June 2024
IN THIS ISSUE
Recession is coming. Or is it?
Game On
Bank of America says do not sell in May and go away, including because the S&P 500 has performed well this time of year during presidential election years, and because the recent move to a new low in the US high yield option-adjusted spread (OAS) is a bullish indicator for a 2024 summer rally.
I don’t give credence to adages like this for a different reason. If investors know there will be widespread selling in May, then why not:
Sell in April before those other investors drive down prices?
Buy in June when those share prices will sell at a discount?
And, why stop there… if forward-thinking investors anticipate preemptive selling in April, then forward-forward thinking investors would:
Sell in March before those other investors drive down prices in April for those other-other investors in May.
Buy in July when those share prices will sell at a discount to June which will then sell at a discount-discount to May.
This is a game-theoretic way of making sense of market adages. Likelyhoods readers know my affinity for Game Theory. Here’s Likelyhoods from August 2021 when I wrote The September Effect:
If enough investors believe in the September Effect, the game-theoretic strategy is to sell in August ahead of the anticipated September selloff and pull the September Effect ahead into August. Well then there is an “August Effect” for which the game-theoretic strategy is to sell in July. With diminishing effects in each month, at some point any actual September Effect is absorbed by the magic of efficient markets, and nothing actionable remains for investors to capture an edge.
…and here’s Likelyhoods in January 2021 when I wrote the Game Theory of GameStop:
Several influential Wallstreetbets folks have publicly set a target of $1,000 per share on GME - classic signaling.
…
Given the $1,000 sell limit, who would buy at $1,000 with such a viral, widely publicized ceiling? The strategic investor would use this information to their advantage by setting their own sell limit at $999 to ensure execution ahead of the other sellers. But who would buy what others are selling at $999 for a measly $1 upside? With strategic investors selling at $999, other strategic investors submit sell limits at $998, inducing others to submit sell limits at $997, you get the idea.
In this endgame recursion, anticipated selling pressure leads prices to converge to an equilibrium, which results from the self-interested incentives of each player to defect from the strategy before other cooperating players. Psychologically, to what extent do WallStreetBets folks trust each other to cooperate in driving the price to $1,000? That equilibrium is anybody’s guess, and volatility will Likely distort this equilibrium. Ultimately however, I expect that self-interested profit-taking defections will trump game-theoretic cooperation, and prices will settle toward an equilibrium that is much lower than the $1,000 price target.
Indeed that price action seems to have repeated. After Roaring Kitty’s Monday meme sent GME prices soaring from $17.46 on Friday, May 10th to a high of $64.83 on Tuesday, May 14th, then have settled into a short-term equilibrium around $25.00 as of this writing. On both sides of the trades, it seems investors have learned from the euphoria of early 2021 when the novel “meme stock mania” sent GME whipsawing from roughly $3 up to $120, then in the subsequent 3ish years to date saw a steady slide back down to the roughly $10 level that drew Roaring Kitty’s attention once again.
Speaking of repeated, I am reminded about what Game Theory calls repeated games in which players have ongoing interactions with each other, and whereby a rational player must take into account their reputation with other players in determining the optimal strategy. If one player burns another for a short-term gain, in a repeated game they ruin any prospect for capturing the benefits of long-term cooperation with that other player.
Indeed, this most recent price action surged to a mere $64.83 rather than the $120.75 high from 2021, which perhaps can be explained by the reputational significance of fellow meme stock traders to take profits sooner before those paper profits evaporate. Those who held onto GME for too long in 2021 (diamond hands!) lost out on significant profits, perhaps placing too much reputational confidence in other fellow diamond hand peers to not take profits either. But the profit motive is strong, the diamond hands sold, and as I anticipated, prices settled to a much lower equilibrium.
So, sell in May and go away? Nah, employ a reliable process to make prudent investment decisions all year long. That’s Thinking in Likelyhoods.
ONE MORE THING…
Recession is coming. Or is it? As Oaktree Capital’s Howard Marks says, “Being too far ahead of your time is indistinguishable from being wrong.“ When two popular recession indicators failed 👎
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