Thursday, July 28, 2016

Is Chinese growth stalling?

I have long had much respect for the folks at Lombard Street Research (LSR) for their unusual non-consensus calls. Back in the days of the Tech Bubble when everyone was focused on the likes of Cisco Systems, Lucent, Nokia and other technology darlings, they had said "watch China" as the next engine of growth. That turned out to be the Big Call that made me forever remember them.

It was therefore with great interest when a Bloomberg story came across my desk indicating that LSR believed that China may be in a liquidity trap. While Chinese M1 growth has been picking up sharply, LSR`s estimate of the growth the broad money M3 has been slowing, which led to the conclusion of a possible liquidity trap.


The full post can be found at our new site here.

Wednesday, July 27, 2016

Is the consolidation over?

Mid-week market update: After the stock market rally off the panic Brexit bottom that took SPX to new all-time highs, the market has been in a tight trading range for the last 10 trading days.

As the chart below shows, the 5-day RSI, which is a useful short-term trading indicator,flashed a sell signal several days ago as it retreated from an overbought reading into neutral territory. This "should" have pushed the index down further, especially with the slightly hawkish tone from the Fed today. The logical initial support level is the mid-Bollinger Band, or 20 day moving average (dma), which is rising quickly but current stands at 2140. The next support would the the breakout level at about 2120.


However, the slightly hawkish statement from the FOMC was not enough to push the market below the tight consolidation range. A market with a weaker tone would have fallen to at least test the initial support level, but it hasn't. The key question for traders is, "Is this consolidation or corrective period over?"

The full post is available at our new site here.

Monday, July 25, 2016

FOMC preview: How hawkish the tone?

As we approach another FOMC this week, much of the short-term tone of the market will depend on the Fed. In order to analyze what the Fed is likely to do, let`s begin with their mandate, which is price stability (fighting inflation) and full employment. In addition, the Fed has taken on a third objective of financial stability.

When I look at what`s happened since the Brexit vote, all signs point to a renewed path towards interest rate normalization. Therefore it would be unsurprising to see the FOMC statement take a more hawkish turn. Expect the post-meeting buzz to focus on one or two rate hikes for the remainder of 2016.

The full post can be found at our new site here.

Sunday, July 24, 2016

In the 7th or 8th inning of the bull market

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on research outlined in our post Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading component of the Trend Model to look for changes in direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of the trading model has shown turnover rates of about 200% per month.



The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Risk-on*
  • Trading model: Bullish*
The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.



Value meets Growth and Momentum
No, I am not turning bearish on stocks despite the title of this post. However, the value side of my inner investor is starting to get a little nervous. The market has risen to a level that can be described as either fair value or slightly overvalued. In addition, the behavior of "smart" investors like insiders are also raising cautionary flags that serve as early warning signs of limited upside potential.

On the other hand, the US economy is undergoing a growth revival, which is helpful for higher stock prices. In addition, the market is experiencing powerful momentum in the form of a FOMO (Fear of Missing Out) rally that's still in its early stages. The irrational exuberance scenario that I postulated two weeks ago (see How to get in on the ground floor of a market bubble) is becoming my base case. Under those circumstances, stock prices can rise further than anyone expects.

My preliminary conclusion is we are seeing the late stages of a market blow-off that will ultimately mark the top of the bull market that began in March 2009. We are in the 7th or 8th inning* of this bull and there are still gains to be made, but longer term investors should start to begin to exercise some caution.

* For readers unfamiliar with baseball, a normal game lasts 9 innings. If the score is tied after the 9th inning, then extra innings are played until a winner is determined.

The full post can be found at our new site here.

Friday, July 22, 2016

The Trump Arbitrage Trade

The reaction to Donald Trump`s speech to the Republican convention has been highly bifurcated. Mainstream media and analysts mostly reacted with horror and raised cautionary notes about his campaign of fear (see The New York Times and The Economist), while social media lit up with "I would totally vote for this guy" messages.


