duCati Report Week 21

Morality is of the highest importance – but for us, not for God.
Albert Einstein

The COT index number for SPY comes in at [11.4%] This number has been consistently negative, yet the market has risen inexorably. Clearly the number for our purposes is ‘broken’ we simply can’t place a trade in any expectation of a winning trade.

However, while I am not willing currently to trade the number, I am wary that due to the market rise – who is actually buying? Watching the CNBC Fast Money show, consistently there is a discussion as to who is actually buying this rally. There have been a number of prominent Hedge Fund managers, David Tepper for one this week came out in support of a fundamentally sound market. Josh Brown also reiterated that on a valuation basis this market is buyable [reversing his seasonality meme].

This is not a fundamental market. This is a market driven by liquidity, supplied by the Central banks of the world: Federal Reserve, Bank of Japan, ECB, and even the Bank of England is joining the party. New Zealand is playing currency supression games.

That the COT index signals selling, indicates that this market is unstable and highly dependent upon continued liquidity. Should that liquidity, or even the confidence engendered by this liquidity fade, this market is likely to correct hard and fast.

While the duCati portfolios continue to be long [they are a long only strategy] they are starting to trigger sell orders that are either being filled, or are close to being filled. Essentially they are gradually increasing the cash position, which will cushion any moves to the downside, but reduce gains incrementally to the upside. This is per the strategy and methodology. As such I can sit with the bull move very comfortably. The SPY portfolio has been long since December 21 2011.

The GLD COT number is [-0.2%] Again, there are some structural anomalies. Financial gold, ETF’s, Futures, etc, reflect the sell-off. Physical gold however is being accumulated in Asia.

As a result of the loss of reliability in the COT numbers currently in the short term [days/weeks] but cognizant of the potential in the longer term [months] a new strategy becomes prudent.

The advantage of this strategy is that it is market neutral. It is volatility based, viz, a big jump in volatility results in big profits. It can capture big short term gains, but can also play the long game where really outsize profits lie.

This week, and each week, I will supply one back-spread trade. The trades will come as a separate attachment so that they will not be disclosed on the blog. Profits can be locked in, and the position allowed to run so that really large profits have time to accrue without placing already earned profits at risk.

 

Notes from Treasuries

The Bond bull is over. It looks as if the top is in and the start of what is likely to be a long [trending] bear market is setting up. If that is the case, at some point, this is a bad thing for stocks.

 

Campbell v MGN [2004]

Just a short note on the opinion from Lord Hope in this case. He cites a judgment from Gleeson CJ and his rule with regard to privacy, which is itself taken from Prosser Privacy 1960.

The matter made public must be one which would be offensive and objectionable to a reasonable man of ordinary sensibilities.

Lord Hope then says:

“it is relatively easy to conclude that a reasonable person of ordinary sensibilities would not regard the publication of further details of her therapy as particularly significant. But I think it is unrealistic to look through the eyes of a reasonable person of ordinary sensibilities at the degree of confidentiality that has to be attached to a therapy for drug addiction without relating this objective test to the particular circumstance.

Where the person is suffering from a condition that is in need of treatment one has to try, in order to assess whether the disclosure would be objectionable, to put oneself into the shoes of a reasonable person who is on need of that treatment. Otherwise the exercise is divorced from its context.

Lord Hope is confusing the purpose of the ‘reasonable person’ test. The test, although referred to as ‘objective’ is actually ‘normative’. Thus it is a value test and values are subjective. As the law frequently resorts to fictions, this is not the primary objection.

The failure of Lord Hope is that the normative test is designed to provide parity between plaintiff and defendant. It removes individual characteristics, and allows the facts to be applied equitably to both parties.

What Lord Hope wants to do [and has done] is to introduce prejudice to the test. The ‘plaintiff’ is now the reasonable person. Of course the plaintiff will feel that they [the facts] are objectionable etc.

 

Overnight

Markets go up. Markets go down. There is a fair amount of digital ink on why Japan opened so much lower. The trite answer is that there were more sellers than buyers, hence, lower prices.

The Federal Reserve has obviously also spooked markets somewhat in talking about reducing the size of the QE purchases from $85 billion to something less. As markets are essentially rising on the QE liquidity and nothing much else, this is a big deal.

The economy is not good. If Bernanke pulls QE, the financial markets will very quickly start to reflect the reality of the economy. Earnings, particularly in the financial sectors will be reduced. The financials are still a major component of the S&P500.

What are the chances of Bernanke pulling the plug? The Federal Reserve are woefully out-of-touch [remember Lehman's], or, so politicised, that they just don’t care. Either way, the decision might not be what we expect. The pledge was QE unlimited until unemployment 6.5%. The economy is nowhere close. Not even with the adjusted and manipulated employment data. You would think then that QE stays.

