Welcome to my first post on Substack.
I am not a writer: don’t expect wonderful prose. I am not an economist: don’t look for nicely crafted theories that ultimately don’t amount to a hill of beans. I am not a mathematician: don’t look for complex models of how the world works.
As a trader and investor, I simply try to apply common sense to the markets, guided by my principal conviction: markets move on liquidity. For anyone who does not currently share this conviction, I would urge them to research the work of and interviews with Stanley Druckenmiller. He is far more persuasive and eloquent on the subject that I ever could be. But above all I am convinced that liquidity moves markets because I have experienced it numerous times, many to my detriment, until I learnt to simply embrace this truth and its awesome power.
Liquidity is like the wind in sailing. Strong liquidity equals a strong and stable wind, poor liquidity equals a weak but still stable headwind. To continue the sailing analogy: marginal shifts in liquidity give you shifts in wind tack. To sail a boat successfully you need to know the strength of the wind and its current direction but also be able to predict, or at least recognize and react to, shifts in its direction and strength. Nothing is more dangerous than when a strong and stable wind suffers a brief and unpredictable shift in direction or speed. This is what happens:
I measure liquidity daily by recording the smallest changes in the prices of thousands of spread relationships, each representing a risk value. The stronger the liquidity, the more risk all market participants as a whole are willing to take on. Until the advent of fast computers the gathering and processing of this data took many hours and used to be run overnight. With today’s technology it takes less than 1 hour. We are truly lucky to be living in an age of accelerated progress. I publish the results as a single distilled value from -100 to +100 daily on www.riskdials.com. Such a shift in marginal liquidity occurred in February 2020.
It was the weirdest shift I had ever seen. It came out of nowhere: the markets had had beautiful sailing on very strong and stable liquidity for many months.
All the liquidity indicators were at almost full power and had been for many months, indicating a beautiful strong breeze at your back. The economy was strong, unemployment was at record lows, consumption and innovation were flying: humanity was firing on all cylinders. And then all of a sudden, this:
In five short weeks of mania the valuation of our Planet was knocked back by over 30%. Not a single country’s valuation. The Planet’s.
I say it was the weirdest liquidity shift I had ever seen. It was. We all know what happened, because we lived through it. But Covid19 was not the “real” cause. It’s not like humanity discovered pandemics with Covid19. And as far as pandemics go, it’s not like Covid19 is even serious. It’s not the Bubonic Plague, it’s not cholera in 1850s London or New York, or the Spanish Flu of 1918: it’s probably the most benign pandemic in human history, coming at a time when we have all the scientific and medical tools to fight it quickly and effectively. It’s not a large scale destructive world war or a huge natural cataclysm or even a wealth destroying financial crisis, which cause recessions in the real economy, knocking it back by years or decades.
When one analyses it dispassionately, in economic terms, it’s a minor blip in humanity’s journey, which will not merit even a footnote in the history books of the future. Why would anyone record that a few million old or very sick people died a tiny bit earlier than they would have anyway, all the while leaving their completely unimpaired wealth to the next generations, a mere couple of years at most, earlier than it would have occurred naturally? In any case, humanity replaced their “loss” in 1 WEEK, with healthy newborns. How is this “news”? How does this complete irrelevancy on our human journey knock 30% off the valuation of Planet Earth? That is The Question.
And the answer is simple: IT does not.
Only a shift in marginal liquidity CAN and DID.
Next week I will examine in detail the background as we entered 2020 and set the stage for what would become one of the most bizarre financial events ever. It merits deep analysis and many episodes. Because we will feel its consequences for many years to come and its ripples will cause almost unprecedented volatility again at some stage. In the meantime, I will leave you with this chart. To paraphrase the wise words of Christopher Cole of Artemis Capital: “There is only one true asset in the world: Volatility.”
Part 2 will follow next week.
I am so glad you are writing. Please, think about a book. Your view is beyond unique and should be preserved for the ages.
Nick I have been following your work on liquidity and riskdials for some time, along with the work of Robert Balan. Looking forward to this series. I hope you have time to cover how to best express a VIX trade for us mere mortals at some point! All the best!!