To be sure, Trump's speech was extremely dark in tone for the presidential candidate of any major party. Here are some key excerpts that painted a picture of a failing America:
Homicides last year increased by 17% in America’s fifty largest cities. That’s the largest increase in 25 years. In our nation’s capital, killings have risen by 50 percent. They are up nearly 60% in nearby Baltimore...

The number of police officers killed in the line of duty has risen by almost 50% compared to this point last year. Nearly 180,000 illegal immigrants with criminal records, ordered deported from our country, are tonight roaming free to threaten peaceful citizens.

The number of new illegal immigrant families who have crossed the border so far this year already exceeds the entire total from 2015. They are being released by the tens of thousands into our communities with no regard for the impact on public safety or resources...

Household incomes are down more than $4,000 since the year 2000. Our manufacturing trade deficit has reached an all-time high – nearly $800 billion in a single year. The budget is no better.

President Obama has doubled our national debt to more than $19 trillion, and growing. Yet, what do we have to show for it? Our roads and bridges are falling apart, our airports are in Third World condition, and forty-three million Americans are on food stamps...

Not only have our citizens endured domestic disaster, but they have lived through one international humiliation after another. We all remember the images of our sailors being forced to their knees by their Iranian captors at gunpoint...

In Libya, our consulate – the symbol of American prestige around the globe – was brought down in flames. America is far less safe – and the world is far less stable – than when Obama made the decision to put Hillary Clinton in charge of America’s foreign policy.
Never mind the pundits who fact checked Trump and pointed out the distortions. If you are a believer in the Trump message and you weren't sure if he will win, what would you do with your portfolio?

The answer is to buy gold. That viewpoint sets up the Trump Arbitrage: If you believe in Trump's assessment of America, you would buy gold. If you thought that things aren't as bad as the Trump view, you would buy stocks. You would buy hope - and innovation.

The Trump Arbitrage trade is either gold, or stocks. Here is the gold vs. equities pair trade, which remains largely range-bound for most of this year.



Here is how I would evaluate the Trump Arbitrage Trade.

The full post can be found at our new site here.


Wednesday, July 20, 2016

When will the bulls take a breather?

Mid-week market update: As stock prices have recovered strongly off the Brexit panic bottom to make a new all-time high, there are numerous signs that the market is ready to take a breather. In all likelihood, a period of sideways consolidation or minor pullback is on the horizon.



The full post can be found at our new site here.




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Monday, July 18, 2016

Demographics Apocalypse Now?

When I was a boy, I can remember the Zero Population Growth (ZPG) movement, which was a response to the Club of Rome's Limits to Growth Mathusian thesis of "the world has limited resources, but human population is rising exponentially and therefore ecological disaster looms". Somewhere along the way, birth rates fell in response to global industrialization, rising incomes and changing incentive structures. In an agrarian society, children are potential units of production. They can be put to work in the fields and support you in your old age. In an industrialized society, children are cost centers. It was no wonder that birth rates fell as the emerging market economies boomed.

Today, ZPG has been realized (and more). Human global population will stabilize and shrink some time in the 21st Century. In fact, global population is about to reach an inflection point in the not too distant future as the number of old people will soon exceed the number of young children (via Business Insider):


A demographic shift like this raises all sorts of questions. For investors, it brings into the question of future returns as Baby Boomer demand for retirement income starts to dominate capital market returns and strain government retirement benefits. For policy makers worldwide, the issues are how to fund retirement benefits, as well as how to structure policies to transition to an aging society.

The full post can be found at our new site here.




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Sunday, July 17, 2016

All systems flashing green for the bulls, but...

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on research outlined in our post Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading component of the Trend Model to look for changes in direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of the trading model has shown turnover rates of about 200% per month.



The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Risk-on*
  • Trading model: Bullish*
The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.


