Contrarian Trading Physics

In the previous article, I may have left some with the impression that the "road to heaven" maxim as a contrarian principle was a mental trick, mere psychology. I apologize for the unfortunate emphasis. Contrarianism is built into physics. You can start with Newton's third law of motion:

To every action there is always opposed an equal reaction; or, the mutual actions of two bodies upon each other are always equal, and directed to contrary parts.

At the very least this implies that to make a change that you want to occur you must experience a force opposite to that you intend to apply. 

We can move forward to the trite and obvious, but frequently disobeyed maxims of trading securities:

Buy low, sell high.

You pay a high price for a cheery consensus.

Make a stand, lose a grand. Have a hunch, make a bunch.

To use the first law you usually have to buy when everyone is fearful, and sell when you feel like everything is going your way. The second is similar; if everyone agrees that you are buying the right investment, then it is probably too expensive. This is not just mind games. This is physics of group thought.

The third gets a little deeper into the psychology (self-contrarianism) of trading: When you try to make something happen, it often goes awry. When you are just inferring, often from scanty evidence, that something might happen, you are often right. 

This leads to some principles of trading that I sometimes use:

1. When you've done some research and found a good investment, buy a little at the start. If you buy too much, it will decline. Buying only a little either insures that it does go up, or that you will get a second chance to buy more at a lower price and to re-evaluate your logic.
2. If you have an informed hunch, buy fast and at the market. It's no use trying to capture a 5 cent spread with a limit order and missing a $2 gain over a week's time. If you find yourself hesitating, stop and don't do it.
3. When the market makes you nervous, but you like your stocks, switch it off, stop checking, and do something else entirely. This especially applies when I have what I call "market maker-stoppers", stocks that I will probably hold effectively forever anyway. I gain and they lose the bid-ask spread on the dozens of trades I never make.

Between 2020 and 2022 principle #3 probably made me more money than any other action. The market is full of noise. Once you have a position, just stick with it. 

This brings me to the most contrarian point of this blog: Though it is titled Vorpal Trade, very little of my commentary will really be aimed at short-term trading. Vorpal Investment just doesn't have the same ring. Which would people be more likely to remember? Which one captures your attention?

Now that I've slipped into the psychological aspects of trading again, it's time to cite biological examples. 

Muscles grow stronger when they are used. They grow weaker if they are not. Species undergo faster evolution in heterogeneous environments. A species which enjoys a uniformly benign environment is therefore less robust against changes to its environment. In any heterogeneous environment, the best ways for an animal to make a living are to move into ecological niches that no other animal is exploiting. In any species, members of the species are in conflict with those that prey on them, but possibly even more in conflict with other members of their own species when it comes to reproduction. Among plants, the tallest one gets the sunlight, but those plants which can specialize as vines and parasitize the tall plans by growing as vines will get the sunlight without investing in costly woody parts.

The structure of the financial system contains many, many contrarian elements. Government guarantees lead to systemic weaknesses. Mandates to service particular markets induce over-consumption leading to societal dead-weight losses and add systemic risk. Taxes reduce market sizes, distort markets, reduce and overall economic vitality. Subsidies lead to overuse, excessive prices and speculation, and destabilize markets. Good-meaning policies lead to more policies which lead to (undetected or "I don't want to see that") bad policies which undermine the financial system. 

I'll leave these statements here without proof, because this is not intended to be a political article. If you want to see some of the logic, here are a couple of places to start:

Lindsey, B., & Teles, S. M. (2017). The captured economy: How the powerful enrich themselves, slow down growth, and increase inequality. Oxford University Press.

Sowell, T. (2011). The housing boom and bust. Basic Books.

(this is part two of a series on contrarianism)

Coming Soon: Making More Mistakes, Faster

Now that the market has corrected enough that there may be some well-priced stocks to be bought, you may see more articles from me in the next few weeks or months. I never announced it, and it may not be completely related, but when most stocks are full-priced, it takes a greater effort to put together a valuation and background story, so I am less likely to publish when the market is overpriced. I did come to view the market as overpriced for parts of 2021. The rally of 2020 was a surprise. That of 2021 even more so.

This is almost certainly ego-driven: I'd much rather publish an article which eventually is shown to be correct, than to publish something that is unfortunate and mistaken. This is a continual hazard when commenting on markets. The usual antidote among newsletter writers is a combination of equivocation and obscurity, so that while you are being dazzled or entertained, whatever happens later can somehow be likened to what was written before.

I think I have a partial solution to this problem: I can write articles in which I actually attempt to make mistakes. This won't be hard [sic]. The motivation is that rather than hoping you will think I am right, that I help you better by printing (virtually) more ideas, faster, with less filtering, and that you can, from your own perspective, correct for my mistakes and see what really needs to be done. I can't vouch for my ability to be wrong [sic]. In my own experience, attempting to reverse yourself in placing trades does not work. That is, you cannot be your own contrarian. It is far easier and more successful to be a contrarian to something one reads somewhere else. And it's not just a matter of not-invented-here. Somehow the brain just works better when it is presented with information that is from somewhere else. So my goal is simple: just continue to write and comment on the markets as I see them. Any mistakes will be easy and free, and you can benefit from them even if I can't.

