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11/14/2002 |
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The Speculator
Forget the news and follow your
intuition
As we saw last week, big events that look bullish often
provoke a bearish response. That's why the best indicator of market
direction is the market itself -- and how well you know
it.
By Victor
Niederhoffer and Laurel Kenner
So many things of momentous importance happen in
the normal market week that one is bewildered as to how to pick out
the most important ones. One way is to measure the size of headlines
devoted to each event. Based on that metric, last week's key events
would seem to be the Republican win of both the House and the
Senate, the reduction in the funds rate by the Federal Reserve, the
agreement at the United Nations on the United States' ultimatum to
Iraq; and the resignation of Harvey Pitt from his post as Securities
and Exchange Commission chairman.
On the surface,
the first three events would seem to have been bullish, as they
either reduce uncertainty or favor the voluntary versus the command
nature of the economy. Yet, markets were down; some of them quite
disastrously:
| Market performance for week of Nov. 4-8
|
| BENCHMARK |
% Chg Mon |
% Chg Tue |
% Chg Wed |
% Chg Thurs |
% Chg Fri |
Change for Week |
| EQUITY |
|
|
|
|
|
|
| S&P 500 |
0.99% |
0.73% |
1.28% |
-2.52% |
-1.22% |
-0.79% |
| Nasdaq 100 |
2.20% |
0.81% |
1.66% |
-3.70% |
-1.99% |
-1.13% |
| Dax (Frankfurt) |
5.29% |
1.00% |
-1.81% |
-3.87% |
-3.18% |
-2.82% |
| FTSE 100 (London) |
3.72% |
0.16% |
-0.86% |
-0.96% |
-0.69% |
1.30% |
| CAC 40 (Paris) |
3.54% |
1.15% |
-1.06% |
-3.26% |
-1.73% |
-1.50% |
| Nikkei 225 (Tokyo) |
Closed |
2.75% |
0.45% |
-1.11% |
-2.58% |
-0.57% |
| Hang Seng (Hong Kong) |
3.75% |
-0.81% |
1.27% |
0.21% |
-0.92% |
3.48% |
|
|
|
|
|
|
|
| FIXED INCOME |
|
|
|
|
|
|
| US 30 Yr Bond Futures |
-0.59% |
-0.23% |
0.43% |
1.85% |
0.92% |
2.38% |
| US 30 Yr Bond Yield Index |
0.80% |
0.57% |
-0.39% |
-3.41% |
-2.10% |
-4.52% |
| Treasury Bill Interest Rates |
0.72% |
-0.85% |
-13.48% |
-0.99% |
0.17% |
-14.32% |
|
|
|
|
|
|
|
| COMMODITY |
|
|
|
|
|
|
| Crude Oil |
-0.66% |
-3.01% |
-1.42% |
-1.51% |
1.58% |
-4.98% |
| Gold |
-0.16% |
-0.03% |
-0.22% |
0.94% |
0.25% |
0.78% |
| Copper |
0.35% |
-0.41% |
0.69% |
-1.99% |
0.07% |
-1.31% |
|
|
|
|
|
|
|
| CURRENCY |
|
|
|
|
|
|
| $ / Yen |
-0.13% |
0.38% |
0.01% |
0.41% |
1.27% |
1.95% |
| $ / Euro |
0.07% |
0.24% |
0.31% |
0.65% |
0.39% |
1.67% |
| Trade Weighted Dollar Index |
0.04% |
-0.24% |
-0.26% |
-0.60% |
-0.45% |
-1.49% | | Source: Bloomberg LP
There
are many reasons why the impact of the announcement of news is often
different from what one reckons it should have been. One reason is
that most news is anticipated and the actual announcement doesn't
provide much new information. This would seem to hold for all the
announcements this week except for the margin of the Republican
victories.
The Iowa Electronic Market (see link at left under
"Related sites") paid $1 for a 29-cent bet on a Republican sweep. We
consider the IEM to be the most accurate guideline in the world by
far since it is based on the bets of thousands of market
participants with a real dollar-and-cents view. Until a few hours
before the polls closed nationwide, a Republican sweep was much the
long-shot trade compared to the IEM market traders' rating for
maintenance of political status quo going into Election
Day.