The all-time-highs explained
Regular readers know that I have been bullish on stocks for quite some time. It was therefore gratifying to see the stock market catapult to new all-time-highs. Just in case you were wondering why stock prices have been rallying in the face of Brexit uncertainty, the blogger Jesse Livermore pretty much nailed the reason with this tweet:


I also suggested last week that the market was on the verge of a growth surprise (see How to get in on the ground floor of a market bubble). The combination of an equity market friendly policy environment and positive growth surprises are acting to push stock prices higher.

The full post can be found at our new site here.






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Thursday, July 14, 2016

How much "runway" does China have left?

As we await China's Q2 GDP report in the face of sharply lower June trade figures, it's useful to ponder once again the China tail-risk question. For years, analysts have been warning about impending doom in China because of the growing mountain of unsustainable debt (see Kyle Bass, Jim Chanos, Andy Xie and George Soros).



In the past, every time China has gotten to the edge of a hard landing, Beijing has confound the bears by kicking the can down the road and forestalling a crisis. That kind of "extend and pretend" strategy is perfectly viable if the road is long enough, but the key question for investors is, "How long is the road?"

The full post can be found at our new site here.







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Wednesday, July 13, 2016

A dangerously extended market, or a FOMO rally?

Mid-week market update: The SPX has staged an upside breakout to new all-time highs and indicators are looking overbought. Now the key question for traders is whether current conditions represent an extended market that`s ripe for a pullback, or does do these conditions represent a "good" overbought condition that accompanies a momentum surge, which leads to a Fear Of Missing Out (FOMO) rally?



The full post can be found at our new site here.







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Tuesday, July 12, 2016

If machines are human, would you let one marry your daughter?*

Several months ago, the internet was all abuzz over the victory of Google's AlphaGo program beating Go grandmaster Lee Sedol (see story here). As the game of Go is a computationally and mathematically complicated game and the number of variations in the game is an order of magnitude higher than chess, it was a great victory for the kinds of "deep learning" artificial intelligence (AI) techniques pioneered by Google's Deep Mind team.

Indeed, there have been great strides by AI research teams in the fields of pattern recognition and natural language processing. As an example, the Washington Post chronicled a startup called Viv designed to be a natural language AI bot that can order you pizza, among other tasks:
In an ordinary conference room in this city of start-ups, a group of engineers sat down to order pizza in an entirely new way.

“Get me a pizza from Pizz’a Chicago near my office,” one of the engineers said into his smartphone. It was their first real test of Viv, the artificial-intelligence technology that the team had been quietly building for more than a year. Everyone was a little nervous. Then, a text from Viv piped up: "Would you like toppings with that?"

The engineers, eight in all, started jumping in: “Pepperoni.” “Half cheese.” “Caesar salad.” Emboldened by the result, they peppered Viv with more commands: Add more toppings. Remove toppings. Change medium size to large.

About 40 minutes later — and after a few hiccups when Viv confused the office address — a Pizz’a Chicago driver showed up with four made-to-order pizzas.

The engineers erupted in cheers as the pizzas arrived. They had ordered pizza, from start to finish, without placing a single phone call and without doing a Google search — without any typing at all, actually. Moreover, they did it without downloading an app from Domino’s or Grubhub.
The full post can be found at our new site here.

* The title was inspired by an old science fiction short story entitled "If all men were brothers, would you let one marry your sister?"

Sunday, July 10, 2016

How to get in on the ground floor of a market bubble

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on research outlined in our post Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading component of the Trend Model to look for changes in direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of the trading model has shown turnover rates of about 200% per month.



The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Neutral*
  • Trading model: Bullish*
The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.


A nascent bubble
Cullen Roche wrote an article last week in Marketwatch making the case that the US equity and real estate market is ripe for the formation of a market bubble.
What’s even more interesting is that this environment appears (at least in my view) to be ripe for a financial-asset bubble. That is, as weakness abroad drives yields lower in the U.S., stocks and real estate look increasingly attractive. Stocks have clearly benefited from this “reach for yield,” as have certain types of higher-risk bonds.
Indeed, as government bond yields turn negative around the world, US Treasury assets seem to be the only yield game in town. Investors are rewarded with the additional bonus of steady US growth. Stocks should benefit as falling UST yields translate into P/E expansion.


