Rescuing turtles - how the ABCT can help trend following investors part I

Futures magazine wondered in 2013 if trend following as an investing strategy was dead:

In 2012, the aggressive and persistent actions by central banks and other authorities worldwide served to maintain an unfavorable market environment that began in 2009 for most trend following systematic programs. Many short, medium and long-term trend following CTAs, as well as other trend following hedge fund strategies performed poorly... While these indexes all reported losses for the second year in a row, the S&P500's climb (+13.4%) continued through year end. Although markets for hedge funds generally were better than for CTAs,... the HFRX Global Hedge Fund Index rose only 3.5% in 2012...the Newedge Trend Following CTA Sub-Index is down 5.89% since the bottom of the financial crisis in March 2009. 

This performance contrasts sharply with longer term numbers, particularly in the CTA space. Since 1980, as measured by the Barclay Hedge Btop50 Index of CTAs, managed futures have returned three times that of the S&P500, approximately 32 times an initial investment vs. 11times an original investment for the S&P 500. And in 2008 the S&P was down 45% while the Btop50 was up 14%.

Japan’s 4th quarter torpedoes Market Monetarism

Japan’s GDP fell 0.4 percent from the third to fourth quarters, which translates into an annual rate of -1.4 percent as it is commonly reported. The shrinkage dealt another blow to Abenomics, the term the press invented for the Prime Minister Shinzo Abe’s economic plan to boost the Japanese economy through massive money printing. Last month, and before the latest data, the central bank of Japan drove interest rates into negative territory in further hopes of jump starting the economy.

"The latest data show that it is difficult to say that the Abe government has achieved of its goal of a 'virtuous cycle' of rising incomes, wages, and investment," said Tobias Harris, political risk analyst at US-based consultancy Teneo. 

"It's getting clearer that Abenomics is a paper tiger," said Seiya Nakajima, chief economist at Office Niwa, a consultancy, referring to Prime Minister Shinzo Abe's policy mix of monetary easing, spending and reform. 

Year ahead forecast - stormy

Austrian economists are not huge fans of forecasting as are most mainstream economists, especially those who add a decimal point to lure the gullible into thinking the forecast is accurate. But that doesn’t mean Austrians don’t forecast. Hayek wrote in his Nobel Prize acceptance speech that... 

"Without such specific information about the individual elements we shall be confined to what on another occasion I have called mere pattern predictions - predictions of some of the general attributes of the structures that will form themselves, but not containing specific statements about the individual elements of which the structures will be made up."

I call Hayek's concept of forecasting, pattern predictions, or qualitative forecasting vs quantitative. In other words, Austrian economists can tell what will happen next but not exactly when or how much.

That doesn’t mean that Austrian economists don’t ever use numbers in forecasting. Obviously, I have provided a few of those. But I hope readers interpret those forecasts as tendencies and illustrations of theory, not as point-accurate forecasts.

Oil can sink lower than we think

Everyone is wondering how low the price of oil can go. It’s well below the profitable level in the US, but the pumps keep pumping. In this earlier post I showed that oil companies will continue to pump at a loss as long as the revenue covers variable costs because the costs of shutting down an oil well can be very high.

But how long will they continue to operate with prices around variable costs? One analyst says they will do so until the cash runs out:

How the Fed creates bulls and bears

If you grasp this you will be light years ahead of most economists. Bull and bear markets can't exist without the Fed manipulating the money supply. Here's why.

Assume the stock of money is fixed. For example, say there exists only $1 trillion in gold and banks have lent out nine times that amount so that the total money supply of gold plus credit equals $10 trillion because the required bank reserves are 10%. Also assume the population remains constant. If nothing changed, prices would remain the same and the economy would be in a state that economists call equilibrium. Profits would equal the cost of credit, say 5%.

Now we have to look at how many times the $10 trillion is turned over, or changes hands, in order to figure out the total sales for the year. We’ll assume that the turnover, or velocity, of money is five. Then total sales for the year would come to $50 trillion. A profit of 5% would mean $2.5 trillion. Now let’s assume the PE ratio, the measure of risk tolerance, is 15. The market cap would be $37.5 trillion.

With a fixed stock of money, productivity increases at zero and the population remaining constant, the stock market would show the same values every day. Planned investment equals real savings.

Poking the bear - what happens next to the market?

The S&P is down about 9% for the year and 10% from the highs last year as of this writing. By the time you read this, the index may be even lower. The bear has been hibernating for seven years and may be waking up. If so, he’ll be hungry for your nest egg. 

Technicians will be looking for the lows of last year for support as if nothing has changed. But a lot has changed. Profits for the fourth quarter of last year are expected to fall over 5%, according to data provider FactSet. And even if you leave out the disastrous energy sector, profits are expected to be flat.

China, Brazil, Europe, Japan are in worse shape. US manufacturing has been in a recession for months. Oil, gas and mining are in recessions. We are beginning to see the effects in the consumer sector as retail sales from the Christmas season sunk below those of last year.

This is a good time to look at where we are in the business cycle using insights from pages 105-107 in my book Financial Bull Riding:

Big Short – good movie, bad economics

The outlaw couple Bonnie and Clyde was not only famous for their bank robberies in the 1930s, they were popular. They lost some of their appeal when they began murdering policemen, but people loved the fact that they robbed banks because the people hated banks. They had watched banks foreclose on farm families during the Dust Bowl and depression. Committing the economic sin of fixating on the seen while ignoring the unseen, an error first identified by the great French economist Frederick Bastiat, they blamed the bankers for the farming disasters.

People have loved to hate bankers for centuries, often for good reason. Until the creation of the FDIC, depositors occasionally lost their life savings to bank failures. Now they don’t, but the people see banks constantly bailed out by governments when they make bad decisions and then foreclosing on borrowers who have made decisions that were no worse.

So it was no surprise that the movie The Big Short blamed greedy bankers for the recent Great Recession. I reviewed the book on which the movie was based, Michael Lewis’ The Big Short: Inside the Doomsday Machine, here. As I noted then, Lewis’ economics is terrible, but the book is a great read because at its heart it glorifies the difficulties, hard work and genius of entrepreneurs and the heroes of the film are entrepreneurs.