"Don’t short this Market"

A reminder that price is the only truth

I just randomly stumbled on a great post on r/stocks. Sharing it with you is also a good way for me to internalize it. My biases have changed over the last 10 years. I used to be a much more optimistic person and therefore what some might call a permabull. The stupidity of the post-COVID rally and the birth of meme stocks made me some good money, but something turned inside me and I became quite cynical about the market. What I had fathomed to be a beautiful pricing machine turned out to be a casino where flows and narratives mattered much more than fundamentals. Over a long time frame, fundamentals still matter, but they don’t live inside my trading time frame (less than one year). I guess the old adage still holds true: “In the short run, the market is a voting machine but in the long run, it is a weighing machine.” The 2022 bear market was the nail in the coffin for me. I tasted the power of the dark side and became somewhat biased and attracted to negative narratives and pessimism. Looking back, my trading is about 50 percent risk-on and 50 percent risk-off, but the market trades risk-on about 80 percent of the time. This mismatch is no longer acceptable, especially when the money is so much easier to make on the long side.

The post I found on Reddit is a great reminder of what matters: positioning and sentiment. We as humans are not wired to succeed in the market. Millions of years of evolution prepared us for survival in the natural world, not for optimal risk-taking on virtual contracts. Trading is hard.

The link to the post is available here; otherwise you can read it below. Thank you, Reddit user proctu, whoever you are. Make sure to scroll until the end of this post.

Reflections of a Macro Equity PM - Don’t short this Market

These are just my views. I can totally be wrong, but what I will try to do is lay out my market psychology and if it can help anyone else put the pieces together then I’ll be delighted.

Stocks move higher or lower based on 1 thing. Supply and Demand. If there is more selling pressure for a stock on any given day, it will go down. The market does not care how low the Forward PE or how incredible the guidance was. To put this into context, the best traders I have met at discretionary macro equity hedge funds primarily build models as a way to understand their stocks and the factors that drive them. The models can be simple, or they can be complicated. (In my experience the simpler models tended to have better track records than fancy ones). Of course we are humans and we override the models all the time. When earnings release, the models get updated and orders get sent once the boxes are checked off. Let’s say a stock is trading at 100 and the estimate is for 2$s in EPS guidance and has already been revised up from 1.5 The number comes in at 3.5. Unfortunately most analysts across the street already had numbers as high as 4 penciled into their model. Thats what allowed them to convince their PM to run an oversized position for the last 6 months. The incentive was that by the end of the year a larger dollar amount of PNL would translate into a higher bonus. The Excel file now says 95. What was initially a 5% pop in the first few minutes turns into a 10% dump from the highs.

There is something profound about price. When price moves higher despite negative headlines and what is obviously bad news, I always stop and ask myself, why am I not long. Is there some bias thats anchoring me in a way that I’m not seeing. Is it some common take in the media thats being repeated over and over again to the point where you don’t even realize it’s influencing your views? The best traders I’ve met are incredible at dissecting these biases and recognizing what drives their own sentiment.

Secondly, All time highs are NOT bearish. How else does a stock go from 150 to 250? its not getting there by being in a 10% correction the whole way! If you want to short something, please do not try to short the stuff that made all time highs before the indexes did. Back to my first point, the demand for that stock relative to supply outpaced the average stock in the index for a reason.

Try to take a step back and remember what past bull cycles felt like. If this is your first, then this post is likely not for you. I hope you bookmark it and come back in a few years. But if you remember what trading coming out of Covid was like, that is the best proxy to dig into. Every Sunday evening, some piece of bad news would have us gapping lower only to reverse higher and maybe even end up green. Sound familiar? Every time theres some ‘escalation’, the market shrugs it off and rallies back to highs. Part of this is because everyone already has one foot out the door. It’s just math. The same supply pushing the market lower then has to come back in as demand and push the stock even higher than it was before. All because there was a quiet bid in the background coming from some factor other than the geopolitical one.

Lastly, figure out the dominant fundamental factor aka the DFF. Theres always a bull case and a bear case, but the only one that matters is the one that lines up with the DFF. To me the DFF is currently AI. This might sound counter intuitive, but I think the market would be lower right now if Iran did not happen. The Nasdaq peaked in November! And was making lower highs on the index. Meanwhile sentiment was at nosebleed levels. That was scary to me. The Iran war just happened to provid a much needed reset to market sentiment. Markets are like Rubber Bands. It’s been stretched lower and the snap back is more violent the more it gets stretched.

Look for the stocks that are giving clues. Theres a group of stocks that isnt much of a secret at this point, that barely got hit in march. Those same ones were the first stocks to make new highs and continue to make new highs after the fact. These are the same stocks that will blow out earnings, and continue to surprise to the upside. Figure out the ones that have a story. Understand that story and then line it up with the chart. If the stock is making new highs while everything else is down.. you have a winner. It happens every single cycle .. over and over. Ive seen it so many times now.

Good things happen in this world. It is in everyone’s incentive that the good outcomes are the ones that play out. It may feel like theres forces in this world that want bad things to happen, but that never happens to be the case.

Be ware of posts “famous economist predicts 30% downturn..”. For starters, these guys are usually wrong and just upset they missed out on some rally from 10 years ago. A broken clock is right twice a day. The more you see these type of headlines, and the more attention they get, the easier it is recognize the bias. The media’s job is to entertain you and get clicks. They do it with fear.

There will always be innovators who solve problems. These entrepreneurs build companies and will require capital. They will raise capital and go public and the cycle will continue.

If you’ve read this far, congratulations! The Dominant Fundamental Factor principle is a very powerful tool to better understand the market and where the money is flowing. It is similar to what a trader on X I particularly enjoy reading calls the Dominant Driver Theory. You can read a detailed introduction to his theory here:

Introducing Dominant Driver Theory

Markets can’t really focus on too many fundamental factors. Right now the dominant factor is AI, but another one is fighting for attention: oil. In the background sit some secondary factors of little importance at the moment; we can call them dormant factors: private equity, the debasement trade, the new multipolar world that encompasses supply-chain reshoring and countries’ rearmament, etc.

Fundamental factors can be antagonistic to one another. At the moment we have a very bullish dominant factor (AI) competing for attention with an extremely bearish factor (energy/Iran). Great trading is the ability to weigh these factors and trade with them—not against them—at the right time. Focusing your attention on the dominant factor is a difficult task. If you don’t let go of your ego and biases, you will end up defaulting to one narrative that leads you to trade a dormant factor at best and to trade against the dominant one at worst.

The latest podcast from Monetary Matters with Warren Pies was excellent in that regard. It perfectly explains the current duality of the market with the widely different factors at play right now: AI and Iran.

The deeper lesson from this podcast is that you should structure your investments around the main bullish factor, which is AI, but you cannot also dismiss the lurking bearish factor that is Iran. As long as the strait is closed, this factor is active in the background and can explode at any moment to take center stage. The solution is not to avoid any risk in your portfolio, but to use commodities and energy stocks as a diversifier alongside your AI / risk-on positions. Diversification remains the only free lunch in finance, so make the best out of it.

Good luck!