Squiggly Lines

#9: The illusion of time, bad excuses, and narratives.

The last two weeks went deep on monetary policy; dense and nutritious posts. This week is a key lime pie, sweet and sour. It’s important to keep a balanced diet.

The Present Does Not Exist

Yesterday’s S&P 500 closing price is now a matter of historical record. On June 22nd, the S&P 500 closed at 3759.9, down 0.13% from the prior closing price of 3764.8. If you were long, you lost, and if you were short, you won. It is old news, water under the bridge. The outcome is known.

What we don’t know, and what we really want to find out, is what will happen tomorrow. Will the shorts win again, or will the tide reverse?

So we fixate on the present because we think it gives a glimpse into the future. We ditch daily stock charts for hourly stock charts, before quickly moving onto minute and second charts. We live on the leading edge. We want to know what’s happening right now because it’s the closest on the timeline to what will happen next.

But the present doesn’t exist. It is a point in space, it has no length.

All market data, no matter how recent, is backwards looking. By trying to see into the future, we end up focusing on the tiniest sliver of historical data. In doing so, we reduce our sample size to a meaninglessly small total and lose sight of bigger picture trends that may be useful in predicting the future¹. One day is merely one more point on a multi-decade series.

Are US Treasury yields rising or falling?

The 10-year US Treasury yield traded down 8bps on June 22nd. But, it is also up 157bps since the start of the year. But, it is also down 1261bps since 1981. Understanding the monthly, yearly, and multi-decade trends is far more useful in projecting what comes next.

Is the stock market rising or falling?

Year-to-date, the stock market has had one of the worst performances on record. Yet, out of 119 trading days in 2022, the S&P 500 has been up 53 days and down 66 days. Each new trading day adds just 1 to either column and in isolation is meaningless.

In financial markets, the lines usually aren’t straight - they are squiggly.

This should come as a relief. Take a breath, take a walk. Experience the future as it turns into the past. Today will come and go and by itself will not matter. Zoom out and focus on the trends.

The Spin Zone

I began to recognize the power of spin after being fooled by it. In my previous job, we made investments in private companies. We met with management teams eager for money and armed with the right story to get it.

You can spin a story justifying a high-level business case, but often it is used to explain away poor performance. A conversation might go like this:

[in meeting with management]

TLBS: So, it looks like your East Coast segment revenue was down 20% in 2018. Could you explain what happened there?

CFO: Yes, actually our flagship store was closed for several months for renovations, which impacted our sales that year.

TLBS: Ah okay, that makes sense!

I had a question, they had an answer. Check it off the list. Later, when presenting the opportunity to our internal Investment Committee (“IC”):

IC Member: Why was the East Coast segment revenue down 20% in 2018?

TLBS: Well, you see, their flagship store was closed for renovations for several months, which impacted sales that year.

IC Member: Well, according to your breakdown of sales by store on page 13, their flagship store made $15 million in 2019 compared to $100 million total East Coast revenue. So even if it was closed the whole year, it could only account for a 15% decline…

[awkward pause, shuffling of papers, death glare from your Managing Director]

TLBS: …Let us…circle back on that…perhaps we can follow up with a bridge detailing 2017 vs. 2018 revenue by location…

After getting duped and publicly embarrassed, you learn that spin is cheap and data matters. Seasoned IC members already understood this lesson.

Here’s another example that is trumped by the data.

In September 2019, the repo market blew up, forcing the Fed to reintroduce quantitative easing for the first time in five years. In its own post-mortem, the Fed concluded that “strains in money markets in September seem to have originated from routine market events, including a corporate tax payment date and Treasury coupon settlement”.

The full paper acknowledges that bank reserves had declined to multi-year lows, in large part due to quantitative tightening (“QT”), yet the Fed’s preferred narrative is that the crisis was caused by “routine market events”. Data defies this explanation.

QT drained more than $700 billion of liquidity over the prior 18 months, far greater than the tax and Treasury movements of that week, which accounted for just a $100 billion draw, well within the range of routine fluctuations by the Fed’s own admission. In other words, “normal fluctuations” do not break markets on their own. Rather, it was the excessive drain of QT that caused otherwise routine events to freeze funding markets.

If you want to understand what really happened with East Coast sales or funding markets, you can’t rely on others’ preferred justifications. Exit the spin zone. Data doesn’t lie.

The Narrative is Fiction

The human brain craves a narrative. Resist this craving.

“Markets [rise/fall] on _____”

I assume there is a full-time employee at Bloomberg, The Wall Street Journal, and Yahoo! Finance tasked with filling in the blank for a daily headline published around 4:05pm. I do not envy this position.

On some days there may be a clear catalyst to explain a market rally or tumble, but this is the exception. Most days there is not. More often, you have no clue why the prices went up or down other than a finger-to-the-wind guess².

Unfortunately, this is unsatisfying and a little troubling. We prefer if every move had an obvious, rational explanation. The alternative - that prices move and we don’t know why - is harder to stomach.

So instead, we pretend. We create a narrative. We goal-seek explanations in hindsight and act like the market must be a rational system with level-headed actors, moving in tandem towards the “correct” fair market value. If we are unimpressed with Bloomberg’s interpretation, we can visit Twitter where your favorite guru provides their own two cents.

Consider that in the past two weeks 10-year Treasury yields are down 39bps off the highs. Some have suggested that the market is repricing the Fed’s long-term rate path based on a tea leaf interpretation of a Fed speaker’s comments or the latest economic data. Yet, this does little to explain the fact that 1-month T-bills are down by nearly the same amount and far below the federal funds rate. Did the bill market also decide an emergency rate cut is imminent, or are there other factors at play influencing both?

There is no Counsel of the Market making orderly decisions and pushing the prices in the right direction. The market, particularly in the short term, is chaos. No one has the same information. No one has the same positioning. Everyone is trying to outwit each other.

Further, some of the biggest factors driving markets may not even have any price sensitivity at all. Do regular 401k contributions reflect optimism in the economic growth trajectory? Probably not, but they do increase stock prices.

Bloomberg doesn’t know, FinTwit doesn’t know, and I don’t know. Over a long enough timeframe, prices will move towards their fair value, but the path is squiggly. There is no consensus. Instead, embrace the chaos.

1. Ok, here is my first caveat. The relevance of daily moves vs. longer term trends depends on your investment or trading strategy. This post assumes the perspective of an average retail or institutional investor who is buying and holding an asset based on a fundamental view of its value and price trajectory over a reasonable period. Alternatively, if your strategy is ultra short-term flip trading (like a high frequency trader in the most extreme case), this may not apply. However, my guess is that a large majority of readers don’t fall into this category.

2. In these instances, rely heavily on generic phrases like [optimism / concern].