What does it mean to be a Credit Flow Investor?
From complex systems and earthquake studies: calm follows calm, earthquakes follow tremors, and stability leads to instability.
The longer and “bigger” a given condition or trend persists, the more dramatic the correction when the trend fails. With stability, complexity increases with time creating conditions for a fall later. The longer the stable period is the greater the earthquake when it arrives but fortunately, periods of instability are shorter. Collapses also simplify the system.
There are four principles (CPTM):
1) Credit and interest rates: Interest rates lead credit flow. Changes in credit flows precede price changes or volatility. See also credit standards. And spreads.
2) Price Changes: I measure as % change in price for 45 weeks. Other volatility measures have many variables of questionable value.
Rapid price changes cluster together. Market tremors indicate there's more to come. A rapid change in price indicates a trend change, for example when SPX swings from -20% to +20%, a bull begins. [VIX by itself isn't useful, but change in the VIX from +100 to -50 in April 2003 led to a new bull market]
The broader the market and the longer the time frame the less ‘noise’ you see. For example, track price changes in SPX instead of individual stocks over a 45 week period.
3) Trend: Ideally, you want to look for long trends - 3 to 5 years. Sector charts and larger cap stocks are also less noisy. The longer a trend persists the greater the volatility when it changes-Minsky instability. A buy opportunity occurs when credit has started to accelerate and price changes are large. A long moving average (simple container) has also been broken. In a change to a bear market, choose the negatively correlated asset (during the bull) and a basic up-trend. In the beginning of a bull market, choose the cheapest positively correlated asset and a basic up-trend.
4) Mean: Prices revert to the mean (and past it) . If buying, below the mean is best.
* Avoid the crisis! Progressively higher and record debt to GDP ratios lead to higher risk. Liquidity has been driving almost every market. The danger is all asset bubbles collapsing at the same time. Consequently, capital preservation becomes a higher priority than return. The investor protects capital by running to safety before a recession. Recessions are led by inverted treasury curves and credit deceleration. Other factors are price changes, operating earnings, and leading economic indicators,. The worst case is what matters when engaging in a policy - the worst case is far more consequential than the forecast itself.