The Real Hand That Rocks the Cradle

From the wires:

WASHINGTON (AP) — Retail sales plunged in May by the largest amount in eight months as consumers slashed spending on everything from cars to clothing. The big drop raises new worries about the durability of the economic recovery.

I can’t imagine why? Did anything happen in May? Why can’t we all be a tad more honest and admit the stock market drives the economy and not the other way around?

Even better? More from the wires:

Total retail sales marked their first monthly drop in eight months, falling 1.2 percent in May — contrary to economists’ consensus forecast for a gain of 0.2 percent.

Said with a straight face: “economists’ consensus forecast.”

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40 thoughts on “The Real Hand That Rocks the Cradle

  1. Michael says: “Why can’t we all be a tad more honest and admit the stock market drives the economy and not the other way around?”

    I had a good friend who sometime ago responded to that by saying, “…that’s starting to delve into metaphysics”.

    “Action” is the organizing factor in the markets and the economy not fundamental explanations. And such action is measurable. It is answerable to scientific observation, analysis, and experiment.

    Uncertainty is implied in the very notion of action. And humans are not comfortable with the uncertain.

  2. Michael –

    I don’t understand how you come to the conclusion that ‘the stock market drives the economy and not the other way around’.

    I accept that, to a point, the stock market drives the economy, in that my propensity to spend will be determined (to an extent) by the value of my stocks and shares. However, the effect of this is arguably countered by the fact that trading is a sum zero game; if I become poorer, someone else is probably becoming richer by equal measure.

    But surely the converse is also true – if the public suddenly buys lots of widgets, then the price of Widget Inc’s shares will rise.

    What am I missing?

    Jeff

  3. Jeff, you don’t understand as you have refused to read recommended readings that would further your education. If you want a source to tell you what you want to hear and do it in one paragraph, there are other locations for that. Stop being lazy.

  4. Michael

    I was simply asking a logical question about your assertion.

    Will any probing questions I ask in the future be met with a recommendation that I read those 3 books?

    Jeff

  5. There you go with the derogatory adjectives again! 🙂

    You don’t know me, so you have no way of knowing whether I am lazy or hard working.

    Could it not simply be that I lead too busy a life to fit in the time to read those books?

    Jeff

  6. If you want to know a subject that you clearly do not know (and have admitted as such), a subject you have refused to learn about even when you have been given very good recommendations that would provide you a much needed foundation, and you refuse to read — yes you are lazy. If you still want to debate those subjects while making assorted excuses as to why those recommendations will not help you — that is arrogant. If you have too busy of a life to learn — this is not the right site for you. Try something like TMZ.

  7. I do want to learn. But whilst I don’t have the time to acquire an in-depth knowledge of politics and economics, I do know enough about both subjects to enter into an intelligent discussion. That’s all I was trying to do.

    And perhaps not all your readers have degrees in economics or understand immediately how you came to particular conclusions, so my questions might benefit them too.

    Jeff

  8. You have been told how to come to those conclusions — book suggestions that have nothing to do with degrees in economics. You have refused in an extraordinarily lazy and arrogant way to move yourself forward.

    Bottom line, most readers who come here actually want to learn, and take advantage of my work and research, not offer childlike excuses when I offer suggestions. You are the first reader in 15 years who has told me that one of my recommended books will not be read due to the publication date. Then when I call you out about that silly excuse, you say you are too busy — all the while defending your supposed intelligence on these issues. Your mindset, that kind of thinking and logic, is why so many millions got caught with their pants down during this economic downturn. Your inflexible attitude, not your questions, is what my readers can take from watching your thought process. They can learn by watching someone think in such a cluttered manner.

    I wish you well, but my responses to you have truly reached a conclusion. There are sheep in my film for a reason.

  9. If we tone down the anger levels, then some learning and conversation can happen with open minds.

    Because there is truth in both views and that is why is seems so contradictory.

    In the long run (say, more than five years), the stock price of a company is driven by fundamentals. economic sustainability, earnings etc.

    In the intermediate term (few weeks to few years), the stock prices are driven by net crowd sentiment, causing trends. This can be so irrational and that is why trend following works better.

    In the short term (few days), market is a stampede.
    No system except microscalping like Jim Simons, or Crabel works.

