How Do You Define Your Reality?

I come at the markets and investing from several distinct perspectives: As a Trader, as a Strategist/Economist, and as an Asset Manager.

As someone who started in this business as a Trader, I know that as a trader your reality is defined by what is on the screen in front of you. The trend is your friend and momentum is your lover. You cannot afford to ignore all the liquidity sloshing around you, or the very obvious underlying bid to the markets. Buying the dips is a money maker (until its not), and you cannot afford to miss that opportunity. I am all too aware that he who lives by momentum dies by momentum.

While the talking heads opined how much the markets liked Bernanke’s comments yesterday, the Trader in me just snickered. Like many of you, I saw the big buyer of SPX futures at 9:59am — he lit up the markets long before any human had the ability to read Bernanke’s comments and determine they were dovish on inflation. It was just a well timed program, and if you ever spent any time on a trading desk, you said to yourself, "Jump on board, the big boys are taking us higher!"

However, the Economist in me sees the widening disconnect between what the majority of the public believes, and the less sunny reality beneath. I know that the Q4 GDP 3.4% data was junk economics at its worst. We know GDP will get revised downwards to 2.25% or 2.0% or worse. We now have 3 consecutive Qs of decelerating economic growth. My inner Economist knows that the business cycle has not been repealed. It notes the vaunted post-Christmas Gift Card Sales Surge failed to
materialize, with disappointingly flat January retail sales. The re-acceleration meme so prevalent last quarter was utter mythmaking spin. These are the facts.

We know that Real Estate has been the prime driver of the Economy this cycle, and the bottom calls for that sector have been dead wrong. I read the "incontrovertible evidence" of the bottom is that the Homebuilders, down nearly 50% from their peaks, have bounced modestly. I remind you that the Nasdaq, was down 41% in 2000, only to be followed by a 34% bounce. I prefer Bill King’s observation: the "major reason to believe housing has not yet bottomed: Yesterday, Easy Al, speaking about housing, averred, ‘I think the worst is behind us.’ Didn’t he say that a quarter or two ago?"

Yes, he did. And that was before the sub-prime debacle began to unfold. Everyone but the Cheerleader-in-Chief should know that it has quite a ways to go before it finishes its painful unwind.

My inner statistician looks at earnings at an historically high percentage of GDP, and knows that a reversion to the mean is inevitable. With this quarter’s likely drop below 10% Y-Y earnings on the S&P, we know that a mean reversion rapidly approaching.

The Strategist in me notes the complacency, the near record levels of
NYSE Margin, the somewhat frothy Bullish Sentiment and the slightly
stock skewed asset allocation, the VIX at ~10. However, none of these factors are at levels that scream contrary indicator. At worst, they are a yellow warning light. Smart strategists have to have the patience to wait for the needle to "get pinned," as exuberance can run further than most expect. Indeed, this most recent two day rally could even jump start the process to take us towards those excessive levels.

As an asset manager, I know how painful it is to miss the upside (we got Bearish in late January 2000, and watched markets scream higher for 10 painful more weeks). But I also know how much damage gets done in the down cycle, and watched people who failed to heed the warnings get utterly demolished, their assets shattered, their retirements ruined. Our aset allocation is now ~65% long, 20% short, 15% cash, with the stocks doing well, the shorts doing not too poorly, and the cash earning 5%. We have mostly big caps and agricultural chemicals and a smattering of other names, and very little tech. But this is uncomfortably long, and I am itching for the signals to move me towards a more defensive posture.

And still, we wait.


Jeff Saut likes to say where you stand is determined by where you
sit. If you sit at a trading turret, you care not a whit for the
longer term concerns. You get a P&L daily, your open positions are
marked-to-market every close. The trader part of your brain is loving the lift, regardless of the source. 

But the rest of your gray matter might be none too happy with everything else you process. It really matters "how you define your reality . . ."

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  1. bbb commented on Feb 15

    great post!

  2. JM commented on Feb 15

    Very well put. Thanks!

