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Fascination Station


About time you realized Snapper's THE man now

"Spanning the globe to bring you the constant variety of sports... the thrill of victory... and the agony of defeat... the human drama of athletic competition..."

If Minyanville ever gets its own TV show, Wassong and Harrison have to promise me that the voiceover on top of the opening credits has to be a derivative of this quote:

"Spanning the globe to give you the constant variety of finance, the thrill of profits, the agony of losses... the human drama of high-stakes investing."

I am fascinated by the current market. I confess I'm a relative newbie at this. I'd even hazard a guess I've been doing this for a shorter amount of time (6 1/2 years) than anyone here. Perhaps that insulates me from the "how things are supposed to work" trap, which in any endeavor I have been involved in, is usually code for "Damn I hate change because it takes me out of my comfort zone. Don't all these new people know they are doing it wrong???"

To those who get all a 'twitter when "the biotech guy" starts talking macro market, stop reading now. Or heck, keep reading if you find what I have to say on the macro picture amusing. Laugh at me or laugh with me, either way the studies prove I just added a few seconds to your life span. (You can send me the check later.)

Preparing to have a point...

I found Thursday's content fascinating. I'm not sure why, because it wasn't thematically much different than stuff I've seen on and off in the last two years. Monday and Tuesday's commentary was much more actionable, as far as I'm concerned. But Thursday's commentary struck a chord.

When I'm drawn away from the tape and to the phone, as often happens when stocks are moving after we publish new research, sometimes I don't catch up with the Buzz or the articles until my closing hours here on the West Coast. Upon further review, so to speak, a few items caught my attention.

Toddo chatted with the always-opinionated Doug Kass, mentioning that Mr. Kass thought he was the last bear standing. Aside from how strange that comment looks to most readers of Minyanville (a point I'll get to in a moment), I just had to laugh (not at Mr. Kass or Todd, but in realization of my own view of the world). In my little corner of the world, almost every long I talk with is looking for new work because the bears handed everyone their heads for the second year in a row. They control the options markets and they control the equity prices. And before you roll your eyes at my use of the word "control," I say with unequivocal certainty that unless you swim in the little corner of the pool that I work in every day, you cannot perceive exactly how inefficient and controllable things are around here. Mr. Kass, swim on over here and you'll likely be the most bullish guy in the room.

Todd's morning Fire and Ice column was fabulous in that it shows Tony Dwyer that readers think he has something constructive to say. It also reinforces that however theoretical we get at times, our readers have a need (and an ability) to distill those theories into actual practice.

Then we get a stretch of mailbags, John's particularly clear column "Currency Stocks", and Fil's comments on whether Professors are writing from the back of a bear den. As I noted above, I'm not certain there was anything earth shattering about any of this but the collective group struck a chord with me and I simply had to try and put fingers to keys to get a few things out of my head and on to the electronic page.

John's comments on currency and valuations are, as anyone who reads his stuff should expect, accurate. However, unless I can find someone to pay me in gold, I'm out of luck. (Even if I could find someone to pay me in gold, I'm fairly sure McGuirk would find a way to be standing in line in front of me to take the job.)

Since our little corner of reality has us all employed in the financial markets, it seems more reasonable to agree with what John said in that article than to completely ignore it as I go to pick the next stock to buy. Why? Since I don't get paid in gold, the best I can do is make money faster than the increase in the prices I'm paying to live. (The reason I say "I'm paying to live" is that I think we've all acknowledged the official inflation figures are bunk.) Even though the import of what John said is incredibly bearish on some levels, and accurate, it is separated from today's business by a large chasm. If you don't recognize that, you risk falling into that chasm as you stand on the "right side" and try to make a living on the "other side."

In one of the mailbags, a Minyan asked Todd "What would make you change your mind and no longer be a bear?" I think that's really valuable as I firmly believe you have to make up your mind on why you would close a position before you ever enter it. For the big picture bears, I'd really like to know what would make them change their minds that the market was no longer heading for disaster. Knowing both sides of the trade in their minds would be exceptionally helpful.

Fil Zucchi ran out some numbers in his piece entitled "Relative Bears." I wanted to add one more set of dates to consider:

Minyanville News & Views story #1 was published on 10/01/2002. From that day until yesterday (12/01/2005), here are the big four indexes (plus one of my favorites):

NASDAQ = +86.80%
DJIA = +37.46%
S&P-500 = +49.15%
Russell 2000 = +87.51%
NASDAQ Biotech = +64.15%

This article is something like #9115, by the way. That's proof you'll never lack for something to read as a Minyanville subscriber.

Almost there...

I wrote a piece a while back called "Wrong End of the Telescope" where I pointed out that macro dangers to the market were not triggers, but accelerants. I had to write that piece to get the overall bearish macro picture out of my darn head for a moment and was gratified to read your e-mails saying it did the same for many of you.

My focus in the market is very narrow. There might be 200 companies I'm interested in and most of them do exactly the same thing. We officially cover only about 10% of that group. I know that sort of focus creates a blind spot to the larger picture.

I learned last year the reverse is also true. I can let the overarching macro view interfere with what's going on in my sector. I did that in August of 2004 and missed a HUGE rally for my subscribers - a rally that Brian Reynolds saw coming well in advance and, in hindsight, I should have seen coming too. While catching that rally would not have allowed us to break even in 2004, it would have made the year a bit more bearable (no pun intended).

