Where Did Market Volatility Go?

[EJ]

Where Did Market Volatility Go?
October 18, 2006 (Project Syndicate)

Television and newspapers continue to trumpet every twist and turn of global financial markets. In truth, however, the big story is the uneerie calm that has engulfed virtually every major asset class, from stocks to bonds. Is the whole investment world on Prozac?

Conspiracy theories abound, particularly among the ranks of financial traders, for whom volatility is like wind to a sailor. These traders confidently figure that as long as markets gyrate, no matter what the direction, they can always make money. And, thanks to the rest of us who don’t have the time, information, and skill to match wits with them, they are mostly right. But, with today’s dormant markets, the pickings are slim.

The favored bogeymen of the day are giant government investors, particularly Asian central banks, with their trillions of dollars in assets. These superfunds, whose managers do not necessarily share the same passion for profit as private investors, are said to be squeezing the life out of interest rates and exchange rates. “The big Asian central banks are oppressing us,” one young trader recently complained to me.

What a difference a decade makes. During the 1990’s, private investors looked at big, lumbering central banks as cash cows, long on money and short on financial acumen. George Soros once made a billion dollars off the Bank of England in just an hour. His basic strategy was a standard one: bet against any central bank that tries to defend an inconsistent macroeconomic policy.

AntiSpin: I have another explanation. I've seen this before. When headline index prices rise to new nominal peaks in the face extremely low volatility and high optimism, it means that the smart money is going short the smart way–quietly. I'm doing the same, starting today.

To add to these indicators, an ill wind blows in from the East. Today Condoleezza Rice talks publically about deterring a North Korean nuclear attack on Japan with a US nuclear counter-attack on North Korea.

Rice promises to defend Japan from North Korea
October 18, 2006 (Colin Joyce - Telepgraph)

Condoleezza Rice warned North Korea today that America would use the “full range” of its military powers if Pyongyang launched a nuclear strike on Japan.

As she arrived in Tokyo on the first leg of a mission to galvanise opposition to Kim Jong-il’s regime, Ms Rice made clear that America would protect its key regional ally against any threat following North Korea’s atomic test.

“I want to make sure that everybody understands that the US will fully act on our defence obligations under the mutual defence treaty,” said Ms Rice. “The United States has the will and the capability to meet the full range, and I underscore the full range, of its deterrence and security commitment to Japan.”

[Jim Nickerson]

Re: Where Did Market Volatility Go?

AntiSpin: I have another explanation. I've seen this before. When headline index prices rise to new nominal peaks in the face extremely low volatility and high optimism, it means that the smart money is going short the smart way–quietly. I'm doing the same, starting today.

Just joshing, but putting it on the board is not "quiet." What is the saying, "No one rings a bell at THE TOP"?

So, EJ, are you calling THE TOP, or beginning to dollar cost average into short positions?

The few people I have run across in cyberspace calling THE TOP so far have missed; it seems risky business when one is putting his/her money where the mouth is, and I am not sure these other people were putting up their money.

I think whenever the top is reached almost no one will be calling it, but, of course, you may be "on the money."

[Jeff]

Re: Where Did Market Volatility Go?

The shorts spent the late 90's leaving the room feet first. That's why shorting is so tough- too early will kill you just as dead as too late.

[EJ]

Re: Where Did Market Volatility Go?

Markets. They're so stubborn. They NEVER LISTEN TO ME!

Seriously, mostly I try to dump the asset class de jour near–not at–the top of the current bubble cycle and go to cash while looking for the next one to ride. I do take sometimes take some short positions in the transitions, but these are never more than 10% of my portfolio. Two reasons. One, as Jeff points out, hardly anyone gets the timing right to pull it off. Two, if you buy and sell trend changes near the top and near the bottom, you don't have to.

When I pronounced the NASDAQ a dead duck in March 2000, as the NYTimes and IBD point out, you didn't have to take a big fat short position that day to make money. You'd already made your money. The trick was to sell and keep your money, not listen to Cramer or Abby. A secular bear market is a complex process of transition from all the forces that drove the secular bull that preceded it. The process involves a lot of ups and downs that, of course, produce more losers than winners among the shorts. We're still in the secular bear market that started in April 2000 when I wrote "A Bear Market is Born." We've experienced a liquidy driven cyclical bull within it, very similar to the one acheived in 1937, six years after the bottom in 1932.

