The Treadmill

Friday, October 23, 2009

When market punters chat to each other, which they often do, the conversation almost inevitably opens with some variant of "So how you getting on?"

The typical response bears a striking resemblance to that of high-level amateur athletes. When you ask somebody, for example, how well they ski, it seems that the best skiers almost always reply with "oh, I'm OK." In Macro Man's experience, people who reply "yeah, I'm pretty good" generally are not. (By way of disclaimer, Macro Man was a "yeah I'm OK" guy before he came a-cropper.)

In any event, Macro Man's standard answer to market punters these days likens his mentality to that of a runner on a treadmill: he feels like he has to run as fast as he can just to stay still. Ever since the SPX market bottom on March 9, the year has been something of a grind. Given his largely incorrect big-picture view, Macro Man adopted a sort of macro RV strategy after he returned from his knee surgery.

It has done OK, but as we approach year end and assets appear to be trading largely off of the available liquidity, his strategy has ground to a halt. So at the beginning of this month, he decided to pump up the vol a little bit and become a bit more directional. The problem with that, despite the SPX and EUR/USD trading at their highs of the year, is that it's been pretty damned noisy. The last 72 hours in US equities are a prime example of how easy it is to get sucked into doing something stupid:

The noise surrounding Fed policy and possible exit strategies doesn't make it any easier. For if and when the Fed does withdraw accommodation, it seems likely that today's stellar performers will be tomorrow's home-run shorts. As such, today's trial balloon in the FT on the Fed's semiotics has sparked substantial interest (though curiously, only fixed income markets seem to have reacted.)

While this will certainly be a key theme for 2010, it looks to be a premature consideratoin this side of new year. Macro Man likes to look at a simple Taylor rule proxy, which is the y/y change in nominal GDP. As the chart below illustrates, it has pegged levels and changes in the Fed funds rate pretty well over the past forty years. What's cool is that the chart highlights two periods of overly-lax Fed policy error: the 1970's, which produced high levels of inflation (and was followed by the Volcker Fed bringing down the hammer in the early 80's) and Easy Al's free-money giveaway in the early part of the Noughties.

While y/y nominal GDP is likely to turn up when it is released next week, it seems unlikely to print levels that would be consisent with a need for higher rates until the middle of next year. Still, this game is not so much about predicting what will happen in 6-9 months as predicting what the market believes will happen. Obviously, there are exceptions to that rule, and the longer your time horizon, the more you can focus on your forecast. But in a world of ten-minute macro, market belief matters.
Ultimately, of course, you can't buck the data, as recent purchasers of sterling found to their detriment this morning. Q3 GDP shocked the consensus by printing -0.4% q/q, prolonging the recession, re-opening the case for QE and giving the queen's head a proper slap on the cheek.
Alas, Macro Man's bearish GBP options look set to expire worthless next week. Such is the joy of directional trading, where you have to get your direction and your timing right. Is it any wonder that Macro Man feels like these guys?

Posted by Macro Man at 9:49 AM  


Strange sport, skiing. I wonder why it makes people think they are good, when in actual fact they are technically horrific, look like they are putting lots of effort in and have no fluidity whatsoever.

Seems to afflict men, I guess it is like dating websites, everyone is "above average looking", which is somewhat difficult to have in a large sample size.

Anonymous said...
11:12 AM  

One of my hard and fast rules is that people who are keen to tell you how much money they're making, aren't making any money.

Skiing, otoh, I couldn't say. But I guess it's all tied up with the Dunning-Kruger effect, which I regularly invoke to explain a lot of things...

Vandalsstolemyhandle said...
12:07 PM  

From Wikipedia:

The Dunning–Kruger effect is an example of cognitive bias in which "people reach erroneous conclusions and make unfortunate choices but their incompetence robs them of the metacognitive ability to realize it".[1] The unskilled therefore suffer from illusory superiority, rating their own ability as above average, much higher than actuality; by contrast the highly skilled underrate their abilities, suffering from illusory inferiority. This leads to a perverse result where less competent people will rate their own ability higher than relatively more competent people. It also explains why actual competence may weaken self-confidence because competent individuals falsely assume that others have an equivalent understanding. "Thus, the miscalibration of the incompetent stems from an error about the self, whereas the miscalibration of the highly competent stems from an error about others

Vandalsstolemyhandle said...
12:10 PM  

The treadmill pulls you in if you don't fight it.
Information overload. Does not compute. Nuff said.

