Charts Explain Everything

Predicting the Future

Figuring out life, the market, investing, building a business, staying sane, enjoying family, planning meals, adventures. Sometimes meals can be adventures, especially when, bringing back a surprise present from India, I have to watch the good and bad bacteria fight it out inside me and wonder how long it will take the good guys to triumph. Sigh.

So, history and the market. Yesterday, I had made a reminder to myself to look at a few sample notes from Momentum Structural Analysis - https://www.olivermsa.com/ . Its goal is to look at long term structural trends all over the economic landscape and make predictions about the future on that basis. It’s the opposite of “past performance is not indicative of future results”. Short of capturing an almanac from the future, the past is probably the best resource we have to make sense of where we are and where we might be going.

I can’t say I loved the sample reports. Maybe I will have to dig in and accept the inevitability of wrestling with them some more. Not sure. The fact that my first run through left me cold - a feeling that every trend prediction is caveated and revised and adjusted as it iterates towards the actual present outcome - makes me skeptical.

Trendlines, datasets, charts are an aspect of investing that helps make sense of what has been. Mostly, I love them. One of the newsletters I subscribe to, The Mad King, uses them a lot and I find them valuable. I am skeptical of the approach that says “when this has happened in the past, this happens next”. I think there is a ton of room for confirmation bias-adjusted charting to prove a hypothesis. When the proponents accept mistakes and learn from it, I am impressed. Admitting mistakes bolsters confidence: it is relatable because we all make them.

Here is an interesting example I heard yesterday on a Hidden Forces podcast (great resource) interviewing Michael Howell of Cross Border Capital. The host asked him to comment on some predictions he had made in 2022, one of which was that we would see a steepening of the yield curve. The yield curve is - and has been for a while - inverted i. e rates are higher at the short end than the long end. Howell acknowledged the shape of the yield curve and then started to explain how things are not really as they seem. Here’s why.

First, a slight detour. Most of the mortgages in the US are insured by the government. Mortgages are originated and then typically sold to government sponsored enterprises (GSEs) such as Fannie Mae or Freddie Mac. This is supposed to remove risk from the originating banks and increase the flow of credit to the housing sector. The GSEs fund themselves by issuing bonds to the public. These bonds are backed by the mortgages whose cash flows are sliced and diced to make different kinds of securities with different maturities (MBS). Because the GSEs are quasi government entities and because of the way their bonds are collateralized, they trade as high quality bonds.

Howell made the point that 10-year MBS have historically traded at around 1.2% higher rate than a 10-year Treasury Bond. In the recent past, however, they have traded at close to 2.4% higher. So...if you look at the steepness of the 2-10 year yield curve by reference to the 10-year MBS, then the inversion goes away. Interesting for sure but also slightly moving the goalposts. His point was that because the Treasury has, over the last year or so, begun funding itself much more by issuing short-term Treasury Bills than by issuing longer term securities, the 10-year market for Treasury Bonds has become distorted. As the longer dated bonds matured, they were refinanced by shorter term bills and the remaining 10-year bonds still outstanding began to trade at lower rates because of relative scarcity. Fair point. Really important to reflect on why the Treasury has started issuing much more at the short end...

The value of a hypothesis is that it creates a starting point for analyzing data. In the case of the financial markets, the story is constantly evolving based on new facts and information. Patterns emerge and either confirm or disprove any number of theories about the economy. The GSEs were created as part of the New Deal during the FDR administration. They have undoubtedly shaped the economy since and have likely done so in ways that were not foreseen at the time.

Interest rates and stock prices are evidence of what is going on in the economy. You have to wrestle with them if you want to broaden your understanding. Charts are probably part of it, but you have to decide which ones are worth looking at, or, which ones are worth paying to look at. I am not sure I am there yet with Michael Oliver’s MSA subscription. If I change my mind, I will let you know.