Rate Spread Update

“Davidson” submits:

Algorithms dominate short-term trading and use as inputs WTI (oil prices), interest rates, and the exchange rate of the US$ vs global currencies. While long-term shifts reflect economic trends and longer-term investor perception, short-term price shifts have become increasingly dominated by algorithmic trading strategies based on past historical correlations. It is problematic to base short-term trading on past price signals when prices represent different fundamentals than those on which the algorithms have incorporated.

Prices do reflect fundamentals over the long-term simply because economic reality eventually is the basis of market psychology. However, interpreting a sudden short-term shift in pricing as reflecting a shift in the long-term economic trend has economic impact. The other issue arises when one recognizes that the basis for algorithmic trading is Modern Portfolio Theory, 1952, a purely mathematical approach purposely disconnected from fundamentals. It is based on the belief that prices are all-inclusive of every factor public and private, The Efficient Market Hypothesis. Multiple Nobel Prizes were awarded to the originators. While this approach does dominate markets short-term, it is incapable of assessing fundamentals of changes in or differences in self-governance regimes and cultural investing preferences. Specifically, countries differ in protections to private property. Neither Modern Portfolio Theory or the Efficient Market Hypothesis has the capability for recognizing the risk of autocratic governance to investment assets. Routinely, companies operating under Chinese, Russian and other confiscatory regimes are compared on the same financial metrics to Western-based corporations as if there is equivalency. No equivalency exists! Algorithms are programed as if the globe operates under US protections for private property.

Some of the programming rules algorithms have been following:

  • Falling 10yr rates signal economic weakness, rising 10yr rates signal economic expansion
  • Falling oil prices signal economic weakness, rising oil prices correlated with exiting COVID lockdowns/economic demand and expansion
  • Rising technology issue prices are correlated with COVID lockdowns
  • Stronger US$ has been correlated to weaker oil prices and weaker economic activity
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Disclaimer: The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or ...

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