2024 Lessons

Another year gone by. Hopefully a lil wiser but plenty of "compelling natural forces" remain unknown...

Apologies for the lack of post the past several weeks. Real life has been busy and there's only so many times I can say “this won't end well” in regards to the final apex of what I've been calling “peak bullshit”. I expect to get back on a regular cadence in 2025 as outlined below.

---

I was deep down a YouTube rabbit hole when I first learned of the Dyatlov Pass incident. Being #1 or #2 on some crappy countdown of unsolved mysteries, I learned how in 1959, nine hikers and skiers died in the Ural Mountains of Russia under what were, to put it mildly, bizarre circumstances.

• Disparate locations of groups of victims.

• Some unclothed, some wearing the clothes of others.

• Abandoned camp fires.

• Crushed tents cut from the inside.

• Missing tongues and eyeballs.

• Traces of radiation.

The official government report from the time cited a "compelling natural force" as the cause. In other words, we don't know, but obviously something happened. In the past several years, new plausible ideas have emerged to explain what happened. New possibilities related to slab avalanches. A phenomenon of wind rushing over boulders at the right speed and angle, creating sound waves that can drive humans insane.

Naturally, all this talk of the unexplained, bizarre behavior, and people going insane reminded me of financial markets; And in particular 2024.

---

---

As the saying goes, "All models are wrong, but some are useful." And just like the Russians some 60 years ago, tasked with explaining just what the hell happened at Dyatlov Pass, it's easy to know when your model of how things “should” work is woefully inadequate. The stock market is very good at exposing this inadequacy. But for those serious about investing or speculating, chalking up failed predictions to a “compelling natural force” is hardly gratifying, though admittedly and more often than I’d like, a necessary choice.

In other words, this is the life of those trying to ride the ups and downs of financial markets. Have the best model you can, but acknowledge it is often more wrong than you would like. And have the humility to respect and observe that error when what “should” happen is one thing, and what is happening is another. Like they say, price is the only truth in markets.

---

Now the most vanilla of market models is that price reflects the waxing and waning of earning potentials of the company's underlying stock, with some multiple being used to capture things like quality, risk, growth, etc. I.e. the whole efficient market and rational actor framework. To those of you who still subscribe to this view after 2024, I offer my condolences for what is sure to have been and will be a very disappointing existence in life and markets. There is little I can say for sure, but the fact that humans are not reliably rational is one of them. That fartcoin trades on future earnings growth is another.

While I am sympathetic to, and likely a believer in the idea that stock prices (particularly on the index level) do inevitably revert to some reasonable range of earnings multiples in the long run (in multiple-year periods) - and history demonstrates the same - this model in itself is minimally useful in a world where results are measured in months and quarters.

This shouldn't come as a surprise, given its simplicity. Simplicity that is far eclipsed by the complexity of just who all is buying and selling stocks of the world's largest corporations. For better or worse, financial markets are nearly, if not the definition of complex adaptive systems. Systems where various agents act in accordance with their own changing desires and abilities, only to have those actions further change their situation and the situation of other agents in the scenario with them. A complex, likely infinite loop of change upon change, with no such thing as a steady state. Sans one brief moment where a seller and a buyer agree, a transaction occurs, and a price is set - yet only to change at the next tick up or down.

---

Now, most sane people, once they come to appreciate this abyss of complexity will throw up their hands, buy some nice treasury bills, maybe some rental property, and go about a more serene life. More power to them. But that complexity is what drew me in and what keeps me in markets, no matter how bewildering they can be at times. I have to remind myself, though, I don't need a perfect model of how things work. It can and will be wrong. It just needs to be useful. And I need to respect the ever-present and often large error—the “compelling natural force” that I can't yet explain.

Just as the Russians and others chipped away at the "compelling natural force" catch-all, I hope to do the same. It might not be knowledge of slab avalanches or insanity-inducing wind phenomena, but I do believe every year I discover a little more about the actors in markets, the ultimate buyer and seller, how they behave, and what inevitably moves market prices.

That leaves my model, though still wrong, a little more useful. And 2024 was no different. So in the below, I capture some things I saw in 2024 that may explain some of the “compelling natural force” I couldn't previously understand.

---

I didn't write a post like this for 2022 or 2023. So briefly, lessons learned in those years.

• What "priced in" means. The importance of "disparity of opinion" and Jason Shapiro's "despite moments." For example, a bullish reversal after a low open following a hot CPI print in October 2022. Stocks rose despite an unfavorable report, i.e., everyone was already concerned, no disparity of opinion.

• Impact of vol decay as hedges and their associated gamma decay over time, and market makers adjusting their positions, creating bullish flows.

