"Look at your fish" - same with market prices

There is importance in looking closely at the things we study. There is an old parable from Samuel Scudder called "Look at your fish". The story can best be described in "The Student, the Fish, and Agassiz," a 19th-century educational parable in which Harvard professor Louis Agassiz forces a student to study a dead fish for days, using only observation and sketching, to teach that true knowledge comes from intense, firsthand examination. It emphasizes finding "general laws" through detail.

The same process can be applied to markets. We can start with price charts. Look at your charts. Look at the prices, but just don't look once; look deeply into what the markets may be saying. Then, after looking at the prices, look at the news surrounding the prices. This does not mean that everything has to have a pattern, but for any analysis, the first order of business is looking at the data. 

See before starting to analyze. 

There is no one beta - It chnages across regimes

 

An interesting but simple paper, “Your Beta Is Wrong Regime-Dependent Alpha & Beta for Major Asset Classes”, explores the issue of regime-dependent beta. Your beta is not stationary, so alpha will not be stable but will move with the regime. This does not mean that you should calculate beta on a rolling basis; assume that beta is regime-dependent, and when the regime changes, so does the beta. Below are two examples of significant changes in beta. One shows silver, and the other is for Alphabet, one of the classic Mag 7 stocks. 

Do not assume there is one beta for any asset. This may seem obvious, but when seen in a distribution, the numbers are stark.

Think of global equity markets as a network

 We have been spending more time thinking about markets as networks or clusters. Don’t think about asset returns in isolation, but through the connections across markets and regions. Some of the latest work in this is presented in the paper, “Clustred Network Connectedness: A New Measurment Framework with Applicaitons to Global Eqiuty Markets” by Buchwalter, Diebold, and Tilmaz. 

These authors have been working on the network process for asset returns through variance decomposition of VAR models. From these models, the authors have been able to distinguish causality from and to markets across a wide set of markets. Their latest work on global equity markets seeks to address econometric issues arising from the decomposition method. This process of decomposition will provide a different narrative but will also answer questions about whether there is contagion or just co-movement across the network. The graph above shows the traditional method for forming the clustered identification. The graph below looks at the same data, accounting for groupings within the network after accounting for generalized identification.

Note that in the clustered identification, the US equity market serve as the center of netwrok behavior while the generalized idienificaiton which accoutns for correlation within groupinsg of the 16 equity markets studied, shows the high connection that is the focus of the EU cluster. Both provide interesting interpretations for how equity markets are connected. 

 

Good News - Bad News - overreaction to the bad news

There is good news and bad news that comes to the markets through new information that impacts expectations. News will have a differential impact, and investors should always be ready for it. Good news will drive prices higher, and of course, bad news will have the opposite effect, yet news will have a differential impact. Good news will usually be met with underreaction, while bad news, at the extreme, will be met with overreaction. To put it simply, the bad news forces investors to sell, and there has to be a buyer on the other side of the trade. To find the buyer, the markets will have to overreact to provide the buyer with a premium for considering the higher risk posed by the bad news. In the case of good news, there is no forced selling that requires new buyers. There will be a reaction, and there may be some extreme buying, but the buying excess is driven by a supply shortage, not by a need for a premium to induce buyers.