  3. Joan commented on Feb 15

    Allow me to disabuse you of the notion that it was Mr. Bernanke’s latest, perfectly-scripted contribution to the ongoing, official tissue of lies that was the catalyst behind yesterday’s walk-about.

    Because as it turned out, the melee was ignited not by his words but by a prescient handful of operators in anticipation of a bouquet being thrown by the Maestro-in-training. How they divine the text in advance remains a mystery. And an enviable one at that!

    Ahem. First of all, the initial spark was courtesy of the 10-yr. note. A split-second later, the fur flew in the futures with a nice chunk (~5k contracts) jump-starting action in the electronic arena while Man and Goldie were among those noted as buyers of size in the pit.

    So far, so good? Cool.

    Now hear this: The above burst onto the scene before 10 a.m. Right. Only a minute or two before the official hour that Mr. B. was slated to chirp, mind you. But unless these geeks are operatin’ in a special time warp, I’d say that somebody(s) has a lotta’ ‘splainin’ to do, Lucy.

    Curiously, and I mean very curiously, after the first 10 minutes of blasting straight up the wall, the futures simmered down significantly, actually going quiet.

    Indeed, they had delivered to the cash market the proscribed shock treatment needed to set off the next leg of the buying frenzy. That accomplished, they were free to slip into a near-coma all their own. Read: having jammed 5 handles higher, heralding Bernanke, they took out the 2/7 high at 10:08 a.m., after which the sideways pattern for which they have become famous, started to trace out.

    We won’t bore you with too many more details. Suffice it to say, then, that any intermittent pops higher after the initial blast were merely involuntary reflexes, the result, perhaps, of being jarred awake from their evident slumber at some oddly-timed intervals.

    Good question: Where were the boys for the expected, exit fireworks yesterday? Answer: Nowhere to be found.

    Rather, they did a slow bleed down thru the 2-handle range, inside of which they had been snoozin’ since 2 p.m.

    In a nutshell, they went out really sloppy, a rather ignominious ending to such a roaring beginning.

    Anything else? Yeah. The volume is noteworthy. We have run up 20 handles in 2 sessions, neither of which was near the running average. I hope you grasp the significance, then, of the scam that is upon us at the moment.

  4. dblwyo commented on Feb 15

    Indeed, Bravo Zulu. Thanks for doing and posting – do you ever sleep ? Or is work plus blogging all the rest you need ?

    That captures the balanced between trading and fundamentals. It also highlights something that greatly puzzles me – in the last 4-5 years I don’t recall a bigger split between the headlines and the underlying structural trends. Not talking about the classic ‘dig deeper in the data’ below the headlines. In this case the split seems to be between those who think this has been and is business as usual and those who a) know that this cycle was different and b) housing was our savior and is imploding. Thoughts or reactions ?

  5. PB commented on Feb 15

    Jan Industrial Production unexpectedly fell .5% vs the consensus of flat and Capacity Utilization fell to a weaker than expected 81.2% down from 81.8% in Dec.

    It’s the lowest since Feb ’06 and is a reflection of the moderation we’ve seen in manufacturing as the ISM is below 50 for 2 out of the last 3 months. The 2 biggest factors in the IP drag was a 6% drop in motor vehicle, parts production as we know the big 3 are cutting production and there was a 4.1% drop in machinery production.

  6. Jdamon commented on Feb 15

    I hope you all remember all these “conspiracy” posts when the market is tanking. I remember feeling the same way during the ’00 – ’03 crash. Market Makers were manipulating things, Greenspan was colluding to destroy wealth so baby-boomers would have to put 10 more years in, etc., etc. I may have actually been right on target, but didn’t matter, I lost a decent amount because I didn’t “get with the program”. Looks like the bears are learning the same lessons…..

  7. Nova Law commented on Feb 15

    “My inner Economist knows that the business cycle has not been repealed”

    One of the best books I read in 2006 was “Our Brave New World” by GaveKal Research, which argued something approaching a claim that the business cycle as we used to know it has indeed been repealed. To me, it explains far more about the current operation of the markets and economy than my dusty Macroeconomics 101 textbook does.