• Current and forward P/E multiples do create some sense of gravity over a long enough timeline. History says as much.

---

2024 lesson #1 - Sentiment asymmetry.

While extreme bearish sentiment works like compressing the spring, extreme bullish sentiment is like hitting the gas on a cargo ship. It takes a long time to slow it down, much less turn it around. A big reason for this is the options market and how negative gamma regimes, i.e., bearish positioning by non-dealers, create volatile conditions as market makers must buy and sell in the same direction as market movements. While in more bullish conditions the options market can help further suppress volatility and lower the cost of insuring long positions.

2024 lesson #2 - Wall Street is judged on the calendar year & "the chase."

I firmly believe that understanding the different motivations of market actors is key to a more useful model. For those managing hedge funds, active managers, and the like, their success or failure is measured in calendar year performance versus the S&P 500. Clients asking the question, "Why shouldn't I just buy the index?" understandably create a situation where managers finding themselves underweight the best-performing sectors of the market are left to buy and "chase" those sectors higher. Often with leverage, creating an upward (or downward) spiral until the calendar flips to a new year. Is it any wonder momentum stocks did so well in '23 and '24, years that started with skeptical outlooks for the S&P 500? (Note: all shackles have been removed on bullishness for 2025.) Similarly, calendar effects likely exist in the realm of hedging purchases, LEAP options, portfolio rebalancing, and re-leveraging. So again, not every day or month is created equal in markets.

2024 lesson #3. Favor the trend.

It's easy to follow a trend when it's going your way. But when it runs against you, it's easy to see every little move the other direction as things finally behaving as they "should." Again, price is the only truth in markets. If the price action isn't what it should be, then you've found a new, yet unknown, “compelling natural force”. And take note that trend changes typically require more than one brief move in the opposite direction, particularly uptrends that are looking to turn into downtrends. See lesson #1. I'll plan to be more objective in judging “trend changes” in the new year.

2024 Lesson #4 - “Common knowledge” and no one really cares about data revisions.

I'm grateful to have found the thoughts of Ben Hunt this year and his thoughts on narrative in markets. His thoughts on “common knowledge” or what the crowd thinks the crowd thinks couldn't have been more timely given the first presidential debate and subsequent Biden withdrawal from the race. A true "the emperor has no clothes" moment. It was a fitting tool throughout the year to observe how common knowledge framed how initial economic data releases were received and revisions ignored, no matter how troubling. And assets bought or sold based on what the crowd thought the crowd thought (AI!). To my somewhat disappointment, we never saw a “missionary” emerge in 2024 to bring people's beliefs on the economy or AI back to a more reasonable level of reality.

Something else I wanted to add from Ben Hunt. I don’t recall the podcast or the exact words but Ben explained his experience with new games or even “games” as….first I’ll win a little, get overconfident, then I’ll lose for a lonnnnnng time, but that’s when I’m really learning. Eventually I start winning again and then I keep winning…… I found this so wise and true.

2024 Lesson #5 - “Past demand”

This lesson may still need confirmation, but when the history books are written on this business cycle, I think the early recession calls that didn't materialize will have failed to consider past demand. The economy writ large is supply on one hand and demand on the other. And while current demand is obvious enough (note: I wrote about it in one of my very first pieces, called "What Makes a Customer"), and future demand is borrowing from tomorrow (i.e. debt) for consumption today. The pandemic created a stockpile of "past demand" in but not limited to foregone experiences, traveling, and the like, with job openings, staffing levels, as well as depleted inventories of automobiles, new single-family homes, and even bygone stimulus that accumulated over $2 trillion in the Fed's reverse repo facility before finally finding its way into the real economy. We will see what 2025 brings now that most, if not all, of these levels have been normalized and “waiting on rate cuts” has put a lot of air in long term project pipelines (lag effects).

2024 Lesson #6 - A “compelling natural force” is always there more than we'd like.

I'm guessing, but if you ever find yourself more than 70% certain a stock or index is going to make a one- or two-standard-deviation move in a certain direction, you're likely falling way short of considering all the possibilities. Again, what “should” happen can be a fool's errand. So thinking about what all could happen is a good reality check. Especially when the market tends to misprice these “tails” (Biden withdrawal, GOP Sweep)

2024 Lesson #7 - Reflexivity of bad decisions when made in mass.

I wrote a piece this year about "It's a fool that sells insurance for houses built upon the sand." Not necessarily the builder. An observation that in markets, it's not whether you jump off a bridge or not, but how far the river is below. If someone wants to sell you fall protection for cheap, then by all means dance on top of the guardrails. This misses something, though. Selling insurance on a beachfront home means that future hurricanes control the fortunes of the underwriter—hurricanes that are independent of the number of homes built, how the insurance was priced, and who sold it, etc. But things are different in financial markets. Selling insurance (read: writing puts or selling volatility) has an impact on the stock market itself. One, it sends a signal to the marketplace of risk-on conditions. (Remember, everyone is rational, and if rational folks are selling insurance on the cheap, then, well...) Two, the more folks who carry insurance, purchase it from the sellers, means there are fewer people to panic sell should a downturn occur. Include passive investing, buying regardless of evaluation, and similar "bad decisions." (See fartcoin). Get enough people doing it, and suddenly there's safety in numbers. Until…. If 2024 taught us anything, ut’s that “until” could be much further away than one would imagine. But….

