July 3, 2013

A Movable Feast

Bonjour! Ca va?

We’re back from touring Provence aboard cycling saddles, weighing heavier on the pedals after warmly embracing regional food and drink. Lavender air, stone-walled villages perched over vineyards, crisp mornings and warm days, endless twilight, chilled Viogniers from small-lot Luberon wineries. If these things appeal, go.

In Avignon we feasted at Moutardier in the shadow of the Palais du Papes, the palace of the Roman Catholic popes in the 14th century. From tiny hilltop Oppede-le-Vieux with roots to earliest AD written in moldering stone and worn cobble we surveyed the region’s agricultural riches. After a long climb up, we saw why Gordes is where the rich and famous from Paris and Monte Carlo go to relax. And on Day 5 I scratched off the master life list riding fabled Mont Ventoux, which will host the Tour de France on Bastille Day, July 14. What a trip.

Meanwhile back at the equity-market ranch, things got wobbly. We warned before departing that options-expirations June 19-21 held high risk because markets had consumed arbitrage upside and new swaps rules would make the process of re-risking unusually testy. Markets tumbled.

The Fed? Sure, Ben Bernanke’s comments unnerved markets. But if we could see it in the data before the downdraft occurred, then there’s something else besides the reactions of traders and investors at work.

This is an essential lesson for today’s IR chair. Market behavior will continue to baffle until you grasp this: Movement in markets reflects a continual yin-yang relationship between asset-exposure and risk-management. Debits, credits. Assets, hedges. In between continuous transfer of risk from one column to the other are intermediaries profiting on whatever inefficiencies develop when the same behavior affects stocks with variable liquidity. Unless you are relentlessly churning material information day upon day (inadvisable anyway), your price on 18 of 20 monthly trading days will reflect these facts and not rational thought.

That’s not bad. It just is, until the Fed stops distorting prices. What matters is measuring behaviors so you identify the real price – and it’s not a moving average – paid for your shares by rational investors competing with these other forces, and quantifying the price-setting power and market-share of the other forces – Passive investment behavior moving from assets to hedges, and intermediary Speculation. Once you’ve done that, you will know your market structure. Easy as coiffing Cote du Rhone in a Sault café.

What do the data say is next for markets? Sentiment is atrocious. I was startled to see it returning yesterday. Any tripwire – a bad data point, a careless central-banker remark – could tip equities sharply down again. If it doesn’t happen, you can thank the machines hunting for relative value and finding it nowhere else. The machines aren’t all bad.

We wish everybody the grandest, sparkling 4th of July in the USA.

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