Too monolithic a statement. Not everything broke yesterday for the first time. CAT had already confirmed its downtrend. We have been short LUV for over a month. These are just two examples -- most of our short book is at breakeven risk levels now. You don't have to be "seriously bearish" to either 1) exploit an attractive risk:reward setup from the short side, or 2) reduce long-side equity exposure (if one is net long) in the face of clear warning signs. Soros (paraphrase): "Volatility is greatest at turning points, diminishing as a new trend establishes." We have not seen back-to-back 1% down days in the S&P since November 2011 -- not to mention powerful range expansions and high-volume closes on the lows. Guess what that portends? A warning if not an invitation (cash is a position). I agree w/ Specterx here.
Before digging in, note the asymmetric profile here. If a bearish trader is positioned to minimize risk of loss via high quality entry points in the right vehicles, these macro downside scenarios represent positive optionality. If nothing happens, not much is lost. If a gray swan does kick in, however, the potential gains are outsized. Much of the point of risk management is cutting off undesirable tail risk, while letting favorable fat tail risk work in your favor. This is an incredibly aggressive assumption. We have no idea what the true impacts of a China hard landing might be. What happens if China starts selling USTs in size, for example (or just stops buying in size)? The Fed would be forced to stabilize the bond market through aggressive monetization policies, which would in turn dramatically weaken the dollar and have a whole raft of unknown downstream effects, including a potential outbreak of protectionist measures as various overheating E.M. economies are negatively affected. And that is only one of multiple scenarios. To a large degree China is a big black box -- with the potential to be Pandora's box. Nobody thought subprime was going to be a problem either -- the issue was "tiny" until it wasn't. Another aggressive assumption that does not fully account for tail risks and the nature of macro crises. Mr. Market's general tendency is to blithely ignore the prospect of a macro crisis -- until the day he doesn't. There is ample historic evidence of problems being ignored for great stretches of time, until finally the problem explodes. In addition to that, as stated, the real turning point re Europe might not be fear of another blowup, but rather dawning realization that Europe could be stuck on the precipice of severe recessionary conditions for quite a long time, regardless of what the ECB does. Earnings season will provide some color here. And markets are supposed to be discounting mechanisms (forward looking) in the first place. One does not need hard evidence of the rear-view mirror type for profit margin contraction concerns to hit markets hard. All that is needed is a general perception shift towards the view that, in light of global slowdown concerns (stalling Europe, China and U.S. in tandem), investors have been paying too much for future profits. Further as to "evidence of it happening:" You mean like volatility increasing markedly at a potential turning point after months of calm? Ha ha ha... now you are lobbing softballs that are almost too easy to hit. Yes indeed, the Fed can create "as much inflation as they want." The Fed could also recreate the conditions of Argentina or Zimbabwe if they felt so inclined. They won't, of course, because such would be disastrous. There is good inflation and there is bad inflation. "Too much" inflation almost invariably turns bad. Do you recall the infamous "Death of Equities" Businessweek cover from August 1979? (I was 3 years old at the time but make a point of studying historic events.) What people forget is that the horrible performance of the stock market in the 70s was blamed on the pernicious effects of inflation: Rising input costs and compressed discretionary income profiles everywhere you look. And also, re, gambling, who is the real gambler here? The astutely positioned trader who can take advantage of a gray swan has tail risk and optionality in his favor. His profile is beautifully asymmetric. The overly sanguine long investor, in contrast, who writes off mounting risks in a couple of hand-waving paragraphs is assuming that "nothing will go wrong" on the strength of surface level assessments, and betting the health of his investment accounts on same. Agree that Iran is mostly white noise. Probabilities bear this out -- same with North Korea etcetera. But that's why Iran wasn't mentioned, along with risk of suitcase nukes going off in Washington DC blah blah blah. We just have different perspectives of how the world works. As for the last statement, "None of those are anything other than outlier possibilities at present," that looks like a combination of straw man (assuming the odds of a large equity market decline are entirely predicated on "extreme" scenarios) and wishful thinking. Perhaps the largest difference in our thought patterns is 1) willingness to predict, versus emphasis on attractive risk:reward scenarios, and 2) attitude towards tail risk. I don't know precisely what the future holds, and nor do I much care. My main goals are to find the most attractive risk:reward setups possible, and to work hard to cut off unattractive tail risk while putting positive optionality in my favor.