“In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could.” — Rudi Dornbusch

2024 lesson #8 - Leverage. Give me a lever long enough and I'll move the world.

We all know this, but it's easy to forget. 10 buyers is the same at 5 at 2X leverage or even just one at 10X leverage. Or as I said in a 2024 post, whether the balloon is blown to a 4 inch, 8 inch, or 12 inch diameter. The actual balloon material has the same mass. The volume and bursting potential increases with each puff in.

Recent years carried one of the trademarks of asset bubbles, new tools, and ways to give ever greater leverage to the common man. Bucket shops, margin loans in 1929, online trading in 2000, Ninja Loans and CDOs in 2007. This time around we have 0 DTE options and two to three times levered single-stock ETFs. Until we don't...

Couple these ways of amplifying demand with a world of passive investing and the idea of “diamond hand” holders. In other words, a world where nobody wants to or ever seems to sell. And you get volatile explosive markets, increased inelasticity.

Unfortunately, all these will eventually cut both ways.

2024 Lesson #9 - Tom Hougaard is plenty wise.

Towards the end of the year, I read Tom Hougaard's book “Best Loser Wins”. Tom's record as a trader is world-class, but his book proved to be a fount of information on how to deal with life, in general, and in particular your own weaknesses.

A few quotes I highlighted along the way.

“Winning traders seem to be much more trusting of the prevailing trend”

“Facing our fears removes their power over us”

“Our minds have one primary objective: to protect us agains perceived or real pain”

“Losers spend their time thinking how much they will make, while winners spend their time thinking about how much they will lose”

“As a famous doctor once said when asked what exercise is best for humans: ‘It’s the one you do’ “.

“We are most apt to change a pattern once we become truly disgusted by it”

“You have to know where your mind lets you down”

“Losing and failing might be a knock to the ego, but it is rocket fuel for growth”

"You can’t catch big fish in shallow waters”

“All slumps end”

“I assume I am wrong until proven otherwise, I expect to be uncomfortable, I add when I am right, I never add when I am wrong”

For me, this book joins "Zen and the Art of Poker" and Howard Marks' "The Most Important Thing" on a short list of books that were intended to be topical. But by chance, or maybe by design, provided much wisdom for life writ large. All worth revisiting more than once.

---

Better structure and process for 2025.

One quote from Tom that I wholeheartedly agree with:

"A stressed mind needs structure and process."

I hope to do a better job of giving myself that gift in 2025 and beyond. 2024 sure came with its share of stress. Having a process, such as writing, helps me zoom out and see that while the last 18 months may have been difficult for me, in and out of markets, that downtrend is merely making a higher low in the long-term uptrend of life.

---

It's taking a long time, but I've been able to reduce how I think about markets to four non-equal pillars.

Here's the list of those four.

• Price Action - Remember it’s the only truth in markets..

• Market Structure - Positioning, Breadth, Volatility, Options…my own oscillators

• Fundamentals, Sentiment - Business cycle, valuations, animal spirits, risk appetite, narrative, “common knowledge”.

• Flows - Money moving in and out of assets (passive, carry trades, vol decay, CTAs/Vol control funds, rebalancing). Relative sector performance.

Similarly, I've come to realize that I'm at my best thinking about 3 to 12 months ahead (but being mindful of December 31st). To that end, looking at charts with weekly candles on a log scale should be primary, only supplementing with daily and monthly calendar observations.

This creates a nice rhythm of being able to think more deeply about markets on Fridays without getting lost in the noise of daily and economic calendar-driven gyrations.

So I hope to do just that. And publish short posts weekly after going through my structure and process to support my often stressed mind. Monthly, I'll plan to write a bit more in-depth and provide a more insightful post. Let's face it, it often takes that long, if not longer, for enough events of importance, or even just one, to emerge.

I hope you'll come along for the ride. My model will remain wrong, though I hope more useful. And I'm sure as the year passes I'll have to chalk plenty of being wrong up to yet another, and so far unknown, “compelling natural force”.

Cheers!