In this edition of

Babak is also the founder of Trader’s Narrative blog – offering “Freshly squeezed market commentary & analysis” at http://www.tradersnarrative.com. Babak found Trader’s Narrative to collect his thoughts in an honest manner, become a disciplined learner, and generously provide guidance to his followers, speaking of which, are regular and devoted visitors to the Trader’s Narrative.

1. Your website offers “freshly squeezed market commentary & analysis”. What’s your background with the Trader’s Narrative and aspirations with the blog?

The tagline is a bit tongue in cheek, but it also encapsulates my approach. I mean, who doesn’t love freshly squeezed orange juice in the morning? Especially compared to the stale frozen variety. Not only is it higher quality, there is a personal touch, a craft, if you will, to it. That’s how  I approach market analysis. I have an infinite curiosity when it comes to finance and wanted to  share that sense of wonderment with others. A long time ago I discovered that I learn best and benefit the most when I try to share something with others so what may look like an altruistic endeavour, is in reality a rather selfish pursuit.

2. What is the most important idea that you have been trying to communicate to your readers in the past 3-6 months?

The one idea that has the most repercussion on future prices of almost everything is the battle between the two opposing economic forces of deflation and inflation. The economic collapse unleashed deflation, of course. We had the price of almost everything fall: real estate, commodities, stocks, etc. Central banks responded en mass with the largest cooperative effort to stoke inflation in modern history. Which force will ultimately win? I don’t know but I have my own ideas. If you happen to be a time traveller from the future, please let me know – I promise to not tell anyone.

3. How do you generate ideas? More importantly, how do you spot and distinguish the important trends from the noise?

I usually get a torrent of ideas just by watching the market and monitoring not only major stock indexes but also commodities and econometric indicators. I try to stay on top of sentiment as well. Most days I have about a dozen things on my mind and the hardest thing is to filter it and figure out which I really want to write about. Readers are also a great source of ideas. I have wonderful readers who are constantly challenging me, asking questions, teaching me, etc.

Regarding managing the noise to signal ratio, it is easy to get swept away by an idea or concept, especially when everyone is suddenly talking about it.  Usually blogs and the mainstream media bombard you with it and then poof! everyone forgets about it, only to jump onto the next thing. Rinse and repeat. That’s just the nature of the beast so you have to step back and get perspective.

If you are a mental midget like me, stand on the shoulders of giants; listen to what they are talking about, what has captured their expensive attention and try to absorb their wisdom. To mix metaphors, I call these mental giants the “greybeards”: Doug Kass, Warren Buffett, Jeremy Grantham, George Soros, David Rosenberg, Marc Faber, Paul Desmond, etc. They have not only been around for more than a few market cycles, they also bear the scars and loot to show for it. Experience is an expensive teacher – what it gives you in wisdom, it steals in its own currency, time. So learn as much as you can from the experience of others.  But let me stress, this doesn’t mean you shouldn’t think for yourself!

4. Your analyses and book-recommendations indicate your passion for technical analysis. How effective has technical analysis been for traders in the last 6-12 months?

It depends on which framework they used and how competent they were in applying it. For example, Stan Weinstein has a simple and effective framework. So does Prechter with Elliott Wave. So do the Turtles. And so on.

The superciliousness is off the charts when traders get into dustups over which framework is better. It reminds me of the endless nerdy debates I used to have with my friends in elementary school. “Who would win in a fight between Batman and Superman? Or Wolverine and Spiderman?” The question itself is ridiculous of course. What will ultimately decide your success as a trader is discipline and money management.

5. After the confusion of the last few years, what indicators do you NOW follow to give you an accurate picture of the market that you didn’t use before?

As luck would have it, I took a break which coincided with the top of the market in 2007. I will always wonder, had I been watching the market, would I have identified it? To be perfectly honest, probably not.

I’ll never know really but unlike, economists, regulators, and rating agencies who should be questioning the very foundation of their work (if not their very existence), nothing much changed for traders. The financial crisis didn’t destroy any important indicators that I watch or create new ones, sadly. I say sadly because getting to play with a new indicator is as fun as groggily opening Christmas presents at 5 am.

