11/23/10…algorithms and correlation

Bloomberg Quote of the Day: “The more corrupt the state, the more numerous the laws.” - Tacitus  

…don’t glaze over on TB…this is not a technical piece…merely an expression of the difficulty in investing in this environment. Starting off the week with a bang was the low volume of 918 million shares. Thanks to Thanksgiving there should be light volume all week and perhaps weaker by the day. Meanwhile the Treasury is auctioning 2, 5, and 7 year notes…the 2 year came off yesterday a bit weaker at 0.52% but was quickly snapped up and is now trading at a respectable 0.46%. Have fun!

Yesterday, TB mentioned that the value of the gold in ETF’s is now equal to NINE years of mining supply! Soros loves it…everyone loves it, but remember it is not an inflation hedge…but is more ‘correlated’ (inversely) to the dollar: the fear factor.

But it is not the only thing…since commodities trade in dollars it should be obvious that a weaker dollar means higher commodities prices…especially energy, but what is energy?

Sugar is now energy and it also now has a 60% correlation to the U.S. stock market, up from a historical 20%. It’s getting weirder and weirder.

The Fed has been concerned about correlation of asset classes since 2008…you do remember that don’t you? When commodities prices, led by energy, went off the charts soaring to a record high in the first half of the year then plunging. The culprit then of course was not the dollar but commodities swaps that were utilized by commodities funds to invest the huge flows coming from pension funds as they were told by their consultants to buy commodities…it seems consultants never seem to pay attention to the size of the market they are recommending…just as they did in the late 90’s when they leaned more and more towards stocks until they were more than 80% of the portfolio…then said in retrospect that they couldn’t have sold stocks and bought bonds as there simply weren’t enough bonds…a spurious argument at best!

But add to this algorithmic trading which is being done by the funds, black pools, etc. who are flashtrading and you push the correlations even higher. So how does one hedge in this market…one doesn’t…not very well anyway if everything is correlated. That would seem to be a recipe for disaster, no?

Looking at yesterday’s stock market, the Dow plunged 60 points on the open…came back 40 then dove to the session lows, down 150, closing down just 25 points, all on 918 million shares. The S&P 500 more or less broke even while the two Nasdaq indices and the Russell 2000 rallied about 0.5%. Go figure…when there is more correlation between commodities and stocks than there is between the Dow and the Russell 2000 one has to wonder…of at least TB does. As for advance/declines they were about even on all exchanges, while Breadth was universally positive and we had 246 new 52 week highs and just 71 new lows! Other than the hype about QE2 lifting asset classes what other explanation is there? It most certainly isn’t new money coming into the market.   

. . . - - - . . . . . . - - - . . . (S.O.S.)

Enough for today…why bother? Time to think about family and for Sarah Palin to be especially thankful.


Trader Bill thinks it is clear to anyone reading these missives that they are merely commentaries...as he sees it...and do not necessarily reflect the views of anyone other than his own. Information is gathered from sources he has found reliable, but no guarantees of accuracy are implied. These are merely observations of events in the marketplace offering in an attempt to offer a non-mainstream viewpoint. Copyright TBD Capital LLC, November 23, 2010.


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