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The QE Sandpile

, May 7, 2013, 1 Comments

Sell in May and go away? What about “risk off?” And ever more QE? Today’s letter is a quick note and a reprise of a popular letter from yesteryear (with a bit of new slant), as I am at my conference in Carlsbad.

But first, I thought I would shoot you a few quick, interesting notes that crossed my desk in the last week. It is almost a ritual for me to mention at this time of year the old investment saw, “Sell in May and go away.” It has been surprisingly good advice in most years. My good friend Art Cashin is a curator (and prodigious progenitor) of investment wisdom. He offers these two insights from his research:

Tomorrow is the beginning of May, so a “Sell in May” review is in order. To avoid reinventing the wheel, let me plagiarize the veteran Jim Brown’s synopsis yesterday.Sell in May? We are at that time of year when investors have to decide if they want to take profits and move to cash for the summer or risk losing those profits in the next correction. The Stock Trader’s Almanac has made the “Sell in May and go away” trade one of the most visible trends in the market. Because the markets normally decline in the summer, they came up with the best six-month trading system. If you had invested $10,000 in the Dow in 1950 and only kept the money in stocks from November through April, you would have had $684,073 as of the end of 2011. If you reversed the strategy and invested for the May-October period, you would have lost $1,024 over the same 61-year period. That is a pretty telling statistic, and the cycle rarely fails to produce.

And Art followed up the next day with:

Mark Hulbert suggests it may be a much older multi-national phenomenon. The “sell in May” pattern also exists in other countries besides the US. Ben Jacobsen, a finance professor at Massey University in New Zealand, reached that conclusion after studying all available historical evidence from each of 108 separate stock markets around the world. For example, his statistical tests detected the seasonal pattern in the United Kingdom stock market as far back as 1694.Jacobsen, in an interview, emphasized that the Halloween Indicator isn’t merely the product of a shameless, after-the-fact data-mining exercise. He said that he found an article as long ago as 1935 – in the Financial Times– in which the “sell in May” pattern is referred to as something that was already well-known and followed.Even though the pattern nearly 80 years ago already had a solid historical foundation, Jacobsen notes, since then the difference between the average returns in winter and summer has become even bigger.This is a crucial point, he argues, since the all-too-usual tendency is for patterns to begin to evaporate once investors become aware of them and try to exploit them.”

China’s PMI came in this week at barely above 50 and has been clearly falling for the last year. Despite what you read, China’s economic growth is slowing, which is NOT good for commodity metals and products (different from the “softs” like grains, cattle, etc.). GaveKal argues that the commodity price fall that we have been seeing of late is possibly structural in nature. Yet the bond market rises, gold is rising, stocks are rising. (Clearly, the market did not listen to my friend Nouriel Roubini this morning – Dr. Doom indeed! After his speech, no one at this conference can call me pessimistic. Although he prefers the term realistic.) Seemingly everything is levitating.

“Where is risk off?” I ask aloud back in the green room as I write this.

Paul McCulley quips to me, “Never get in a …… contest with a man who buys ink by the barrel.” The clear implication is that this levitation is all central bank-induced. The Fed, Japan, and the ECB are all in full gear, and England is only waiting for Mark Carney to arrive from Canada with the North American printing technology employed so well by his friend Ben Bernanke.

The question I am asking at the conference is, “What will happen when quantitative easing has to end? What does that look like?” I will report next week on what I am learning here, but right now let’s return to what has proven to be the most popular piece I have written over the last 13 years. And as you read it, think not just of sand piles but of the analogous pile of electrons of quantitative easing as it mounts up toward criticality.

Friedrich Nietzsche knew just how the troubling unknown grips our imaginations and compels us to look for answers:

“To trace something unknown back to something known is alleviating, soothing, gratifying, and gives moreover a feeling of power.  Danger, disquiet, anxiety attend the unknown – the first instinct is to eliminate these distressing states.  First principle: any explanation is better than none…. The cause-creating drive is thus conditioned and excited by the feeling of fear….”  –Friedrich Nietzsche

“Any explanation is better than none.” And the simpler, it seems in the investment game, the better. “The markets went up because oil went down,” we are told. Then the next day the opposite relationship occurs. Then there is another reason for the movement of the markets. But we all intuitively know that things are far more complicated than that. As Nietzsche notes, dealing with the unknown can be disturbing, so we look for the simple explanation.

“Ah,” we tell ourselves, “I know why that happened.” With an explanation firmly in hand, we now feel we know something. And the behavioral psychologists note that this state actually releases chemicals in our brain that make us feel good. We literally become addicted to the simple explanation. The fact that what we “know” (the explanation for the unknowable) is irrelevant or even wrong is not important to the chemical release. And so we look for reasons.

That is why some people get so angry when you challenge their beliefs. You are literally taking away the source of their good feeling, like drugs from a junkie or a boyfriend from a teenage girl.

Thus we may reason that the NASDAQ bubble happened because of Greenspan. Or was a collective mania. Or was due to any number of things – pick your favorite belief. My favorite: just as the proverbial butterfly flapping its wings in the Amazon triggers a storm in Europe, maybe a borrower in Las Vegas triggered the subprime crash.

Crazy? Maybe not. Today we will look at what complexity theory tells us about the reasons for earthquakes, disasters, and the movements of markets. Then we’ll look at how New Zealand, Fed policy, gold, oil, and an investor in St. Louis can all be tied together in a critical state. Of course, how critical and what state are the questions here.

  • Great piece, John. Heartwarming to see somebody quote Nietszche!