Towards the end of 2008 I grew cautiously optimistic and then eventually outright bullish. For example, in late November 2008 when the S&P 500 was trading around 850, I wrote: Why Long Term Investors Should Consider Buying.  As you may recall, this was also the time when “greybeards” like Grantham started to slowly build long positions while the majority of the investing public was running around rending their garments and wailing. By the end of March 2009 I wrote: Another Reason We’ve Seen The Market Low. And then by May 2009 I was quoting the Simpons: “I, for one, welcome our new bull market overlords.” anticipating the all clear from the Coppock Guide. So that should give you a good overview of some important indicators that helped me to be on the right side of the intermediate trend.

Watching sentiment is also an important part of how I approach the markets. Most people concentrate on the news. That is, what is happening or where the collective attention is at the moment: the President’s state of the union speech, LEI numbers, unemployment data, monetary policy meetings, etc. But the truth is that news does not make price. Price makes news.

Put another way, what really matters is not what happened but how the market reacts to it. If you’ll allow a tangential thought, this is also the key to life. What happens to us is not really important. What is pivotal is how we give meaning to it. Two different people can have the same experience and come away with vastly different destinies based on how they choose to find meaning in that experience. For that nugget of wisdom, I’m indebted to my brother who is a brilliantly successful brief therapist.

Anyway, as I wrote more and more bullish comments, there was a surprising amount of pushback from people. I could understand that from the general public, since they had been wiped out from the real estate and stock market crash. But even your average trader hated hearing positive things being said about the market. Without fail, every single time I wrote bullish things, they criticised it, picked it apart, came up with excuses why it wouldn’t work, etc. This went on for month after month as the market clawed its way higher. So it was obvious that the majority where leaning against the rally in a very emotional way.

6. You wrote about treasuries recently, and it appears that you don’t think treasuries are in a bubble. Would you put money on that theory?

I was taking the other side of the argument that I had made earlier and presented the bullish side. Previously I had written several times about the bubble in the bond market. But I try to be agnostic when it comes to the market. I’m not a perma-anything and am only seeking truth and profit. So if you present to me a persuasive argument, I’m more than happy to consider it.

Nothing turns me off faster than when someone is fastidiously wedded to a belief, either bearish or bullish, and does not change their views no matter what. It is really easy to pick a side and continuously hammer away at it from that perspective. Congratulations! You’ve chosen to see the world from your particularly colored lens and you’re losing out on all of that marvellous reality. The pom-pom waving guys over at CNBC are a great example. On the opposite spectrum are guys like Howard Ruff who are forever preaching the imminent approach of an economic Apocalypse. By the way, as you’ll see from that previous link, CNBC had Howard Ruff as a guest exactly at the market bottom, at the time I called it “a contrarian signal from the trading gods”. Another example is Jim Rogers who has been pounding the table for commodities for 18 years.

It is much more challenging (and rewarding) to be humble and jump on trends in either direction. In any case, getting back to your question on treasuries, with all due respect to David Rosenberg, I find Michael Belkin’s arguments more persuasive: fixed income is a bubble. Retail investors are notoriously clumsy and they jump on the bandwagon right when it is about to topple. Also based on historical precedents, buying bonds here is like stooping down to pick up pennies in front of an oncoming road-roller. You can read the details of these historical studies here: Why Today’s Bond Investors Will Be Disappointed. If you disagree, then basically what you’re saying are the most dangerous words in investing: “No, this time it is different.”

7. These days an important variable one day that leads the market could be completely forgotten the next day in the face of more news. Do you feel the market has hardly any memory going from one day to the next?

Yes, the market definitely has a memory. The media may not, but the market most definitely does. Technical analysis is based on the price memory of market participants with support and resistance levels set by the aggregate behavior of traders based on this same memory. So the key is to concentrate on price, not headlines. To be honest, I get apprehensive when my favourite indicators get a lot of attention. I’d much prefer they stay as esoteric as possible. When CNBC started talking about the Coppock Curve, I think I aged 5 years in the 5 minute time span of the segment. But then they quickly forgot about it.