We reproduce below the snapshot of the IEM quotes taken
at the close of NYSE on Election Tuesday:
| IEM quotes at market close,
11/5 |
| Trade |
Average expectation of win |
| Republican House & Republican Senate |
29.1% |
| Republican House & Not Senate |
57.9% |
| Not a Republican House & a Republican Senate |
2.0% |
| Not a Republican House & Not a Republican
Senate |
11.0% |
| Total |
100% | | Source: Iowa Electronic
Markets
The other reason that the markets frequently
go against the news is based on the kind of reasoning that
philosopher of science Karl Popper made popular. Knowledge increases
when hypotheses are falsified. If a market theory is falsified, then
it is possible for a new paradigm to develop. One market paradigm of
last week was that the market couldn't go up unless there were major
Republican gains in the Senate. When this was falsified by the
global equity markets' decline on Thursday and Friday, a new model
could come to the fore. If the market had gone up on the news, then
there would have been no increase in the knowledge. Thus, the
Republican win had more potential for disaster than the Republican
defeat.
Listen to the
market
The difficulty of unraveling the effects of
announcements like these is one of the reasons that Vic's guiding
principle for the 40 years he's been trading has been that the
interaction of markets, their leads and lags and their variations,
contain all the information that's fit to make a speculation on. Vic
disregards all news items, reads no newspapers except the National
Enquirer and bases all his decisions on multivariate time series
analysis of markets.
Along these lines, there was a very
unusual happening in markets in the past few days. Bonds were up
while stocks were down. In other words, as the table shows, interest
rates went down while stocks went down. Let's leave aside the
conventional view of the past that a decline in interest rates is
great for stocks as the discount rate applied to future dividends
and earnings is lowered. Or, the current view that anything that's
bad for the economy, i.e. coming or current weakness, is good for a
reduction in interest rates and bad for stocks.
Let us study
just the facts.
On a weekly basis, the stock market has gone
down just 10 times in the last six years when bond prices rose by 2
or more points in the week. Last week, the S&P 500 Index
($INX)
was down almost 1% and bonds up just under 2.5%, thus satisfying the
conditions for our search.
We found that in the following
week, the expectation is highly bullish for stocks as measured by
the S&P 500 index, up about 2% to the middle of the week with
the expectation for bonds to be down about -1/2% to the middle of
the week. Of course, this is a small sample of six observations and
the results have a high uncertainty (an uncertainty which will have
been realized either way by the time this column is published on
Thursday). But it is one good way and one somewhat scientific way of
making market decisions.
It is the kind of reasoning that
tends to differentiate speculation from superstition, science from
pseudo-science, and the kind that Vic and Laurel like to follow in
their speculations. (A reader is sure to write in to remind us that
Vic's fund went under in 1997 with that kind of reasoning, so kick
him the Hades out of here.)
We give below a glimpse into the
kinds of things we take into consideration in our speculations by
reproducing some items from the trading diary we kept for the past
few weeks. It will give our readers some insight into the
difficulties and potentialities of this kind of
speculation.
Vic's Diary, Wednesday,
Nov 6, 2002
"I have an intuition of grave foreboding
about the market," he wrote at the 925 level in the S&P 500
index futures.
"Usually I'm not an intuitive man but a
quantitative one. Yet. George Soros always claimed that he could
tell when it was time to get out of a good position by the ache in
his back. After exiting totally, he'd always say 'Could you believe
it, they bought them all from me at the high. What were they
thinking?' I noted that his strongest intuitions were those of grave
disaster. A trader (usually me) would have a position, and he'd
sense that something life-threatening could develop. Next thing you
knew, he'd have a position (a 'nostra', he'd call it) exactly equal
and opposite to yours. Presumably a similar feeling led to his
dumping all his Nasdaq stocks when the Nasdaq was gyrating between
3,000 and 4,000 or so in early-mid 2000.