Roche continued:
But we haven’t seen the big boom in real estate yet (with the exception of, maybe, San Francisco). But could we be there? I am not certain, but here in Southern California the chatter is starting to get a little crazy again. As rents rise rapidly and future returns on stocks and bonds just don’t look that great, many people are turning to real estate.

The other day I was talking to one of the most rational and intelligent guys I have ever known. I was talking about all of this and how absurdly low mortgage rates are. He said: “Yes, that’s why you buy a house in today’s market and then go out and buy another one.” Now, this is an Ivy League econ PhD talking here, not your average stripper circa 2006 from “The Big Short.”

When rational people start saying irrational things, my ears perk up. And it makes me wonder (still) if we’re not on the precipice of something that looks a lot more like 1999 than 2008. Add it all together and it makes you wonder: Are we ripe for a big financial-market bubble, thanks in large part to foreign economic weakness? It might seem paradoxical, but don’t discount that risk.

While a market bubble is not my base case scenario and I don't like to bet on market bubbles because the thesis depends on the Greater Fool Theory of investing, what Roche says deserves some consideration. I would like to expand on the points made and explore how a bubble could form based on the following factors:
  • Better than expected growth
  • Skeptical sentiment turning into greedy sentiment
  • A market friendly Federal Reserve
The full post can be found at our new site here.



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Wednesday, July 6, 2016

A NFP preview: When will the Fed raise rates again?

In the wake of the Brexit shock, Fed governor Jerome Powell was the first Fed speaker to give a speech, which gives some clue to the direction to Fed policy. While what the Fed does near-term is important to traders, the longer term thinking is important to investors as the definition of the Fed's reaction function to events will affect the timing of rate hikes, the next recession and the next bear market.

The full post can be found at our new site here.









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Tuesday, July 5, 2016

How to beat Wall Street analysts at their own earnings game

In the past few months, I have received a lot of feedback and criticism over my use of forward 12-month EPS estimates, such as the chart below that appeared in last weekend`s post (see Brexit panic: A gift from the market gods?). I would like to clarify why this form of analysis matters and this is a valuable technique to beat Wall Street analysts at their own Earnings Game.


The full post can be found at our new site here.











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Sunday, July 3, 2016

Brexit panic: A gift from the market gods?

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on research outlined in our post Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading component of the Trend Model to look for changes in direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bullish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of the trading model has shown turnover rates of about 200% per month.

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Neutral*
  • Trading model: Bearish*
The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.


A gift from the market gods?
Now that Mr. Market has decided that Brexit has been "fixed", it's time for a sober second analytical look at the impact of this historic decision by the UK electorate on the US equity market.

The knee-jerk market sell-off appears to be a gift from the market gods to investors. The economic impact of the event on the American economy seems to be relatively minimal. Risk premiums have risen in response as the world is witnessing a repeat of the usual European theatre, whose last major production was staged during the Greek crisis of 2011.

The full post can be found at our new site here.











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Wednesday, June 29, 2016

How to trade the US election

Mid-week market update: There isn't much to say about the short-term stock market outlook, other than to acknowledge that a strong reflex rally is underway. As the markets are reacting in a highly emotional way, I have little to add other than to say that the market will be volatile. If you did jump on the buy signal issued on Monday night (see Hitting the Brexit trifecta), you might consider scaling out of your long positions as prices rise, especially as SPX rallies to test the underside of its 50 day moving average.



Brian Gilmartin pointed out that both the bond market and gold are not retracing the Brexit panic move the way stock prices are, which is a worrisome sign. I interpret these conditions as a bottoming process, where the market will bounce around in a range and re-test the lows before it can mount a sustainable rally.


