The market made a new all-time high this past week. However, the manner in which it pulled back from that all-time high on Friday has caused me to slightly modify my expectations.
I have now seen about a dozen articles over the last week, mostly presented as head-scratching ramblings, discussing the breakdown of so many “correlations.” One of the recent articles noted:
“Under normal circumstances, you could wake up on any given day, take one look at the yen, and make a pretty solid prediction about how Treasurys traded overnight and/or how the Nikkei held up. And vice versa. Lately, that relationship has broken down almost entirely.”
And, in early 2017, even Morgan Stanley had taken notice:
“Regional correlations, cross-asset correlations and individual stock and FX correlations have fallen simultaneously. That’s unusual; we haven’t seen a shift this severe in over a decade . . .”
Yet, despite pointing out how the market does not make sense, some of the same authors attempt to use the paradigms that broke down in order to explain that which they say does not make sense. Yes, you heard me right. They recognize that their analysis methodology has failed to keep them on the correct side of the market, yet attempt to explain that failure using the same methods which they noted have failed them.
One attempted to “explain” why correlations have broken down through a, as he put it, “truly torturous, yet completely plausible, explanation for what we’re seeing in equities and rates.”
So, rather than assuming the old paradigms were simply wrong and led them to look the wrong way in the market, many have gone to “truly torturous explanations.” Has anyone ever heard of the term Occam’s Razor?
I would imagine this is akin to attempting to cross a river with a row boat that has a hole at the bottom, sinking, fishing out the row boat, and trying again. Would you not at least attempt to fix the hole or even buy a new boat before attempting to cross the river again?
I wish I could say I am surprised by the confusion in the market. But, the makings for this “storm” were quite evident well over a year ago, as I had been warning the members of my trading room that this will likely occur.
Now, I have to note that the most insightful things I have found after reading a dozen articles about the correlation break downs were in the comments section rather than the articles themselves:
“So the whole premise here is that two different things used to act similarly, but now they aren’t. Couldn’t the simple explanation be that those two different things are acting differently because they are not the same thing?”
“if the market was as logical as 2+2, we would all be rich. The most astute investors accept, embrace, expect disconnects and non sequitur in the “markets and (gasp) — even make money despite of (because of) it. And they always do so.”
“A lot of things appear to be disconnecting. Makes you wonder if they were ever connected in the first place.”
You see, the biggest problem here is too many equate correlations with causation. Moreover, they rely on these correlations as if G-d himself were speaking to them about what the market is going to do. And, when these seeming correlations break down, they are left with a host of losses and no way to explain why they are on the wrong side of the market.
I have noted this many times before. If you are trying to trade based upon some seeming correlation then you are doing more analysis steps than necessary. First, you have to perform analysis to get the direction of the correlative asset correct. Second, you have to “hope” that the correlative asset maintains the same seeming correlative relationship with the underlying asset. Hence, you require a two-phase step, one of which is based upon “hope,” in order to make money. Would it not be much simpler and easier to analyze the chart before you and see what it is saying rather than performing the dubious two-phase process just noted? You certainly take the “hope” out of the equation that way.
I mean, if your analysis methodology is sound enough to provide a strong directional bias for the correlative asset, should you not be able to perform that analysis on the underlying asset directly?
Moreover, just because two assets seem to be moving in the same direction or even in opposite directions for a period of time, why would you rely on that continuing ad infinitum? I mean, applying linear analysis directly to a single non-linear market alone comes with great pitfalls, and you want to add a second layer of linear analysis on top of it? Unless you understand the market beyond a superficial seeming correlation, you will never have forewarning as to when such correlations may break. So, yes, placing your money in the market based upon correlations is doing no more than “hoping.”
Anyone that has followed any form of inter-market analysis over the last few years understands the huge flaws in such methods. They have seriously underperformed the market due to their multi-layered linear perspectives that were unable to identify the shifting correlative paradigms in the market. And, sadly, ,many have still not recognized it.
Last weekend, I noted that if 2420SPX held as support, we should expect to head higher. While we certainly held support and headed higher, the manner in which the market reacted on Friday suggests that we are one wave degree ahead of where I expected at this time.
Therefore, the modified support region I put out this past week in my trading room was the 2410SPX region. As long as that holds, I am looking for a rally up to the 2473SPX region into the end of the month.
A break of that region will cause me to re-assess the potential for the 2500SPX region to be struck before the fall.