    Market is random chaos in the very short term, a voting mechanism in the short term and a weighing machine in the very long term.

    My view, at least.

    Ravi Annaswamy

  10. I am many things, but a sheep is not one of them! I may ask you probing questions, but I am also highly critical of what the government tell me!

    I like to think of myself as an independent thinker…

    On a lighter note, and further to your previous entry, here’s the It’s A Rich Man’s World video: http://www.youtube.com/watch?v=ETxmCCsMoD0&feature=channel. BTW, the pop song that I feel best addresses the inequalities brought about by capitalism is Band Aid’s Do They Know It’s Christmas? (http://www.youtube.com/watch?v=zT9lKyi0dDM&feature=related). The irony of the line ‘Thank God it’s them instead of you’ is delicious (even though the irony was probably not intended!).

    Jeff

  11. Michael –

    PS Just to clarify, I didn’t say I wouldn’t read the books you recommended due to the fact they were published over 50 years ago. I merely questioned their relevance to the current political and social landscapes. For example, anything those books have to say about the situation facing women or African Americans will be completely out of date.

    Jeff

  12. There’s no need for that. Firstly, because I am neither anti-capitalist nor a nut. And secondly, I haven’t called you any names. If you want to attack my views, feel free, but why resort to personal attacks?

    My MTV video link was in response not to van Mises, but in response to the Abba lyrics that you posted…

  13. Ravi says: “In the long run (say, more than five years), the stock price of a company is driven by fundamentals. economic sustainability, earnings etc.”

    Although your idea is very popular I doubt if price is “driven by fundamentals”.

    Fundamentals do not exist in a vacuum separate from the people that make them.

    In my experience fundamentals are driven by the long run psychology of the market place[say, more than five years:)]and price action is the best reflector of that psychology. Price moves first and fundamentals follow.

    Here is an interesting quote from a famous Value guy:

    “You never know for certain, but the nature of value traps is, they tend to have certain characteristics. Typically, one is that the valuation of the business or the industry is lower than its historical norms. The company or business normally has a fairly long history, so the historical normal valuations provide a lot of comfort. Therefore, when you get down toward the lower end of these valuations, value people find them attractive. The trap comes in when there’s a secular change, where the fundamental economics of the business are changing or the industry is changing, and the market is slowly incorporating that into the stock price. So that would be the case over the last several years with newspapers. They are a good example of where historical valuation metrics aren’t working.” –Bill Miller

    He then promptly goes on to make a really bad bet:
    http://executivesuite.blogs.nytimes.com/2008/09/08/bill-millers-really-bad-bet/

  14. Yes, Trender, I agree, very good point.

    George Soros also points out how market impact economy and stock prices impact fundamentals. He calls it reflexivity, a fancy term for the positive feedback loop that value investors often ignore.

    In my observation, two cases in point:
    When stock price falls, it becomes hard for the company to raise cash for an emergency or an operation and credit ratings fall.

    Buffett’s having to sell Conoco at a loss to raise cash for emergencies.

    Miller’s example is also one of my case studies.

    I consider value investing as know-it-all or know-as-much attempt – bet big when you are very sure. The flaw, though, is that it ignores the big elephant in the room – the speculating public. The philosophy suggests to ignore Mr.Market until he makes a foolish offer in panic.

    All value investors successfully did this and prospered for long. Until oct 2008 when Mr.Market made a foolish offer, which most took, out of their habit, only to see Mr.Market turning down further. Then the other flaw was exposed. The fund manager may ignore Mr.Market, the investing public does not. They pull money and cause force selling. The wise Klarman says value investing requires not only patient managers, but patient investors.

    You may choose to dance with Mr.Market, or listen and learn from him but if one tries to ‘exploit’ or ‘ignore’ for long, they could be surprised.

    I see value investing and trend following not as incompatible philosophies but a conscious and subconscious attempt to same underlying money movements of economies and markets. Markets and economies are also not two separate entities, but a whole. Again, my view.

    Ravi Annaswamy

  15. Wow, interesting comments. I am new to learning this trending stuff. Have read Trend Following and Turtle Traders, got to re read them. Very interesting.
    Michael what are the books you recommended to Jeff that were printed 50 years ago?

