry and the potential for some short ideas. It turned out to be correct, but was it luck or quality analysis? I can’t truly quantify how I came to the decision. I review certain indicators. Observe past price action. Note the extremes and their duration. Extrapolate data and choose to establish a play. My analysis shared on MarginRich was not exactly deep, especially when compared to the MT team’s post titled, Tanker Stocks Have Triple-Digit Upside (If They Survive). A little self-deprecation is in order when I say that their analysis of the Baltic Dry and the dry shippers makes my post look like a donkey wrote it. The MarginRich post may have been prescient but I wouldn’t exactly give myself an A+ for thoroughness. All the same, I just wanted to briefly provide a tradable idea for readers. Mission accomplished. And in pointing out MT’s article, I am looking to illustrate the analytical skillset of what the average amateur speculator is up against.

The second example is from the Price Action Lab blog. Michael Harris is the creator and proprietor of Price Action Lab software, which is geared to the professional speculator. The software allows for systematic, algorithmic trading which is very simply the trading world we live in today. I don’t utilize an algorithmic approach which is probably very hazardous to my financial health, but I also don’t blindly follow patterns recognized 80 to 100 years ago and fully exploited by the 80’s and 90’s. A double-bottom or a heads & shoulder may be indicating something or the pattern may just be telling you that you’re about to get your face ripped off. That’s where the ability to fundamentally assess an equity or truly evaluate the macro-economic outlook for a particular ETF or commodity can provide a potential edge when going up against the algos. Mr. Harris provided a great illustration of that utilizing Google in his most recent post, Naive Chartists Get Crashed Shorting Google.

Defining your edge and ensuring it is truly robust is more important than ever if you’re going to play the game. Thousands of hedge funds sprang up between the late 90’s and now…and thousands have closed up shop. Even really and truly bright fund managers with a great educational background combined with an advantageous family lineage are consistently getting burned, having to pay out and close up. Don’t agree with my post’s title heading? Here’s some content from an interview with Stanley Druckenmiller that made its way around the web during the summer. The interview content is courtesy of ZeroHedge via Hugo Scott-Gall of Goldman Sachs. No matter what you think of his political ideologies or anything else about the man, Druckenmiller’s success speaks for itself and his commentary is always worth a listen. Druckenmiller states about speculating:

It has become harder for me, because the importance of my skills is receding. Part of my advantage, is that my strength is economic forecasting, but that only works in free markets, when markets are smarter than people. That’s how I started. I watched the stock market, how equities reacted to change in levels of economic activity and I could understand how price signals worked and how to forecast them. Today, all these price signals are compromised and I’m seriously questioning whether I have any competitive advantage left. Ten years ago, if the stock market had done what it has just done now, I could practically guarantee you that growth was going to accelerate. Now, it’s a possibility, but I would rather say that the market is rigged and people are chasing these assets, without growth necessarily backing confidence. It’s not predicting anything the way it used to and that really makes me reconsider my ability to generate superior returns. If the most important price in the most important economy in the world is being rigged, and everything else is priced off it, what am I supposed to read into other price movements?

For most it is simply not practical to be actively managing your funds. Now with the recent announcement of the dismal science Nobel winners, EMH and passive indexing are making the heavy rounds around the web. For good reason too, when you consider all the recent performance data. There is always more than one way to skin a cat and the truly resourceful(but “un-utilityful”) will continue to discover profitable ways of moving money around to generate profit. Build your knowledge base, simplify your financial life, and find that edge if you really think you have the chops to beat the market.