Monty Hall Market

The market gave investors three doors to choose from this morning (big drop, small drop, no drop), and in best Monty Hall style, teased us by showing one door not to choose at the open (no drop). Investors who were betting on the big drop may have felt confirmed in their position, but an understanding of the The Monty Hall Problem would have clarified that the odds favored the other door. 

This problem is well studied but little understood. In the game, behind one door is a cool prize, and behind the others is a goat or similar joke prize. Contestants can choose one of three doors with no information, creating odds of 1/3 for any choice. Then the game show host opens one of the two unchosen doors to show a goat, and asks the contestant if they would like to change their choice. Oddly enough, most contestants hang onto their initial choice, when switching is a 2:1 favorite. 

Many people - including PhD's in stats - get confused by this. They think that after the goat has been shown, the odds shift to 50:50 as to which door the prize is behind, so why not just stick with the first choice, stubbornly? Not so: before the pick, the odds the prize was in the other doors was 2/3, and after the goat is shown, the odds are still 2/3 - but now in only one other door. The 50:50 odds would have been correct of Monty Hall were to pick the other door randomly, revealing the prize 1/3 of the time; but the host has superior information, and only picks the goat. 

Being stubborn as a goat makes you the goat!

After the market broke below Sp1170, the bottom of the trading range "plateau", it was as if Monty had opened one of the doors to show the goat was behind all the wave counts that meant a continued correction. The choice was down, but which door? Big or small drop? The market trended down on lessening breadth and volume, and began to come back almost immediately That was the "tell" to watch, according to yesterday's STU. 

Today we finished a little wave v to end a wave 1 down from May13. Today's special STU adds that we hit the lower trendline of the drop and bounced, confirmation of the pattern. This chart from EWTrends captures the action and gives targets for this wave 2, which normally should run at least 50% back up (Sp1107), and may go 62% (Sp1122):

 

Fascinating to me is how quickly some wavers now count the whole Flash Crash and after as but a correction in a continuing Hope Rally, an ABC flat that just ended this morning. By breaking the Feb5 level (Sp1045) and the February Bifurcation Point at Sp1063 on Feb16 (which marked the moment when the market shot back up above the congestion around the bottom), the market has confirmed a longer and deeper correction than that. 

This wave 2 is a great setup to take a short position, and may come quickly - the end of this week or early next. There is a gap way back at 1115 which will likely be closed, so the bet is for a robust bounce back to the Sp1120 area. 

Comments

[yelnick]

Hock, on whether we rotate into necessities as the end nears (oil, food vs treasuries, stocks) - this confuses investing with consumption. Near the end of the debt bomb we won't be running out of oil or food, and only if we get hyperinflation will there be a panic that way. Instead money should be hoarded and people will bury it into things of lasting value. Oil and food are consumables. Oil wells and farms, maybe. I would say keep an open mind about rotating into the AUD, NZD, Loonie and Swissies.

[yelnick]

Hock, ok, read the Bill Gross comment. Love this paragraph:

"Several months ago I
rhetorically asked whether it was possible to get out of debt crisis by increasing
debt. Yes – was the answer, but it was a qualified yes. Given
that initial conditions were favorable – relative low debt as a % of
GDP, with the ability to produce low/negative short-term policy rates
and constructively direct fiscal deficit spending towards growth
positive investments – a country could escape a debt deflation by
creating more debt. But those countries are few – the U.S.
among perhaps a handful that have that privilege, and investors,
including PIMCO, have strong doubts about U.S. fiscal deficits leading
to strong future growth rates."

Greece and the PIIGS will default. This is what happened in the 1930s - a rolling series of sovereign defaults. History shows nations default more often that you might imagine. I think Japan will also need to default, but in such a way to preserve the savings of their greying population. 

The idea that more debt can resolve too much debt is laughable without either (a) investing it wisely in production for the future or (b) defaulting first. Sadly, governments tend to spend the debt on political claims such as retirement and not on new foundations for growth. Austrians call that "malinvestment".  

[Roger D.]

Yelnick,

William Tehan years ago described the then credit condition as a "upside down debt pyramid". Gold at the bottom and levels of credit risk going up from there. Tehan thought the greatest problem would be moving to short term instruments as the debt spiraled higher. Eventually the pyramid would collapse as all creditors would become "suspect". We are nearing that point rapidly. He also said that interest rates would rise as debtors would pay higher rates just to survive. He never thought hyperinflation would be a risk in our credit system as it is currently structured.

Roger D.

[yelnick]

Roger D, love your charts, and this last comment was quite interesting, of how the end will come when the debt pyramid collapses. Interesting to envision debtors bidding up rates to survive as the edifice crumbles under their feet. That seems like the signal to get out - the final death spike.

[Roger D.]

"the final death spike" Yelnick

I think that sums it up perfectly, I like it.

I'm glad somebody finds my charts interesting,lol.

Roger D.

[guido]

I thought the goat's rear end was behind(no pun intended) door #2 and only door #1 is a mystery. Is that not right?

[Hockthefarm]

Thanks Y:

Apparently Jeremy Grantham thinks bonds are at insanely high prices (i dont have a link). He likes timber and large cap multinational US companies. Tonight's STU indicated that the drop in yields may have run its course. A steady rise from here would put the dent position in play I think. Regardless, lots of pennies to drop ahead.
Hock