  16. Markets and economies are not two entities because money raised in the markets feed the businesses and wealth gained in economies is invested back in markets.

    I called trend following as ‘unconscious’ – wrong words.
    Let me clarify. Trend following does not try to build a concrete model for price movement, but learns to watch the price and respond to it in a continuous unquestioning dance with Mr.Market, just making sure, when Mr.Market stretches you with profits you go all the way, but step out of the way when he can stomp you. (Sorry to mix up genders here).

    While value investing bets that high quality, underpriced assets will reach fair value sometime in future, trend following bets that when speculative fever catches up, it will go up ignoring values and versa.

    Ravi

  17. Hempman, three classics:

    ‘Human Action’ by von Mises.
    ‘Atlas Shrugged’ by Rand
    ‘Fountainhead’ by Rand.

    Three timeless titles for anyone who wants to understand why the ‘government as daddy’ path is dead on arrival.

  18. To finish the thought, value investing ignores the one big elephant in the room, the speculating public, (or Mr.Market), while trend following ignores the other big elephant in the room, economic fundamentals that provide a long term justification for a price.

    The observation that trend following, as implemented, is able to survive the error of totally ignoring value, (while its momentum investing cousin fails), is because of its quick loss-cutting habit. (In other words, wrong decisions made in momentum chasing are quickly identified and rectified when price goes the wrong way). My respect for trend following is its
    ‘know-nothing’ humility, though it is carried to an extreme.

    Correspondingly, a deep discount buyer can also survive
    if he has the wisdom to cut loss, but since they gain their ‘conviction’ by deliberately learning to ignore the market, it hurts their ego.

    But ignoring value and ignoring price are both suboptimal, and may be superseded by techniques that
    acknowledge both realities.

    Markets seem to have a way of punishing egos (of careful analyzers) as well as ignorance of price-followers as we have seen value investing fail for long periods and trend following going through dry spells too. Mr.Market’s dance keeps us all on our toes.

  19. “But ignoring value and ignoring price are both suboptimal, and may be superseded by techniques that
    acknowledge both realities.”

    Pie in the sky! 🙂

  20. Hi Ravi,

    I agree with some of your #19 comments.

    You said:
    “… money raised in the markets feed the businesses and wealth gained in economies is invested back in markets.”

    Yes, it’s all reflected in the price and the fundamentals are discounted! Let me explain.

    1. Markets move based on expectations(psychology), not facts! If markets behaved based on facts, they would barely move at all as they would quickly discount all relevant information. Although markets in the long run reflect all available information this discounting process is a very long and slow one(read trend). Generally, the arrival of the discount marks the end of a trend.

    2. With value investing traditional discounted cash flow analysis is used, you predict cash flows to estimate a stocks value. Trend following starts from the other end. It starts with a rich under utilized source of information – the stock price. Often it’s not explicitly stated that market expectation is embedded in the price. Over time, this state of expectation manifests as trend. And this is what TF’s trade.

    3. Although markets move based on expectation such expectations are “not” formed by free-willing or rational actors. If markets were rational they wouldn’t move at all![Ed Seykota goes quite a bit deeply into the psychological process and the formation of such expectations.] Knowledge does not begin with facts. Although we may not be aware of it at no time do we make observations free of expectations(and that goes for everyone).

    4. Aware of it or not, everything is Trend Following.

    “We do not understand a thing until we see it growing from its beginning.” -Aristotle (384-322 B.C.E.)

  21. Jack,

    I was going to add ‘Virtue of selfishness’. Excellent writing. “Objectivist epistemology”, can also to be added to the list. Kind of a dictionary of terms from Objectivism.

    It is interesting to note that
    Greenspan was a great fan of Ayn Rand. My opinion on Ayn Rand is that lot of good ideas, if you can patiently absorb and use it, otherwise harsh as an ideology. I value enormously the thought process Ayn Rand setup in me, long after I may not agree to the conclusions.

    Also, Now I know where the angry young man that runs this blog comes from 🙂

    Michael, the airplane was a pie in the sky until someone figured out how to do it (W)right. Trend following was a pie in the sky until people got more systematic about it. (Think Jesse Livermore vs Ed Seykota).

    Trender, thanks for the insights.

    I fully agree ‘Markets move based on expectations’.