  8. Steve Dussault commented on Feb 15

    Your comment about being “uncomfortably long” is very telling. I’m in the same boat myself, but think this is a good place to be. When I’m uncomfortable it means that others are probably afraid to take similar positions. From a contrary point of view this is probably why they tend to be profitable. I try to keep these uncomfortably profitable positions until the sell signal is so obvious it slaps you in the face.

  9. mh497 commented on Feb 15


    I’m starting to think you are this cycles Julian Robertston (or maybe Desmond?) and the market won’t plunge until you throw in the towel and join in. You’re wavering here already, aren’t you? Come on, admit it.

  10. Philippe commented on Feb 15

    As an economist you know that the Philips curve is going in reverse ie more unemployment.
    The manufacturing sector worlwide is slowing
    The central banks are aiming at retreiving their generous supply of money.
    The respectable Mr Bernanke is having one of the most hardous task given to any new comer at his post since decades.
    As a day trader you have never seen so many catches of 5/10% a day.
    But as a money manager your nights are better than their days (see the latest Merryl Lynch survey).

  11. apw commented on Feb 15

    I wish B.R. would explain why so many official numbers are rosier than reality. It isn’t really due to “conspiracy”; rather it’s a result of many years of institutional fudging.

    It’s safe to assume that all borderline decisions made about calculation of CPI, GDP, unemployment, etc… are made on the “good” side (since the people doing the reporting usually have a vested interest in things going well). If the Fed can’t nail the true CPI due to the complex nature of the index, which side do you think they will err on? The side of generally overstating inflation, or the side of understating inflation?

    After 20 or 30 years of these types of decisions we end up with a CPI that doesn’t include food, energy, or home prices. A geometrically weighted CPI that hides price increases via substitution, but immediately reflects price decreases in the previously substituted goods. An unemployment rate that makes no effort to include people not taking unemployment benefits (why bother, since it’s so hard to do?).


    BR: I think TBP has done a substantial amount of work explaining why the models are biased to show more growth and less inflation — use the Google search function above on BLS, GDP, and “Inflation ex inflation”

  12. DavidB commented on Feb 15

    My inner Economist knows that the business cycle has not been repealed

    The ex printer-in-chief would disagree with you. Not only has he said the housing market has bottomed which you already quoted above but he is also stating the yield curve has now been effectively marginalized:

    “What we have is a very unusual and very different economic climate,” Mr. Greenspan said. “The implications of this are that people are looking for yield… people are reaching out to get higher rates of return and that’s what’s pressing yields down.”

    He was particularly impressed by the compression of emerging market debt yields.

    “This is the first time I remember when you could see a period in which you took all the developing countries and all the emerging market countries…. and inflation is all single-digit,” he said. “This is a global phenomenon and it’s quite extraordinary.” But Mr. Greenspan said such comfortable conditions “can’t last forever.”

    These formerly control and command economies will eventually lose competitiveness with Western markets, disinflation will lift and interest rates and inflation will probably move up, he said.

    This compression of yields, especially for longer-term maturities, has also made the U.S. government yield curve an ineffective tool in predicting recessions. An inverted yield curve — where short-term maturities are higher than longer term maturities due to a rise in interest rates which eventually crimps growth — has preceded nearly all U.S. recessions since the Second World War.

    “What we have is different type of yield inversion,” he said. “What the evidence statistically shows is the correlation between the yield curve and the economy, which was so tight in earlier periods, gradually declined over the years, so that in the last four of five years that correlation is virtually zero and so it’s one of those extraordinary economic statistics that worked for a long time. People suggested it was something permanent … but it was not.”


    Housing slump all but over

  13. Bob A commented on Feb 15

    Reality is whatever makes George Bush look good.

  14. Sponge Todd Square Pants commented on Feb 15

    Great post Barry. Really excellent analysis. You have your eyes wide open. Thanks for sharing.

