What You Want vs Expect

The Game Changer for compounding returns

What You Want vs Expect

Is it just me that thinks every big piece of economic data could possibly change the narrative and trend? After all, an object in motion tends to stay in motion. The same is true in the markets, stocks and economics. Rarely does a trend reverse course quickly and without warning. In fact, most trend changes occur at extremes when the object in motion is “acted upon by an external force”. In stock and bond markets, that external force can be Fed action, investor capitulation, second derivative changes, price exhaustion or breaking out of a range. The CPI report for June in the US will be reported on Wednesday morning. Bonds have been selling off hard the past couple of weeks as the Fed introduced another 1-2 hikes possible in 2023. The P/E of stocks historically correlates with interest rates both from an investment competitive standpoint but also discounting of cash flows and risk. Is Wednesday a tipping point, change in trend and narrative? Let’s discuss.

First, let’s remind readers of a trend following system we use by Tom Demark which is available on Bloomberg called TD MA2. Quite simply, the study uses moving averages to identify trend changes. Definitionally, TD MA2 is:

A study that uses two moving averages, a shorter 10 day and longer 50 day that identifies divergences between them. A divergence occurs where the shorter and longer moving averages are moving in different directions. A bullish divergence occurs when the shorter is making lower lows while the longer moving average is making higher lows and vice versa (for bearish divergence).

Jargon aside, see the chart below for the QQQ and the color change at divergences. If this doesn’t wake you up on the length and power of trend changes, then nothing will! Most traders and investors understand the concept of letting your winners run and cutting your losers early. Few live by it in practice. Unfortunately, it is human nature to do the opposite, take profits quick and fight your losers adding as they go against you. Until any of us master this concept, compounding returns is extremely hard. It is ok to be wrong (we are all wrong likely 1/2 the time) but to stay wrong in investing is what kills performance. What is the first step to fixing this dilemma? I say a simple phrase each time I make a decision to buy or sell a new security: “What do I expect to happen, in what time frame and what price would tell me I am wrong?”