Saturday, February 07, 2015

Listening to Markets and Finding Market Themes

When psychologists listen to people in counseling, they not only process what is being said, but also the connections among the various topics.  Themes connect the issues we face in life, cutting across relationships, work, and our emotional experience.  To an untrained observer, it might seem as though a person is jumping all over the place when he talks about drawdowns in markets, arguments at home, and an ankle injury from running.  The psychologist, however, finds common threads linking these.  All represent frustrations, all represent real and feared losses, and all impact self esteem, motivation, and mood similarly.  Instead of working on three different issues, a person in counseling learns to identify the theme connecting all of these and develops skills for dealing with that theme. 

Markets also reflect themes, as geopolitical, macroeconomic, and sentiment-related factors drive buying and selling decisions.  Just as a therapist listens for shifts in themes in a client's talk, a savvy trader is sensitive to market themes and their waxing and waning.  Friday was an interesting day in the market from that vantage point.  We had strong economic data and interest rates rose significantly (top chart).  The sector that had been leading market strength, utilities, sold off in sympathy with the rate rise.  Stocks overall, which had been seeing strong buying interest on my measure of upticks vs. downticks (middle chart), saw significant downticking for the day, as large market participants persistently hit bids.  Meanwhile, the market's larger picture of weakening breadth (bottom chart) remained intact.

A random blip or a meaningful shift in theme?  Expectations of economic strength and the pricing in of Fed hikes sooner rather than later strengthened the U.S. dollar on Friday, but did not benefit stocks.  Should stocks and bonds move lower in concert, that would be quite an unwind of the risk parity trade that has worked for a while:  the volatility-adjusted position of long bonds and long stocks.  One day doesn't make a trend and one thematic shift doesn't necessarily reflect a significant change in a person's life.  But when a psychologist perceives a dramatic shift, the ears perk up.  Reading markets is not so different from reading people.

Further Reading:  Social Intelligence and Trading Skill