12/19/14 The Black Swan/ A Remarkable U-Turn

With regard to Emerging Markets, it's likely the 'black swan' arrived (and has since departed) in the form of a collapse in crude.  Tuesday's open may have marked a low in the sector.  RSX (Russia) spiked down to 12.50, a remarkable one-month decline of -40%.  EWZ (Brazil) touched a 6-year low.  EEM (Emerging Markets) successfully tested its early 2014 low.

There are several reasons to think the worst is over for EM:

(a) Investors (myself included) invariably fail to recognize black swans.  Asset prices will usually reflect all of the risks and rewards we are able to foresee or 'imagine.'  What trips us up is (i) a consistent lack of imagination + (ii) the failure to consider all possibilities (ie, there will always be category of events we casually dismiss by adding 'and there are probably a few things I haven't thought of').  No one (publicly, that I know of) predicted a -40% decline in oil prices to under 60 this year.

(b) Emerging markets assets display high relative correlation to the price of crude.

(c) IMHO, Tuesday was a very low-risk entry point into EM.

(d) As you all know, I suffered two weeks of consecutive losses (all minor hits, to be sure- but two weeks of even minor losses add up!) trying to time a low in the BRIC sector purely based on negative sentiment.

(e) The nadir arrived Tuesday morning around 0715 pst in the form of capitulation (on my part).  Let me share a post I drafted (but never published) just minutes before making a U-turn (for context, I've included the two comments made prior to the unpublished draft):

Tuesday, December 16, 2014 7:21 AM

Global markets continue to sell off this morning.  The media (a business that depends on volatility and sensationalism) is attributing investors’ anxiety to Russia’s decision to raise interest rates to 17% (a 650 basis point increase).  The move succeeded in temporarily stabilizing the ruble, but the bounce appears short-lived. 
 
Global indexes were deeply in the red earlier this morning.  US indexes have recovered from an opening gap down, and are now off just -0.1%.
 
I have no take on whether indexes recover, or whether they continue to sell off.  It doesn’t really matter.  All trades had a one-day time frame, and with the exception of CAF (the Shanghai Composite rose +2.3%) all positions are moving against me.  Discipline dictates I close immediately for minor losses. 
 
Is a collapse in oil prices good or bad?  It’s clearly taken down with it a majority of asset classes.  Global markets may well recover today and go on to new highs (which is my favored scenario).  However, the possibility of a ‘flash crash’ is now on the table. 
 
The ability to change one’s outlook on a dime?  Generally not well regarded in most pursuits, but essential when trading.  Do you ever find yourself taking the wrong exit or driving east when you should be heading west?  The sooner you acknowledge your error, the better.  That’s one way of explaining why I take losses immediately when I’m wrong.  Hope is not a strategy.
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Monday, December 15, 2014 12:19 PM


(a) Germany, France, and the UK off an additional -2%+ following last week's precipitous declines.
(b) Brazil's Ibovespa -2% (and recovering from an earlier -3.5%).  Mexico -3.6%.  Argentina -7.9%.   RSX (Russia) off an additional -11%.
(c) DJIA -50 to 17230 (but well off a -165 plunge earlier in the day).  SPX @ 1996 (bouncing off a 1982 print this morning).
(d) Gold off -25, GDX (miners) -5.63%.
 
In my opinion, we have panic.  I buy panic.  It's not always a successful strategy, but my experiences sweeping up with Alice after the ambulances go have generally been positive.  If not when blood runs through the streets, when would you buy?
 
I may be wrong, and global markets crash over the next 24 hours.  I don't think they will.
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Monday, December 15, 2014 7:32 AM
 
It may be crazy, but I'm reopening positions in Emerging Markets at the 1030 window.  EEM -0.5%, EWZ (Brazil) -3%, RSX (Russia) -6%.

(f) I've often pointed out that successful trading includes (i) the ability to change my take on a dime + (ii) an understanding of my psychology ('knowing thyself').  So what happened Tuesday morning?  I had orders to close RYWVX (Rydex 2x Emerging Markets) at the 1030 am est trading window.  (I was also ready to close positions in RSX, EWZ, GREK [Greece], PBR [Petrobras], and CAF [China 'A' shares]).  Two minutes prior to execution, my mind flashed back to March 9, 2009.  That was the day, of course, the DJIA and SPX marked the beginning of the current bull.  I canceled orders to close the Rydex position at 0728 pst.  That's about as close as I come to a 'cliffhanger' when trading! 

(g) Make no mistake- I still believe US indexes are overdue for a 'significant' correction.  I'm less concerned about a pullback in EM.  And of course, my outlook can change in any direction, at any time!