Wobbly Understanding

“Even sophisticated researchers have poor intuitions and a wobbly understanding of sampling effects.”

-Daniel Kahneman

That quote comes from Chapter 10 of “Thinking, Fast and Slow” where Kahneman discusses both the Law of Small Numbers and what he calls a Bias of Confidence Over Doubt. After a day like yesterday, I had to re-read that.

Reading and re-reading my notes is what I do. I don’t read books without marking them up. I haven’t gone a market day in almost 13 years where I didn’t systematically take notes by hand on market prices. It’s not perfect. But I have yet to find a better learning process.

Re-think, Re-build, Re-learn. It’s not only my advice for the political leaders of this country, it’s the advice that I rinse and repeat with my team each and every risk management day. If you’re not finding a better way, you’re falling behind.

Back to the Global Macro Grind

I was almost certain that the SP500 was going to finally snap my immediate-term TRADE support line of 1345 yesterday. It did, but it didn’t close there. Closing prices matter more in my model than intraday ones.

Math matters. So do emotions. If you can find a way to harness both, you’ll probably make less mistakes than I did earlier in my career.

Dan Kahneman and his former thought partner, the late Amos Tversky, came up with what they contextualized as “strongly worded” advice for researchers like us. They suggested we consider our “statistical intuitions with proper suspicion and replace impression formation by computation whenever possible.” (Thinking, Fast and Slow, page 113)

Re-read that. It’s really good.

I can’t count the amount of investment research meetings that I have been in over the course of my career where someone just goes off with their qualitative observations. It’s probably endemic to the industry I follow most closely (Global Consumer), but I still don’t get how a billionaire can sit across the table from me talking about the deal he got on a fire-pit at Costco.

Over the years, after making plenty of qualitative assumptions that turned into quantified P&L mistakes, I’ve tried to cleanse myself with the “proper suspicion” of pretty much everything I think. My risk management governor is a repeatable quantitative overlay that captures real-time price, volume, and volatility signals.

No matter what we think we know, the market often has a not so funny way of thinking otherwise.

Obviously if you change the duration embedded in that thought, you come up with price disconnects that you, the great researcher, can capitalize on. But if your process aspires to be Duration Agnostic (measuring risk across different durations, all at the same time), you’ll see that you probably don’t know what you don’t know about a lot of things. That’s why I usually defer to last price.

Let’s isolate the SP500 and consider it across our 3 core durations (TRADE, TREND, and TAIL):

  1. Immediate-term TRADE support = 1345 and resistance = 1360 (we call this our immediate-term range)
  2. Intermediate-term TREND resistance = 1363 (April 2011’s closing high)
  3. Long-term TAIL support = 1267

Now if you are day trader or Warren Buffett, you could very well read into my risk management conclusions in completely different ways. If you are not Duration Agnostic, you probably should. Unfortunately, the market doesn’t care about our individual investment styles.

What happens when you overlay a fundamental Global Macro Research View

  1. US, European, and Japanese fiscal and monetary policies drive currencies
  2. Currencies drive immediate-term correlations in market inflations/deflations
  3. Inflations/Deflations drive real (inflation adjusted) Consumption Growth (71% of US GDP)

Then…

What if you have to think, fast – and slow, about all 3 durations (TRADE, TREND, and TAIL) and all 3 fundamental factors (Policy, Inflation, and Growth) – all at the same time?

I call that being Multi-Factor, Multi-Duration. I also call that Wall St 2.0.

Embracing Uncertainty and accepting that (unless we are trading on inside information) we all have a Wobbly Understanding about what is going to happen to our positioning next is what gets me right fired-up every morning. It’s my opportunity to improve the process.

My immediate-term support and resistance ranges for Gold, Oil (Brent), EUR/USD, US Dollar Index, Nikkei225, and the SP500 are now $1, $116.35-119.95, $1.30-1.33, 78.86-79.79, 8, and 1, respectively.

Best of luck out there today,

KM

Keith R. McCullough
Chief Executive Officer

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