“The inside of the stock market, which is the best economist I know and which I've used every cycle when I've invested, is saying there's something not right there,” - Stan Druckenmiller, 12/18/18
“The best forecaster of market action is the action of the market itself” - George Chestnutt
Inside markets are cross market relationships seen in prices and not based on exogenous information. The inside markets are the arena of technical analysis, through broadly measuring all the information embedded in prices.
Prices are a measure of weighted opinions of market participants, and they provide our best guess of what investor are thinking. They may get it wrong, but the base assumption should be that it is a good average guess on what is going on in an economy. For example:
- The slope of the yield curve tells us about the opinion of market participants on whether monetary policy is loose or tight and whether there may be a recession. The relative performance between cyclical and defensive stocks tells us something about the likelihood of recession.
- The difference between low volatility and high volatility stocks tells us something about whether the environment is risk-on or risk-off.
- The difference between value and growth tells us something about the expectations of more distant future cash flows and overall economic growth.
While many investors try and anticipate the direction of these relationships, the inside market investors will try and extract meaning from these relationships to guide their behavior. The trend-follower may extract meaning from prices, but only act on the activity seen under the belief that it will continue in the future.
Using inside market information is core foundation to good investing regardless of how decisions are made. Opinions embedded in prices matter about what was thought in the past, where markets are currently, and where they may be headed. The choice is whether to follow this weighted average opinion or make your own decision against the crowd.
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