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Trading  | June 28, 2018

Submitted by Nick Colas via,

“You’re making this harder than it has to be.” 

In my time at SAC, I rarely heard Steve Cohen give his traders advice about their portfolios, but that’s exactly what he told one PM who was having a particularly hard day. It was easy enough to see what had gone wrong. Too much capital in all the wrong places, not enough intraday hedging. All textbook stuff, even if this particular (very experienced) trader couldn’t see it through his stress.

Over the years I have come to appreciate the real meaning of Steve’s advice. He wasn’t saying that outperforming the market is easy. Rather, his message was to structure your process so you don’t make it even harder. His on-staff psychologist, Ari Kiev, drilled that into us every week during mandatory sessions to discuss our trading. Keep things simple. Routinize your entire process, from data collection to risk management. Lather, rinse, repeat.

I always return to Steve’s dictum on volatile days like today because it helps cut through the noise and frame authentic market narratives.

Three examples, all based on “Not making things harder than they have to be”:

#1. Be very careful about extrapolating moves that happen at the end of a quarter. Today’s outsized sector losers were Technology and Financials, the performance bookends of the last 3 months.

  • Financials are so bad (-3.1% three month returns) than even long suffering Consumer Staples (-1.4% over the same period) look good in comparison.
  • Tech (+7.0% three month returns) is fully half the S&P’s 3.6% return for the last 90 days.

The underperformance of small caps today (Russell -1.6%, S&P -0.86%) fits the same pattern. This asset class is +8.7%/+9.5% (Russell/S&P Small Caps) over the last 90 days, more than double the return of US large caps.

One last point about today’s wonky action: the open was fine. We’ve run enough analysis over the years to believe the old maxim that “Retail opens the market and institutions close it” still applies. Today’s selloff wasn’t driven by an adverse event (retail is the lightning rod for those). Rather, it felt like institutions reweighting winners and losers.

#2. Price leads fundamentals, not the other way around. The painful case study here: Financials and the shape of the yield curve. Ask any good bank analyst and they will caution that the difference between short term and long term rates is only one factor in the sector’s fundamentals. Credit quality, loan growth, and regulatory issues matter too.

But the ever-flattening Treasury yield curve (32 bp today, a new +10 year low) is hurting Financials for a macro – not micro – reason: it signals the real possibility of a recession in the next 12-24 months. That, along with some quarter end pressure, pushed the S&P Regional Bank Index lower by 1.9%. Even large cap Financials were “better” than that in today’s session, down 1.2%.

#3. Sell when you can, not when you have to. We’ve been picking up on an “Everything old is new again” market narrative in recent weeks that bears a mention, especially because we have not raised it with you before.

The issue is market liquidity, and May’s Italian bond market rout put it back on traders’ radar screens. Elections there spooked sovereign debt investors, but since the ECB wasn’t in the market at the time real “natural” bids were few and far between. Two-year yields went from 27 basis points to 2.4% in 3 days. That simply should never happen.

The growing fear now: US equity market structure has changed dramatically in the last decade and remains untested in stress situations that last more than a few days. It has certainly not lived through a recession, for example. Layer on what the Treasury yield curve is saying on that point, and we understand why equity market structure concerns are bubbling up to the surface in earnest for the first time since the “Flash Boys” book came out.

The bottom line from all this: simple thoughts don’t always drive stock prices, but respecting their power is basic intellectual risk management.Today’s market action means little, but against the backdrop of rising recession fears it illuminates an important macro worry. That skittishness then becomes fertile ground for other concerns, like the proverbial butterfly of Italian bond markets causing a hurricane in US equities. Yes, we still believe US equities will produce 5-8% returns this year. But we respect the simplest arguments against that optimism.

A revolutionary initiative is helping average Americans find quick and lasting stock market success.

275% in one week on XLF - an index fund for the financial sector. Even 583%, in 7 days on XHB… an ETF of homebuilding companies in the S&P 500. 

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