Market Strategy – Capitalism in Action
October 2011
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“I’ve missed more than 9,000 shots in my career. I’ve lost almost 300 games. 26 times, I’ve been trusted to take the game-winning shot and missed. I’ve failed over and over and over again in my life. And that is why I succeed.” ~ Michael Jordan
In This Issue:
- Strategic Resources/ News
- Global Macro
- Contrarian View-Points
- Disclaimer
Strategic Resources/ News
For up-to-date news on Market Insights, see my twitter postings:
- 1) Financial markets have become driven by politics
- 2) Too many indicators?
- 3) Do technology revolutions drive economic revolutions?
Global Macro
Ripple Effects of Sovereign Debt
Leverage is a double-edged sword with a multitude of implications. All around the world, politicians are loathe to cut spending and afraid to raise taxes. Instead they continue to borrow and borrow, and borrow (or print fiat currencies, but that’s another story).
The natural question for traders is: what are the implications (or ripple effects) of continued debt expansion by sovereign nations? How will this shape the trading landscape? As I think about how debt re-shapes world dynamics, a number of implications pop into my head related to Political, Economic, Societal, and Technological factors. To start with, let’s classify countries as Snails (with No/Low Growth) or Gazelles (with Accelerated Growth).
PEST
Political/ Economic
Snails:
Austerity measures may be order to stave off more serious future consequences. While tempted to kick the can down the road, a tipping point will eventually be reached where the shit hits the fan – most likely resulting in serious economic damage. Politicians focused on keeping their positions of power often play a dangerous game of chicken with national economies. If (when) the train wreck comes, the question to ask is will it be Deflation or Inflation that rules the day. Deflation may result if economic growth slows drastically and if consumers and businesses retrench too much, it will wreak havoc on a country for many years to come. Inflation on the other hand may be more manageable – if it doesn’t spiral out of control into hyper-inflation and if governments don’t clamp down too hard – causing another market crash.
Gazelles:
Inflation is a major concern. In an effort to further boost growth, even Gazelles may over-stimulate, thereby causing too much inflation. Therefore, political and monetary measures to stimulate the economy must be carefully measured.
Societal
Snails often suffer high unemployment rates and even civil disruptions ranging from simple protests to outright mob violence.
Gazelles tend to suffer less unemployment, yet must remain on guard as wage increases may flame the inflation monster.
Technological
Snails, with less money sloshing around the country, may struggle to fund/ jump-start the industries of the future. Furthermore, business may significantly decrease capital spending and consumers may hold off on discretionary spending – such as electronics, as they dive in to survival mode.
Gazelles are much better equipped to jump-start future technologies, yet they must be sure to arouse enough domestic demand to offset less demand in Snail countries.
Inter-Market Effects
In the end, perception of No Growth (Deflation) / Growth (Inflation) scenarios around the world accounts for a significant share of market movement. What should traders keep their eyes on?
Deflation
- The USD$ rallies significantly, staking out new highs.
- Interest rates will tend to fall and bond prices will correspondingly rise. To watch: TIPS, 10/ 30 yr. Treasuries
- Commodity prices by the very nature of deflation will fall, although some commodities (such as precious metals) may spike if doomsday scenarios play out whereby national economies experience a loss of confidence domestically and/ or internationally.
- Stocks in general are likely to decline due to diminished demand for products, although this may vary sector by sector depending whether the sector is defensive or non-defensive in nature. You might want to keep an eye on the S&P Sector ETFs which may be split into Offensive (Risk on) and Defensive (Risk off); Offensive: XLF,XLY,XLK,XLI,XLB | Defensive: XLE,XLP,XLV,XLU.
Inflation
- A declining USD$ is both a cause and consequence of inflationary pressure.
- Interest rates will tend to rise and bond prices will correspondingly fall. To watch: TIPS, 10/ 30 yr. Treasuries.
- Commodity prices by the very nature of inflation will rise, although some commodities may fall if inflation gets out of control. For example, agricultural products may fall in price if demand falls off due to consumer substitution or avoidance if the price rises too much.
- Stocks in general are likely to rise, although this will vary sector by sector. As an example, companies unable to pass along input price (wage or product) increases will suffer unless they can mitigate such costs in other ways.
Final Thoughts
Countries around the world might be divided into Snails (with No/Low Growth) or Gazelles (with Accelerated Growth). Economic growth is in large part the deciding factor on the rise and fall of financial markets. Governments, in an effort to boost economic growth, often intervene and lately they’ve done so by adding huge amounts of debt to their balance sheets.
Fortunately for traders, we live in a world where you can go long or short. Based on history, economies are likely to either deflate or inflate – although politicians sheepishly call for a smooth ride as everything magically works out. So be on the lookout for signs/ continued signs of either deflation or inflation and then follow-up with a look at each scenario’s ripple effect – then take action in the markets accordingly.
I sincerely hope I stimulated your Trader Mind. Feel free to contact me with your comments or feedback. Until next month!
Contrarian View-Point
Contrarians by their very nature must challenge assumptions, which naturally are the mother of all screw-ups.
Once common assumption amongst investors/ traders is that past earnings growth is a serious indicator of future growth prospects. Although it may seem natural for this to be true, it may be deeply flawed. Earnings tell you what happened in the past – usually for the past quarter or year. Earnings or EPS Growth is not a crystal ball – it does not tell you what will happen next. What traders need to do is to dig deeper into what’s going on beneath the surface. Just like an iceberg, 90% of what drives the market is buried deep – way beyond mere numbers and statistic measurements. Remember that markets are made up of people and people are driven by emotions.
Actually Traders, especially for those with mid to long-term time horizons, need to dig deeper into what’s the underlying story. The underlying story is what the Smart Money relies on when they place their bets. And, the reason they’re so Smart is that they look at the Big Picture. Retail investors get swept up in the moment, jumping on the trend de jour. At the other extreme are institutional investors who in essence are the market in that they shift billions of dollars around each day. Slipping between the cracks are obscure hedge funds and market savvy traders.
“The secret to being successful from a trading perspective is to have an indefatigable and an undying and unquenchable thirst for information and knowledge.” ~ Paul Tudor Jones
Best of luck out there in the trenches and drop me a line sometime.
Disclaimer
All material in Byvation is for informational purposes only. Any and all
ideas, opinions, and/or forecasts, expressed or implied herein, should not be
construed as a recommendation to invest, trade, and/or speculate in the markets.
Be advised that Michael Davis and/ or Brencom Business Technologies, Inc. will
not be held responsible for any investment actions that you take as a result of
any information mentioned in Byvation.
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