There are many iTulipers here who are happy not because they made money shorting the NASDAQ, but because they got out with a lot of profits, or at least avoided major losses. There are just as many who started to sell real estate in mid-2005 when I called a "top" when I was writing over at Always On. There are iTulipers who are happy because they read the Sept. 2001 piece about gold being cheap at $270 in and bought some. So as far as the value that iTulip provides, generally buying market trend changes seems to be it. As for making short trades, or specific stock picks, my record is ok but nothing to brag about, so I don't.

So, to be clear, when I say today I'm going short, it means that I smell an opportunity to get out of stocks, preserve some gains, and place a couple of short bets. That does not mean a crash tommorrow, but that we are–in my humble opinion–close enough to this dead cat bounce top for me to want to dump what few stocks I own and take a couple of modest short positions... I'll risk losing out on further gains. Previously, on this subject, I was fairly confident that the Boyz could keep this going up to end-of-year bonus time. Now I'm pretty sure that they are pretty sure that they can't.

[Jim Nickerson]

Re: Where Did Market Volatility Go?

The question, if one believes in trading trends, is what indicators can one use to determine when to go long and when to go short. It is germane to making money, whereas discussing why the markets should do one thing or another and expecting such to move the markets may not be at least over any short or medium term. The latter may be the effect of irrationality. Take the comment by Jeff above--nothing in my experience is truer. From the end of Nov. 1999, I could see all sorts of reasons not to be long, and risked being short, and I straightaway got slaughtered, and then got long only to get slaughtered again.

Not on Wall Street, but on iTulip there is currently, and for the recent past, I believe a lot of bearishness. I am a bear. EJ in opening this thread put forth three reasons he apparently is bearish right now, and again who knows he may be correct.
Hussman has an interesting chart this past Monday http://hussmanfunds.com/wmc/wmc061016.htm that shows the number of trading days the DJI has gone before experiencing a even a 10% decline.

Date	Trading Days	P/E at high	T-bond yield	Decline
09/03/1929	719	20.6	3.8%	-40.0%
03/10/1937	654	11.3	2.5%	-14.9%
05/29/1946	1020	16.2	2.1%	-23.2%
01/05/1953	617	9.4	2.8%	-13.0%
07/12/1957	960	13.0	3.7%	-19.4%
02/09/1966	912	17.6	4.6%	-25.2%
08/25/198	780	19.7	8.9%	-36.1%
07/16/1990	657	13.6	8.6%	-21.2%
08/06/1997	1723	23.7	6.4%	-10.6%
10/13/2006	906	18.3	4.8%

Now the current uptrend seems sure to move from 5th into 4th place in its longevity without a 10% correction. Is anyone willing to say it could not move into 3rd, or second, or, heavens forbid, 1st place?

Paul Desmond of Lowry's reports who might be best known for his study of identifying market bottoms, in a paper http://www.lowrysreports.com/research_studies.cfmregarding the nature of bull market tops wrote, " Bull market tops, on the other hand, tend to develop gradually over a long period of time. The reasons for this gradual process are easy to understand: It is the Law of Supply and Demand at work. Just as bull markets result from strong, persistent investor demand for stocks, bull market tops evolve when investors gradually stop buying. Some investors simply run out of new money to invest. Others begin to see individual stocks as being overvalued, and begin to hold back on new purchases. Whatever the reasons, the stock market cannot continue to advance without Demand exceeding Supply. The evolution of investor psychology from strong buying enthusiasm for stocks to passivity or complacency does not occur suddenly. Thus, bull market tops are commonly diffuse, possibly lulling most investors into inaction. Perhaps it is the slowness of the entire process that makes it difficult to recognize a bull market top."