  15. jj commented on Feb 15

    If you’re 65% long and 20% short , that makes you 45% net long + 15% cash = 60%

    where’s the other 40% ?

    what’s your beta adjusted net ?


    BR: 65 + 20 +15 = 100

    You better let your wife balance your checkbook . . .

  16. anon commented on Feb 15

    “What we have is different type of yield inversion,” he said. “What the evidence statistically shows is the correlation between the yield curve and the economy, which was so tight in earlier periods, gradually declined over the years, so that in the last four of five years that correlation is virtually zero and so it’s one of those extraordinary economic statistics that worked for a long time. People suggested it was something permanent … but it was not.”

    The available evidence does not support this claim. The yield curve has become much more inverted in the past two days just as we’ve seen weaker economic data, and despite reports of foreign outflows. I think that makes it very hard to argue that the inversion of the yield curve is not simply a response by the bond market to a worsening economic outlook.

  17. Incognitus commented on Feb 15

    The thing is, people aren’t REALLY looking for yield.

    The structured finance is looking for yield no matter what the quality to put into structured products such as CDOs, which then get their tranches sold as if they were mostly AAA/AA, with a little bit of A/BBB/BBB-, even if the credit it was made out of was all BBB and a bit of A.

    This is the real thing behind all the spreads tightening. Originators of debt don’t care what they originate because they sell it. Buyers of debt don’t care what they buy because it’s mostly rated AAA/AA with the odd higher yielding tranches being A/BBB/BBB-.

    It explains everything.

    Ah, and when it blows up those A/BBB/BBB- will simply be worthless (which, I might add, nobody holding them expects).

  18. DavidB commented on Feb 15

    It won’t be the first time Greenspan has been wrong anon (most recently, on the housing market).

    He is blaming people searching for yield as the reason rates are being pushed down. I would argue that with all the paper money flooding the world prices for bonds will naturally be pushed up which also pushes the yield down. This is once again evidence that prices for everything and anything is going up thus skewing even the bond market and giving Greenspan yet another excuse for myopia

    Either he is in denial or he is lying through his teeth!

  19. Paul Castro commented on Feb 15

    “The Strategist in me notes the complacency, the near record levels of NYSE Margin, the somewhat frothy Bullish Sentiment and the slightly stock skewed asset allocation, the VIX at ~10.”

    Barry and others, do yourselves a favor and read Adam Warner’s piece in Minyanville’s daily Buzz re the VIX yesterday or the day before. Just do a search of their site for “VIX”. In summary, Adam believes the mean for the VIX is between 10 and 15 and the readings above 20 we saw earlier this century were not normal. As Adam stated, the VIX at this level is the norm, not the exception.

    I happen to agree with him. I’m a trader though and not a macro hedge fund manager so I find fundamental calls useless. Interesting to read, but useless in the turret every day.

  20. donna commented on Feb 15

    The inflation is in the market.

    Until it isn’t….

    slosh, slosh, slosh….

  21. jj commented on Feb 15

    You run a hedge fund

    65% long , 20% short is 45% net long

  22. Winston Munn commented on Feb 15

    If you look at the past month of treasury auctions you find that Foreign Central Banks are not rolling over their entire positions, still taking big chunks but not enough to keep prices from rising and yields from falling. As a result, bond prices have crept slowly upward – the canary in this coalmine might be a sharp decrease of FCB GSE bond holdings.

  23. VennData commented on Feb 15

    Some comments on the posts…

    How about Mark Haines’ interview – Scoreboard! – with perma-bear Peter Shiff? Wow. Brutal. My advice to bearish commentators getting a call from CNBC programming is: stay in the closet… do not speak the love that has no name…

    As for GaveCal, their assumptions are all based on one important claim: that businesses are now “platform companies” that outsource all the old grubby business-cycle-causing stuff. My question to these claiments and their supporters is: what businesses are doing all the old grubby business-cycle-causing stuff?

