What's Up Big Perm? I Mean Big Worm

The title of this week’s report is a quote from Chris Tucker’s character, Smokey, in the 1995 movie, “Friday.” 

Smokey is greeting his neighborhood drug dealer, weighs over 300 pounds and sports a head full of curlers.  And as it turns out, Big Worm had a couple of insightful quotes in the movie that can help us as we try to make sense of the markets that are in front of us now.

When Big Worm discovers that Chris Tucker doesn’t have his money, he exclaims “Playing with my money is like playing with my emotions.”  Most people feel the same way about their money as Big Worm feels about his….that’s why most people aren't successful traders or investors.

The one thing that you can’t afford to do is get emotional about money.  Emotion clouds judgment.  Emotion leads people to become perma-bullish or perma-bearish on particular markets.

The moment that you become “perma” anything, you’ve already lost.  You begin to ignore data that's counter to your bias and only pay attention to the data that's supportive. This anchoring to a particular bias leads to you missing critical data that could clue you in to a potential change in the direction of a market.

The only two biases you want to strive for is perma-flexible and perma-agnostic.  Your sole focus should be on accurately determining the intermediate term direction ofa particular market (up or down) and then pin pointing the appropriate entry point for that market. Markets are dynamic and it’s important to consistently re-evaluate your bias based on the most recent data.

Every weekend, I re-evaluate my bias on all markets based on the latest economic data as well as any policy changes from the past week.  It’s also critical that you look at each market with a clear mind and without preconceived notions, especially markets where you have a currently open position. In fact, those are the markets that you want to judge most harshly to make sure you are still on the right side of the intermediate-term trend.

Here’s a quick look at my current biases:

US Equities – NEUTRAL

Chinese Equities – SHORT

US Investment Grade Corporate Bonds – LONG

US Treasuries – LONG

US Dollar – SHORT

Euro – NEUTRAL

Oil – LONG

Gold - SHORT

How long will I maintain these biases?  I have no idea.  We're trading markets in a time when unelected officials (Bernanke, Yellen) rule the airwaves and demonstrate immense power over the flow of capital. There’s an old saying “Trade the market you have, not the one you want.” 

That 's the quintessence of my discussion up to this point.  It’s also important to point out that the quote implies that you should strip out emotion and any mental biases towards the markets that you trade.

So while Big Worm was wrong about being emotional with his money he got one thing absolutely right. In another exchange with Chris Tucker, Big Worm explains “I had to warn you too many times about my money…You see, it’s the principal. There’s principalities in the whole thing.”

When it comes to US economic growth, there are certainly “principalities” in the whole growth thing. Historically, the strongest economic times in this country have been accompanied by a strong US dollar and elevated or rising interest rates. 

This was the environment in the US in late July 2012, when interest rates bottomed and started to rise.  The US Dollar had already bottomed in late February 2012 and was on the rise. So let’s take a step back and evaluate the performance of certain markets and the corresponding US growth rate to see if we can evaluate what kind of growth we are experiencing right now with less than a month left in the second quarter of 2014.

I’m going to evaluate the performance of yields, the US Dollar, my High US Growth index and my Slow US Growth index to determine if these markets are real-time predictive of actual US GDP growth numbers, which are always reported after the fact. let me state clearly that there is no such thing as a Holy Grail or sure thing in the world of trading.

Your mission, should you choose to except it, is to find data points, markets or sentiment indicators to better help you understand what is currently happening. Most investors are either trying to forecast what is going to happen in the future or they are overly preoccupied with what happened in the past.

You can give yourself a trading edge if you focus your energy on getting better at understanding what is happening right now. By the time Q2 GDP numbers are officially reported and markets react to them, we will be half way through the Q3. Trying to better understand what is happening right now will allow you to position yourself ahead of the crowd because they are driving looking in the rearview mirror.

The performance of the markets under review and corresponding US GDP growth rate is outlined in the table below. The final row of the table also shows the outperformance of either slow US growth proxies or high US growth proxies during that particular quarter.

 

You can see that as US GDP growth rates were accelerating quarter-over-quarter until they peaked in the Q3, US yields increased each quarter, and high US growth proxies outperformed slow US growth proxies.

In the Q1 of this year, we had yields fall, the US dollar fall and slow growth proxies outperform high growth. The US economy contracted for the first time in 4 years in Q1.

So far this quarter, yields are continuing to fall, the US dollar is unchanged and slow growth proxies are continuing to outperform their high growth counterparts, albeit by a smaller margin. Will this slow growth regime stay in place?

Or is the narrowing of the outperformance margin indicate a regime shift? I’m not sure but US growth could accerlate higher from -1.0%  in 2Q and still not be indicative of US growth truly accelerating higher in the second half of 2014.

As always, these markets bear monitoring for clues as to the future of economic growth.  Future economic prospects can change quickly.  However, the “principalities” of the whole US economic growth thing have never changed.