Actually, that's not true. An article I wrote yesterday was written by a different person. I'm a different person today. So long as I am sufficiently good at changing from day to day and don't drag my ego along with me, I too can benefit from my being wrong in print.

I have been working on article on contrarianism that is getting close to being ready for publication. If all goes well, you will see it here in the next day or two. It should go very well with this article, which in reality is about contrarianism too.

Target vs. Amazon

As a kind of warm-up exercise, we can see that in the last few days Amazon said that it's Amazon's Prime Day will be on July 12 and 13 this year. Within a day or so, Target announced that it was scheduling its own Deal Days event for July 11 through 13. 

Perhaps Target is thinking:

• they get free publicity for their own sale, since people will conflate the Amazon and Target events
• people will spend all their money on the 11th, nothing left for Amazon!
• Target's sale will be seen as better since it is for three days, not two
• people will mentally equate Target's product selection with Amazon's

Contrary take: People will compare Target and Amazon service and fulfillment, as well as prices. Frankly, Target could lose frequently in this comparison. Also, this kind of alignment clearly marks Target as a follower behind Amazon.

Marketwatch reports that "Target said during its most recent earnings [discussion] that it had a glut of inventory to sell." Will retail competition slay inflation? Unfortunately, neither event includes discounts on gasoline, housing, higher education, or medical care. Both sales may accidentally feature lots of products made in China. But most Americans have too much stuff already, and right now they want to spend time outside and spend money on experiences, not buy things for inside the house.

Gasoline is Gold

Mini-theory: gasoline is expensive because people are doing all the outdoor things they were blocked from doing in the two-year pandemic lockdown. In which case we have yet another unintended consequence of aggressive social control public health policy. Demand won't let up until everyone has slaked their thirst for living rather than waiting inside, masked, watching Netflix and eating microwave popcorn.

Current Thoughts

Federal Reserve raised its benchmark interest rate 0.75% to a range of 1.5%-1.75%. These rates are still too low, and will be followed rapidly with more hikes. The Fed is behind the curve. Worse, "amateur pundits" were ahead of the Fed in calling for this move and the Fed has lost some credibility. Does it understand the markets?

Thoughts: The initial surge of post-COVID, stimulus-caused inflation was highly predictable. The additional surge of "return to normal" from pent-up activity was also predictable. When the country went into lockdown, the economy at that time was already hot and in need of higher rates; there may have been some residual of that still in late 2021 and early 2022, but that would not have been easy to call. What the Fed and many misunderstood was the secondary effects of the combination of return-to-work and stimulus money sloshing through the system. These will be transitory yet leave long-lasting marks on the economy. Gas prices at $5 (actually, diesel prices at $6) will do damage that could last past 2024. The sharp tightening of the housing market will leave many without good options and paying rent, both in the colloquial sense and economic sense, far beyond when they should have. The sharp rise in the housing market should have been a signal to the Fed to hike rates much earlier. Why didn't they? Excess concern with politics and appearances, and a sharp impact on Government borrowing costs.

What are the odds that interest rates will go structurally higher, causing a large step up in Government financing costs? Before COVID U.S. debt was too high at $24 to $26 trillion, but at least interest rates were low. Post COVID, if 10 year and 30 year rates have a secular rise to 5% or higher, the U.S. Government will be significantly hampered in its ability to service its debt. $30T at 5% is $1.5T in interest payments a year, vs. $24T at 2% and payments of $0.48T. In other words, the penalty for the bouts of COVID stimulus may be an extra $1T of interest payments annually, indefinitely.

Put options assigned early, traders may be thinking the market will be lower today and Friday, and higher next week. Certainly the emotions from the sharp losses last week and this week could dissipate over the weekend.

Though short term interest rates are sharply higher, not all banks are responding with higher savings rates. Capital One's online savings rate is still 0.3%, while Ally has raised its savings account rates at least three times, from 0.5% to 0.6%, then to 0.75%, and recently to 0.9%.

Marketwatch: Eleanor Laise and Katie Marriner report that housing prices in small towns have exploded. There is no inventory left, and the homes are often smaller, in need of work, and outdated. "Many baby boomers have sought out retirement properties far from the bigger cities" is part of the problem. To check, I recently looked at homes for sale near Lynchburg, TN, and found many $400k+ properties. The bonus: a number of these "over-priced" houses come with property, from 20 to 90 acres. Another aspect of the problem: areas near high density cities are most affected. Property in the Shenandoah Valley in Virginia was in short supply more than 10 years ago. The article also cites tight supply in New England, where proximity to Boston and NYC means that there is an oversupply of people fleeing urban areas.

(10:00 a.m. update)

Barrons reports 6/15/22 that Facebook ad rates have declined in each of the last 6 months. This includes declines of declines of 15% in March, 19% in April, and 19% in May. Instagram ad rates were up 15% in May, however. FB sells for a little over 12x TTM EPS of $13.21.

In a 6/1/22 WSJ article Karen Langley reported that some investors were seeing bargains in small caps. The decline in small caps has outpaced the market YTD. However, it was too soon then to turn bullish. As of today, the four stocks mentioned in the article have fallen significantly further. Using prices as of about 9:30 a.m. today, SHAK is down another 18.5% since the 6/1 article. ANF is down 9.4%, BCRX down 6.1%, and CUBI down 17.7%.