Price
is reality; price is the most objective data investors see, price is what
influences the most market participants.
I
believe there are three key factors behind market price evolution that are
structurally inter-linked:
1.
Marginal change in macro data (namely economic activity and financial
conditions) in perspective with a specific macro context
2.
“Market resonance” or echo
3.
Price Inertia.
A.
Change in macro data
Change
in macroeconomic data is a consequence of change in the business cycle and
aggregate demand which ultimately impact companies earnings, commodities prices
etc..
Macro
data are often considered by “fundamental investors “ as useless as their
release is most of the time disconnected from market movements. This is probably because data that matters evolve with the macro and
price action context. I believe that investors need to define first what
type of macro data is important in a specific macro context. Which means that
investors need to define what is the main “macro risk” for the market. For
example, in a low growth / low rate environment, change in economic growth
expectation will impact more market sentiment than change in financial
conditions expectation (lower rates for ex). In a high growth environment,
change in financial conditions will be more important. Currently in the US, as
economic growth is growing at a relatively stable pace (upside surprise
unlikely), I believe that change in financial conditions will be the key data
to look at.
Moreover,
the market needs to be in a position to
“listen” to the marginal change – i.e the market consensus (price action)
needs to be positioned to either continue a trend or reverse it – for ex, now
in the US, unless there is a massive positive change in financial conditions (probably
fiscal at this stage), each market correction will attract buyers
at these levels of economic growth.
B.
“Market resonance”
I
believe that the market needs to be in the “mood”, the “right context” to
listen to the new additional data; Let’s use an example to be clearer: let s
imagine we are friend, and I know very well the type of music you like, we
actually share the same tastes for music. Now let’s say I m in my car, the weather
is grey, it is the autumn and someone just announced me over the phone that my
old dog, loyal guardian of my countryside house, died. As a result I feel sad -
then great blues music is played by the radio and I feel a specific emotion
listening to it. I like it so much that I m using Shazam to download it. Back
home, you visit me, you just come back from a tennis match that you won against
a challenging opponent and you had the chance to play during the only sunshine
moment of the day. You are clearly very happy. I would like to share with you
my latest music find and put it on my huge HI-FI, absolutely certain that you
will love it as well. But... you laugh at me! You tell me that this is music
for looser... Why is that?
Well
this is because when I listened to the music I was in the "mood" to
like it, I was pre-conditioned to like it. Whereas, my friend was absolutely
not in the same emotional conditions.
I believe
we can apply the same process to market behaviour - in a low inflation
environment and low rates environment AND
more importantly after a significant downtrend that is fading, the market
will resonate quite positively with "any" type of positive macro news
that concern economic activity: even a pause in the bad macro news momentum will
trigger a market reversal - or at least, we can say that the probabilities are
at their highest to trigger a market reversal. So the context is both coming
from the macro environment but most importantly coming from the market price trends.
C.
Then prices inertia kicks in: as prices rise despite the still bleak economic
pictures, pundits yelling on CNBC that the end of the world is coming, market
participant will start to try to rationalize the upward move. They will
overtime, become biased by the price movement – looking at macro data in
another way - and position themselves accordingly which will force more market
participants to do the same, which will ultimately create a new up trend. Now,
the uptrend will not last long if the next marginal change in macro data is
large and on the other side.
In
the absence of news, or in a long range trading market the probability of
success are lower for directional macro trades and investors need to wait for
the market to move in one direction to take positions/increase their exposures.
In such a context, investors can get help from the level of the macro context –
where the market might tend to go down to attract buyers at a lower level as
macro did not change and price offer a cheap buy opportunity for market
participant.
There
is NO need to go against the market; there are ALWAYS opportunities with high
probability of success. We just
need some patience and not forget to stay objective.
