Sunday

Forces of Divergences Across Markets

Post a Comment November 15, 2009 – 10:24 am |   | Permalink |  Print This Post |

We remain confident of our positions despite some being deeply in the red. We got a few phone calls from our trading colleagues expressing concern over some of our hedging strategies, in particular Hang Seng (surrogate market for China) Vs Nikkei(developed G3 nations). We maintain that profitable strategies are always frowned upon and met with a great degree of scepticism - hence only a small number of traders are profitable in the long run. That said, this strategy remains unproven to the point of statistical significance. We are confident that this trade will come good as long as this is not a secular bull run. More on this later. For now we wish to look at the question: assuming we ARE in a secular bull market (unlike for the Dow but this is a very real possibility for emerging markets), is it a nice smooth ride up? Some argue that China’s recent collapse is a golden opportunity to load up on the longs, as it is at a similar stage to the Dow post 1929 collapse where the Dow fell from 400 to 50 (China H Shares fell from 20k to 5k). Imagine inheriting long positions of the Dow from 50 to 14000 over 80 years. We believe China have hit rock bottom earlier in the year, but will have its hiccups along the way up. So let us go back to 1929 and follow the subsequent rise of the Dow and its journey from the pits of the depression to greater heights.

The Dow Jones Journey From 50 to 14000

Note the attempt of a double bottom at 50 in 1932-1933. The Dow rose to above 100 in mid 1933, and stayed at 100 until early 1935 (1.5 years). This is exactly the type of bottoms we want before a secular bull market. Note the similarity to Agriculture Index in our post Agriculture on a Launching Pad. Even after the market broke higher, it came back to 100 3 years later in 1938. Whilst trying to jump in and out may result in you losing out on potential gains, if one were to buy and forget, 3 years of gains were wiped out.

The point of this analysis is this: Markets go up and down. You may trade based on technical analysis or fundamental analysis, be a bull or bear, inflationist or deflationist, etc - ultimately only one thing is certain: markets never move in one direction. This is how the Big Boys make money. They thrive on roller coaster rides which many do not have the appetite for.

So let us go back to our Hang Seng Nikkei trade. We will let the chart below speak for itself. The divergence is huge. We believe the weak USD is pushing the Hang Seng higher (the same way it is pushing the Dow higher - China hedged the Yuan to the USD in 2008) and Japan lower (strengthening Yen); so unless this reverses itself the gap may widen further (ouch!). Even our $1 positions are down 1K (!), but we are still hoping for the gap to widen. Barely though. This is getting ridiculous.

www.theinflationist.com

www.theinflationist.com

A few reminders from our previous post. The image below captures how previous tops look like. This is what people mean by “Tops are processes, NOT one off events”

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  1937 Top

The picture above shows the first top in the 1937 rally, which occurred over a 40 day period. Note our current top is 10360 (new high for now). We believe this is necessary for the Big Boys to unwind their huge positions.

Meanwhile our indicator remains unchanged. Here is a picture of it.

Indicator

www.theinflationist.com