What then was the purpose of raising doubts in the market? There is a lot of dissatisfaction within the real economy that the holders of equities [the minority] are profiting disproportionately to those [the majority] that do not. Whether that would actually make any difference…I have no idea.

Certainly a few weeks ago the COT index, historically highly reliable, started signalling a divergence. The COT was flashing sell signals and the market rose, and rose and rose some more. The issue is, in a falling market, who will buy this dip. Currently, the COT commercials are not. Sure the first dip, today, is bought by all those who missed the run-up. They are very weak hands, and will sell out quickly, or sink with the ship. Who will provide the sustained buying pressure?

The absence of buying had me switch to market neutral strategies a couple of weeks back, simply as the market’s divergence suggested that all was not well below the surface. Whether we get a deeper correction, or the market somehow settles, big directional positions for the moment, would be foolhardy.

 

flippe-floppe

The market has given up a 150 point rally. Under normal circumstances, I’d say “be careful, the market might go lower now.” But this market is anything but normal. At the sight of any dip, you will bear witness to financial perversion, as fund of funds allocate all of their money into long only funds. I don’t even want to talk about pullbacks anymore and how horrible they will be, once they arrive.
What’s the point?

I’ve been waiting for a significant, earth shattering, correction since 2009. Yes, I’ve been long and always bullish. But deep down I’ve been scared of a 2008 redux. Like many others, I was shell shocked by the crash, even though I was 100% short.

Here’s the thing…flippe-floppe is always his most trenchant at inflection points, where, he is invariably [to date] wrong. Contrary to his claims, he was not 100% short in 2008, he was almost entirely long.

The current reversal today may, or may not signal a correction. A correction is somewhat overdue. If we do see a correction, then that will become a buying opportunity for those that have missed the last few weeks run-up. How deep? I have no idea. I’m guessing at least to the statistical median and possibly a bit deeper. I’ll be watching.

 

Purpose of studying the law

The purpose of studying the law, is to understand the law. To understand the law, one must seek to uncover the conceptual limits of liability.

The problem[s] with the concept of ‘privacy’ and the privacy cases is that the Judges constantly duck the responsibility of attempting to define the concept and therefore its limits of liability.

As I have seen in the string of privacy cases, harking back to Prince Albert v Strange (1850) where privacy was articulated as a species of property [right's], the development of the case law subsequent to that has been shoddy.

Where there exists a ‘right’, there by definition exists a ‘remedy’. One is the inverse of t’other. The courts are providing remedies in these privacy cases, yet, they decline to apply themselves to the intellectual task of defining the conceptual boundaries of the liability, or ‘right’ transgressed.

The cases are remedied in ‘equity’. Equity is shorthand for: there is no articulated principled approach, therefore, as a Judge, I shall make a purely subjective, arbitrary decision and call it ‘law’.

In the US, back in the early 1970′s, the abortion cases were, supposedly, to be developed as an extension of privacy, as were the various obscenity cases. When I have a bit of spare time I’ll research the opinions in some of these cases to see if a principled approach was ever developed.

 

Monetary easing and QE’s

The chart below shows the annual real rate of US GDP growth going back to 1930. In the last 84 years, the US economy has averaged an annual growth rate of 3.34%. For the chart, we have color coded each year based on whether or not annual GDP growth was above (gray) or below (red) 3.0%. Currently, the US economy is in the midst of its eighth straight year where annual growth has been (or will be) below 3%. This eight years also happens to coincide with the entire tenure of Ben Bernanke as the chairman of the Federal Reserve. Prior to the current eight year stretch, the longest streak of sub 3% growth was the four years from 1930 through 1933.

While the blame for the current period of sub-par growth hardly rests on the shoulders of the current Fed Chairman, one can imagine that he will do whatever he thinks is humanly possible to make sure that the streak ends before his tenure is up. For this reason, for better or for worse, we would expect that the Fed will keep its current policies of accommodation intact until it is abundantly clear that economic growth has picked up

GDP is calculated via the number and dollar value of exchanges. There is a further chart that clearly shows why with all the extra liquidity created by the Federal Reserve, that GDP is so anaemic.

This is the demand for money. For all its efforts to increase the supply of money relative to demand, and thus lower its price [inflation], the extra liquidity is not flowing to the average man-on-the-street. His wages are not rising. The prices he pays for food, energy are all rising. Those two items are of course excluded from the CPI.

Housing. The recovery. Pffft. Houses, foreclosed units are currently being purchased by Hedge Funds. Hedge Funds are speculators. They are not going to live in them. They may rent them out, but, they may also want to sell them, unless they plan to convert their status into a REIT. Did their investors invest in them for that type of risk and return…I hardly think so.

As such, although the market is currently in a bull phase and looks unlikely that the bear will return anytime soon…use the rising prices to sell into booking the profits from when you bought in the trough. You did buy in the trough right?