Every now and then you come across a quote or a phrase that makes you roll your eyes.

In the working world I tend to find quotes such as ‘touch base’, ‘wait til the end of play’, ‘synergy’, and my least favourite, ‘singing from the same hymn sheet (it translates to ‘I want to passive aggressively make sure you do as I say)’ are all eye rollingly, teethgrindingly, fist clenchingly annoying.

In the world of markets, there are a few words and phrases that also get on my proverbials.

One is using ‘pips’ context of any asset other than FX.

The other is the term ‘smart money’.

Smart money.

Really think about it.

I could believe that it was created by someone always looking for an excuse.

For a reason to divide their reasons for losing into ‘not my fault’ and ‘not my fault’.

I’ve seen so many people talk about smart money in hindsight that I reckon we may have actually created a fault in time somewhere along the line.

Smart money is simply those investors who have more efficient means of coming to an investment decision, whether it’s based on time, money or more effective ways of entering the market.

That’s it.

It’s not some shady cabal of blokes sitting in a dark ex-monastery, plotting which way to send the markets next.

It’s simply those with access to information or the means to break information down and analyse it in a faster way.

And I think too many place too much emphasis on tracking smart money intraday. That money is not ‘smart’, that money is simply noise getting people offside short term. Probably mostly algos. But I don’t know enough about whether they are or not, neither could I care enough to delve into whether what their intraday aims are.

My focus this year and late last year has been to be building a thematic case based upon one or two key themes in the market and finding a corresponding asset class to execute in.

My post yesterday spoke about China and how they are facing some structural issues.

Since AUD is a proxy for China (AUD is correlated with Chinese aggregate demand) and JPY is bid when sentiment is risk off, it makes sense to be short AUD long JPY.

However, this pair is also a proxy for US equities since FX tends to be a more sensitive and leading indicator for intraday risk.

Cumulatively then, we can start adding other indicators in to measure whether our thesis is correct or not.

One of those is the Smart Money Flow Indicator.

This indicator is derived through the following equation:

Today’s SMI reading = yesterday’s SMI – opening gain or loss + last hour change

The reason the importance is put on the open and closing action is that covering occurs at the start of the day and more experienced investors/traders tend to trade during the end of the day since they have a more complete picture of the market.

But David, you’ve just said how you don’t like the term smart money?

Yes, well it wouldn’t be a half decent introduction without a Business Insider-like U-turn.

Bear with me.

Take a look at the SMI below.

What do you notice?

…apart from the large drop from 20k to the current index price?

Look at the support we have broken and correspond it with the years that the two supports were formed.

It should be glaringly obvious what happened at these two periods of 1999-2000 and 2007-2008.

If we take diagonal support levels as gospel then it would seem that we are in for a bit of a crap time since the smart money has now punctured through.

And there isn’t much distance between breaking the DotCom and GFC’s horizontal supports either.

There are some reasons that could be causing the fall other than smart money jumping out.

That could be due to limited retail demand while there is excessive corporate demand for equities due to buybacks – but you can’t trade stocks for buybacks in the last half hour of trading.

Longer term though, the data shows that a fall in the SMI precedes a stock market crash.

In my view, the fundamentals are aligned for another one – the question is always when?

And in my view, that will be when the US has a real risk free rate of return again.

Sometimes you just have to accept that you are going to be really silly and maybe just not follow your plan.

Yesterday that was me, and I ended up down 3% on account.

The first thing that went wrong was that I actively wanted to do business on ECB day.

I never do that, and the select few times that I have, I’ve been spanked, with one exception.

The second issue I ran into was buying the Euro thinking it would shift to the upside quickly due to there being a build up of stops. See here:

Price did run them, but I should have used this as a sign that the move would be fuelled to the downside, the reason being is evidenced here:

Trying to buy the Euro at an area of key support with a volatile ECB presser, with market flow being to the downside are you, David?

Bellend.

The third problem with yesterday was that I really didn’t even follow my longer term view for the Euro… which I had posted the night before.

https://twitter.com/david__belle/status/989223413632905216

I’m honestly laughing to myself now, because I feel like a total tool and I shall not be making this mistake again… what’s worse is that I had never been this unbelievably stupid before.

However, my saving grace is that I have a 3% limit on the day and a 5% limit on the week.

If I lose 3% in one day, I go away, don’t look at a chart for a day, then come back and see what I’ve done wrong the next day, as I’m doing now.