8. One of your goals with setting up Trader’s Narrative was to continue to learn every day and help others find their path. How’s that going?

I’m indebted to my amazing readers who come and share their expertise with me and each other. I’m continuously astounded and humbled at the caliber of my readership. I’ve met so many traders over the years; hedge fund managers, institutional traders, prop traders, CTAs, etc. Recently I checked my traffic data and noticed bulge bracket Wall St. firms reading my blog. That is something that I never really thought about when I began to write.

9. Now, starting with 100% cash, how would you allocate it to various asset classes, with an investment horizon of 5 years?

Answering that is difficult. Not only because I would need more information (for example, what is the risk tolerance, sophistication and goals of the person for the portfolio) but also because I wouldn’t be comfortable with a “set it and forget it” portfolio since we are not enjoying a secular bull market. Also a 5 year time span makes it difficult to use technical analysis since most of my tools in that regard are more short term in nature.

But I’ll stop being difficult and do my best to answer your question. For an autopilot portfolio like the one you’re implying, during a secular bear market, the goal should be preservation of capital. I would suggest high quality equities, Canadian REITs, and a smattering of timber. I would also add a little bit of leverage – nothing crazy, maybe 20-25% depending on the risk tolerance.

There are some calling the Canadian real estate echo-boom a bubble. But I think there is an opportunity within your time frame. Remember, a bull market is just a bubble that you are invested in while a bubble is a bull market that you’ve ignored. If we do get inflation, then REITs will do well as the economy will have recovered and they will be able to increase rents and therefore, distributions.

As well, the Canadian government has basically outlawed income trusts through a tax law change that will go into effect in 2011. There are billions right now invested in income trusts and at least some of that yield starved capital will find its way inevitably into REITs.

Finally, Canadian REITs have incredibly solid balance sheets and are now peering over the border at the wreckage left in the wake of the residential real estate bubble and the impending commercial one. In the next few years, you’ll find them swooping down to take advantage of the carnage. So I would accumulate these REITS on any weakness.

I’m trying to stay well away from specific recommendations but will say that right now, it is very easy to find large common household name US and Canadian companies with solid balance sheets, single digit P/Es and yields around 4%. So if you’re bullish on inflation, then that means that eventually, some time in the future, who knows when exactly, these companies will gain price traction. When that happens I think you’ll see dividends keep pace with inflation or outpace it due to the economic recovery as well as healthy balance sheet positions.

Basically it boils down to avoiding the expensive and buying what is on sale. Know the difference between price, value and worth. Be nimble and opportunistic. And when you figure out how to do that consistently, please teach me.

10. Where do you hope to bring the Traders’ Narrative in the future?

I hope to continue to share ideas on the market and develop as a trader.

Babak, thank you for that incredibly insightful piece. We wish you all the best!

Kid Dynamite is the man behind the popular blog “Kid Dynamite’s World” – http://fridayinvegas.blogspot.com/. Kid Dynamite spent 8 years as a trader at a major Wall Street investment bank. From June 1999 through April 2005 he specialized in portfolio trading, and from May 2005 through November 2007 he was the head trader for an internal hedge fund on the buy side of the same firm. Kid Dynamite managed a multi-billion dollar merger arbitrage portfolio, and continued to implement portfolio trading related strategies as well.

1. How did your blog transform into one discussing and evaluating financial markets?

I quit my job about 5 months before Bear Stearns blew up.  Once I was free of the shackles of the corporation, I could write much more freely about financial markets without fear of enduring negative consequences if my employer had found out about my blog.  You are probably aware that big companies are very wary of having the views of employees misinterpreted as the views of the company, and thus they usually don’t look kindly on opinionated writing.