Again, too monolithic. Your simplification makes it sound as if the only available trades are in the major indices. This is not the case at all. If anything we are starting to finally see a rich differentiation of themes, with different areas of the market bullish and bearish. Where do these numbers come from??? You speak with a certainty that would make Miss Cleo blush. Consider the following: * Being 80% certain is probably the high end. In markets it is hard to be 80% certain, barring extreme outlier situations (such as the insane valuations created by forced selling at the 2009 lows). * The more variables involved, the dicier things get. If you are 80% certain on 4 variables instead of just one, your probability of getting all four of them right drops to just 41% (0.80^4), or worse than coin flip. * To wit, certainty is seriously overrated. A methodology that allows for scenario assessment with an eye for attractive risk:reward and negative tail risk minimization, without over-reliance on assumptions about the future, is far preferable. The old monolithic assumptions again. There are far too many ways to slice and dice exposure, risk profiles, bull / bear themes etc. for blanket statements like this to have much value. You are presenting "generalized index trader" in the same ham-fisted style as the neoclassical "rational economic man."
I don't disagree with any of this in abstract terms. I am not shorting here and have no expectation that current prices offer a good entry point. However I would say that using strict technicals on a daily timeframe, the thing to expect now is actually consolidation. I relax these definitions if I think the instrument concerned is in a secular bull market but that requires another level of analysis.
The difference is that you appear to view market history as being on a straight and narrow track with occasional deviations from that baseline 'normal,' while I prefer to divide it into periods characterized by a unique combination of fundamentals, valuation, special circumstances etc. On this front I believe we've been in a secular bear since 2000. Current conditions see badly overvalued markets confronted with generally dire fundamentals (not dire immediate month-to-month economic reporting of the sort that would be priced in were it to emerge, but rather factors not yet priced in that should affect the path of stock prices over the next 1-10 years). All significant market advances have been correlated with central bank printing, which is not a sustainable driver of corporate earnings, valuations, general business activity, and so on; in fact previous rallies have fizzled literally within weeks of the liquidity operations ceasing. The implications for one's investment strategy - if not short-timeframe trading strategy - from these two interpretations are meaningfully different. You make a number of rather breathtaking assumptions in your post - from the implausible contention that any foreseeable economic difficulty or crisis will result only in a "5% to 10%" correction to the heroic assumption that you'll be able to beat the rest of the world out the exit door once a major market decline or major economic/financial crisis becomes manifestly obvious. It actually begs the question of why you bother to perform all this fundamental macro analysis at all, rather than go by technicals exclusively, or just 'stay long unless the world is collapsing'.
Nobody said anything about shorting. Shorting after four down days coming off the tippy top is not a situation I prefer. On the other hand your estimate of the risk:reward setup here is just nonsense. The market is up 30% in six months and at multiyear highs; in the past decade there have been maybe one or two places where it paid to 'buy high' to the extent you'd be doing so now, and that's assuming you were buying for a trade and timed the exit well.
Indeed - and of course if you are a long-term investor, than other things like severely stretched SPX valuations, margin compression and baby boomer demographics come into the picture.
For the love of god, I think you top-ticked TLT yet again. Write on the chalkboard 100 times: "Buy low, sell high."
It's rather instructive that you cite the example of a 500 billion dollar company which is up more than 50% in just over three months, and for which 87% of analyst ratings are either 'buy' or 'outperform,' as a supposed example of how current 'neutral' psychology is supportive of a bull market. What on earth would be hyper-bullish psychology in AAPL look like?
Like this http://www.bloomberg.com/news/2012-...-stock-to-1-001-within-year-analyst-says.html http://www.reuters.com/article/2012/04/03/us-apple-pricetarget-idUSBRE8320K620120403