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A Few Charts To Chat About

Every quarter JP Morgan Chase put out what they call a Guide to the Markets. The report itself is largely noise and is the sort of thing that research departments like to show to clients in an attempt to convince them that they are more than the sum of their convictions and misdemeanours. Generally I ignore this sort of thing but there are two charts within the report making the rounds and these deserve comment and the third is one that doesn’t get much attention but which is perhaps the most useful chart in the report.

The first chart I want to look at is the one titled S&P 500 at Inflection Points –


To be honest I have never known what they mean by the term inflection point. Inflection simply means a change in the form of a word although I do think they might be trying to be a little bit clever and use the meaning that is derived from differential calculus which is the point at which a curve changes from being convex to concave and vice versa. So the implication for the average punter seeing this is that the S&P 500 is at a point of instability or change when in fact all you are seeing is a series of straight lines drawn with the benefit of hindsight. I have been receiving these reports for some time and the terminal point of the final line has been creeping up as the market has moved up. Whatever predictive value they think is has is eroded by this simple fact of self correction. The other point that concerns me about this sort of thing is the small call out box in the middle of the chart which offers a series of metrics which are designed to offer a comparison between the present day and two points of previous reversal. Again the implication is to convey the notion that the market is at some sort of tipping point.

One of the things that amazes me most about trading is that the longer I do it the more I admit that I dont know. For a very long time I have been convinced that I have no idea where the price of instrument is going. I certainly know a lot about market dynamics, the history of markets (which is something everyone should study) and about my own reactions to events. But I have sod all idea about where the market is going. Granted I can create a narrative in my own head to justify my own positions but at the end of the day I simply make a bet on the direction of an instrument and I am consciously aware of my own behavioural short comings. Charts such as the one above try to convey a form of pseudo scientific form of prediction that does little more than seek to appeal to the various biases of the reader. Readers viewing this sort of thing will anchor on the two highlighted points and use them as a reference for their decision making when they are probably little more than a Ludic fallacy.


This second chart only tells us one thing – an index go up over time. But even that is not as obvious as it seems. Firstly, the S&P 500 is a relatively new index it certainly was not around in the early 1900’s. So what you are seeing is an artefact, something that is not real. Secondly, the chart doesn’t show the real changes in the index when adjusted for inflation. Accepting that the index did not exist for the majority of the period under investigation and using as much historical data as I could find I have adjusted the index below for inflation. You will also note that even though I have adopted the same log scaling the scaling of the data is different – this is what happens when you are plotting a made up version of the index.


As you can see the almost linear climb of the last few decades is not as pronounced when the data is adjusted. Whilst I dont want to overstate the impact of adjusting the data it is important to understand that the reality of investing over the very long term as opposed to the rosy picture presented by simple price data.

The final chart is actually what I would consider to be the only useful chart in the entire report because it documents the extreme rebound that equity markets are capable of.


As you can see despite some deep falls within the year the index has in the majority of cases managed to finish positive for the year.  However, it doesn’t man that the index has an ever upward trajectory – it can still go nowhere for periods of time which is what catches the buy and hold brigade. They misinterpret this chart as indicating that markets always get better and markets or more correctly indices do climb over time of their upward bias but that doesn’t mean your stock or collection of stocks will follow. The usefulness in this final chart is that it reminds us that markets change and they change over a variety of periods – change offers us the potential for involvement and therefore profit.

Professional Short Seller – Marc Cohodes

In our newest conversation on Bespokecast, we sit down with short seller Marc Cohodes. Marc manages his portfolio from San Francisco, and has had great success with high profile bear cases focused on frauds, fads, and failures in recent years. His investment industry experience dates to the early 1980s, and has helped him hone his process for picking out companies unlikely to succeed. Marc goes into detail on his approach, including how he thinks about finding potential shorts, timing, and risk management. He discusses with us recent successful shorts including Valeant, Concordia, and Home Capital Group, as well as another new bear case he has been building a position in Badger Daylight. You can read more about Badger at Marc’s website discussing the company. Marc is the first short seller we’ve had on Bespokecast, and we learned a ton about his approach to the market. We hope you do too! If you like what you hear today, you can learn more about our firm by visiting our website, Bespoke…

Click here to listen on Overcast

Surplus to requirements

One of the best things about heading away for a few days is not necessarily the break from Melbourne’s winter  but rather the enforced break from trading. Whilst technology now gives us the ability to trade from anywhere there is a stable internet connection I tend to switch off when on holidays and drop into cant be bothered mode. I know for some this is difficult and from my perspective this is either a compulsion or a sign of the rather egotistical belief that the market cannot do without you.

When I come back from holidays I always have an expectation that the world and by definition markets will be vastly different. Sadly this is not the case. The world is pretty much the same and markets have gone on without me as evidenced by the chart of the S&P500 which is pretty much the same as when I left.


Some might find it distressing that the world goes on without them – I find it very comforting…….

As markets shed billions, traders welcome return of volatility

So says this piece in the Fairfax press this morning. The headline contains two interesting assumptions. That the market has become more volatile and that this volatility leads to the potential for profit. I will state at the outset that the linkage between profit and volatility that is often asserted by both some members of the finance community and the financial press at large is wrong – no such nexus exists. It is based upon a profound misunderstanding between trend and volatility. Volatility is simply the speed and magnitude of price movements, there is no directional component  implied in any statement about volatility. Trend is the capacity of price to demonstrate an underlying direction on price distribution.

The first statement about the return of volatility is an easy one to look at. In this instance the volatility measure being referred to is the somewhat flawed marker the VIX. The chart below shows a spike in the VIX when the ginger gibbon Donald Trumps month went from bad to worse.