Gregor Samsa said...
12:17 PM  

Given the impact of the pretty horrific "miss" by the UK GDP data this morning, God's currency could clearly do with a morale boost, so here goes:
1.The UK economy is in trouble but for a variety of different reasons, there are plenty out there equally sick.
2.Is there anyone left who is not a £ bear? Be afraid Grizzlies...
3.Most importantly, forget the financial markets and look at the real world - this week's discussions on this site over foreign carmakers abandoning any supply of new cars to the UK due to £ weakness and the consequent impossibility of profitable sales suggests there is a currency overshoot. Not to mention my understanding that the new BMWs and Audis that were in the country had been hoovered up by cross channel shoppers taking them back to Euroland ...another sign...

Anonymous said...
12:31 PM  

Vandal, interesting stuff. I wonder if the answer isn't more internal, so to speak: the truly knowledgeable know their weaknesses; they know what they don;t know, so to speak, and thus are aware of their "mortality." The inexpert practitioner, on the other hand, does not know what he doesn't know, and thus assumes a higher degree of ability than is acutally the case. The you have Donald Rumsfeld, who knew about "known unknowns" and "unknown unknowns", but was still a donut....

Macro Man said...
1:17 PM  

copper rocketing thru 6700 while wti finding support > 80.....mostly us$ driven though cause fundamentals are not underpinning this at all.

Anonymous said...
2:12 PM  


Intrigued by your macro rv characterisation and wondered whether you would care to shed some light on themes/trades that you were working that are now long gone.

Obviously you were long some divs,oil and the whites but were you short something against them? Aside from above were you pretty much just trading fx - aside from model-driven Korean equity punting?

Pls feel free to tell me to poke off if you don't wish to divulge but don't ask don't get..

Think yday and Monday's price action confirms that running short risk will be a painful experience into y/e.

Enjoy the weekend.

Anonymous said...
2:22 PM  

Crikey, do you know me, or have I revealed all that on the site over the past few months? If so, then you've been paying better attention than me.

As an example of RV: I've been long divvys, as you know, and held index puts against them. The latter have, in aggregate, cost money, but smoothed the occasional hiccup in the divvys. All in, the return stream has been been quite smooth- which is what you would expect given the relative undervalutaion of dividends to indices over the past 8 or 9 months.

I've held midscuve puts against my long whites: again, a drag on aggregate PnL, but it has certainly smoothed the vol.

Stuff like that....

Macro Man said...
2:42 PM  

The occasional unseen tree stump just below the snow can make a monkey out of any skier who is normally quite proficient. That's the way LB thinks about this late 2009 market - the basic plan is OK, and the results aren't terrible, but you still end up on your arse a lot, and feel like a complete tool almost every day, while 7 year olds ski merrily past you. Still, you feel like you want to go round the blind corners under control because you can't shake the feeling that there is a steep drop out there somewhere.

leftback said...
2:59 PM

The Evolution of Overconfidence

Dominic D. P. Johnson, James H. Fowler

Confidence is an essential ingredient of success in a wide range of domains including job performance, mental health, sports, business, and combat. Many authors have suggested that overconfidence--defined here as believing you are better than you are in reality--is advantageous because it serves to increase ambition, resolve, morale, persistence, and/or the bluffing of opponents. However, too much overconfidence can cause arrogance, market bubbles, financial collapses, policy failures, disasters, and wars, so it remains a puzzle how such a false belief could evolve or remain stable in a population of competing accurate beliefs. Here, we present an evolutionary model that shows overconfidence actually maximizes individual fitness and populations will tend to become overconfident, as long as the resources at stake during conflicts exceed twice the cost of competition. This is because overconfident individuals make more challenges when there is uncertainty about the strength of opponents (and thus the outcome of conflicts), while less confident individuals shy away from many conflicts they would win. Where the value of a prize is at least twice the cost of trying, overconfidence is the best strategy. The model suggests that the conditions under which humans would have evolved to have a "rational" unbiased view of their own capabilities are exceedingly rare, and it helps to explain why resource-rich environments can paradoxically create more conflict. Moreover, the fact that overconfident populations are evolutionarily stable may be one reason why overconfidence persists today in politics, business, and finance, even if it causes occasional disasters.

Anonymous said...
3:38 PM  

Hmmmm. I wonder what Messrs. Johnson and Fowler would have to say about overconfidence on a) one's chance of success, and b) one's prize for winning. Seems to me that the past two and a half years have been reaping the foul harvest of a decade (plus) worth of overconfidence on those from financiers.

Their model seems to take a) and b) as known certainties, which of course they are not in the real world....

Macro Man said...
3:44 PM  

From Kruger + Dunning paper...

In 1995, McArthur Wheeler walked into two Pittsburgh banks
and robbed them in broad daylight, with no visible attempt at
disguise. He was arrested later that night, less than an hour after
videotapes of him taken .from surveillance cameras were broadcast
on the 11 o'clock news. When police later showed him the surveillance
tapes, Mr. Wheeler stared in incredulity. "But I wore the
juice," he mumbled. Apparently, Mr. Wheeler was under the
impression that rubbing one's face with lemon juice rendered it
invisible to videotape cameras (Fuocco, 1996).

