Conspiracy Theories and Bigger Suckers

Since I last posted on Sunday night, the market has taken the path of least resistance and continued its drift higher to 2000, but what’s been interesting to note has been the continued out performance of mid and small cap names. Now we can get into a long discussion involving any of the following to explain why they’re outperforming like:

  1. Higher beta – higher return
  2. Playing catch up following period of underperformance
  3. People levering up their operating leverage expecting the economy to take off

And I’m sure these are all at least somewhat right, but hey, they’re also really boring. So let’s go all conspiracy theory on this one although not to the extremes of my colleagues at Zero Hedge. BTW, I love Zero Hedge so I’d encourage all of you to check it out.

In my former life, one of my bigger competitors was Good Harbor Financial and I do mean bigger. In the alternative or tactical market, they have quickly risen to become a multibillion dollar shop on the premise of offering strategies that seek to enhance returns in up markets with reduced volatility while protecting capital in down markets. Sound familiar? It should because it’s exactly what EVERY FIRM in that segment of the business is trying to do.  Or every firm that’s charging a fee anyway. There are a variety of means for investing with them, but there are two mutual fund’s publicly available on a number of platforms including Fidelity, Pershing, Schwab etc. For us,  tt’s the Good Harbor Tactical Core US Core or GHUAX.

All well and good and while it’s human to hate the successes of your rivals, whats been interesting to note is how their growth in assets has begun to shift trade patterns in the market. From what I understand, Good Harbor uses a quantitative method to rotate between “risky” and “risk-less” assets and will employ leverage in it’s strategies, all of which is disclosed up front so good for them (they are scrupulously honest which I do have a lot of respect for.) They also trade on a calendar system, generally the first of the month with the option for a mid-month trade and as they’ve grown in size, their market impact has changed accordingly, so much so that even the WSJ has made note of if it several times and that traders are now waiting and trading around Good Harbor trades to put on new positions (more here.) And here’s why:

This is a chart of UWM, the Ultra Russell 2000 ETF and one of Good Harbor’s preferred vehicles for when it chooses to go long equities.  If you look at the volume on the bottom of the chart, there is a massive volume spike on certain days which coincide with known trade days for Good Harbor.  Once you have that, it’s relatively easy to spot their trades into other products such as IWM, or UST.  Using this chart, what also becomes immediately apparent?  Largely that GH transactions do a perfect job of capturing the turning points in the market.

GH1So why do I bring this up now?  We can have a long-winded discussion of mechanical trade systems or concave/versus convex trade strategies but let’s keep it simple for now.  What’s coming up soon?  Yep, a new month and since Good Harbor didn’t appear to make a mid-August trade, there could be a doozy of a ticket coming up in the next few days.  Take a look at this YTD chart of IWM.  You can see some long bars on days when Good Harbor goes long equity and then shift your focus to last week with IWM holding the 50 day at $115.  If you think a reallocation could push it to $120 and you’re sitting on strong support…what’s the real risk of going long IWM?  Wait for Good Harbor to not just come into the market but to BECOME THE MARKET and either sell to them or wait a few days and then blow-out of your position.  Good Harbor is providing liquidity and taking whatever price the market is willing to offer; what’s the downside risk to you? 

I’m sure there are more than a few lessons to be gleaned from the story of Good Harbor, like understand what you’re buying, size does matter, etc.  Take a look at what happens when your system begins to break down (and why you should always have a place for human learning in your system. gh3I can tell you that trying to overcome a 2200 bps spread to the S&P 500 is a herculean task.

While I’m sure there are other lessons to be learned, you’ll have to get there on your own.  Time to get my day started and the garden won’t weed itself.

7 thoughts on “Conspiracy Theories and Bigger Suckers

  1. So I heard from a friend who generally like the post but pointed out that a firm like GH is going to work an order and have shares created rather than just simply buy in the market. He’s totally right and I guess I did a lousy job on trying to hit my mark, which is about how having a pre-set trade model and system can leave you vulnerable to more “active” traders. I was more interested in showing how some participants could use GH trade history to discern how they might shift direction and what vehicles they would use in an effort to essentially front run them. I’ll try harder in the future.

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  2. Haha very true JV, the strategy had been reverse engineered by several trading firms and gamesmanship does happen although GH has been proactive in switching up how they access liquidity.

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