Trading the US election
Now that the Brexit has been "fixed", I turn to ways of trading the US presidential election this year. The last polls show that Hillary Clinton well ahead of Donald Trump and the Iowa Electronic Markets indicates that HRC has about a 70% chance of winning.



The analysis from FiveThirtyEight show similar levels of probability:



I have a couple of suggested trades to take advantage of either Clinton or Trump winning. As Clinton is currently in the lead, I will frame these trades as a "long" Clinton trade, but if you want to be "long" Trump, then all you have to do is put on the reverse trade by shorting instead of buying.

The full post can be found at our new site here.









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Monday, June 27, 2016

Hitting the Brexit trifecta

As I pointed out yesterday (see Brexit: LTCM or Lehman?), my Trifecta Bottom Spotting Model, which has shown an uncanny record of spotting short-term market bottoms. This model flashed an "exacta" buy signal as of Friday's close and it has now flashed a "trifecta" signal based on Monday's close.

The model is based on the following three components. An exacta signal occurs if two of the components are triggered within a week of each other and a trifecta signal occurs if all three are triggered:
  1. VIX term structure is inverted: When the ratio of 1-month VIX (VIX) and 3-month VIX is above one, it indicates a high level of market fear.
  2. TRIN above 2: When TRIN is over 2, it is an indication of indiscriminate forced selling by either risk managers or margin clerks - and often marks a capitulation bottom.
  3. Intermediate term overbought/oversold: When the intermediate term OBOS is below 0.5, the stock market is oversold and stretched to the downside.
The chart below shows the past signals of this model in the last three years, with exacta signals in blue and trifecta signals in red.


The US equity market is setting up for a short-term face ripper of a rally very soon.

The full post can be found at our new site here.










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Saturday, June 25, 2016

Brexit: LTCM or Lehman?

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on research outlined in our post Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading component of the Trend Model to look for changes in direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bullish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of the trading model has shown turnover rates of about 200% per month.


The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Neutral*
  • Trading model: Bearish*
The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.


What now?
In the wake of the Brexit referendum surprise, I sensed that a lot of investment professionals were in shock and didn't know how to react to the market turmoil. I have found that having the proper analytical framework focuses the mind. I found one tweet by the FT`s Gillian Tett particularly useful for investors.


That's the critical question: Does Brexit represent a Lehman moment or LTCM moment for investors? In the former case, investors should de-risk portfolios and sell equities down to a minimum weighting in order to avoid severe losses. In the latter, investors have been handed a golden opportunity to buy stocks, Blink and the correction will be gone.

For traders, it's entirely a different story, which I will also address in this post.

The full post can be found at our new site here.








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Thursday, June 23, 2016

Brexit fallout watch

Well, my Bremain call didn't go so well (see Positioning for a Bremain result). As I write this, the BBC has called the referendum in favor of Leave by a margin of 52-48. GBPUSD is down about 10% and Asian stock markets are down 2-4%.

If you were correctly positioned for this outcome, congratulations, but don`t get overly excited about doing a victory lap as there is going to be market volatility ahead. During these episodes of unexpected market shocks, here is what I am watching for:
  • Technical: Watch for logical areas of technical support
  • Sentiment: Signs of panic and oversold reading that signal a bottom
  • Macro: Either official intervention or policy responses that could rip a short`s face off
The full post can be found at our new site here.







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Wednesday, June 22, 2016

Positioning for a Bremain result

Mid-week market update: Even though the polls show the two sides running neck and neck, my inner trader is positioning for a Remain result in the UK referendum for the following reasons.
  • Polling internals indicate momentum towards Remain;
  • Bookmaker odds overwhelmingly favor Remain over Leave; and
  • Market anxiety is rising - so a "buy the rumor, sell the news" position is not warranted.
This is obviously a speculative trade and much could go wrong. The pollsters totally missed the results of the last UK election. In addition, severe weather in southeast England could affect turnout and therefore skew results.

The full post can be found at our new site here.







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