HFT to Reversion : The Greatest Marginal Advantage

Having been a part of building operations which are strictly HFT and absolutely reversion, here are a few observations.

 As we know, from HFT to reversion, the slightest edge, informational or strategic can make the difference.  For HFT it is doing whatever it takes to get a peak at momentum or over weighting the probable.  With reversion it is under weighting an event which will occur but no one knows where or when.   HFT will not accept the market's underlying volatility and is a market taker while reversion accepts it and conversely is a market maker.   Unlike most investors, HFT is risk seeking with gains for very short durations in time and are risk averse with losses over longer durations in time.  Time to reversion is not meaningless but definitely not as important.  So markets in time are always looking for the great marginal advantage (GMA). 

In reversion time, here is QRiskValue's Over/Under Values along with GMA leanings.

Operation Descending Exponential Twist

Ties that bind the banking community to the Fed and Treasury,  which help  bring about the near collapse of the world banking system in 2008, to the rescue through the secret terms of TARP, to the new Bernanke Bubble in 2013, the same outflow and inflow investment cycles prevail.   Fund outflows found the bottom in 2009 and now fund inflows funding the top in 2013.   Their entrance into the market comes after a DJIA rally of 114% from 2009 lows and a mere 33% higher since the Fed instituted Operation Twist in September of 2011 as the markets were about to renew their downside momentum.   But just as this blog warned of the AAPL bubble floating where ever in may, so to will the S&P 500 and the DJIA drift with the collective descriptions of wonder attached to their ascension.  But just as before, those subtle negative calculations begin to factor until a descending exponential event occurs sending markets lower. Same game.

In Bubbelot

Market continues to bubble-up in Bubbelot, a land of the great expectancy of continuing low rates, low volume, and lots of lowly.  This is the time of season when the impressive gaming occurs over the hills of  stock expectations. It is a thing of beauty where an analyst and the company he covers dance together over better than expected earnings.  What a surprise. There is joy everywhere.

And it came to pass in the land that there was plenty of talk about the how everyone had missed the big move in stocks.  This could not stand. Yet one might understand however why the folks in Bubbelot might be afraid of getting smoked by the great downside again after being so patient for anything good for the previous 10 years.  Their great hero, Ben of Bernanke, a tiny little man of great intervention, has committed himself to the struggles of the lessers by instituting what is being called the great wait and see.   There is much to live for in Bubbelot.

Happy Anniversary Collapsing DJIA

It is only fitting as we mark this week, the 13 year anniversary of the DJIA hitting a high in 2000 before it collapsed from euphoria, with the celebration of two creative ideas made over the last week or so;  the trillion dollar coin and Buffett's declaration that banking is forever clear of disaster.

The trillion dollar coin concept ranks right up there with all great concepts that occur when all the koolaid is gone.  Turning all the challenges in life into good thoughts where nothing bad can happen and everyone is good at sports.   

And now Warren Buffett, who looks at the world from a vantage point as market wizard with extraordinary perceptions that go beyond any bearish thoughts formed by ordinary accounting, says the banking system in the US, which went broke just five years ago, is now fixed even without much change in their cloudy murky real financial status.

A trillion dollar coin for you, and a banking system for you, and good everywhere where accounting is a bother.

Delivering Up

Today's sharply higher opening reminds me of the first trading day of 2000.  Markets exploded on the upside as investors tried to get in on what was thought to be another year of up.  It would of coarse ultimately represent a market beginning to hit severe stall speed.  That year turned into crap as the market players scrambled to adjust to the downside momentum of the bubble burst. And while no two markets are the same, it seems impossible to believe in whatever perception of good which may have seemed to have been delivered by the Fed, Treasury, or Congress is for any other reason but to continually perpetuate a notion that in seeking returns, price is a proxy for value.  It is an approach where all values are put at risk. 

Its All Good

As the year wraps up for 2012, markets continue to benefit from the Fed's ever corralling of investors to seek returns exceeding treasuries. Wall Street claims the US is only in need of a resolution to the fiscal cliff problem to resume an even greater growth trajectory.   Proof they say comes primarily from the recovering housing sector and in the never ending story of cash on the sidelines and strong corporate balance sheets. 

Regardless of the fiscal cliff, although certainly made more troubling if no agreement is ever reached, is an economy weighted by dismal job growth prospects as a result of demographic and structural productivity changes effecting future income potential for its citizens.  The US economy may be at the end of a powerful economic run starting after WWII which had tremendous spill over in job opportunities engined from investments in infrastructural, housing, and technology.  And while modest economic growth will continue, job and income upside may be capped for generations.

Equities are currently pre-priced for the next leg up and commodities correspondingly are  priced to accommodate growing demand.  The Fed has helped a recovering economy by keeping rates extraordinarily low.  But like all actions, there are multiple potential outcomes and not all of them are positive.  The Fed believes if they accommodate long enough the same economic mechanics which worked in the past will catch on again.   But the reality is equity and commodity markets sit atop a massive rally supported by pathetic annual growth rates and future expectations.  Playing the odds on that continuing is risky. 

Odds Increase of an Over the Cliff Event

In this game of Over the Cliff, the odds of going over the fiscal cliff now are 50/50, up from about a 33% chance earlier.  As a player, assume there are three potential choices; 

(1) Over the Cliff           (2) Good Compromise          (3) Bad Compromise (Boehner Plan B)

Given these three choices, in a game of chance you would have a 33% of picking the right one.  But now with the White House rejection of the Boehner Plan B proposal being representative of the Bad Compromise choice, it it would seem there are only two outcomes left;  Over the Cliff  or Good Compromise.  In this particular game you would then have a 50% change of choosing the right one.

Inside the game you have two choices while outside of this game, given these two choices, the path of least resistance for all parties is to do nothing or Over the Cliff. 

Bears may feel an Over the Cliff event is a win for them, but the event itself would lead to another set of possible outcomes.

Over the Cliff Rally                  Over the Cliff Break             Over the Cliff Nothing

Even knowing the outcome of the first set, you can be sure market players are positive they know the market direction given the particular outcome, but they really only have a 33% chance of being right here.

Political Tradeoff Matrix

The political deal tradeoff matrix gives you two most likely scenarios of action by the Washington participants.  Choices (in red) on any two leaves the probable required tradeoff (in black) for the particular strategy.   There seems to be no real difference between choosing to do the top matrix action and doing nothing in the bottom set.  So the political choices probably leave the same economic results; a declining economy. You can play the game by picking any two.  No winners here.

Market Participants Begin Move to Sidelines

Next week, with the fiscal cliff approaching, many market players will  begin to reduce daily exposure to trading in futures and equities leaving  the bulk of price action to professional traders to play thinning volume and the resulting increased volatility.  Decision strategies for Democrats and Republicans have begun to emerge with  both sides claiming they are restricted to an all or nothing outcome and unable to compromise.  Of course, the rule here is to never press the other side with what you think is a dominant strategy unless you absolutely know your own worse case outcome.   Many fools over the years have increased their own exposure by pressing a strategy they believe will absolutely motivate the other side.   More to come.....

Preparing For Cliff

Fed shifted the qualitative and quantitative asset rules a bit today when they decided to use an economic outcome as a benchmark for continued accommodation; 6.5% unemployment rate.   In a news conference later, Bernanke seem to be preparing for what the Fed sees as a long drawn out battle for economic recovery, one that is threatened by a likely over the fiscal cliff event.  Equities seem to be convinced of a just in time end of year positive outcome to negotiations which may confirm the contrary.