If I lose 5% then I simply come back the next week. I don’t even bother looking at what I did wrong that week because there was clearly something up and so I wouldn’t be able to analyse my own behaviour properly.

Now I know what I’m doing next week on the Euro, but I also know what I’m doing on  AUDJPY next week now too.

Here’s my plan on AUDJPY:

Stop is above 84, target at 80.75 with a sell above 83.10, depending on how price behaves.

If it does extend higher then I’ll divide my positions between 83.10 and 84.00, but ideally, I just want to sell into a peak above 83.10.

I wanted to write this post more for a cathartic reason – I don’t mind losing, but when I’ve done it in such a stupid and more worryingly, rather careless way, it gets to me.

Sometimes I like to have absurd predictions.

I find that by looking at a long term chart, you can build a macro reasoning around a trade idea.

It doesn’t have to be right, but it has to have validity at least and you have to be open to changing your beliefs.

I think in the next few years, we will return to cheap holidays in the US, where £1 = $2.

Here’s a 6 month chart of cable.

Looks like a head is forming.

I’d argue that a mid term hold of 1.45 and you could hold GBP and keep adding to a very long term position.

This would put British firms who deal in USD in a tight position, since you’d really have to be hedging the dollar downside heavily, although that will be perfect for FX desks looking to make budget.

This could also be reliant on a Euro collapse.

I always note that fundamental moves have to be unwound, and you can see these in the charts.

Just like how the dollar move is currently being unwound (when the Fed stopped balance sheet increases, the dollar rallied through 2014), a failure of the Euro could mean that the EURGBP position is unwound – and that can also be seen in cable.

Take a look.

Cable

EURGBP

When I refer to Euro being introduced, I mean that in 2002, this is when it was introduced as legal tended to the initial 12 countries (banknotes and coins).

This has a vastly different usage to simply being currency, since it is now connected heavily to economic activity of consumers.

This is what has changed.

Back in 2002, no one knew what monetary union would bring (well, they did, but consumers and the EU didn’t).

They didn’t know that it would bring high amounts of unemployment, huge deficits, some nations benefiting more than others, countries requiring bailouts, 5% of loans in the Euro area being non performing, Deutsche Bank holding $75tn of gross exposure to derivatives and the ECB balance sheet being the highest in the world.

They didn’t expect cheap money being the only thing to be propping up large firms.

They didn’t expect a lot of these issues that have arisen.

Yet here we are with Draghi inflating the ECB balance sheet continually.

How is he going to unwind?

Well, he won’t be able to – not at the rates currently; who will be the buyer?

So he’s in a predicament.

This is the main reason as to why I do not think the Eurozone will last. There is inevitably going to be a liquidity crisis when it comes to wanting to get rid of these bonds.

Is China going to be the country to buy EZ bonds? Not with their epic debt issues.

I think confidence will be lost, gradually.

Even as recently as yesterday, the German ZEW Economic Survey had a huge miss, and EZ data hasn’t been fantastic this quarter.

The ECB, by trying to provide liquidity to the market, are actually creating a huge liquidity issue.

Back to the trade though.

The logic is pretty simple.

If we see the Eurozone start to fracture, accumulating longs above $1.45 would be a good idea. Even buy a Sterling ETF like FXB if you don’t want to be sitting managing it. See below:

I think a combination of high dollar funding costs, of which I referred to a few years ago here in relation to oil, Trump’s trade war with China and the Fed’s unwinding are going to keep the dollar suppressed for the foreseeable future.

On sterling side, I think Brexit is going to be a catalyst for growth.

With the service sector infrastructure we have, removing ourselves from EU regulations, especially in finance, should create a more competitive environment – everyone wants an FCA & PRU licence, very few care about being regulated by EU local regulatory bodies.

If the Euro were to go, it would mean that EU financial regulators would also go – because of the above reason, and London’s name as being the world’s biggest financial hub, I’d expect this to be hugely GBP bullish (no sarcastic comments about being a typical Leave voter, please).

There is no timeline for this, since that would mean I would have a crystal ball.

But any fracturing that is apparent will solidify this as a decent bet.

I’m concerned.

The below chart of the FTSE does not look healthy to me.

We are currently facing a lot of downside pressures, with the FTSE breaking below 7000 and pushing back up twice in the last few weeks.

This gradual probing is worrying and it’s not really being spoken about too much.

