Intermarket Correlations

Intermarket Correlations

Quick:  What do great symphonies, great novels, financial markets, and the conversations of clients and therapists have in common?

Answer:  All follow distinctive themes.  Much of the meaning that we find from all of them lies in our ability to track these themes across their many shifts and permutations.

A composer or novelist brings themes to life through the lines of different musical instruments or the story lines of various characters.  Financial markets express themes of economic growth/weakness, inflation/deflation, and stability/instability through the movements across asset classes and national boundaries.

Such communication by themes is familiar to psychologists:  What typically brings people to therapy is the fact that they are living out themes that aren’t of their choosing (and maybe not even within their awareness).  A common example is the abused child that, later in life, finds herself distancing from relationships and fleeing from even normal, healthy financial risk-taking.

As I emphasized in a recent post, the dominant theme in recent market action (risk assumption vs. risk aversion) has been driven by global macro investment.  We can see from the correlation matrix above, taken from my post, that a significant proportion of variance in the daily returns of stocks is shared with the U.S. dollar and commodities, as well as with 10-year Treasury yields.

After strong ISM data around 10:10 AM ET, we saw notable strengthening of the U.S. dollar against the Aussie dollar and euro, as well as a pullback in 10-year Treasury yields and a dip in oil prices.  The confluence of this and subsequent market action suggested that global macro participants were firmly in control of market action, shifting from risk assumption to risk aversion.

Our job as traders and investors is to be the therapist, the concert aficionado, and the sensitive novel reader and track themes as they emerge and shift.  If we view market action as a conversation, then we can appreciate that listening is a core investment skill.

Category: Commodities, Currency, Fixed Income/Interest Rates, Index/ETFs, Psychology

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

19 Responses to “Investing Like a Psychologist: Listening to Market Themes”

  1. ben22 says:

    Nice post. Enough said.

  2. dead hobo says:

    Then how come I hear so many crazy people, gypsy grifters, and con artists shouting so loudly in the background and often in the foreground? And why should I give them my money?

  3. dead hobo says:

    dead hobo Says:
    September 1st, 2009 at 2:24 pm

    And why should I give them my money?

    reply:
    ————-
    I know. They really like me, they only want what’s best for me, they all want to make me rich, and they’re all just really swell people.

  4. cvienne says:

    How can anyone “listen” to what the market is telling them when they’ve got the OCTABOX on CNBC filled with the Brady Bunch (minus Alice) yelling at them all at once?

  5. MRegan says:

    Very fine post. Appreciate the the risk focus and the nod to narrative. If you don´t get the story, and understand the characters, best not to play. Speaking of risk, here´s a high risk(?) possibility for those who might be interested.

    http://www.google.com/finance?q=CVE:CWV

    Very good commentary from a guy who knows what he is talking about (investment in LA w/o consulting his blog is decidedly high risk):

    http://www.incakolanews.blogspot.com/2009/09/crown-point-ventures-cwvv-two-from-two.html

  6. Are you going to run an open thread while Barry is away? He said we could…….right guys?…..guys?….Bueller?

  7. leftback says:

    Some of us spend our lives thinking and looking at data and ignoring the incessant inane babel all around us.

  8. constantnormal says:

    I was never a good dancer. I can carry a tune, but moving in time to the music … not so much.

  9. hammerandtong2001 says:

    It was said that Jesse Livermore could “see” price. His description of this ability — which was evidently self-taught — included the imagery of water, and the flow of rivulets as they embarked on their downwater streams following the paths of “least resistance.”

    The book “Jesse Livermore — The World’s Greatest Stock Trader” by Richard Smitten, includes numerous references to Livermore’s personal views about the harmony of markets and how they resembled a musical score. In fact, Livermore had to invent and then perfect a method to track his trading targets, their sector comps and his indivdual trades which were recorded by men on vast chalkboards using symbols and codes of Livermore’s own devising. Akin to music.

