Process First

Process First

Here’s the thing: the future is unknowable. That’s problematic, as this job is based on predicting what’s likely to happen going forward. What to do? Focus on the process.

That’s germane right now, as we have a virtually identical situation to the August rally. In August, we got a very friendly inflation print showing 0% CPI growth m/m. The Fed didn’t tighten for a few weeks, which in part just happens as a function of how they are shrinking their balance sheet. Volatility trended lower over the same time period. The Treasury added money to the economy.

At the time, I wrote a blog talking about my frustration that we weren’t involved with the move up, but it didn’t make sense to chase, as the rally was due to temporary factors. As you can see below, that was a good call.

We wrote the same basic thing two weeks ago, saying the potential upside was as high as 4100, but the eventual downside potential is greater.

I don’t mean to belabor the point of those blogs, but I do want to make it clear that having a process makes these situations less stressful. What’s the range of what’s happened in these situations in the past? What conditions are different? Having that process yields much better results over time than just winging it.

We all care about results, but we can’t actually foretell what other people will do, and they affect the shape of forward prices. Can people keep pushing on hopes for a year-end rally? Can RRP money continue to get put to work somewhere more exciting? Sure. All we can say is that conditions similar to this have not worked out in the past, and that yield curves and data tell us the bear market bottom is likely to be some time away. Time seems to be on the side of the cautious.

At the same time, we are looking for a high-quality bear market bounce. Maybe we never get one, but we only really want to engage in a bear market rally when the odds are firmly on our side.

What would that take? Lower prices, of course. Firm risk-off positioning. We’ve already had those to some extent, though not to any sort of extreme degree. The one thing that we haven’t seen yet, and that I’d like to see, is real selling from households and the likely commensurate jump in volatility that we’ve never seen this year.

Maybe that never happens, but like we talked about two weeks ago, the conditions are potentially coming. There’s little hedging going on and a lot of data incoming. This is a market that could potentially fall sharply. Maybe it does, and maybe it doesn’t, but we’re focusing on having a good process to handle the current conditions.