2020 has been a weird year, hasn't it?
'Weird' is probably a bit of an understatement, actually.
We thought the world was going to be plunged into another Middle Eastern war in January when the US killed Qasem Soleimani, the head of the Iranian Quds military group...
That was then displaced quickly by the obvious...
The thing that still is affecting us today.
One of the most harrowing series of events of my lifetime...
Him coming onto Netflix for a 10 part series...
No, I don't think what has actually ruined 2020 has to be mentioned, since it feels like we're just at the beginning, judging from what's coming out of the UK at the moment, not to mention the response from governments and central banks over the last 9 months.
Yes, it does feel like we've just been in some weird pregnancy until now when the vaccines have pretty much all been announced...
A decline in health, earning power (for many)...
Lack of freedom, a worry about the future.
One thing that certainly hasn't felt the effects of COVID for too long a period are asset prices.
The chart below shows the SP500, NASDAQ, DAX, Gold, Bitcoin and AUDUSD (a nice high beta risk proxy).
From the March bottom, risk has been on a tear - some may think, 'what the f*ck? Why is this happening?'
I explained it in the video below (from August).
If you have been shorting this market, then quite frankly, you truly have been crushed.
And the saying 'don't fight the Fed' certainly comes to mind.
Now, this is a great chart.
My personality is certainly to be contrarian.
But I'd like to think that really what I am doing is trying to find something that many others perhaps haven't seen - something that might be taken for granted that provides optionality...
Here's a good explainer from Adem Tumerkan.
I'd consider my 'safe' plays to be conservative bets on FX at standard position sizes and my 'highly speculative' plays to be event driven with larger size but also can be combined with longer term plays (uranium is one of them) and cross asset, although naturally the two merge as well.
Many people have been contrarian simply because they think that the economy should be be reflected in the market.
Here is the soundtrack to their belief.
One of the Fed's mandates (and I would say is the primary one if we look at how asset prices have moved over the past 10 years) is financial stability.
So the payoff of trying to time a short position on risk assets when the most powerful force in markets has constantly signalled that they would prop them up isn't contrarian, it's just dumb.
And it's probably why the brightest minds play with volatility products, rather than outrights.
If you're interested in volatility, there are a few good Twitter follows.
Ben Eifert, Kris Sidial, Squeezemetrics, Artemis Capital and Harel Jacobson are a couple that I follow or have been suggested.
It begs the question then...
Why are people contrarian in the largest bull market ever?
I guess it comes down to wanting to be right.
Being long in perpetuity is boring (and also, surprisingly difficult since calling time on a bull run can be easier than persevering through the smaller troughs where doubts come into play).
It's very much the 'stairs up, elevator down' type thinking.
Walking up stairs is long and arduous, but the elevator?
Love it - won't be out of breath any time soon.
It's the desire to be a hero, and being short, shouting for doom gives a bizarre sense of achievement if it does come off.
You can say, 'see, I told you so.'
And that comes at the price of being wrong for a long period of time, and in no uncertain terms
WANTING TO END HUMANITY.
Let's go back to the elevator down analogy.
Mike Harris has written a short post on the March Madness.
The index fell -7.5% yesterday or about -7.9 standard deviations.
Market participants should understand what they are dealing with when the return distribution is highly leptokurtic as above: there is large tail risk. When one is caught betting against the tails, left or right, there is potential for large losses. However, passive investors profit longer-term because the mean return is positive although that comes at a relatively high standard deviation.
According to general statistical principles, a 4-sigma event is to be expected about every 31,560 days, or about 1 trading day in 126 years. And a 5-sigma event is to be expected every 3,483,046 days, or about 1 day every 13,932 years.
So a -7.9 sigma move is practically beyond statistical comprehension...
Which tells us one thing - the risk models are broken.
Here's an excerpt from this piece on uncertainty.
See, the market isn't always right at all given points of time.
Take the Great Financial Crisis, for example.
Value at Risk models were used extensively to judge how risky or not a book was.
See, rather than using VaR as a tool, banks tended to use it as an ultimatum for risk management - this is what we'll use and this is the consensus in the industry.
When you get a consensus opinion in an industry, you generally get a skew towards a certain type of behaviour.
In this case, that skew was literally a skew - fat tails were largely ignored or at least underestimated by these consensus models.
And fat tail risk is what caused the 2007/8 financial crisis.
So no, markets are not always rational or efficient...
The elevator down analogy is a good one to explain human behaviour.
We are on alert - why do markets not go up faster than they go down (generally)?
Well, in the current market context, I think people are looking for an excuse for it to fall since even the last 10 years has not confirmed to them that ample liquidity is the driver.
They're stuck thinking that valuations matter massively (they do but under certain conditions).
So the key takeaway for me from 2020 is two linked points.
1) Stop comparing past periods of high valuations (price/earnings) with current valuations without also factoring in the difference in treasury yields between the two periods...
2) Central banks have your back - financial stability is the name of the game.
Don't fall into the trap like the Tiger King did of thinking it's all over just because the market fell by nearly 8 standard deviations.
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