However, on this chart I have plotted the long term average daily value for the VIX, at present this long term average stands at 20.1. The market is still substantially below this figure and as can be seen from the chart the VIX is prone to short lived spikes. These spikes are inevitable because at its core the VIX is a measure of perception and perception is a uniquely flawed mechanism for generating any form of metric. You can think of the VIX as a sort of how do you feel today index. As such it is prone to all sorts of maladies just like an individual is.

The question of whether an increase in volatility is a good thing is an interesting question and it is the one which often demonstrates peoples misunderstanding of volatility. The chart below focuses on the period 2003 to 2008 so it encompasses the US markets rise post the Dot com boom and the resultant carnage of the GFC.

vix comparison

The central theme is that high volatility leads to an increase in opportunity and therefore an increase in traders profitability. On the chart above I have marked the average volatility for the period 2003 to 2008, which for this period sat at 16.1. As can be seen for the majority of the period the VIX sat at below its long term volatility. During this period the market more than doubled. Low volatility is not an anathema to the potential for profit, the inability of the market to establish a trend is of more of a concern for traders.

There Are Now More Indices Than Stocks


Source – Bloomberg

A Basic Misunderstanding

The chart below is from a site called Spurious Correlations, it takes seemingly disparate facts and matches them together to create the illusion of a positive correlation. It is a simple and effective way of illustrating the problem of mistaking causation for correlation which is constant problem in the way people both think and view data.


If you were to take this at face value you would accept that there is a link between the number of films that Nicholas Cage has appeared in and the number of people who drowned by falling into a pool. You could even stretch the data a little and suggest that these drownings were not an accident and anyone who had even seen a Nicholas Cage film would nod sagely in agreement. Now consider the chart below which looks at significant historical events and the rise of the Dow.

This rather imposing looking chart is the centrepiece of an article titled The Dow’s tumultuous 120-year history, in one chart which appears on the MarketWatch site.  The article boldly claims the following –

At its simplest, the chart proves once again that over the long term, the stock market always rises because “intelligence, creativity, and innovation always trump fear,” according to Kacher.

No it doesnt – this is mistaking causation and correlation. What the chart shows is the profound upward bias of the Dow and this is the driving force of the index moving higher. This is an example of survivor bias nothing more. The original Dow components were as follows


It is obvious that these components would change over time and that this change would drag the index higher as non performing or irrelevant issues were moved out. The notion that it is innovation that is moving the market higher is not true and can be illustrated by the simple fact that Apple arguably the most innovative technology company of recent times was only added to the index in 2015. Google whose technology permeates everyday life and Amazon who have revolutionized retailing are nowhere to be seen. The Dow has remained technology light since its inception – if technology and creativity were the drivers of the market then these new companies would be added to the index very quickly.

It is quite a simple matter to generate events stick them on a chart and say they have some significance but simply saying it doesn’t make it true. As I explored last week news and significant events tends to have a complex relationship with an index and the question of does news move markets has been answered in the negative.

The article then goes onto make the bold claim –

 Investing is more challenging than brain surgery,” Kacher told MarketWatch.

I will leave others to ponder the idiocy of this last quote.

Gold Vs S&P500

I am still intrigued by the US markets reaction to the results of the US election when viewed in tandem with an instrument such as gold which is generally seen as a hedge against uncertainty (in this instance read outright dickheadedry) As such I though I would look at the relative returns of both instruments over a series of times frames if that told me anything about the market currently being uncertain about its own uncertainty. In looking at these two instruments I have cheated a little bit in that I am using a proxy for gold. I am using GLD which is an ETF that tracks the physical price of gold. I accept that this is a broad brush approach given the nature of the construction of GLD. However, I am looking for at a battleaxe approach not a rapier so the small inconsistencies dont bother me. I am more interested in looking at the broad pattern. If you have to look too hard then there is no pattern at all. If the relationship is not then when being as subtle as a sledgehammer then it is not there at all.

The firts thing I wanted to do was to look at the relative performance of the two since the US election and this can be seen in the chart below.

gld 1

My reading of this from left to right is that Trump wins the election and the long term rally that has been in place since 2009 reasserts itself with equities taking off and GLD drifting. A few weeks later the ramifications of electing a buffoon become apparent and the market stalls and GLD rallies slightly. We now have the situation where the market is rallying in the short term as is GLD. A cynic might suggest that trades are hedging their bets a little.

However, it is important to note that these sorts of performance comparisons are dependent upon the starting date. If I roll the starting date back a year a different picture emerges.The big picture alters every time you change the starting date.


We can see that GLD actually begins to drop off in the second half of 2016 as physical gold runs into a wall and begins to fall back. The out performance of the S&P500 over this time becomes even more apparent but the bounce in GLD is still there but the performance of the S&P500 is so much more apparent. This raises the question as to whether this sort of analysis whilst mildly interesting on an academic basis actually provides any insight that is worthwhile. Such a question also highlights a simple fact of analysis and of system design in general. Everything you do needs to add some form of value to the system. Unfortunately academic interest does not add value to a system so on this basis my feeling is that this sort of thing doesn’t add any value outside of curiosity and the vague conclusion that traders are uncertain about being uncertain. To be blunt you have to ask the question does it help make money since that is the aim of trading. For some it might but for me it just kept me occupied for half an hour.




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The Trading Game Pty Ltd (ACN: 099 576 253) is an AFSL holder (Licence no: 468163). This information is correct at the time of publishing and may not be reproduced without formal permission. It is of a general nature and does not take into account your objectives, financial situation or needs. Before acting on any of the information you should consider its appropriateness, having regard to your own objectives, financial situation and needs.