2. What kind of economic/market issues do you like to address in your writings?

What bugs me most is when journalists try to write about trading or mechanics of trading that they simply don’t understand.  They invariably get it wrong, and that “wrong-ness” usually spreads.  I found that for a while most of what I was writing was simply correcting factual errors that people have in their understanding of things like high frequency trading, program trading (my background), flash trading, etc. Lately, too, the biggest problem is the pervasive populism that has taken over even the mainstream media.  It skews the facts, and the reader sentiment just spreads ignorantly like a snowball.  At the same time, it fails to address the real issues, and ensures that they will not be addressed.

3. Do you think the current debt situation in developed economies is bigger than most other problems capitalist countries have faced before?

Yes.  I happen to think that we’ve reached the end of a massive multi-decade cycle of debt accumulation, and that debt must be reduced.  This is true on an individual/household level, corporate level, municipality level and national level.  It shocks me when economists predict recoveries based on, literally, a HANDFUL of data points, which by themselves would be statistically insignificant.  Add to that the fact that the inputs are vastly different now, and it shocks me that people quote past recessions, past stock market rallies, past periods of unemployment, etc.

4. Do you believe the unintended consequences of government action are getting bigger than the problems which government action was meant to solve?

Well, I believe you can’t cure a leverage problem with more leverage – so in that sense, yes.  The cliff gets pushed back, but also becomes taller with each intervention.  The problem is that there is no solution – politically, we just aren’t willing to make the difficult decisions.  Without making this a political issue, this for me is the most disappointing factor about Obama’s actions thus far.  It’s not that McCain would have done better – it’s that Obama, upon entering office, had so much support and the American people had such faith in him.  Combine that with his eloquence and leadership skills, and it’s possible he actually COULD have made the hard choices and talked the public through the aftermath.  Very few Presidents even have that potential – but I think he did, and he missed his chance.  So now, we continue to extend and pretend, delay and pray, and there is no solution.

5. Have economies just resigned to moving from bubble to bubble in different asset classes? Is there a solution to this cycle?

Right on cue – I think I just answered that question above!

6. Do you think the bailout strategies being contemplated in the Euro zone will work any better than the ones that were utilized by the US government?

I am not qualified to comment intelligently on the Eurozone.

7. Is the debt situation just something we are worried about in a downturn and something that’ll be much easier to control in once economic growth returns?

You are assuming that economic growth returns!  Growth will certainly resume someday, but I think that anyone who expects the kind of housing market performance we saw in the last 10 years anytime soon is delusional.  That housing bubble really affected all other aspects of our economic growth and juiced it way beyond normal levels. I mention housing because I think it was a huge part of the bubble in America – people spent paper profits on their homes, accruing debts in the process. MEW – mortgage equity withdrawal!!! It fuelled everything.  As long as we don’t have a downturn, you don’t have to worry about this debt – you just refinance it – MAGIC!  Of course, that MUST end at some point.

8. How has your past experience helped you get a better grasp of issues that hit the headlines and are often blown out of proportion or at other times understated? Any examples?

Well, everyday journalists misinterpret financial stories.  Some do it out of ignorance, some do it to appeal to what they know are their readers’ views.   I addressed this above when I mentioned populism.  The Goldman Sachs – Greece story is a recent excellent example.  Der Spiegel broke the story (http://www.spiegel.de/international/europe/0,1518,676634,00.html) of how GS helped Greece structure a currency swap.  This swap was a bit unusual because it was done at non-market rates so that Greece immediately got a big payment upfront from GS.  Of course, that payment needs to be paid back at some point, and we’re now seeing the consequences.  Anyway, everyone loves to hate Goldman, and this is actually a pretty interesting story, because this  swap allowed Greece to fool European regulators and may have been a key factor in its inclusion in the European Union’s formation!   So far so good – but then the NY Times picks up the story several days later (http://www.nytimes.com/2010/02/14/business/global/14debt.html?hp=&pagewanted=all) and gets sidetracked with:

“In Greece, the financial wizardry went even further. In what amounted to a garage sale on a national scale, Greek officials essentially mortgaged the country’s airports and highways to raise much-needed money.

Aeolos, a legal entity created in 2001, helped Greece reduce the debt on its balance sheet that year. As part of the deal, Greece got cash upfront in return for pledging future landing fees at the country’s airports. A similar deal in 2000 called Ariadne devoured the revenue that the government collected from its national lottery. Greece, however, classified those transactions as sales, not loans, despite doubts by many critics.”

That’s pure garbage – Greece selling assets to pay down debt has absolutely NOTHING to do with hiding their financial situation via a non-market rate currency swap designed to deceive European regulators and gain entrance into the E.U..  It happens to be a shortsighted, doomed to fail way to fix budget problems (since they are selling income producing assets) – but it’s a total red herring to include it in a discussion of spurious financial dealings.  Of course, the readers don’t get this point (surprisingly, since it’s not a complex one) and just rail on the “Goldman Sachs is the root of all evil” train.  GS may be evil, but the way to illustrate it is with the off-market rate currency swap it structured for Greece, not the sale of assets it arranged for Greece.  Kudos to Felix Salmon for taking an unpopular view and doing an excellent job summing up the facts in his piece: http://blogs.reuters.com/felix-salmon/2010/02/16/the-greek-derivatives-arent-goldmans-fault/

9. What do you see becoming the big surprise for market investors and observers in 2010?

I have no idea where the stock market is going short term, (read this, though, for my imparted wisdom: http://fridayinvegas.blogspot.com/2009/12/kds-year-in-review-part-1-isaac-newton.html),  but I would be shocked if we didn’t have a major selloff sometime in the next few years.  That sounds vague, but one thing I’m learning over and over again is an oft repeated cliché:  The markets can stay irrational longer than you can stay solvent.  It’s a slight twist on that – governments can extend and delay problems longer than we think – it may take 18 months, 5 years, or even 10 years, but I would be very surprised if we don’t see SPX 800 again. I am still waiting for the mainstream press to pick up the pending disaster in underfunded pension plans, and in the numerous major US municipalities which are bankrupt.

10. What are some of the other blogs you read for insights into new developments?

Calculated Risk – for not-too-opinionated, very educated, and very accurate interpretations of economic data points.  Barry Ritholtz – for more opinionated and less censored interpretations of the same.  David Merkel’s Aleph Blog, Paul Kedrosky’s Infectious Greed,  Tyler Cowen’s Marginal Revolution, Michael Panzner’s Financial Armageddon, for focused and always insightful pieces.  I think Felix Salmon has become one of the better mainstream writers – he is a journalist, but he gets the facts straight, doesn’t manipulate them, and accurately explains unpopular views in an attempt to educate, not to generate hype and hysteria.  Mike “MISH” Shedlock has also done a good job repeatedly focusing on the municipal debt problems we are facing – which no one seems to be talking about.

Note: See important disclaimers below article.

Another month, another year, another attempt at a correction and another inevitable bounce. The chart below highlights the sentiments carried by many investors.

All the believers of the mantra that “Nothing ever goes up in a straight line”, have been forced to challenge their beliefs when every attempt at a correction in July, August and September gave way to higher highs and higher lows. Every time the market attempted a correction the blogosphere will be awash with claims of the baseless rally finally ending.

And so here we stand again, in the middle of the most recent bounce from a seemingly major correction when the markets fell for close to 6% in the span of two weeks from Jan 20-29. Is this time any different than every other attempt? Sure, there seem to be more solid, fundamental reasons this time for a proper correction – Obama is attempting to regulate the banking sector into submission, sovereign debt problems around the world occupy the headlines, existing and new home sales came in lower than expectations. But so what? Is this time really any different?  The believers of the above-mentioned mantra, the value investors, the Buffett followers, all gain hope at every market inflexion point that maybe this time the valuations will finally come closer to fundamentals. But as they wait by the sidelines for new lows to buy in, the market bounces and just keeps on going in a straight line.

