There is nothing more useless than making bold predictions without any data or reasonable logic to back them up. You know who I’m talking about: the guys who are constantly making big predictions, hoping one will turn out to be right so that they can circle back and say “I told you so.”
Within hours of the European Central Bank’s monetary policy meeting last week, I saw one such prognosticator doing his best Babe Ruth impersonation, calling the bottom in the euro and saying, “The Euro will be going to $120 [i.e.$1.20 USD] if not higher.”
I don’t usually find it necessary to comment on such ludicrous stances, but something about this guy’s self-proclaimed “insight” hit me sideways.
Each week, I give a well thought-out case for a given market perspective and I always back that perspective with data. It drives me nuts when I see market-related articles with as much value as the nutrition in a Twinkie. You eat enough Twinkies and you lose a toe to diabetes. Likewise, following the investment advice of “prediction” commentaries could cause your portfolio to lose a whole damn leg.
So, to Graham Summers, a.k.a. Captain Prediction, of “Gains, Pains & Capital”, I’d like to thank you for providing my readers with a learning opportunity. I promise to be as gentle as I can, but it’s woodshed time.
Action Speaks Louder
Captain Prediction starts by writing, “The European Central Bank (ECB) just announced it would be tapering QE.” Erroneous Captain, erroneous on all counts. C’mon Captain, you’ve got to read past the headline if you want to play this game at a high level.
Look, I don’t know where this cat went to school, because he’s not willing to share his bio, but the ECB’s stance last Thursday was anything but tapering.
Graham—and others who interpreted the ECB’s action as a taper—focused on the fact that rather than maintaining its asset purchase rate at €80B a month, the ECB is dropping it to €60B, starting in April.
However, certain “experts” missed a major point: most investors were expecting the ECB to extend its asset purchases for six months, but instead it is extending them for nine months. Now, I know math is hard for some folks, but the last time I checked, nine times $60B was more than six times $80B.
So the ECB is going to buy €60B more assets than investors were anticipating. Not only that, but it expanded the range of maturities it can buy. This is critical because it makes expanding the size or duration of these asset purchases in the future much, much easier.
Lastly, the ECB removed the minimum yield requirement, so now it can buy bonds with any yield it wants, including bonds yielding less than the ECB’s deposit rate of −0.40%.
You don’t take these actions unless you are fully prepared to deploy more capital and know that you may need the extra inventory to purchase.
And if that isn’t enough non-taper reality for you, Draghi ferociously defended the fact that tapering wasn’t even discussed. “… a sustained presence is… the message of today’s decision… that’s why tapering was not discussed.” When he was asked if the ECB would taper if economic and inflation data turned favorable, he responded, “We haven’t discussed that at all today. We seem to be fairly far away from any such high-class problem.”
I’m not sure how anyone can misconstrue the ECB’s actions. The euro clearly got the message, declining more last Thursday than the day after the U.K. voted to leave the eurozone.
More Pain than Gain
Based on just a headline, the Captain made his bold prediction, “The Euro will be going to 120 if not higher.” No rationale, no timetable, no historic precedence, and certainly no data. Heck, he couldn’t even muster an astrological chart or an abandoned baby Japanese candlestick pattern to back his prediction.
If tossing out random prices on markets so you can circle back at any point in the future to say “I told you so” qualifies as “insight,” then I’m sure glad this guy doesn’t manage real money. My guess is that his performance would look a lot like the Munder Net Net Fund and would emphasize the pain in “Gains, Pains & Capital.”
I don’t deal in absolutes; I trade in the real world, which consists of probabilities. I manage real money based on a multifactor, multi-duration framework, which allows me to evaluate markets across the three most critical forces, or gravities, that impact asset prices: fundamental, quantitative, and behavioral.
3G Says What?
Fundamentally, it doesn’t get more bearish for a currency than to have a central bank hell-bent on burning it like a Salem witch. As long as growth remains tepid and inflation (currently 1.6%) keeps running below the ECB’s threshold of 2%, the ECB will continue to gobble up bonds of all shapes and sizes. This can only add to the euro’s weakness.
But it’s not just the fundamental gravity that puts Graham’s prediction in doubt: both the quantitative and behavioral gravities are pointing to the SHORT side as well.
The euro has looked like a train wreck since peaking in 2008. For the last two years, it has consolidated between $1.14 and $1.04. It showed some strength in early November, but has since fallen right back to the low end of this range, and is resting on a floor just above $1.045.
On the downside, if the euro closes below that critical $1.045 level for three consecutive days, then its two-year consolidation will have ended. It will sink through an air pocket until it hits the $0.90 area.
Frankly, a price decline on its own is not necessarily bearish. But in the euro’s case, the recent decline has been accompanied by a pickup in its volatility, which bottomed in mid-September and has been climbing ever since. The most bearish quantitative one-two punch I know of is when price is declining while volatility is accelerating.
Even if the euro could lift itself off the mat and attempt a run at $1.20, there is more resistance between $1.088 and $1.115 than when people try to convince me that LeBron is one of the NBA’s all-time greatest players. Call me if he gets five chips.
From a behavioral perspective, the SHORT positioning in the euro is at extreme levels, but so is the LONG positioning. LONGs have been building up their exposure for well over a year now, while SHORTs have just started to ramp up. The spread between LONGs and SHORTs is leaning SHORT, but that spread could more than double from here before it hits a level where a short squeeze would be a concern.
Know this: if the euro takes out the $1.045 level and sustains that breakdown, those LONGs will capitulate, quick, fast, and in a hurry. You’ll hear a loud flushing sound as the euro breaks parity with the U.S. dollar on its way to $0.90.
“Time-stamp this. We’ll be happy to return to it in the future,” writes Summers of his prediction. I’m sure you will, Graham. Markets are cyclical, so the odds are good that at some point “in the future” the euro will trade at $1.20 again. The real question is this: how many times between now and “the future” will people following your advice get their faces ripped off?
That said, I would never ask anyone else to put on the big boy pants of accountability if I wasn’t willing to do the same.
Unlike Graham, my bio and my track record are readily available to anyone who would like to see them. Every week we update my overall performance as well as the performance of every single closed trade idea going back to inception.
The euro is one of my eight focus markets and each week I give it a market bias of LONG, SHORT, or NEUTRAL. If the reward-risk balance is tilted in our favor, I give a detailed trade idea with precise entry and exit points.
Since The Whaley Report’s inception 208 weeks ago, I’ve carried a SHORT bias for the euro for 60% of the weeks, a NEUTRAL bias 29% of the time, and I’ve actually traded the euro from the LONG side for 11% of those weeks.
In weeks with a SHORT bias, the euro has fallen an average of 9 basis points. It fell an average of 16 basis points during the weeks I was NEUTRAL, and during the 11% of weeks that I actually was bullish on the euro, it managed to gain an average of 6 basis points.
This means that rather than trying to be Captain Prediction, I’ve actually helped investors to both sidestep danger and profit when the reward-risk balance is tilted in our favor. I manage real money, in real time, and I earn above-average returns by being process driven. Calling tops and bottoms may be one way to get clicks and retweets, but I’d rather follow a disciplined approach that enables me to limit risk while being consistently profitable.
Feel free to timestamp that, Graham.