    ‘Markets have to face facts someday’ probably completes the picture. Please note that since this resetting process is also a ‘trend’.

  22. After reading this thread I have just one comment… some people like to think they’re intelligent, others take the time and work hard at acquiring intelligence.

  23. Ravi says: ‘Markets have to face facts someday’ probably completes the picture. Please note that since this resetting process is also a ‘trend’.

    Yes, I agree. The process ends when the fact is faced.

  24. Ravi,

    p.s. If a given principle is valid it should work at all times, or you have no principle! Value investing does not work all the time.

  25. I’ve read the two Rand books you mention. Not heard of the other one. I’ll have a look for it.

  26. Trender, what do you mean by ‘working all the time?’

    If that means, showing a marked-to-market profit each and every day, or year, then no investing or trading technique can accomplish that. And if you mean, for everyone who uses it, again no technique.

    If you think of an investment a success if it is highly likely to be sold for a higher price in a reasonably long term, then you can comfortably sit through market quotations. This is the viewpoint from
    value investors.

    Value investing has worked for many many investors for a long time, including the two large two billionaires on the Forbes list. You can read Buffett’s paper ‘Superinvestors of Graham-and-Doddsville’ for an excellent discussion.

    My point was that in markets as in life, there are several principles at work all the time, and anyone exploiting few principles may succeed until the principles they have ignored seem to take over.

    The fact that birds fly does not mean gravity has stopped to work, but the birds are utilizing some OTHER principles to temporarily defy it.

    It is OK to be enchanted by one technique or ideology, that is how you learn and become successful. But it is like wearing a particular kind of filter on our eyes because we are looking for a specific thing.

  27. While trend following works on stocks, meaning the investor can make money on them, it could harm the businesses.

    Businesses, new and old, need patient capital – money that they can use to build teams, systems, patents and organizations that can get and stay profitable over time.

    If the investor says: I will give you lot more money if the others are giving you a lot, but will take away as soon as I see others taking away, I dont care what your business model is and how good it is, then businesses have to resort to tricks to cheat or make sure to tap into the wealth and hide it away when available.

    Of course, traders dont see what they do as investing or capital allocation, so my comment may be off the mark.

  28. Ravi,

    If a principle is valid, it has to remain valid at all times. If a principle can be dated, then it’s not a principle at all. For example, the principles of thermodynamics are valid under all circumstances.

    TF ignores nothing. Unlike value investing, the principle behind TF explains the most facts with the least number of assumptions. TF is a first principle. A first principle is one that cannot be deduced from any other.

    The value investors strategy of 1) figure it all out 2) find a sure thing and then 3) bet the ranch is a bad strategy.

    You may find the following of interest. Surviving the Worst Case: Risk Management and Value Investing: http://seekingalpha.com/article/135686-notes-from-the-value-investing-congress

  29. I don’t mean no disrespect but after reading that link value investors sound more confused than ever to me.

  30. Yes, Trender, good point.

    I said, “TF ignores the other elephant – value”, but I was mulling over that fact. You articulated it correctly. TF does not ignore value – it sees value WHEN the value is being recognized, through price appreciation. In other words, if a undervalued value stock catches up in price, TF will latch on to it.

    I like the view that TF explains markets with least number of assumptions. “If there is something worth buying, many start buying and buying causes more buying until there are no more buyers at the high prices. Selling starts and proceeds until everyone has sold.”

    I think in trading world, trend following provides the same contrast to value investing as iterative (successive approximation) solutions provide to analytical formulations in physics and math – a guess and check approach rather than an explanation. Its strengths and limitations may flow from that. Its appeal to various temperaments may also be due to that core difference.

    Thanks.
    Ravi

  31. Thanks for the link.

    To be fair, end of 2008 got almost everyone confused.
    From Mutual funds to hedge funds. When investors get that anxious, they pull money off their losing funds and from their winning funds.

    It is possible that the value investor’s buying primes the pump leading for a trend to emerge.

  32. Ravi,

    I like your view ‘…a guess and check approach rather than an explanation’. You never know until you act.

    Precision and certainty has limits. So the supreme task of a trader/investor is then to arrive empirically at a broad and basic set of rules that govern the profit generating process and learn to stick to them.

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