    Greenspan is talking his book. He wants to collect the big fees, so he tries to talk up the market. If housing holds, his era can be considered a success, if it doesn’t he’ll be derided as a clown.

    Sadly… bunching my towel up into a ball… but holding it, still.

  24. muckdog commented on Feb 15

    I agree with many of your points, BR. But we can’t ignore that gasoline prices were falling during winter. That leaves more money in our wallets. And since we all tend to spend whatever is in our wallets, that should be good for retail and eateries.

    Chipotle… for example.

  25. jagmohan swain commented on Feb 16

    “65% long , 20% short is 45% net long”.Indeed but that still takes 85% of portfolio and he has other 15% in cash.So maths add up after all.LOL.

  26. pj commented on Feb 16

    Nice post.

  27. jj commented on Feb 16

    if you’ve seen a prime broker report (daily hedge fund positions report) , jagmohan swain , which I’m sure you never have , you would see that shorts are subtracted from longs

    stick to your post office job

  28. JH commented on Feb 16

    Same song and dance from Barry. You will get it right one time. You are closer this time than anytime before.

  29. JWC commented on Feb 16

    Wow, just Wow!! Great post. I think I will print it off and give to my hubby – who keeps asking me “Whats your guy saying now? … the market keeps going up.”

  30. jagmohan swain commented on Feb 16

    “If you’ve seen a prime broker report (daily hedge fund positions report) , jagmohan swain , which I’m sure you never have , you would see that shorts are subtracted from longs”

    Hey JJ we are talking of his asset allocation not his net position.Obviously you are dumb enough not to recognise that and equally dumb to make a guess where I work.Doesn’t speak too highly about where you work.LOL.

  31. Peter commented on Feb 16

    2 days after Bernanke said “inflation pressures are beginning to diminish,” the Journal of Commerce Index has rallied today to an all time record high. It’s an index of 18 industrial materials including crude oil, cotton, burlap, polyester, steel, copper, aluminum, zinc, lead, tin, nickel, hides, rubber, tallow, plywood, red oak, benzene, and ethylene. The CRB index, which includes agricultural commodities in addition to industrial materials, today is at its highest level since early Jan.

  32. jj commented on Feb 16

    Jag man swain

    equities … long or short—- are the same asset class

  33. jj commented on Feb 16

    jag man swain

    a retail daytrader doesn’t cut it

    you don’t know the institutional biz and never will

  34. jagmohan swain commented on Feb 16

    “equities … long or short—- are the same asset class” – boy that’s news

    “you don’t know the institutional biz and never will” – a little presumptuous may be

  35. Lem commented on Feb 19

    “If you’re 65% long and 20% short , that makes you 45% net long + 15% cash = 60%

    where’s the other 40% ?”

    jj repeatedly insists that 40% is missing because he knows the “institutional biz”.

    Even with my vast ignorance of the “biz”, I know that telling someone how net long you are is not nearly as informative as telling them the amount of long and the amount of short. BR was trying to be informative, and I bet he thought most of us could compute the net long from his figures. I can, but that is the extent of my figuring ability. I seriously ask for anyone’s help in understanding how positions within a portfolio should correctly be expressed in percentage terms. For example, if I have an unlevered 100k portfolio of 85k in longs and 15k in cash, I am 85% long and 15% cash. But what are the percentages if, maintaining the same 100k net value, I add 20k’s worth of shorts?
    And what if I then use margin to add 25k of additional long positions, still maintaining the 100k net value?

  36. ashwin commented on Mar 26

    the blog is really nice of its own kind,and has relevant information regarding easy daily cash ………Easy Daily Cash/EDC

  37. monica gagnier commented on Apr 5

    One of your most thoughtful posts ever. I never knew how many hats you were wearing until now. I think many of your critics are envious of your success. Even if they don’t agree with your market assessments, there’s no denying your eloquence. And when there’s nothing left in this country but Wal-Mart and Wall Street and we’re all carrying yuan in our wallets, you and Steve Roach can say: You read it here first. (P.S. I know you and Steve aren’t exactly on the same page.)

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