I wasn’t built for speed. Physically. I’ve been accused of speaking quickly (I don’t get it) but have never really threatened any land speed records. After 37 years on this Earth I am willing to accept that I am built more for endurance. Instead of working out to try and win that 40-yard dash, I’m happy to know that I can do it more times than most – that’s not the worst thing in the world. What does this revelation have to with anything in the finance world? More and more I think that investors are missing that they too are not build for speed in today’s world. Think about it. Market inefficiencies have always existed – they just change form. Back when I started trading bonds in the early 2000’s, there really weren’t many algorithmic trading systems. Some bonds were traded electronically, but most were still done over phone lines (with people!). When data came out, it took a little while for the market to settle down and often there were serious price swings over the days that it took for risk to find the proper clearing level. Those who could decipher the data correctly and quickly had an edge over the rest of the market.
Today’s world is different. Machines can parse data in milliseconds. Voice trading is widely seen as a relic that will fade away. The Chicago Board of Trade has basically ended “pit trading” – so you’ll have to show your children great movies like Trading Places to see how it worked back in the Stone Age. There are some serious market implications here as well.
The biggest one has got to be that markets are now instantly efficient and long-term prone to epic corrections. In other words, unless you are a computer, you are no longer built for speed, no matter how good of a trader you were in the old paradigm (I’m sure there are some exceptions, there always are). You’ll read lots of articles bemoaning the lack of volatility in today’s market, but those articles miss the point. What used to take place over the course of a week or month is now taking place over the course of a few seconds. In other words, if you graph price action on a very small scale over extremely short periods of time, there is volatility that a computer can capture. Viewed over the course of a week or month, the same graph doesn’t show any volatility. I’ve included a chart showing a minute-by-minute chart of the 10-year US treasury future. The contract is more-or-less unchanged over the 9 hours shown – the biggest swing is around 25 cents, but you can see how it has significant peaks and valleys along the way.
Of course, when there is “volatility” in the classic sense it seems to be the type that makes you hide in a closet. For example, the S&P moving from 1600 to 650 over the course of a few months, or oil, the world’s most important commodity, free falling from ~$100 a barrel to ~$45 in a few weeks. I think this is the tradeoff we are paying for speed – things are correctly priced instantly but can be way off fair value long-term and correct over impossibly short periods of time.
What do we do? We need to rebuild ourselves for endurance. As long-term investors, that means missing the beginning and end of large moves in order to survive the big corrections. It means not falling prey to the prevailing wisdom. If I had to pick one aspect of today’s market, I’d start thinking about the way we value cash. Central banks have spent the last 5 years lowering rates to the point where some have adopted negative rates – imagine paying to keep your money in a bank instead of just keeping it in your mattress? The message is very clear – cash is a bad thing to have around. I’d suggest that to endure whatever the next market cycle has in store, investors that start investing in cash or self-maturing assets not correlated to liquid markets will outperform, even though they will give up some upside in the short-term.
There’s a famous scene at the end of Trading Places where the defeated and broke Mortimer Duke yells “Turn those machines back on!” His hope is that somehow, given another few hours, he can make back his fortune that evaporated in frozen concentrated orange juice. As investors, we know this is impossible. You can never “make money back.” You can only survive and advance, taking your wins with your losses and adapting to whatever the market environment is. It is time for everyone to take a big step back and think about how to invest in today’s market. It’s a long race – there’s nothing wrong leaving the sprints to someone else and realizing endurance is the key to success.