It is our assertion here at 3ptCapital that price movement is Random and Unpredictable. We'll discuss this in detail in Chapter 3, so for now you will have to trust us and accept this premise.
We also know that Futures and Options are derivative instruments that carry explosive leverage which makes them WMDs. As such we need a mechanism to ensure that under no circumstance will we ever get blown up on a single given trade by some “1 in a million” event.
We must digress for a moment to discuss “1 in a million” events and overall risk in the market place today.
They seem to be happening on a regular basis these days. Since I don’t believe in coincidences, but I do believe in cause and effect, there must be a suspect behind this crime. The culprit is…. Leverage
Governments and Central banks over the past 45 years have been concocting a financial potion of poison and death. Ingredients are:
1) Spend what you don’t have.
2) Issue Debt to pay for it.
3) Cut Interest rates to make borrowing more affordable to “Help the People”.
4) Print unlimited money to then buy this debt and flood the global economy with more currency units than anyone knows what to do with.
And they will do something with it. It will be wasteful and unproductive, but by golly, something will be done!
Empty Cities built in China? - Check
"At least you don’t have to wear a helmet when riding your bike."
Millions of unsold new autos across Europe & the US that nobody needs? - Check
"Anyone need another Million Cars?"
Graft, Corruption, and never-ending War in the good ol’ USA. All made possible by an Ocean of debt financed by we the people, and the magical printing press of the Global Central Banksters.
Democracy – “You better vote for it”
The Financial Markets are not immune to the flood of money and Financial repression that is the inevitable result of all this intervention and chicanery.
When Central Banks Print trillions and buy Treasury bonds they are manipulating the Risk Free Rate that all other financial decisions are based on. This has distorted the price of absolutely everything - Including Stocks, Corporate Bonds, Real Estate, Higher Education, Healthcare - you name it. It's a very simple math formula. Let's say your net take home pay is $10k a year. Let's say that interest rates are at 10% currently. This means you could afford to borrow $100k and make the minimum interest payment. But what if they cut rates to 1%? Well then you can now afford to pay the interest on $1m in debt! And what if they cut rates to zero or even below zero? Well then you can borrow unlimited forever, provided rates never move back up.
This is basically what has been going on for the past 40 years since the U.S. severed the dollars' convertibility to Gold, and went to a 100% paper backed currency.
Economic Growth driven by a Tidal Wave of debt. This is the sole reason your parents house they bought 30 years ago at $100k is now worth $700k. Sorry to tell them, but it's not because "they were so smart" - It's because rates have collapsed from 17-18% to zero, and this has enabled qualified borrowers to massively increase the notional amount they can borrow, regardless of whether their income has increased or not.
Same thing with higher education. These zero rate government backed student loans have enabled the universities to gouge the eyes out of the poor young student who is trying to get ahead in life. But don't worry, the administrators are living large now, while the kids have a $1Trillion anchor of debt around their neck. They get the European sports cars with vanity plates, while you get a new couch to sleep on in Daddy's basement - Sounds like a fair deal to me.
"Too late, we got your money! Hahahahah"
When interest rates are artificially suppressed through monetary policy, they are enabling debtors to continue to borrow more, and service existing debt that the marketplace would have cleansed and wiped out if we only would have let it. They effectively are subsidizing the losers and bad decision makers by providing them unlimited quantities of liquidity.
And hence, we have a unlimited quantity of bad decisions being made by an unlimited quantity of losers.
Financial Markets Today
So where are we today then? Pension funds, Insurance companies, your grandma & mine, that all relied on the income they received by earning a 5-6% yield holding securities like Government Bonds, High Grade Corporate Bonds and Bank CDs, have seen this safe, reliable income stream vanish.
They are forced to go someplace else to replace this missing return. Their only option is to now move into more risky assets, or buy a badly mis-priced "safe" one - they have no choice. If they stay where they are they die of thirst..
S&P, Junk bonds & derivatives, here we come! Yeee-Haaaa!
And the punchline here is that as more and more people pile into those risky assets, they become even more risky. You have unlimited liquidity chasing limited assets which is how you end up with:
1) S&P at 25xs earnings.
2) Junk bonds yielding less than 5%.
3) A 2000 Square foot shack in Vancouver selling for $3m.
4) Governments and Corporations issuing long term debt at zero or negative rates – You now pay them to lend to them your money?! …and the list goes on and on. No telling what price you might pay for something as long as the monetary spigots are turned on and flowing.
Like a starving and thirsty animal in the Sahara Desert during dry season, that finds its’ way to a watering hole where Lions, Elephants, Hippos and others are wallowing, so will investors take the risk of getting eaten and trampled by large and carnivorous animals for a measly sip of water.
If you are forced to go to that watering hole, then you better get some protection. If you don’t, it’s only a matter of time before you become someone else’s tasty snack.
"I told you not to go over there Bob - too dangerous!"
"Fuck you man! - I was searching for yield... - Goddamn those Central Banksters!"