Market's Risk vs Over Under

Passive indexers will say the market is efficient and few can beat it.  How we look at data and especially how we determine risk is the key to successful strategies.  Despite many bright folks who view the world in a macro perspective, they often under perform the market in big ways because their process depends in large part on luck.  Many of the greatest stock fund managers owe their entire success to the great secular bull market.

But a closer look at markets reveal there are few efficiencies and price discovery creates great opportunities to create excess return.  Transactional premiums and discounts in price are created to accommodate attitudes formed by bias and perceptions of future prospects.  For example, market trends are generally viewed as either over bought or under sold.  But there are examples of more complex set ups.  When looked at in terms of risk or least risk participation against over bought and over sold for 2014, here is the data.

Least Risk/Overvalued     AAPL
Least Risk/Undervalued     GS
Most Risk/ Overvalued    BAC
Most Risk/ Undervalued    F  

The natural inclination is to look for the least risk / undervalued stock but that is two easy.  AAPL for example has had a tremendous year but there are transactional elements which continue to create a premium even though it is substantially over bought.  It is always easier to effect the risk side of the equation as opposed to over bought or over sold.  As such, AAPL will probably become Most Risk / Overvalued in the near future.


Data Provided by CoverRisk.com

Crying

Lots of carping about algos as it gets tougher for a large number of participants to beat markets.  Without going into the efforts designed to magistrate the upside of equity prices by sovereigns and Fed, the main problem with non performers is their approach.  Works for a bit and then dies.  Adaptive quantitative approaches out perform year after year.

As for the general complaint about algos; what did the complainers think was going to happen?  The world is headed towards algo solutions in nearly every business enterprise.  And as for front running market information based on latency, it exists because exchanges want it to exist.  Volume transactional deals abound because markets are primarily transactional machines for price discovery.  The uncertainty of price movement creates opportunity for applications to take advantage of structural price execution mechanics.  

Algo participation can be changed by exchange rule based on viability of price.   The IEX is an alternative to place limits on latency but it will not end algo development or dominance of strategies which provide excess return in all time series approaches not just HFT. 

No Bears Left, Let's Get Short

Indexes stalling here with extremely low volume at record highs.  Not good.  Russian invasion of Ukraine an event markets will have to sort out but the global impact on financial world is a negative no matter what the Fed does.   Oil price declines are meaningless unless they go to 100 per barrel.   New power structure in Washington meaningless as always.

Takes big balls to get short this market after the straight up move of last three weeks. Ran over every bear that ever lived.  As stated earlier posts, if you are a manager with great returns and not just a long zombie, you should have been out before now.  There is no room left on the ledge for bears so, lets get short.   Best prices ever to do it. 

The Fed and Bad Paper

Major indexes have the October jobs report behind them and the market bulls will now focus on marking up prices until the year end.  Little has been able to side track the recovery from the Oct 16th lows where suddenly a curious black hole appeared and sucked up all the volatility of any price movement. This vanishing volatility clearly indicates the markets ultimately fear no downside and that every stock and any paper representing a sector of equities is protected by the belief in the Fed's ability to guarantee up.  For its part, the Fed is eager to spin the dove whenever it feels necessary since the only world metric for zero rates is the price of equities. 

 The Fed's message is one of accommodation and the resulting mechanics are transactional trade offs where chasing returns, stock buy backs, and finally, the belief in upside invincibility have produced a flood of additional ETFs and the soon to be delivered ETMFs.  While the ease of transactional variety is pleasing to investors of all sizes, the motivation is a race for market share among ETFs while creating  pseudo primary market products which have serious secondary market implications.  These creations are much like all financial engineering vehicles of the past where good paper becomes bad paper when the mechanics behind pricing fails and liquidation creates panic.