I fight the allure of the exploding sun viewpoint, to use Tony's particularly apt metaphor, every day. Because risk is so pronounced in my world (Where else is a 50% decline in market cap a reasonable reaction to bad news?), I'm wired to pay close attention to any whiff of trouble. It takes considerable effort to balance the overall big picture versus my sector's big picture - particularly when they are so strongly diverging.

My point...

The funny thing about all of the above is that I am increasingly convinced none of it matters. Bullish, bearish? It doesn't matter. They are arcane terms describing a market that simply no longer exists.


That's particularly ironic coming from me given I started in this business as a chartist looking to define bullish and bearish by squiggles on a chart. In 2001, I determined the charting style I was using was too crowded of a trade. I believed the only way to be able to get market-beating returns was to frontrun the charts by knowing the fundamentals of a particular stock cold. More specifically, by finding a place in the market where a small firm with limited resources (in comparison) would be able to know the fundamentals before most other participants. That sector was the research wasteland of dev-stage biotechnology stocks.

I share that story to make it clear that I do not say the following lightly. In fact, forgive me if I choke a little.

Not only do bullish and bearish no longer matter, neither do fundamentals - at least not most of the time.

This business has changed dramatically. I no longer believe this is a business of fundamentals interrupted infrequently by derivative transactions. This is a business of derivative transactions interrupted very infrequently by fundamentals.

The discussion that permeated the 'Ville yesterday is a perfect example of that. Each of the participants have their facts right. Heck, sometimes they even use the exact same set of facts. Your point of view as to whether people are overly bearish or overly bullish on a particular fact is mostly governed by which side of the position you are on when the fundamentals interrupt the normal flow of the markets.

Billions of dollars are flowing into funds that do not want equities (what most of us still consider "the market") to move outside of a certain range. Within that certain range, they can use derivatives and leverage to essentially print money.

As pension funds pour more and more billions into funds like this, the problem will only get worse. Fundamentals will matter less and less to the price of an equity, primarily because all the money in the market benefits most when the equity doesn't move. It will take increasingly large changes in the fundamentals of a stock in order for the stock to move considerably - in order for the fundamentals to interrupt the business of derivative transactions.

Why is everyone in the business so frustrated and frazzled? We're all still operating under the wrong impression that fundamentals are the primary movers of equities. We see huge disconnects in the fundamentals and believe that a breakdown just has to be coming soon. We see a recurrence of a pattern that has made considerable money in the past, so we believe a rally has to be coming soon.

When the market stays flat and range bound, we freak.

Succeeding in this brave new world of the markets will be a function of how well you are hooked in to the real forces driving the markets - the maze of derivatives now being traded off the "real stuff." Your ability to outperform will be limited by your ability to understand the complex web of transactions and either (a) correctly anticipate the next strand in that web, or (b) determine how best to take advantage of the inefficiencies that occur when the web is constructed.

If you want to still play the fundamentals game, you have to acknowledge that your returns will no longer come from skewing slightly to one side of center or the other on the bell curve. Your performance will only come from correctly anticipating tail events (if you read John's work, that term will sound very familiar). More specifically, outperformance will be a function of staying even with the herd as it topples from one side of center to the other and (and) correctly guessing which tail of the curve is the right one to make your stand when the tail event finally arrives.

Minyan Franklin made an excellent point Thursday morning to Todd when he said, "We may grind the next 10 years at very modest returns or we may go down hard in '06, nobody knows, and the future is not written yet. I actually think the more you tune out the macro type calls and filter them the better you are as an investor in common stocks."

He's got a point here, but I think you need to go one step farther. If you are going to make money in equities, you also have to filter out most of what is going on in that equity. Strong performance will only come if you can figure out how to be positioned for the tail events.

For most of us, however, the first step will be learning to understand the derivatives market to the point where we can see at a glance how that tail is wagging the equity dog. When someone makes an unusually large play in a call option, how does that affect the underlying equity? How about a very large put option bet? When you see a large number of options trade in two different contracts, what does the fact they were selling one to buy the other say about what range the underlying common might trade in? Can you tell by looking at an option chain that the owners of a large short position are selling calls to generate income? And if that's true, who is buying the calls? And who is buying/selling the puts? And how do you measure a "large" play, anyway? It might take tens of thousands of contracts to pin a big-cap stock to a strike at expiration, but only a couple of thousand to do the same month after month for a small biotech stock.

That's hard stuff that only a fraction of market participants understand. Worse yet, it's only the tip of the iceberg if you want to play the equity fundamentals in this new market. Once you master the options stuff, you have to develop an ability to sense what magnitude of fundamental "interference" is necessary to upset these entrenched positions. Only then can you understand where the tail you need to catch begins and ends.

In my neck of the woods, you also have to understand what side of the tail has the least resistance (in dev-stage biotech, it's the short side right now since bad news drives a stock down 50% and good news boosts it only 20-30%).

If you've lasted this long on a Friday, congratulations. I hope the insights (or the chuckles) were worth it.

Circling back...

I think the argument about whether Minyanville is too bearish misses the point. It's like arguing which buggy whip is better - it's entertaining for a while but it really has no connection to the real world outside this browser window. It would be a much better use of all our time if we can help each other (a) understand the complex world of derivatives, and (b) figure out where those profitable tails might be.

For my part, I'll do my best over the coming year to point out potential disconnects in my neck of the woods. These disconnects are the genesis of potential tail events necessary to outperform the markets. When I can't point out potential tail events, I'll see if I can do a better job of discussing tail events that have already happened. In my little corner of the world at least, one good way of finding the next tail event is to study past tail events.

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