    A classic quote from “Reminisciences…”:

    “…And right here let me say one thing: After spending many
    years in Wall Street and after making and losing millions of
    dollars I want to tell you this: It never was my thinking that
    made the big money for me. It always was my sitting. Got that?
    My sitting tight! It is no trick at all to be right on the
    market. You always find lots of early bulls in bull markets and
    early bears in bear markets. I’ve known many men who were right
    at exactly the right time, and began buying or selling stocks
    when prices were at the very level, which should show the
    greatest profit. And their experience invariably matched mine –
    that is, they made no real money out of it. Men who can both be
    right and sit tight are uncommon. I found it one of the hardest
    things to learn. But it is only after a stock operator has
    firmly grasped this that he can make big money. It is literally
    true that millions come easier to a trader after he knows how to
    trade than hundreds did in the days of his ignorance.
    The reason is that a man may see straight and clearly and
    yet become impatient or doubtful when the market takes its time
    about doing as he figured it must do. That is why so many men in
    Wall Street, who are not at all in the sucker class, not even in
    the third grade, nevertheless lose money. The market does not
    beat them. They beat themselves, because though they have brains
    they cannot sit tight. Old Turkey was dead right in doing and
    saying what he did. He had not only the courage of his
    convictions but the intelligent patience to sit tight.”

  10. I-Man says:

    Excellent work Steenbarger:

    “Our job as traders and investors is to be the therapist, the concert aficionado, and the sensitive novel reader and track themes as they emerge and shift. If we view market action as a conversation, then we can appreciate that listening is a core investment skill.”

    Well said.

    Listening is a bit of a lost art these days… anywhere you look.

    Kind of reminds me of a PTJ interview I read recently where he said that the main hurdle facing today’s younger generation of macro traders is their inability to lose the “why”. I’m so guilty of this myself, and its a reflection of the lack of listening (exemplified earlier when I was wondering what the hell caused that weird correlated spike earlier around 11 am EST)… not to mention a major stumbling block to trading successfully.

    Doesnt matter the why…

    Listen, and ye shall hear.

    Great thoughtful post.

  11. Steenbarger says:

    @I-Man 3:49 PM – Thanks for the comment. The PTJ observation is right on the mark. There’s a creative process of information synthesis that is derailed if the mind cannot exit the mode of analysis. So much of successful (discretionary) trading hinges upon pattern recognition. That means catching the connections among observations, not just drilling down to the “why” of each of them.

    Brett

  12. flipspiceland says:

    @h&T2001

    Didn’t Livermore commit suicide in his 60s?

  13. emmanuel117 says:

    @flipspiceland:

    Was worth $100 million shorting the Crash of 1929, but somehow lost it all by 1934, and was never able to regain his trading confidence. Shot himself in 1940.

  14. cvienne says:

    @emmanuel117

    We all have our inner demons.

    My goal in life is to be the kind of person my dog thinks I am :-)

  15. dead hobo says:

    I just do what the voices in my head tell me to do.

  16. hammerandtong2001 says:

    @ flipspiceland

    Yes, Livermore died by his own hand, detailed in the following post by emmanuel117.

    The accounts suggested that he suffered from severe depression, exacerbated by an unhappy personal life.

    Yet, the account of his trading philosophy and the important impact of psychology on a trader’s success or failure as memorialized in “Reminisciences of a Stock Operator,” remains an investing classic and a must-read. I have actually watched a grizzled MD at a well-known house hand his personal dog-eared, well-used and notated copy of this book to a favored minion, a few months before the MD left Wall Street for good. It was handed off like a sacred talisman for a following generation to learn about and absorb its endless lessons. I know people who have read this book, literally hundreds of times, and yet they still comb some of the key passages for a small drop of wisdom they may have missed when their last trade went south.

    .

  17. flipspiceland says:

    @h&T

    thx.

  18. I-Man says:

    Esta es the truth.

  19. deckard says:

    Thank you Mr Steenbarger for this interesting post.

    This association of the market with themes and narratives is one that’s being looked at by sociologists of finance. Unlike speculators, the focus for them is not so much early spotting of emergent themes, but rather how these stories arise out of social interaction. The book “Pop Finance” by Brooke Harrington takes an interesting look at investment clubs, for example. Papers by David Stark and Daniel Beunza look at how stories about risk and opportunity are constructed in trading firms. And Caitlin Zaloom has a fascinating book, called Out of the Pits, on how traders adapted to technology that removed them from the pits to the terminal.

    I just wonder how all these local constructions of stories and narratives accumulate into the broad macro-market theme, as evidenced in the correlation table above.