"The last time I had
a terrible intuition of impending doom was with my Thailand position
on Sunday, Oct. 26, 1997. The weekend was beautiful. I was
ice-skating on a beautiful Indian summer day at Central Park in
Manhattan, with my six daughters and lovely wife, but I could almost
feel the debacle that was to come the next day. Sure enough, after a
bit of a rally from the open, the NYSE market in the United States
closed limit down and trading was suspended much to my own and my
customer's cost.
"More important than my own attempts to use
intuition are those of my hero, Captain Jack Aubrey in the Patrick
O'Brian novels. Lucky Jack knew much more about the ocean, the ship
and the weather than I'll ever know about the market. But he
frequently felt that the weather was going to be bad, or that a
terrible blow from the enemy or his evil financiers on land was in
the offing. My friend Dr. David Brooks, a surgeon at Brigham and
Women's Hospital at Harvard Medical School points out that his
intuitions often came 'when chasing an enemy frigate or 74 during a
moonless night with shifting winds, impaired visibility and a highly
competent adversary flying false colors.' Invariably, Aubrey's
intuitions were correct and he was able to maneuver his ship to the
exact sweet spot, or as they say in nautical novels, to gain the
weather gauge.
"Of course, the leopard cannot remove his
spots. My foreboding about the market is based in part on systematic
studies as well as on anecdotal evidence.
"I don't like that
the S&P 500 index futures closed yesterday at 914, a 1 1/2 month
high. I like it even less that it has managed to move up
continuously some 20% from its 767 low, just 19 sessions
earlier.
"I am a great believer in the predictive value of
durations of rises without the failure event of a decline on the
other side. The longer the rise, the more bearish it becomes, at
least for the stock market. Taking one consideration with another,
this kind of rise that we just witnessed has, say, a 1-in-3 chance
of gaining another 5% before it declines another 5%. That's what the
statisticians call a bathtub kind of lifecycle.
"The chances
of failure are very high at the beginning of the rise, relatively
low and constant in the middle, and the chances of failure increase
once again as ageing catches up. The shape of the graph of the
chances of failure on the y axis versus time on the horizontal axis,
like a \____/ , is somewhat of the bathtub.
"In any case I
will be putting on a reasonably sized short position at the close. I
dream and hear Jack Aubrey's favorite Locatelli quartet, taste his
toasted cheese sandwiches and feel the pain of Soros'
backache."
Right time, right
place
If there is one thing we are most proud of vis a vis
this column, it is that we have evolved into taking advantage of
what Friedrich Hayek calls "knowledge of time and place." We thereby
avoid the fatal conceit of believing that established experts have
more information of value than those involved in any
occupation.
As Hayek says, "after we have completed our
theoretical training, how big a part of our working life we spend
learning particular jobs, and how valuable an asset in all walks of
life is knowledge of people, of local conditions and of special
circumstances."
Our request for guidance from those with
knowledge of the time and place of intuition elicited many erudite
and valuable insights. One came from Russell Sears, an actuary at a
Midwest firm. We've nicknamed him Achilles in honor of the
4:05-minute mile he recently ran in competitive conditions and the
similar speed shown in battle by his eponymous namesake in the
Illiad.
Sears suggests that intuition is a subset of
inspiration. Intuition, he points out, is the inspiration that can
be proven as truth.
He suggests four ways to develop
intuition and to separate intuition from superstition et al.
- Surrounding oneself with inspirational works of others -- such
as music, art and books.
- Immersing oneself in studying the problem intently, without
trying to solve it right away.
- Letting the subconscious mind mull over the information with a
view to isolating the influence/projection of moods and other
psychological factors out of the equation.
- "Clearing the deck," or, cleansing the mind of toxic negative
energy, stress-inducing factors, emotions, etc.
Final note
Inspired by all the valuable
feedback we get from our readers, we endeavor to answer all letters,
augmentations and critique which we encourage you to send via e-mail
to gbuch@bloomberg.net.
Occasionally, a transmission glitch occurs -- so if you haven't
received a response or material requested from any of our other
articles, we encourage you to try again. We also suggest that you
visit our Web site at dailyspeculations.com,
where we post the valuable insights we receive from our readers,
including recent sets on intuition, imposters, baseball and Paul
deRosa's skewering of the prediction of Dow 5,000 by Bill
Gross.
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