Anonymous said...
3:51 PM  

He was later put in charge of the Pirates...

Macro Man said...
3:53 PM  

Thks for insight MM, you will be pleased to know that I am 1 UK based participant who hasn't unmasked your identity so it was purely the fact that I have been involved in the aforementioned that they came to mind.

And the market schizophrenia returns to make my risk comment temporarily look rather silly.

Personally have pretty much flattened my equity and fx books and just left myself to party in STIRs between now and year-end.

Happy trading.

Anonymous said...
4:11 PM  

Anon, sometimes it feels like you're the only one who hasn't figured out my secret identity!

Funny, I have done sort of the opposite as you: Amped up risk in FX and equities. While I have traded the stir stuff around, I haven't really added/rolled risk- just waiting to clip my final coupons in the fronts

-MM (blackberry)

Anonymous said...
5:08 PM  

This isn't you:


Nic said...
7:39 PM  

No, though we often get mistaken...

Macro Man said...
8:09 PM  

Hmmm, I guess based on your classification MM I am in the ""yeah, I'm pretty good" category, which should make me an average skier. Yet, based on my objective results I belong to the elite in my snow country. On the other hand, I am happy to admit "I am an OK" trader, and my P/L for the year tells me that is about right... When you throw in above mentioned Dunning-Kruger effect it seems even more confusing.

Still, my 2 cents as an "OK" trader, I think we will stumble and limp into the end of the year with equities higher and generally risk on. I am trying to think of a big enough sell off that would scare the herd and I just can't see it. So far 2-5% pullbacks have done nothing and with low volume I can't see them getting worse. Koreans are shopping for energy in Canada, which should keep a bid under oil and commodities. The data has too much noise to make a solid case either way and with the type of cheerleading I saw in AMZN into the close, this herd is on something a lot stronger than LSD.

mike said...
2:53 AM  
This comment has been removed by the author.
Yvonne said...
6:53 AM  

How well you're doing is unfortunately entirely dependent upon who you're benchmarked against - if, say, you're benchmarked against the kinds of Evil Knievel EM managers who dropped 30 last year and gained 40+ this year and did 30-40 that doesn't mean you'll get a whole world of love from the fund of funds even if you didn't lose the plot last year.

Nemo Incognito said...
7:14 AM  

When a blog like this which has been quite bearish in tone starts to see more risk on into end of year it's additional info to me that a squeeze is due.
Reporting season ,call it what you will which isn't important has failed to get prices moving up on volume..fact not opinion.
The inflationary breakouts have not been confirmed by their underlying stocks this time..fact not opinion.
Data stream on recent releases (forget sentiment) have been running the wrong way now we have the summer season behind us..fact not opinion.
Whilst CAN$ and AUD$ etc have run away the USD basket is holding now above .75...fact not opinion. The Yen and GBP part of that are now heading the otherway..fact not opinion.
Treasuries still do not show any confirmation that bond holders share the equities and comms view of market recoveries.

And sentiment now looks far too complacent again smacks of the run up to summer.
A squeeze at least inline with the summer correction is my highest probability situation giving the markets something to rally off for December.

Anonymous said...
9:55 AM  

Coming late, sorry...
There is a big difference, unfortunately, between the individual and the group (crowd) behaviours. No matter how fascinating we find the individual behaviour might be, we cannot infer, forecast etc. the group's behaviour, let alone the actions themselves. The best we can get is the so called anecdotal evidence. The last one and a half years produced an elevated level of anxiety (hysteria) in the market where there is no good answer one can act upon. Think of the hysterical child hitting the supermarket's floor or one's girlfriend/boyfriend in a hyperbolic state for that matter. Monthly retail sales number now claims the status of NFP judging from the market reactions effectively blocking everything you might call a well-thought out trading idea/strategy....

Anonymous said...
11:59 AM  

Fear in action is probably the best theme for 2009 - up to March, it was fear about what else could go wrong, no one wanted the dirty bathwater or the diarrhoea prone babe. From then to present, it's fear of losing out on the fast scoop - after all no one wnts the year end figures to look too bad. how else could you prove your worth (not to mention bonuses for some in question.) With all the negative reaction surrounding the recession and "crisis" , even big corporations and politicians are getting addled - how else do you explain rightwing politicians getting primetime exposure on national tv (when the going gets tough, all our closet demons come out to party - it's still a week to halloween and guy fawkes!)and a 23 year old sparking the banana movement in old francois?

so, vandal, technically speaking, society averaged up ranks as "duh dumb"?

Judy said...
12:33 PM

2:38 PM  

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