From Now On, No More Second-Guessing

We’re still a few months away from January 1, 2018, but I’m making my New Year’s resolution early: no more second-guessing my indicators.

Last week when I sold the oil put, my decision came despite ongoing negative signals from my oil stock indicator. Had I heeded them, it would have kept me in the put.

The reason I wavered and sold was the big rise in oil prices, and on the face of it that might seem a reasonable reason to exit the put. But I’ve carefully constructed the indicators so that the one for oil the commodity is distinct from the one for oil stocks. Often they correlate, but at times – with 2008 the best example – stocks lead the commodity and sometimes lead it dramatically, meaning stocks can tumble before the commodity gets the message.

Don’t get me wrong, I wasn’t looking for a replay or even a mini-replay of 2008. And there is no way I should have sold the put in the face of on ongoing sell signal in the indicator governing stocks.

After all, one reason the indicators work as well as they do is that if they err, I can fix them. For example, I can uncover a previously valid relationship that no longer applies. This, however, doesn’t happen often, since most relationships such as the divergences among averages tend to be pretty timeless. A likelier fix is to discover a new relationship that has emerged because of economic changes. In this instance, the biggest example is China.

I continue to add more and more variables related to the Chinese economy, ranging from interest rates to stock prices to changes in the yuan. One reason I was feeling extra cautious right now is that China is in the midst of a twice-a-decade Communist party congress, whose message will set the tone for the economy over at least the next five years and likely beyond.

China’s economy is much more open than it was even a year ago, but the opening-up process is far from complete. One sign that the government still can play a big role in Chinese markets is the lack of movement that occurs during the nearly two weeks in which the party congress takes place. This lack of movement can distort our indicators, not in a major way, but just enough to make me a bit wary.

And it’s also possible that China could announce something at the meeting that the market is not expecting, anything from a willingness to let the yuan float more freely to the creation of new markets. One prospective new market could be an Eastern benchmark for oil that is traded in yuan, with the yuan exchangeable for gold. A new market in the world’s most important commodity, oil, that also involves one of the world’s most important currencies, gold, could easily have effects on various indicators.

So while if we had to do it again we would have followed our indicators to the letter and held onto our put position, at least you know that getting out wasn’t an impulsive decision. We’ll simply take our indicators more literally going forward. In that vein, we are staying with the put option we have on the SPY, which is consistent with our reading on a higher VIX. And we will be scouring the markets for new trades once the picture from China comes into clearer focus.



Stock Talk

Add New Comments

You must be logged in to post to Stock Talk OR create an account