Archive for the ‘Thinking’ Category
The Commodity Futures Trading Commission (CFTC) requires futures traders to categorize themselves as Commercials or Speculators (in 2009 they changed that to provide more clarity on the possible motivations behind groups of traders.) Bloomberg, however, still receives the old data, so the three groups are:
- Non-Commercials (clever)
Over time, the parties have become known as hedgers and speculators, so the groups can be re-grouped as follows:
- Large speculators
- Small speculators
Furthermore, because they tend to be wrong at turning points, the speculators have become known as the Dumb Money, leaving the hedgers as the Smart Money. In the case of traditional commodities, like gold or corn, the hedgers are the producers–in our case the mining company and the farmer. To generalize a lot, the speculators tend to be trend followers, thus, they buy/sell as trends continue, leaving themselves over-exposed when the trend changes.
Every Tuesday, futures participants report to the CFTC whether they are long (expecting higher prices) or short (expecting lower prices) and by how many contracts. The CFTC makes this Commitments of Traders (CoT) report available on its website, and Bloomberg makes it all available for charting and other analytics. As a result, we can see how all the groups are positioned, specifically, whether they are, in aggregate, long or short a particular commodity. And by the way, financial futures (e.g. stock indexes) are commodities, too. Also, the corrolary to the farmer in financial futures are the big money center and investment banks.
They’re an important group to watch because, while they all have spokesman/strategist types who tell you what you should do with your money, they never tell you what they’re doing with their money. The CoT report, however, gives us an idea of what their firms are doing at least.
Enough of the background…
Right now, the Commercials/Hedgers/Smart Money have the largest net-long position in almost four years. They’re not infallible, as they’ve been wrong in the past, but it presents a far better picture for the market than were they net-short to a record degree.
After the jaw-dropping decline of late July/early August, we’re now in what appears to be a bottom testing phase. It’s probably not an inappropriate metaphor to think of testing the ice on a pond. So far, the testing is going okay. Yesterday’s drop in the S & P 500 stopped right at the trend line defined by the August 9 and 22 lows, meaning that each low has been higher than the previous low, the simplest definition of a trend. Now, if the trend gives way, we’ll be headed back to that August 9 low.
Here’s what the picture looks like.
There is still plenty that can go wrong in the world, and investors are on high alert for them. I’ve maintained for a while that the problem is Europe, and what’s seen as an eventual blow up there is being increasingly referred to as a Lehman Bros. moment, the period of time begun on September 15, 2008, when the market went into freefall. It appears that Greece is circling the toilet bowl, and the sooner the country can be allowed to default–in whatever form it takes–the better. That it might not be the worst thing was on evidence today in the Greek stock and bond indexes. While the 1-year Greek note now yields–I AM NOT MAKING THIS UP–89.18%–yesterday it yielded a mere–I AM NOT MAKING THIS UP–80.483%. That’s a bond that’s not going to get paid back. At the same time, the Greek stock exchange was up by +8%. The fine folks at Miller-Tabak mused that some bond pain might be good for the economy; therefore, bonds down, stocks up.
Please note the +14.5% and +8% (today) pops. To me, those are indications of a severely oversold market. Perhaps one thing that happened over the past month’s equity volatility is that market participants are geared up–maybe inured is a better word (no, not injured, although that, too)–for the worst case scenario in Greece. Anything better than worst would be good (huh?)
This is a horse I shot repeatedly in the Spring of 2011. I thought that it was troubling that the economy was turning out considerably poorer than the economists had expected while stocks were shrugging it all off. That is, the economists were optimistic about the economy and they were being disappointed. The chart I showed then is pictured below, and, in hindsight–naturally–this should have been a screaming sell signal. Stocks were going sideways whilethe economy was weakening.
On a daily, and perhaps weekly, basis, security prices reflect a whole host of influences, not the least of which are fear and greed. Over longer periods of time, however, security prices and trends should reflect fundamentals, and the most basic fundamentals are the economy–or economies. So, generally, stocks should rise as the economy improves and fall as it deteriorates. Non-fundamental factors can trump fundamentals for quite some time, however. One thing should be added at this point. The Surprise Index can rise while the economy is deteriorating if it’s doing better relative to economists’ forecasts.
In the chart below I’ve freshened up the chart–and complicated things by reversing the order of them. The top panel shows the Citigroup U.S. Economic Surprise index, while the bottom panel shows the S & P 500 as a proxy for stocks. I’ve divided the chart into three zones and will proceed to spill more electronic ink than necessary to explain the zones and the possible implications of where we are now, which is zone C.
- Zone A – in this zone everything is as it should be. The economy is doing better than economists expect. As that plays out economists will be forced to raise their estimates for the economy, which eventually translate into improved overall earnings for companies that comprise the economy.
- Zone B – all is not right. In this zone economists –for at least three months–overestimate the strength in the economy, yet stocks don’t reflect it, although the flattened trajectory seems to acknowledge that something isn’t right.
- Zone C – stocks play catch up, as talk of recession heats up. On August, The Economist magazine features the cover below, where recession is lurking just below the surface. Note, though, that in this zone the economic surprise index has turned up.
So, if a falling Economic Surprise Index heralded a decline in stocks, is it possible that a rising index might herald a rise in stocks? Maybe the gradual upward trajectory of the line suggests that a recovery in stocks won’t be vigorous, but if nothing else this should tell us that economic Armageddon or Financial Crisis 2.0 is not yet upon us. That’s sort of how we have portfolios structured at present. Within a modestly overweighted portfolio structure our portfolios are positioned defensively.