With regard to the "top" in the DJI 5/10/06 on 6/29/06 I wrote in post #10 http://www.itulip.com/forums/showthread.php?t=142 that " I have mentioned Paul Desmond's 90% volume and point days, either up or down, before. I hate to reference Barron's, because I expect not everyone can readily access it online; however, in this past weekend's edtion there was the article "Bad-News Bear" which recounted some bearish orientations by Lowry's Report (this is Desmond's Co.), Ned Davis Research, The Leuthhold Group, Walter Deemer, and Jeremy Grantham. All very bearish with what their indicators are telling them. Try to read it for yourself. Someone (not in Barron's article) has said "they don't ring bells at market tops and bottoms," but it seemed to me this aritcle was "ringing the bell," as the death knell of the cyclical bull run, and it was published in a widely read financial journal.

Desmond said, (and if I am breaking any copyright laws here, someone needs to tell me)

Quote:

Ordinarily, the arrival of the bear would be confirmed when the market experiences two "90% downside" days, like May 17 and June 5 -- when 90% or more of the trading occurs in declining stocks, says Desmond. But sharp moves of similar magnitude both down and up in a 30-day period since the market peak in early May have led him to discount the significance of the action. Instead, a new watch has begun for the next 90% downside day. And a real bottom.

I think this indicator has been remarkably good, though not perfect. It struck me that possibly Desmond for likely a lot of good reasons is so bearish that he thinks his bullish +90 day buy signal on the NYSE is fallacious. I surmise that could be "denial" on his part. I have begun to keep calculations on the NYA (stock index) myself, and today was the second +90% up day in points and volume in the past 10 days. These follow the two minus 90% days Desmond mentioned plus two more near 90% down days on 6/12 and 6/13. According to Desmond's research on this indicator there is a "buy signal" in place--which Desmond just denied. It would be interesting to know what he says after today."

I don't subscribe to Lowry's Reports, so I do not know what more Desmond may have since said. However since those two +90% days mentioned by Desmond, if my tracking data are correct, there was yet third on 7/19, and two back to back +80% days, which according to Desmond's theory count as a "+90%" day. These four very positive days suggest to me that the bottom was a "good" bottom. Apparently the DJI "thought" so too having moved up 800 points or 7.17% since 6/30.

Anything may be possible when talking about markets, so I will conjecture that it is possible that perhaps we are again in a period similar to late 1999, when by many accounts the market was irrational, but if one bought into that irrationality by being short the major indices, then one lost money. For one thing, we are in or about to be into the favorable seasonality period. To my very primative assessment there is no shortage of liquidity possibly to fuel these markets higher.

I personally have a tremendous amount of respect for EJ and the opinions he formulates from a lot of knowledge. I am in no position to challenge him and am certainly not challenging him. What I would like to know is how other people see these markets, and at what sort of things they may be looking before reaching decisions to short this market?

[bart]

Re: Where Did Market Volatility Go?

...
So, to be clear, when I say today I'm going short, it means that I smell an opportunity to get out of stocks, preserve some gains, and place a couple of short bets. That does not mean a crash tommorrow, but that we are–in my humble opinion–close enough to this dead cat bounce top for me to want to dump what few stocks I own and take a couple of modest short positions... I'll risk losing out on further gains. Previously, on this subject, I was fairly confident that the Boyz could keep this going up to end-of-year bonus time. Now I'm pretty sure that they are pretty sure that they can't.

Just a point of clarification here EJ - when you say "stocks", does that include metal and mining shares too?

[jk]

Re: Where Did Market Volatility Go?

Anything may be possible when talking about markets, so I will conjecture that it is possible that perhaps we are again in a period similar to late 1999, when by many accounts the market was irrational, but if one bought into that irrationality by being short the major indices, then one lost money. For one thing, we are in or about to be into the favorable seasonality period. To my very primative assessment there is no shortage of liquidity possibly to fuel these markets higher.

