Investors aren’t limited to only investing in the S&P 500 and the Dow Jones Industrial Average. Every week we share the market trends we are following. We are interested in whether the trends in those markets are continuing or if they are experiencing a temporary or complete reversal.
When we identify trends, we are only concerned about the price data and what it says about any given market. We don’t need to know why a trend has formed to invest, but our human nature wants to understand what is driving them. Each week we try to offer some perspective on what we think the most substantial moves are and what critical drivers are behind them. Here we look at what is going in our globally diversified, non-correlated Crystal Bay Ubitrend strategy.
Last week’s continuing trends:
- Soybeans
- Palm Oil
- The Nikkei
- Russell 2000
- Australian ASX SPI 200 Stock Index
Last week’s reversing trends:
- German Government Bonds
- Heating Oil
- Brent Oil
- The Japanese Yen
- The Brazilian Real
What we are taking note of:
Momentum in asset prices is a universal property of the markets, observed across 800 years of history and thousands of financial instruments, from stocks to bonds to currencies to commodities. It is now the most documented empirical feature of asset markets. The existence of momentum is no longer disputed; however, there is much debate about its origins and the mechanisms by which it works.
The most commonly proposed explanation focuses on the slow diffusion of news into market prices. When unexpected news arrives, it is not immediately incorporated into price. Some people receive the news first and act on it quickly. Others receive the news but fail to act on it immediately; maybe because it contradicts their beliefs or because noise in the markets makes it hard to evaluate the news’s true importance. Other people only find out about the news with a delay. This slow incorporation of new information creates momentum, as prices move to new, correct levels with a delay.
This may not be the only reason why prices show momentum. A less discussed dynamic concerns the behavior of market participants and their response to movement in prices. We’re seeing a great demonstration of that dynamic today in US farmers’ response to rising soybean prices.
Farmers use futures markets to reduce risks to their business from price fluctuations. Most of the time, they hedge by selling futures when prices are high, thus locking them in. Conversely, when futures prices are low, they reduce their hedging. But there are times in the market when they start behaving differently.
Today, US farmers have been reducing their hedges and are keeping this year’s crops unsold in storage, speculating on higher prices down the road. Their actions in turn drive prices up: fewer crops are being delivered to meet strong demand, spot prices are rising, and shortages are starting to develop. This entices the farmers to hold out even longer for the promise of exceptional prices. This self-reinforcing loop powers acceleration in price momentum beyond what could be expected by only looking at supply and demand.
Eventually, prices will overshoot and correct. It is impossible to forecast the timing and magnitude of the correction. It will not be driven by supply and demand, it will be driven by the psychology of market participants. Greed will turn into fear, and farmers will rush to empty their storage bins and sell futures, triggering a reversal.
Great intellectual firepower has been wasted on trying to forecast these turning points, with little to show for it. Such events are chaotic; random small triggers snowball into large effects. The insight of trend following comes from the recognition that forecasting is hopeless, but that emotionless, systematic response to common market dynamics is a viable strategy with positive returns over the long term.
Soybeans – Past 6 Months
