Wednesday, November 13, 2013

More than "Just a Market"

The market often seems cold and uncaring, which makes it easy to forget that the market is anything but.  The collective we refer to as "the market" is in fact a living, breathing organic entity made up of millions of real people.

Each and every day, behind every single tick of the tape, someone's personal drama is unfolding.

On one tick: a young couple puts their life savings into Apple (AAPL), in the hopes of funding their newborn baby's college education.  The couple is excited -- so excited that they're inspired to take an impromptu family portrait, smiling and holding baby next to their computer.

On another tick: an unemployed man just lost his family's last dime on an options trade gone sour; he will miss the coming mortgage payment.

And on yet another tick: a retired man is lost in reverie, as he finally cashes out stock he and his wife purchased together many years ago, with the hopes of one day taking their dream vacation to the Bahamas.  They never did make the trip.  He's finally decided he will go anyway, to honor her memory... but he's in tears as he closes the trade.

The market is all of this -- and so much more than we can imagine.  I'm sure if you recall your own experiences as a trader/investor, you'll find your own personal drama stories fit right into the mix.

And this is why we consistently fail when we try to apply rationality to markets.  Markets are not rational, because people are not rational.  Markets are made of motivation -- and motivation, even within ourselves, often comes from places we simply do not understand.  Sometimes these are dark places we're not really aware of; places inside ourselves that we're frightened to explore, which we blind ourselves to, while at the same time pretending they don't exist.  Other times our motivations are straightforward and honorable -- but even those motivations are often emotional, irrational, and cryptic.
Ultimately, the market is not driven by questions of "what," but by the question of "why."  And why individuals are in or out of the market at any given moment is simply unknowable.

Fortunately, while not a rational place, the market isn't total chaos either.  At least, I don't believe it is: experience has led me to conclude that there are definite patterns which, at times, unfold in very predictable ways.  This begs the question:  If the market is ultimately irrational, and individual motivations are unknowable, then where do these patterns come from?

My conclusion is that, beyond the personal drama which is unfolding daily across millions of trades, there is also a collective drama unfolding on a much grander scale.  And while this collective drama is no more rational than the individuals participating in it, it is at least more knowable and predictable.

Virtually everything in the universe experiences cycles of one degree or another, on both the macro scale and the micro.  Something as small as an grain of sand experiences the equivalent of a "life cycle" (it comes into being; it ages; it eventually breaks down), as do entire galaxies.  People and their constructs, such as civilizations, are moving within cycles of their own.  And these cycles, while often not rational, are at least repetitious enough to become somewhat predictable.

For example: in our modern civilization we've experienced fairly predictable boom and bust cycles caused by the expansion and contraction of credit.  There's a psychological component to this, and when credit is expanding, the temptation of the collective is to believe that the good times will never end.  Accordingly, towards the end of the cycle, there's high confidence in virtually every speculative asset class, and a general mood of societal elation.  The late 90's represent one such example.

The problem, of course, is that credit cannot expand indefinitely because it's a self-limiting cycle.  Eventually, we reach the extreme end of the cycle and start to move the other direction -- gradually and imperceptibly (at first), but with increasing velocity. 

When credit is contracting, and especially once it starts collapsing, the mood becomes very dark and fearful -- 2008 being the recent example.  Eventually that mood, too, reaches the extreme of its cycle.  If a secular bull market is to be born in the wake, then in time the mood of fear passes completely, and we repeat the entire cycle over, ultimately heading back into euphoria.  However, cyclical bulls can fall short of realizing the full cycle of euphoria, and often pass away somewhere in-between -- generally creating an abatement of fear, but not quite reaching the "irrational exuberance" stage.

The question is which cycle we're in today.   

This is a tough one to read currently, because the situation we have in today's market is somewhat unique, at least to our generation.  We have a market which is being forcibly pushed higher by the Fed's expansion of money -- but meanwhile we have economic fundamentals which don't seem to support current valuations.  Up to this point, this has generally led me to think cyclical bull instead of secular bull.

The late 90's, part of a secular bull, were markedly different: we had a Fed which made credit cheap and easy, and thus encouraged credit expansion -- but we also had willing economic participants feeding the sense that there was at least some form of genuine prosperity underway.  As a result, today's market "feels" somewhat unnatural and forced, for lack of better descriptors.

While it may feel forced, it's not exactly a surprise we've gotten this far (the mid-1700's were my long-term target back in February).  Consider the market as a giant liquidity machine, with assets being buoyant.  When liquidity pours into the market, then assets float higher, like a tub full of rubber ducks.  When it drains out, then they sink -- and some of them get sucked down the drain and into the sewer, never to be heard from again (I'm not sure if rubber ducks do this, but the other material I thought of for the "float and sink" analogy isn't really suitable for a family-friendly publication).

Anyway, the bottom line is this means that someway and somehow, it's going to require credit and money supply to start shrinking in order for this five-year bull market to end.  Either the Fed will do it willingly, by tapering -- or something will eventually cast asunder the best laid plans of mice and men.  In other words, we can't simply assume complacently that as long as the Fed prints money, there will be no declines or bear markets.  Liquidity crunches can and do happen while central banks are still creating money -- but they requires "events" which drain liquidity faster than it's being created.

It's virtually a mathematical certainty that at some point the cycle will peak and begin to head the other way.  The question is whether we're there yet.

Frankly, in my opinion, it's still too soon to say.  I personally can't predict every move the market is going to make in advance, but I can usually identify the important pivot zones.  Weeks ago, I began talking about the current price zone as a larger inflection point, and the market has borne that thesis out and remained stalled ever since.  The victor has not emerged yet.    

Just one chart today, because there is really very little to add to the past few weeks of updates.  Near-term, I would expect another leg down.  First targets and signals to watch are noted on the chart below:

In conclusion, near-term I expect a trip into the price targets noted above.  Intermediate term, our collective drama is still unfolding.  Trade safe.

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Reprinted by permission; Copyright 2013 Minyanville Media, Inc.


  1. Jason,

    Great writing.
    Is this on Minyanville? If not, it should be.

  2. Thanks, David! Minyanville re-billed it with a new title: