Some thoughts on recent market action, and George Soros

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Many financial markets continue on what seems to be a never-ending path upward as the dollar continues on its path downward. The chart above shows the daily action of the etfs representing the S&P 500 in the upper sub-graph, and the Nasdaq 100 in the lower. Trends in both are clearly up. Every attempt at a pullback toward or slightly through the moving averages being a good buying opportunities. Actually these pullbacks were met with what looked like urgent buying. This urgency is even more evident by looking at the intra-day charts. It seems these pullbacks are quick and shallow, followed by buying that seems like a stampede.

When these trends are as persistent as they have been recently, it is financially dangerous to attempt to call a top, or at least call for a meaningful pullback. Obviously a pullback will have to happen at some point. It always does, especially at a time when it looks like it never will. “This time is different” is never different. Bulls will argue that the pullbacks on the charts have been bullish, thus creating a self-correcting uptrend, which is healthy for continuation. So far they are correct. Uptrends have to breathe. They always have backing and filling when the trend is progressing. It is only in the final exponential blow-off that the price ticks seem to only go in one direction. So far we have not seen that, although at times on the intra-day charts it seems like that is the case. On the chart above I have a red line drawn at the high pivots on September 23rd. There was a clear breakout on the S&P in the upper sub-graph. There was a pullback Friday toward that breakout point, which could be a normal re-test of the breakout. If it holds and momentum resumes to the upside then all is well with the S&P. In the lower chart of the Nasdaq the breakout of the same pivot was less successful. The breakout was only by a very small amount, and the close of that bar was a tick or so under that previous high pivot. Over the next two days price was unable to reclaim that breakout point. What is left so far is a double top. This divergence between the two indexes could easily resolve itself to the upside, of course. But the divergence is worth watching. In certain market environments the Nasdaq can lead and give import clues around divergences between indexes and with divergent momentum indicators. So far this seems to just be a warning and something to keep an eye on. So far the uptrend will be intact until or unless the low pivot on October 2nd is taken out. Obviously a new higher pivot can form if the uptrend continues, so the October 2nd low is only meaningful related to the current upswing. As long as higher highs and higher lows continue, then all is well for the bulls. But watch out for low pivots being taken out. The divergence just pointed out can be an early warning signal of the possibility.

What is disturbing to me about this uptrend, apart for the persistence of the direction without meaningful corrective action, is the disconnect between the price action and the fundamental background. I made an attempt in my last blog post to offer a possible explanation. That explanation is based on the assumption that the market in its efficiency can effectively discount the future. Of course there is a problem with that assumption.

Theories often read in books or listening to market gurus suggest that the market is always correct. They treat the market as if it were a living organism that knows all, and that can see into the future. They think the market is efficient and a perfect discounting mechanism. Nothing could be further from the truth. The market is made up of individual humans, each with different objectives and biases. The collective buying and selling of this very large group will set the current price of any given market. Much of the trading volume on any given day is made up of traders who create liquidity by their very short term methods, so they should probably be excluded from this explanation, contrary to what some politicians think who want to tax their activity. However, the outside paper, that is the buying and selling interest of longer term traders and investors, are what create the directional price moves seen on the charts. (And directional can also mean sideways, not just up or down.) It is assumed these trends are caused by fundamentals, such as company earnings, economic policy, or by political decisions. And certainly a big company news item, a huge change in political policy, or a big economic event can cause a change in the major trend. But does a trend always suggest or imply something about the future? I don’t think so. Is the market always right? I would say no. It can be wrong to stand in front of a major price trend, even if that trend is based on a false assumption. But that doesn’t mean the trend is correct. A trend is based on the prevailing buying or selling of the market participants, disregarding the short-term activity of those providing liquidity. Those market participants have biases that can influence the trend. The important point is that the trend will influence many more market participants, thus perpetuating the trend. There is a belief by most analysts that the trend is seeing something down the road that is not yet in the news. But is the market really seeing anything? Once the trend is visible there are many participants willing to jump on board the bandwagon with the hope that the fundamentals will merge with the existing price action. There are many technical traders and large funds with technical models that will jump on board these trends, without any concern about what is causing the trends. Therefore, it is often the case that the cause of a trend is the trend itself. A trend will often grow by feeding on itself, and doing so without any insight into the future.

One of the great books on the market is “The Alchemy of Finance” by George Soros. His description of price trends as explained by his theory of reflexivity is well worth studying. A quote that stuck in my mind the first time I read it many years ago is a better explanation of trend than anything else I have seen.

“Economic history is a never-ending series of episodes based on falsehoods and lies, not truths. It represents the path to big money. The object is to recognize the trend whose premise is false, ride that trend, and step off before it is discredited.” George Soros

Of course recognizing the trend is the easy part. Riding the trend can be difficult. Exiting the trend at the right time is the hard part.

There are many bright people trading the financial markets. Many are considered gurus, at least for a short time. But few I would consider a genius. I do consider George Soros a genius. His writings on the market are beyond anything else being written or discussed. However, there is a fine line between genius and insanity. I think Soros straddles that line. His views on politics seem to cross over that line. They seem to contradict his core beliefs. They contradict the system he works in and the system that allowed him to become wealthy. He has written negatively on Marxism and communism, yet he backs extreme left wing causes. He will give money to Air America and Moveon.org, among many others. He backs many anti-American and anti-capitalist movements. I attended a speech he gave prior to the 2004 election. His thinking seemed irrational and distorted. There was bias and falsehoods in his thinking that seemed similar to what he defined for financial trends. At the end of his lecture I expected him to say he had to leave as his spaceship was waiting. That’s how nuts he sounded when discussing politics, however his views on financial markets are brilliant and deserve close examination.

It really annoys me that many people profit greatly from the very system they trash. The list would be very long if I were to name them. They would include most of Hollywood, a few on Wall Street, many current politicians all the way up to the top job. One that stands out is Al Gore, that very annoying close call from nine years ago that refuses to go away. When he lost the election he was estimated to be worth about two million dollars. Personally I don’t think he is worth two cents, but that is how much money he was estimated to have had then. Now he is estimated to have over one hundred million dollars. That’s over a hundred million is about nine years. Is he a genius? I would say yes. Here’s a man who took some sketchy evidence that there could have been slight warming of the Earth’s temperature over the last hundred years. Of course over the last ten years the temperature has declined, but we won’t address that. He built up a theory that the world was going to end as we know it if we didn’t take drastic measures to control many aspects of our lives. Measures that would decimate the economy and destroy capitalism. At the same time he was preaching to all of us how we should live, he was flying around in private jets, riding in limos, and using many times the amount of electricity in his mansions that anyone else was using, and he enriched himself by over a hundred million dollars in the process. He refuses to debate the issue. Recently he cut off the microphone to a filmmaker trying to point out as fact that the polar bear population was actually increasing, when Big Al said the opposite. End of debate. Facts don’t matter. He has major corporations and politician on board his crazy theories. The public doesn’t seem concerned about the consequences of his proposals, or the fact that he refuses to debate the facts. He is a genius. He is pulling off one of the greatest hoaxes in history. It will eclipse Bernie Madoff. He is a genius in a negative sense. There is also a very long list of genius that had a negative impact on the world. If he pulls this off he will join that list, laughing all the way to the bank.