What was the big trading idea in the past

What’s the Big Idea? – Part 1

Sometimes, when searching for trades, it pays to take a step back. If one formulates a valid long term investment theme, it can be used as a bias to trade for months (given confirming price action and momentum). An example would be the post we wrote about the Turkish lira back in October. That article described our bias, and since then, as technical traders, we’ve been using that bias to our advantage when price action confirmed. Aggressively buying corrective dips in USDTRY with confidence, and being slow to take profits in it have been the benefits of trading around a correct theme.

The Wolf spends quite a bit of time thinking about these types of “Big Ideas.” In short, they are about defining an important macro factor, or factors, that will have significant implications for a single market, or markets.

A “Big Idea” can make the difference between huge profits, and average returns.

In swing trading, or even day trading, usually much of a month’s worth of returns will be generated by just a few trades. And, in hedge fund circles, managers are always looking for ideas that can establish strong trends so they can ride it, even if they do trade around a core position.

So, regardless of your size, or trading strategy, getting a “Big Idea” right can make the difference between huge profits, and average returns. Let me share some of the “Big Ideas” from recent history.

Big Ideas of the Past
  • 1994-2000,No US Recession” – Despite President Clinton raising taxes, there would be no US recession during this period of time. Understanding that, allowed investors to “buy the dips” and to profit from a bull market that took the Dow from 3,750 to 11,750. Laszlo outlined a key “buy the dip” opportunity seen in 1998. Certainly the way to make the most amount of money during this time period was in the NASDAQ, with names like AOL, Cisco Systems and Yahoo! But, in a big bull market like this, the key was to keep on buying.
Dow Jones Industrial Average 1994-2000
Dow Jones Industrial Average 1994-2000
  • 2000-2002, “Tech Bust/Recession” – Oh how quickly that tide turned! After doubling from November 1999 to March of 2000, the NASDAQ fell over 75% from its peak. Understanding that when a bubble bursts, “prices return to the origin of the rally” was the key in understanding how far many “good companies” would fall (CSCO, INTC, MSFT, etc.). The combination of the tech bust and 9/11 combined to push the US economy into a recession.
Cisco Systems Long Term Chart
The “Big Idea” Took Even the “Good Ones” Down
  • 2003-2007, “Housing Bubble” – There was almost no end to the easy money available with nothing down, no documentation, stated income “LIAR” loans at 110% of the value of the home. The easy money policies from the Federal Reserve bled into housing, which then entered every facet of the economy. The chart below is of the Federal Funds rate and the Taylor Rule which is a guide to what the Federal Funds rate “should” be based on objective criterion. It shows clearly that policy was too loose from 2001-2007. We wrote about this chart in last week’s Wolf’s Prey currency review. Starting in 2001, as well as from 2008-today, the Federal Reserve made a grave error. It focused on keeping asset markets elevated, when it should have been paying more attention to the real economy. For instance, in 2002 there were brisk home and car sales, which are two of the most important sectors of the economy. It didn’t take a PhD. in economics to figure out the economy didn’t need such low rates for such a long period of time.
DR Horton Long Term Chart
Get the “Big Idea” Right: Boom & Bust
  • 2007-March ’09, “Housing Bust/Financial Crisis” – Asset prices fall and leveraged financial institutions implode, are sold at fire sale prices, or are bailed out. If you understood the 30X leverage Bear Stearns, Lehman and others used, it was instructive on how far they, and the economy, could fall. After all, if you’re leveraged 30X and your assets fall 3.4%, you’re insolvent. Citigroup, Washington Mutual, Countrywide, Wachovia, Fannie Mae and AIG were the who’s who of the leveraged basket cases. And, home builders combined with financials to suck in capital on the way up, and burn it on the way down. These two sectors took the real economy to its knees.
Taylor Rule and Fed Funds
Too Loose Fosters Housing Bubble & More
  • March ’09-present, “ZIRP – Don’t Fight the Fed” – Despite the problems on Main Street (chronic unemployment, inflation & 46.2 million people on Food Stamps) the party on Wall Street would continue. Lower interest rates means that streams of cash flow are worth more; and, so, asset prices push relentlessly higher. Higher bond prices (resulting in lower interest rates) and government deficits showing up as corporate surpluses allowed both strong and weak borrowers alike to refinance and lever up. Looking back at the Taylor Rule chart, we can see that the Fed has had monetary policy too loose since 2008. In fact, it missed an entire “tightening cycle” when it failed to raise rates (and instead conducted open ended QE) from 2010-2013. Notice that the Taylor Rule has now begun to head down once again foreshadowing another recession, or worse.
Amazon.com long term chart
Amazon Took Full Advantage of Loose Policy

It’s the implications of this last “Big Idea” that is most important in deciphering the next one. We’re planning on releasing our next “Big Idea” on Friday, but we’ll give you a preview, since we’ve written about it before.

Change in investment markets always happen at the margin. What we mean by that is that all of a company’s shares are valued at the last transaction price, not at which price someone would buy the entire company. So, if “distressed sellers” show up in a stock, or other asset class (especially an illiquid one), they can impact the value of the asset – which may force more selling. So, where has the marginal capital flowed in this particular up cycle, and will that capital flow back out?

Today is a bit like 2007, in that low interest rates have impacted every single asset market. But, from where The Wolf sits, it’s the highly leveraged, low-credit quality, covenant-lite, high-yield bonds that will be the epicenter of this next Big Idea; but, they aren’t alone, and in fact, high-yield bonds are higher on the capital structure than stocks. We’ll walk through several scenarios of how a recession, and corresponding decline in asset prices could play out.

Until Friday evening,

Happy Trading!

The Wolf

 

The time zone we reference on our charts is Pacific Standard Time. Therefore, the U.S. cash market opens at 6:30 AM PST and closes at 1:00 PM PST.

About The Wolf

Twenty years is a long time to be involved in the trading business. Through many battles in every asset class known to man, knowledge has been gained; and, this project is a way to share that knowledge.
The Wolf is a big fan of repeatable market work, or the creation of a “process.”

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