I personally have a tremendous amount of respect for EJ and the opinions he formulates from a lot of knowledge. I am in no position to challenge him and am certainly not challenging him. What I would like to know is how other people see these markets, and at what sort of things they may be looking before reaching decisions to short this market?

there's another theory that explains the low volatility. i got part of it second hand via references to an article by [very successful] hedge fund manager steven cohen. there are so many money managers, so many hedge funds, so many private equity pools, i.e. so much liquidity, that all the edges have been arbitraged away. [and everyone leverages up to try to generate a decent return.] according to cohen, "it's hard to find ideas that aren't picked over..." thus, he concludes, we have entered an era of low returns.

but to the degree that all the "ideas" are arbitraged away, we've approached the random walk. now i don't believe in the random walk model, but under current conditions it may apply on the small scale we are discussing here. if the "ideas" have lost content, you'll have every move by some money manager faded by some other manager.

this reminds me of another thought i've had re; the commoditization of the equity markets. with program trading making up a huge percentage of current volume, with etf's allowing retail customers to execute something like "programs" themselves, the equity markets trade more like commodity markets. the stock market as a whole gets repriced during strong trends, and then there is differentiation among the market components while the overall averages drift.

as for your conjecture, jim, that we're partying like it's 1999, i've been having the same feeling. i have a long history of premature shorting [sounds like something with a remedy being advertised on tv by a big pharma company.] i've had the thought that i should send out notes saying "stop me before i short again." and i've been holding a small portfolio of shorts for some time. late summer i also bought some leap puts, some for jan 07, some for jan 08. the 07's have lost value, and i was thinking of adding to them earlier this week. 3 things stopped me: 1. richard russell's "pti" indicator has become strongly positive, and russell, who is very skeptical about the market and mostly in cash himself, likes to say that his pti is smarter than he is. 2. john hussman indicated monday morning that his measures of "market climate" were becoming somewhat positive. he thinks valuations are crazy, but when the "climate" is right, the market has "speculative merit"- i.e. it has on average produced a return worth the risk of some net positive exposure. so he was saying that under certain conditions he might be buying some index calls to offset a little bit of the full hedge of his stock portfolio. 3. it felt like we were partying like it's 1999.

so anyway, i didn't add to my puts. bill fleckenstein and fred hickey are still convinced the end is nigh, and that the earnings reports and 4th quarter guidances we will be getting this week may well mark the turning point. but i didn't have the stomach to add to my bear positions.

[Jim Nickerson]

Re: Where Did Market Volatility Go?

there's another theory that explains the low volatility. i got part of it second hand via references to an article by [very successful] hedge fund manager steven cohen. there are so many money managers, so many hedge funds, so many private equity pools, i.e. so much liquidity, that all the edges have been arbitraged away. [and everyone leverages up to try to generate a decent return.] according to cohen, "it's hard to find ideas that aren't picked over..." thus, he concludes, we have entered an era of low returns.

but to the degree that all the "ideas" are arbitraged away, we've approached the random walk. now i don't believe in the random walk model, but under current conditions it may apply on the small scale we are discussing here. if the "ideas" have lost content, you'll have every move by some money manager faded by some other manager.

this reminds me of another thought i've had re; the commoditization of the equity markets. with program trading making up a huge percentage of current volume, with etf's allowing retail customers to execute something like "programs" themselves, the equity markets trade more like commodity markets. the stock market as a whole gets repriced during strong trends, and then there is differentiation among the market components while the overall averages drift.

as for your conjecture, jim, that we're partying like it's 1999, i've been having the same feeling. i have a long history of premature shorting [sounds like something with a remedy being advertised on tv by a big pharma company.] i've had the thought that i should send out notes saying "stop me before i short again." and i've been holding a small portfolio of shorts for some time. late summer i also bought some leap puts, some for jan 07, some for jan 08. the 07's have lost value, and i was thinking of adding to them earlier this week. 3 things stopped me: 1. richard russell's "pti" indicator has become strongly positive, and russell, who is very skeptical about the market and mostly in cash himself, likes to say that his pti is smarter than he is. 2. john hussman indicated monday morning that his measures of "market climate" were becoming somewhat positive. he thinks valuations are crazy, but when the "climate" is right, the market has "speculative merit"- i.e. it has on average produced a return worth the risk of some net positive exposure. so he was saying that under certain conditions he might be buying some index calls to offset a little bit of the full hedge of his stock portfolio. 3. it felt like we were partying like it's 1999.

so anyway, i didn't add to my puts. bill fleckenstein and fred hickey are still convinced the end is nigh, and that the earnings reports and 4th quarter guidances we will be getting this week may well mark the turning point. but i didn't have the stomach to add to my bear positions.

jk, your "premature shorting" comment brought tears to my eyes from laughing. I appreciate your offering your perspectives.