Let’s face it, we’re currently off the highs up at 7800 by 800 points. This has been a gradual grind down over the past few weeks.

Why? Well I have one main reason.

The Fed is unwinding their balance sheet.

We have to remember that a huge amount of the FTSE is denominated in USD, since many sales are done in the greenback.

This therefore has a direct correlation with Fed tightening monetary conditions – one component of that is shedding the huge $4.2tn balance sheet that they have acquired over the last 9 years through quantitative easing.

No more will firms be able to stay afloat by cheap credit.

No more will retail investors be able to hold as cheap margin positions on US equities, and more specifically, products such as $SPY, an ETF that tracks the SP500.

The former has a direct effect on the financial fundamentals of a firm.

If a firm’s price has been propped up for 9 years trough cheap credit, buybacks and corporate bond purchases by the central bank, and these are all of a sudden removed, investors will see this as a negative price effect.

This has a knock on effect on FTSE firms, not only purely from an investor standpoint, but the BoE tends to follow the Fed’s Mon Pol signalling.

The overarching mechanism here is something known as equity risk premium compression – there has barely been an attractive risk free rate for such a long time, that investors have been looking for yield as if they are jacked up on testosterone.

Here is a chart showing this.

What is hugely dangerous about this current market cycle is that only 9% of the price increase of the SP500 on the past bull market is due to earnings growth.

The majority of this cycle has been caused simply by low rates.

And now that rates are increasing, I see the most violent move to the downside that we have ever seen occurring when the Fed, and consequently the BoE, begin to really shed the assets off their books.

In fact, I believe that the Fed are only increasing rates to accommodate when another crisis hits.

It is easier in terms of economic confidence, to lower from $4tn to $2tn than to increase balance sheet holding to $5/6tn when the inevitable occurs.

I drew up the below chart a few months ago of the USD.

And this is the chart now.

The Fed has been hiking, which should mean a bullish dollar.

But the dollar has been falling.

For me, this signifies a lack of confidence in the US economy, where we are reversing the 2014 move I.e the end of the balance sheet increases.

I’m not advising to do anything, but if I look at the probabilities and where the easiest money will be, I’d be looking to get short on the FTSE (or long GBPUSD as an easier trade, although with that method you’re more susceptible to price shocks).

Please see alternative non clickbait title: ‘Why the media’s interpretation of Warren Buffett’s claim that ‘low cost index funds are better than actively managed funds’ is wrong… I wouldn’t get as many clicks that way though.

Yes, I am shameless.

That is quite a statement.

I do not claim to know more than Buffet, obviously.

But the way the media have taken a statement and run with it is ridiculous.

Take a look at this article for a recap.

Buffett made a bet with Protegé Partners that buying a low cost SP500 tracker ETF from 2007 til 2016 would return more than the fund of funds that Protegé bought.

I don’t actually believe that anyone would argue that long term, SP500 trackers are the best investment…

And the stakes that they were playing at in relation to their total managed capital was so small; they initially bet $320k which then you have to question their convictions over this.

But what financial journo’s have seemingly forgotten is the motivations for investing in both and the client types that use both vehicles.

Hedgefunds are totally different to passive trackers for many reasons.

The ‘hedge’ part of the word indicates some kind of risk management or risk aversion.

Hedgefund managers want their strategy to be as uncorrelated to traditional market benchmarks as possible.

In this way, they are able to provide more consistent returns with less drawdown than you may receive where you simply invest in an index.

The returns are more bond-like where it may not beat an index benchmark, but it beats an agreed benchmark set by the fund manager in the prospectus provided before an investor comes on board.

Do you not think that all hedgefund investors would be pulling their money out if they wanted to simply buy $SPY or chuck a load of cash at other passive index funds?

The dishonesty that many outlets push with this is crazy.

Sure, a low cost index tracker is fantastic for non accredited investors and possibly as part of a wider portfolio, but when you have $100m, you certainly do not want your cash following the herd.

What if a downturn occurred?

Would there be sufficient liquidity to pull $100m out of the market?

Many live off the interest – people with a lot of money aren’t exactly saving for retirement.

If you have $100m and you’re making 6% a year net of fees (underperforming the broader market) that’s $6m for doing nothing.

The financial media, once again, has ignored specifics of the three W’s – ‘who, what, why?’

Zero nuance.

But hey, pushing money towards Vanguard is always great right?