Days After The Bottom

Oct 26, 2019

As the new year, 2019, has come amidst a rather angry global selloff in 2018 I had some time to contemplate the two biggest angry markets that I’ve participated in directly, the 2000-2003 Dot Com Recession and the 2007-2009 Global Financial Crisis or the Great Recession. Within the 20 years, or so, that I’ve been an active participant in markets, those two were the most painful for nearly everyone whether you were a market player or not. They effected everyone.

On this first day of 2019 all global markets, with the exception of Brazil, Russia and India (3/4 of the BRIC’s) are down since Jan 1, 2018. The S&P 500 for its part is only down 6% on the year, but that doesn’t tell the whole picture of the carnage, from top to bottom the S&P was down 26% at December’s low and currently down 16%. Look here to see the carnage.

As a systems trader, none of this really matters to me to inform my trading, however when market regimes change and we get bigger moves my position sizing gets smaller, by design. But that is really all that changes when we enter this Bear Market Volatile market regime. Worked the same way in 2000 and 2008, during the “Flash Crash” during “Brexit” and any other high volatility event. Even if my positions go against me, due to position sizing the pain is limited.

Being able to categorize this high volatility bear market regime is a big advantage. Nearly all strategies that work in low -vol and high-vol bull markets, they even hold up decently in low-vol bear markets, but they break down during these high-vol bear market types.

The thing about high-vol bear markets is that these don’t happen all that often. They also don’t happen globally all that often. The reason it was called the Global Financial Crisis was because the whole world was effected. When markets are strong or even just sideways, bad things can be shrugged off, we can take the punches and keep on going. But when everyone is taking a beating and it continues, bad things have a different effect.

In 1999 everyone knew it was a bubble, everyone knew the day of reckoning would come, no one knew when, until it happened. But everyone knew it was coming. In 2007, not many people knew what was going to happen, sure we all knew that houses were a bubble, but as far as the majority of people believed, housing prices never go down. And when Bear Sterns, Lehman Brothers and AIG happened in slow succession, we were not prepared. Why is Bear Sterns in trouble? They were an investment bank, a bunch of traders and certainly not a mortgage company. Same with Lehman same with AIG. It was an unknown threat for the vast majority. Sure there were people who knew here and there, but it was a huge surprise for almost everyone else.

This was a timely and great recount of the crisis, told by the main participants in a rather candid and honest way. Go watch this now! Vice News Great Recession

The Known Knowns

The former Secretary of Defense during the Bush presidency had a saying about the known knowns, the unknown knowns and the unknown unknowns.

There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we know we don’t know. But there are also unknown unknowns. There are things we don’t know we don’t know. Donald Rumsfeld
Read more at:

Now, day 1 of 2019, the entire globe is basically in a bear market or recession except for BRI and not the C (BRIC=Brazil, Russia, India, China), China being the behemoth of the gang, so while it’s cute that BRI is holding up China has more than a sneeze, they are down 25% for 2018 and down 35% from top to bottom. This is being felt all over the globe.

Then we have the Energy Complex, down 25% in 2018 and about 40% off its highs selling off in nearly a straight line down since the beginning of Q4. When the energy market sneezes, the entire world es effected. The Energy Complex has done more than sneeze, it has caught the flu.

2018 has been the year of the trade war, and everyone (except Brazil Russia and India (BRI)) is in some state of sneezing, coughing, gasping for air vomiting with at least a mind splitting headache.

There are plenty of other threats to the world that we know and I could go on, but that’s just apocalypse porn and Financial Media does a way better job of exploiting that than I care to do.

The Unknown Unknowns

There are a number of known knowns and even unknown knowns out there. These are what everyone has built into their models, what military’s and governments train and plan for. These are what moves markets around pretty often, this is what keeps people glued to Twitter or Cable News, saying “I think” as a hedge to “I Know” which they would never be able to do, because well they don’t, it’s an unknown unknown.

We’ve had about six 20% selloffs in the S&P 500 since the global financial crisis, all fairly short lived though 2016 was a bit longer and wider, but generally speaking the recoveries were fairly quick.

So what’s different this time, why might we want to be concerned that the markets have something in store for us, and not in the good way?

Most interesting to me is that we have a generation of investors, managers, traders and market participants who have only ever had a rising market. They’ve never had selling this bad, they’ve never experienced a recession, fear, real fear in the market. BTFD has worked amazingly since good ‘ol Uncle Warren (great uncle?) bought Wells Fargo with both fists and helped save the world, or whatever narrative is now being incorrectly recalled. Maybe this?

Then of course we have the cohort who has called 85 of the last 0 bear markets since 2009, let’s call it the ZeroHedge cohort. (I would much rather name a bunch more people here but that’s just too easy and mean). They have experienced looking into the abyss and seeing nothing looking back, the utter fear, the pain, the chaos, the havoc that this created and they could be best suited to help people prepare for the panic, but they have called wolf so many times you can’t take them too seriously.

Nicholas Taleb’s Black Swan (check that link to NYT article about it in 2007 BEFORE the real thick of the GFC) is what is the Unknown Unknown.

Why I’m Looking At

My main reason to have concern is not the news, not the energy markets or central banks or whatever Financial Twitter has convinced people is the problem. As a systems trader I don’t pay attention to that for my trading. What I do pay attention to is price action, how the markets are trading, quantitatively. The outlier, THE THING that has me most curious even concerned is the velocity of this selloff DURING the least volatile historically time of year.

Fund Managers that I’m talking to have been getting a bit more redemptions in Q4 than normal. But more importantly, the market didn’t get too wild until later in the quarter. Each fund is different but generally LP’s (investors in funds) need to give 90 days requests to get their money back. I’ve been talking to some other funds, they still have to shore up those redemptions. And this is where it gets a bit scarier, a lot of institutions and pension funds have a requirement to only be 10% or whatever value, of the total Assets Under Management of a fund, so as smaller LP’s redeem, the bigger ones are forced to as well, further fueling the selling.

For now I’m spending my time thinking about what is the unknown unknown’s, will a Bear Sterns moment happen, what will it be. What could it look like, what aren’t we seeing. Mnuchin calling the banks before Christmas and that secret getting leaked is just too obvious.

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