The winners in the past 9 months have very much been the people who have believe that the market has little to do with fundamentals and will continue to remain disconnected from them. The winners have been those that have used different barometers from traditional fundamentalists in assessing the markets. But will that logic continue to hold weight into the future? Most likely only till the real big correction is upon us. But wait, can that even happen? Have investors already forgotten what it feels like to be in falling market?

For their sake, I hope not, because this time it might be different.

Disclosure: Long stocks, for now.

Disclaimer: Views and opinions expressed on above are those of the author alone and do not in any way represent the official views, positions or opinions of the employers – both past or present – of the author in question, or any other institutions and corporations associated with the author. Neither the information nor any opinions contained or expressed above and elsewhere on Young & Invested constitutes or should be construed as a solicitation or offer by Young & Invested to buy or sell any securities or other financial instruments or to provide any investment advice or recommendations. Young & Invested shall not be liable for any claims or losses of any nature, arising indirectly or directly from use of the information on or accessed through the site. Please see full disclaimers here.

It seems the consensus of bullish investors and authors about 2010 predicts strong emerging markets, glimmering gold, weakening US dollar and weakening bonds, which portrays my outlook for 2010 precisely. Additionally, I’d like to add that in my vision of 2010:

Mr. “Rich” Consumer

Americans will continue to keep finding a way to live above their means. Recently, claims for unemployment and lay-offs have shown to decline to an 18-month low as the economy slowly recovers. This latest employment news has a double-pronged effect. First, a recently reported jump in average weekly working hours means increased income and ability to spend. Secondly, on a more aggregate level, the trend of stabilizing unemployment will improve consumer confidence of job security, a critical factor to assess consumer spending, especially for large-ticket items large cars. Together, these effects will translate into increased consumer spending in 2010.

Mr. “Rich” Consumer without a Job

On the other side of the argument, unemployment will remain relatively high around 9~10% for the entire year due to a prolonged economic recovery. Despite lower layoffs and unemployment claims, which represent incremental increases to unemployment (i.e. the number of unemployed is still increasing but at a slower rate), the overall unemployment rate will slightly decrease from current levels to about 9~10%. Although unemployment may remain high, the stabilization and slight-decrease in the unemployment levels will mildly contribute to increased consumer confidence, but will also generally improve with the economy.

Yes, More Housing

The housing market will stabilize as the S&P/Case-Shiller index has shown uninterrupted growth in price of home sales for the last 6 months; the absolute number of home sales has also increased in the same period. So, homes are being sold more often and for higher values. As shown in the graph below, the Case-Shiller index is barely at its 2003 highs, and down 32.6% from a peak in the second quarter of 2006, so I doubt that any bubble-concerns will arise as the market is still evening out.

Continuing Low Interest Rates from the Fed

Analogous to the notes above, the Fed is obviously aware that economic conditions are showing signs of recovery. The Fed was already noted to exercise some exit-strategies such as ending purchases of Long-Term Treasuries and also stated that debt purchases will significantly decrease into early 2010. But, rates were maintained near 0% during December, 2009. To raise interest rates now, when the level of economic uncertainty is still highly elevated would result in highly-detrimental effects to the economy and the Fed’s reputation – homicide and suicide. Until signs that unemployment levels have definitely peaked and positive economic indicators show long-term trends, rates will be maintained at a low level until 3-rd quarter of 2010 or early 2011.

All of the above point to a pretty good year for the equity markets. Recent analysis I’ve been seeing is consistent with this hypothesis, including increased EPS and operating profits for a majority of companies and all sectors in the S&P500. A recent Wall Street consensus expects forecasts revenue growth in 2010 to be 8%, with improved earnings as well.

I’m a firm believer that history repeats itself, leading me to believe the tradition of the S&P500 index will continue in 2010. Expect a good year for stocks coming up; we’re still about 30% from the market highs of 2007. So, stock market running out of steam? Leave that for 2011.

Disclosure: Long Market

Image Credit: pfala under a Creative Commons license

Young & Invested is THE hub for finance and investing insights from the new generation. Head to our blog for more insights! — http://youngandinvested.com