[EJ]

Re: Where Did Market Volatility Go?

I got my butt kicked enough times trying to short the markets in the late 1990s that now I wait until just about every bear has given up. Did much better in 2000 and 2001 as a result.

It's true that when the last bear finally throws in the towel, that the end is near. Roach turning bullish a few months back was a good start. Fleckstein is nearly always bearish, and I'd be encouraged to short in earnest if I heard him turn bullish, but that's no sure fire indicator. I'm also looking for momentary anomalous changes in body language among the poster child bulls. Most forget this, but Abby Cohen made her only cautionary comments in late March 2000–stepping momentarily out of her role–before returned to it in April to ride the sucker all the way to the bottom with "cash on the sidelines" and other nonsense to explain why it was coming back any day now.

But we are not in a bubble market like early 2000. We are in a dead cat bounce of the largest market bubble in history–a different animal, so to speak.

The bounce in 1937 was fueled by the sudden surge of inflation and liquidity produced by the Fed starting in 1933, and driven by sentiment that was a mix of optimism and nostalgia, and some real growth. But the looming threat of war killed it.

Another happened after year after the collapse of the 1980 gold bubble, as inflation made a surprise come-back and it looked like maybe the Fed didn't have the political will to keep up the fight.

Didn't happen in Japan... they blew it. They listened to us.

These secondary bubbles end when an event ocurrs that informs market participants of what they already suspect, that the rally has no substance, that underlying conditions for growth are deteriorating. In this case, that the stock market is being driven largely by liquidity and credit, that if the iron lung of fiscal stimulus funded by foreign borrowing is removed the US economy will stop breathing, that the Chinese are not going to cave in and allow the yuan to depreciate the way the Japanese allowed the yen to depreciate to acommodate the US at their own expense, and that the US might be forced to leave Iraq without a clear victory, and all that implies.

You can smell the fear, and everyone seems to be waiting for something to happen. Eventually, something will. After everyone is tired waiting, is focused on other matters, and no one is paying attention. Thus the difficulty of shorting.

[Jim Nickerson]

Re: Where Did Market Volatility Go?

EJ,

I ran across a report that I think arrives at the same place you may be in your thinking, but by a different route.

The first article http://www.financialsense.com/editor...2006/1019.html had a link to a previous one http://www.financialsense.com/editor...2006/0517.html dated 5/15/06. Both are by Bob Bronson.

They are long, and I did not read every bit of either. In the second of the above links, Bronson writes of bear market supercyles and points out what he call the "top of echo-mania" highs. Perhaps what could be the picture if such a cycle were in play now is copied below from his second link.
This label accompanied the image. " In the Supercycle Bear Market from December 1968 through October 1974, as seen in the chart below [above], the stock market made “all-time new highs” at the top of its echo-mania (B) cycle-trend." He analyzes a number of similar events. This is showing the bear-market "bounce" exceeded the previous bull market high, a picture similar to what may be happening if one looks at the DJI, which it seems a lot of people are.

The first link contains Bronson's arguments dealing with conflicting reporting of when recessions begin and end. One conclusion: "
With all the data revisions and other strong analytic support for a change in the dates of the last recession, it is obvious that the previous recession was worse in both duration and magnitude than previously acknowledged, just as Bob Bronson had forecasted. Current economic data, as well as history, also suggest that the incipient recession will be even longer and deeper than the last one since, among other recessionary factors, it will be associated with the more severe, second downleg of a Supercycle bear market. It certainly will be far more severe than the current consensus of economists, and far more severe than investors have yet priced into stocks."

I also found of interest his impression in the last three segments of the first link.
a: New Highs In The Dow Are Not Bullish in which he pointed out referencing the 1973-74, "The whole irrational, new-highs affair proved to be no more than a relatively short-lived sucker’s rally at the end of a lengthy bull trap." This section is worth reading
b: The Dow Is A Defective And Misleading Measure Of The Stock Market
c: Declining Oil Prices Are A Reliable Indicator Of A Recession

For anyone feeling exceptionally bullish now, these articles might offer cause to reflect carefully on whether to be seriously long these markets.