Malt Liquidity 48
The Curious Case of Cranial Correlation, pt 3
Previously…
It doesn’t take a highly observant reader to notice that the frequency of this column is an instance of tapering that has actually happened. In part, this is a broader phenomenon I have noticed where people are generally tired of the over-stimulation derived from the constant churn of narratives and attribution bias to what is essentially television static with prices attached. In fact, this is what the “Trading Day” posts took inspiration from: with markets, the time spent is retroactively defined as worthwhile based on PnL (or friends made along the way, I suppose) - in real time, the drudgery and banality of combing through haystacks with no needles sets a finite limit on the amount of time one can spend watching markets.
While retail discovered markets as a speculative source of entertainment while shut in during 2020, it is pretty clear that the novelty has worn off as trading volumes dissipated, people looked for something else to do, and markets lurched upwards slower than a summer analyst trudging their way to work hungover. As such, my conversations about markets have morphed into financial therapy rather than quantitative discussion - seemingly everyone is convinced the market is going to crater in six to nine months, yet nobody wants to step away from the table lest the markets run up a bit more. Suggesting that people realize gains is the "don’t pass” bet of equities - how dare anyone suggest that someone might not time the top perfectly! Apparently, there will always be sufficient liquidity once the news clearly tells people to get out. Though I hate the acronym, for a retail investment portfolio, inflation fears are precisely what “fear, uncertainty, and doubt” was meant to encompass: as I’ve written before,
Inflation is a systemic problem sold to individuals as their own. As long as the individual does not continue to take out debt as the rate of inflation increases, they will benefit from it even if their salary lags, due to their debt accruing at the already-issued rate which is not adjusting for inflation. Individuals also benefit because institutions have to outpace the rate of inflation as the cost is so massive to them - they have to allocate assets to anything that can potentially return more.
Inflation preys on the extremes - the people who have to scrape together coins from their couch to cover the increasing cost of gas so they can get to work, or the multi-billion dollar pension that guarantees an inflation-adjusted return. Your Tesla stock is up 500% in the past few years - a couple quarters of 4% inflation is not something to freak out about.
In the retail (and twitter) purview, assets that trade work something like this:
asset price is going up/down (ignoring book depth and spreads), clearly this means there will be a lot more people buying/selling this going forward, I can’t miss out
asset price is going up/down, some news must have come out that moved it. I should go read the news and show my reaction to it by trading
something similar to an asset got a lot of internet traffic, I should buy this asset and sell it to someone else who thinks that it’s representative of whatever was trending (regardless of whether anyone mixed it up in the first place)
While 2020 was the year of “we trade because we are bored”, 2021 seems to be the year of being ignorant of asking why things trade in the first place. The thing is, none of those bullet points are inherently false - they’re simply predicated on other people with the same philosophy continuing to participate in the markets. They can only remain true as long as retail trading volume holds, which it does not appear to be doing.
Why do people trade? Well, this is too broad of a question for a newsletter - it’s more of a dissertation or a product of Ray Dalio huffing paint at Burning Man - but a very important thing to remember is that institutional money doesn’t care about intraday movement. Their priorities are a stable yield over time, and their size is too large to move in and out of the market without impacting the price and destabilizing this yield. Indeed, the entire equity option market spawned out of demand for insurance against stock positions - puts are simply insurance against your stock moving down, and public markets are just a way of democratizing the ability to sell it.
So who is trading intraday? Outside of retail, it’s primarily arbitrageurs replicating equity performance in publicly traded products and market makers. Most of the volume in the day is simply facilitation of products to track what they are supposed to - there has to be a long/short mechanism keeping, say, QQQ in line with its underlying components - it’s not simply a handshake agreement to transact at whatever the math says the product would trade at. This volume is sort of an illusion - you will never really trade against these market participants, because they are not speculating on the underlying price in the fashion you are. If I buy AAPL, I’m not 1v1'ing Citadel if they so happen to be the one who sold me the shares.
Perhaps I was too harsh in what I called 2021 a couple of paragraphs ago. Maybe it is the year of people searching for a reason to continue trading. 2020 conditioned everyone to such volatile market conditions and outsized price movement (especially given the fact that tons of people started trading in 2020) that when markets went back to normal, people sought out volatility for the sake of it, whether it’s weed stocks, pictures of apes, or FrogSolana.
And that’s sort of the current state of markets. Institutions are overcrowding and bidding up every asset class, adjusting equity positioning, and biding their time for when rates inevitably rise. The retail traders that are still trading are trading in ADHD fashion no matter how puerile the asset class may be. As for macro events, like China’s debt situation, well, that’ll take years to play out - it’s not a day to day Evergrande doom and gloom fear narrative that seems to be playing out on the front page of the Wall Street Journal. Unlike auto-generated Netflix content or Twitter, narratives and news of substance do not generate each day and impact the long term view of markets. Not that much happens, no matter how badly we want something to fill our time, I suppose.