You either love it or hate it. It is impossible to ignore it. It was romanticized in movies like "Wall Street" and "Barbarians at the Gate". It was vilified in the "Wolf of Wall Street" and "Rogue Trader". It is the conflux of animal spirits. It is the embodiment of capitalism. It brings out the best and worst human emotions. It is the stock market and for many, it is one giant casino.
Studies show that the average human spends more time researching the purchase of a washing machine than a stock. For these "investors", there is no difference between buying Amazon stock and shooting craps. Also, humans are horrible investors - they are led by their emotions and are easily influenced. The potential to make and lose large quantities of money causes greed, fear, panic, and anxiety to bubble to the surface in a stressful cauldron. Add to this the fact that most investors are like sheep and easily lead astray, and you create a fertile breeding ground for exploitation.
In 2016, one of the greatest traders ever, the Hungarian George Soros, was interviewed on CNBC. He was strongly advising the audience to buy gold. Two weeks later, it was revealed in a regulatory filing that Soros's flagship fund was selling gold. Was this a case of dishonesty or fox-like cunning?
Economics 101 teaches that a market is a place where buyers and sellers interact. If you are a seller, you need to find a buyer. Soros was doing exactly that – he was a seller and was inviting the world to take the other side of his trade.
So how do we approach this market? Dominating the stock market is not difficult. All you need is to disconnect your emotions and follow the stupid money. Everyone tells you to follow the “smart money.” That is horrible advice. You should follow the dumb money. Why compete with the smart guys when you can compete with the dumb asses? So where is the stupid money?
To answer this question, we go to the greatest financial fuck up in modern economic history – the Great Recession of 2008. The global banking system almost collapsed when Lehman Brothers went bust in September 2008. The crisis gave us an insight into how different markets operate under pressure. It separated the smart from the stupid. How do we find the dumb money? I am looking for the market that was the quickest and most efficient to assess the gravity of the crisis, discount all the immediate factors and then project what would happen in the future.
Financial markets are discount mechanisms. They process current information and then discount what is going to happen in the future. The markets that reacted quickest are smart and the markets that reacted slowest are dumb.
The four major markets are equity (stocks), fixed income (bonds), currency (U.S. dollar) and commodity markets. The fifth market is the derivatives market, but it derives its value from these four base markets.
The first market to hit the bottom and then recover was the currency market. The U.S. dollar, as measured by the dollar index, cratered one week after the Lehman Brothers collapse on September 22nd and then rallied 17 percent through to March 5th, 2009. Gold reached its minimum point on November 12th, 2008 and then rallied 40 percent to February 20th, 2009. The third market to hit rock bottom was the U.S. Treasury market. The yield on the 3-month treasury dipped into negative territory for one day on December 4th, 2008. This was a point of extreme pessimism showing that people had lost confidence in the banks and were prepared to pay the U.S. Federal Reserve to look after their cash.
When did the stock market hit the bottom? Three months after the treasury market. Both the Dow Jones Industrial Average and the Standard and Poor's 500 Index found their bottoms on March 9th, 2009.
This is the timeline:
22 September 2008: Currencies (U.S. dollar Index)
12 November 2008: Commodities (Gold)
4 December 2008: Bonds (the U.S. 3-month Treasury)
9 March 2009: Equities (Dow Jones and Standard and Poor’s 500 Index)
The time between the smartest money (currencies) and the dumbest money hitting their lowest levels was 168 days, which is almost 6 months. That is the gestation period of a baboon. Many believe that capital markets are linked – that currency traders talk to bond traders, who talk to commodity traders and equity traders. Nothing could be further from the truth. They are like ships passing in the night. Besides, the one market that many believe to be the smartest is, in fact, the dumbest. It is this kind of information asymmetry that gets my heart racing, my palms clammy, and my pupils dilating.
The Darwin Awards are bestowed posthumously on people who unwittingly play a key role in their own deaths. One winner was an ice-fisherman with a hankering for dynamite. Accompanied by his golden retriever, he drove his new Jeep Jerokee onto the middle of a frozen lake. He whipped out a stick of dynamite and his Zippo lighter, lit the stick and hurled it 30 meters out. His best friend obediently sprinted after the flaming stick and proceeded to bring it back and...boom. The stock market is the lifetime recipient of the Darwin Awards.