Traders like to look for tells, or leads, in the market. It is a fairly simple and obvious strategy. Figure out what is most important to the market at any given time, see what that is doing, then use that indicator as a way to define your trading. Those leads are usually something that has an obvious macroeconomic impact, like the dollar or interest rates. I will assert that in this current speculative environment, two of the most important leads are the most visible speculative memes: Tesla (TSLA) and Bitcoin.
Today is an unusual one by recent standards – we actually see a decline in major indices (at least when I write this). The pullback is hardly huge. The S&P 500 Index (SPX) was lower for the week for about a minute before recovering somewhat. (Whew, what a relief!) Considering that we opened the day higher, it was curious to see what might have derailed the latest upward leg. Then I looked at what I consider the current bellwethers of speculative fever and noted that both were lower by about 4%. While there are plenty of other speculative names that kept moving higher, such as pot stocks, TSLA and Bitcoin both sport immense market capitalizations that require continual flows of new money to maintain.
The concept of trading leads is crucial to understanding how algorithms affect the market. Remember that in many cases, the algorithms codify and refine behaviors that were employed by traders for decades or longer. If it seems as though the equity markets are following the lead of, say, the yen vs. the dollar, you can believe that algorithms have noticed that relationship as well. Data mining would reveal a link, if one exists, and trading models would adapt to purchase or sell stocks based on the movement of the yen.
The problem of following leads is that they can be fleeting. I gave the example of the yen as an SPX indicator in the paragraph above. I can think of periods where it worked well as a lead but then stopped as the market moved onto another concern. When I started in the business, the most important economic indicator was the weekly M2 money supply. Everyone was watching that indicator, so it became a lead in itself. Now I will argue that its cousin, the Federal Reserve balance sheet, is of similar importance, but its importance as a lead has diminished except in extraordinary circumstances. The market’s attention can and does change focus.
Leads can also be so long-term in nature that they don’t work well for traders. Last week we explored the relationship of bank stocks to the steepness of the yield curve, noting that they tended to outperform when 10-year yields rose faster than their 2 year counterparts. That is a structural feature of the banking business. But even a factor like that does not work perfectly. Long bond yields declined after today’s CPI release, but the Financial Select Sector SPDR (XLF) is marginally higher. The yield curve is a long-term factor that influences investment decisions more than trading decisions. It is an important lead, but not a perfect one for bank stock traders.
Today’s market environment is dominated by speculation. That means that speculative sectors provide important leads for the markets. I have come to consider TSLA and Bitcoin to be two of the most resilient and profitable items for speculators. TSLA’s recent investment in Bitcoin makes the relationship even more explicit. For now, I will consider those two investments to be a key lead for speculative trading and market sentiment as a whole. At least until that relationship inevitably breaks down like most do.
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