Monday, September 22, 2008

Panic Isn't Paying

We've had panicky selling in stocks on Thursday morning, only to be sharply reversed in the afternoon. We had panicky stock buying on Friday, only to be reversed in today's trade. Now we're seeing a panicky inflation trade, selling U.S. dollars and buying gold, oil, and basic materials shares This is a market that has been punishing panic, and the latest panic is that the government's rescue plan will flood us with cheap dollars and rising prices. Meanwhile, financial institutions hoard cash and restrict lending, a clearly deflationary dynamic. It wasn't so long ago that markets were pricing in a Fed tightening; until the day of the Fed meetng we were then pricing in a rate cut. Both hopes were dashed. In a time when fears run strong, scenarios tend toward the extreme. The market, so far, is doing a fine job of punishing such extremity.
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8 comments:

Firebird said...

Dr. Steenbarger,

As always, right on spot. Last Thursday at some point I had to go to the gym to work out so I wouldn't lose my mind and both Friday and today at some point I had to walk away from the computer so I would calm down (no losses here, though, just upset at missing superb opportunities over a couple of ticks).

I guess those who are keeping their heads over their shoulders all the time these days must be making a killing (and those who don't must be blowing their accounts big time). Congrats.

Best trading,

Jorge

Keith Shepard said...

I don't see how people can't panic given the current quality of information available to them.

dgoverde said...

Doc,

I think you've missed the mark badly on this one. If not now, panic when? The people who are making the inflation trade are merely the first movers. Those same people who are long oil and shorting the dollar will be shorting the market straight through the lows. And not only will we get a full-scale depression, but this deflation meme will get punished badly. The proposed bailout package is clear confirmation that the government is in inflate or die mode. I'll bet you a cigar that someday, we're going to look back at this time, and realize that it was a tipping point of sorts: where once we undoubtedly were, now we're not really in the mood to smoke cigars anymore. Moreover, I think if you'll mull it over, you might agree with me when I warn you that your archetype is the kind that tends to recognize the black swan event only when he sees it in the rear-view mirror. You do not have the type of personality that is capable of great paradigm shifts. If you ever succumb to the urge to explain to us later why we should have seen this coming, I'm going to remind you of this post. You, in fact, did not see it coming. It takes a certain amount of courage to make this black swan call. The trade requires that you intellectually disown your country and its currency. And I just don't think that you would be capable of doing that. Not from what I know of you-- you, who are by nature, much too optimistic to be able to play the role of the pariah. I could be wrong on all counts, but I doubt it. Let's compare notes at the end of 2009.

Yours truly,
Dgov

Firebird said...

Let's keep it friendly - please.

Best trading,

Jorge

Brett Steenbarger, Ph.D. said...

Thanks for the comments, Jorge and Keith. I totally agree that there is plenty of cause for concern, worry, and even panic in these markets. Managing risk is paramount; I find that proper position sizing is the only thing that enables me to weather the heat some of my trades take in this volatile environment.

Brett

Brett Steenbarger, Ph.D. said...

Hi DGov,

Thanks; I always find comments that challenge my views to be informative, from the most tightly researched and reasoned critiques to the most sharply worded projective identifications. My point was that the markets have been moving in short, sharp panicky moves and that it has been dangerous to chase these. Even just since my post, we've seen retracements in oil and gold following their sharp spikes.

As to whether or not inflation will roil our economy going forward, that's another matter. I agree with you that it's a concern, given the amount of debt we're adding to the national balance sheet. Should we see the dollar tank and commodities skyrocket from here in response to such an inflationary scenario, I'm not sure I'd see that as a "paradigm shift", but rather as the resumption of a trend that's been going on for some time.

Brett

dgoverde said...

Jorge,

You misread my tone. My intent was not to offend Dr. Steenbarger. My intent was to point out to him that, by the personality type concepts that I know he himself is very familiar with, we shouldn't expect him to be able to "see" this trade as anything other than a bunch of skittish people panicking.

Now, I am well aware that it is in my nature to see such a trade, and that is precisely why I would be inclined trade it. But there are plenty of other trades out there that I am incapable of seeing. The probabilities for what I'll call a "stagflation" trade are the absolute best right now that they've been in the recent past. And to say, "Don't panic," is essentially to miss this trading opportunity. Don't panic? Do panic. But do it before everybody else does-- do it while oil is trading at 106 and @DX is trading at 76.85, and while gold is trading at a "mere" $900.

Friday would have been a good day for the trade. But anytime this week might serve you well. In closing, Brett, the paradigm shift that I'm talking about isn't the idea that our recent growth-driven run-up in commodities prices will continue. In fact, what I am talking about is the very possibility that there can be inflation even in the face of negative economic growth. Most economists equate recessions with deflation. But it doesn't always work out that way. If the government increases the money supply by too much, which I think it already has, it won't matter whether or not we are in a recession or depression or any other part of the market cycle. Our currency will collapse. And the prices of everything that is dollar-denominated will increase dramatically. Of course this is the worst-case scenario, but sometimes the time is right to bet on the worst-case scenario.

Placing such a trade takes an inordinate amount of courage if you are optimistic by nature. If, like me, you are cynical by nature, it does not. But if you are optimistic like Dr. Steenbarger, then in order to place this trade, you would have to disavow your optimism (because you would be betting on things not working out,) and that's probably asking too much. Also, you would run the risk of making yourself a pariah if you let your views be known (because your friends don't want to hear that things aren't going to work out.) And wouldn't Dr. Steenbarger be the last person who would willingly make a pariah of himself? Doc, I only bring your personality type to bear on this discussion because I think it is an interesting point. Are you capable of making this trade? I would say no. Now that doesn't mean that you are a bad person, it just means that your personality type is not suited to this trade. And that's true even if the worst-case scenario doesn't play out! Different personality types are suited to different trades. You probably shouldn't be taking my trades, and I probably shouldn't be taking your trades, and maybe I should even refrain from taking my own, who knows?!

Jorge, we should be able to discuss these things, even if they are indeed too personal, as in fact, they probably are. If we want to grow as traders, we'll need to bring our personality types to bear on our trading.

Hope that you didn't take offense, Doc, and I trust that you didn't.

Sincerely,
dgov

Brett Steenbarger, Ph.D. said...

Hi dgov,

No offense taken whatsoever. Your read of my personality is pretty far off the mark, but I see how you might get that impression. Best of luck on your trade.

Brett