Traders Interview: How Peter Navarro Identifies Trades Triggered By Major Events

Eddie Kwong: I guess just to start off, maybe you can tell me a little bit about your background and what you do and how you became interested in trading off of macroeconomics.

Peter Navarro: Sure. I’m a professor of economics at the University of California, Irvine, Business School, and my task at the school is to teach MBAs macroeconomics. Over the years I’ve learned that the best way to teach macroeconomics was really to explain to my students how closely tied the business cycle is to the stock market cycle. So, about five years ago, I basically started teaching the class as both an economics course and a quasi-trading course.

One of the assignments I have in the class is for the students to trade a mock portfolio. But interestingly enough, I don’t have them trade stocks. I have them trade sectors, exchange-traded funds and the iShares. And what I try to do is get them to think about how sector rotation occurs in response to different macroeconomic events and in the case of the recent terrorist attack, a macroeconomic shock (for example, “An Earthquake in Taiwan,” was the title of a book I just got published, or a drought in Brazil).

So, by teaching that class, I myself began to develop a much keener sense of how the markets move and react to different kinds of news events. And it’s been very, very interesting to me. So, I basically took what I learned and put it in that book “If It’s Raining in Brazil, Buy Starbucks.” It’s a catchy title that often gets a laugh, but the sub-title really tells more about it — “The Investor’s Guide to Profiting from News and Other Market-Moving Events.”

Eddie: Now what’s really interesting is that there are two — it’s kind of like a perspective from the standpoint of traders. Typically, traders think, “Oh, macroeconomics. I need to focus purely on the market action. And everything that is contained in the price and volume action is all I need to see. And these news events are already factored into the market.”

Peter: Well, there are two things that are important to note for any trader, even daytraders. Watching the macroeconomic calendar and the flow of events will help gauge the trend better, the broad market trend, but also the sector trend. The other thing is it will help traders prevent themselves from getting caught in traps. For example, if you’re in a large position, and if you enter a large position 10-15 minutes before Alan Greenspan goes to testify before Congress in what is expected to be a major policy speech, you’re really risking a tremendous amount of capital because depending on what Greenspan says, the market can move literally a nanosecond after he said it. And so if you’re oblivious to the flow of macroeconomic news, you can get caught.

In the book, I actually had a number of examples of how traders got caught in bad positions when, say, the Consumer Price Index came out unexpectedly, or the Jobs Report, and things like that. So, from the trader’s point of view, to ignore the broader macro-fabric is really to take on a lot more risk than they need to.

Eddie: Well, certainly most traders that I know — we have what we call here the War Room where we have a bunch of analysts who are continually monitoring what’s going on in the market — most traders I know, whether they’re the real short-term daytraders or they trade on a two- to three-day time horizon like swing traders, they do maintain an awareness of major economic events scheduled on a calendar. You’re taking it one step further, which I find really fascinating, which is basically to look at the real, real big picture, what’s unfolding in terms of the macroeconomic cycle, which could take, I suppose, years to unfold. And you’re saying that this is something that any trader, regardless of how short their time frame is, should pay attention to, or at least have in the back of their mind, right?

Peter: Absolutely, and I’m sure that for the stock trader, macroeconomic news is probably of the least value, but valuable nonetheless, and as you move into swing and position trading, it becomes absolutely essential. For example, if you see in Argentina at the beginning of the currency crisis, you can envision a whole train of events in which that particular problem in one very small country very far away could lead to massive movement in the values of currencies worldwide, a weakening of the dollar, for example, and have a tremendous impact on a variety of stocks. For example, stocks that are in export industries in the US, which might actually benefit from a weaker dollar, to stocks which are multinational, which in fact, have a lot of revenue generated in foreign currencies and would see their profits cut dramatically by a weaker dollar. So, the point is that this is what I call macrowave thinking.

The whole idea about macrowave is that their are really two dimensions to it. One is the whole idea of watching the broad macrowaves. The other is engaging in what I call macroplays. A macroplay, for example — well, let’s take one right out of the book — ^UAL^ announces the acquisition of ^U^. The “checkers” play for traders when that happened would be to go in and try to go long on US Air, but the problem with that is that the stock gapped up almost immediately, trading was halted for a while, and people who got in after trading resumed ended up getting in at the top and losing money. I mean, the only play there might have been to short it.

But a macroplay “chess” move would have been to look at that industry and say, “Hey, look. If this merger goes through, it’s going to create one of the largest companies in the world. That means that American
^AMR^ and ^DAL^ are going to be looking to get big themselves, and that means they’re going to go out and acquire somebody else, and who would that be?” It doesn’t take you too long to figure out ^NWB^ would be a likely acquisition target. In that actual event, Northwest actually got a very, very good price move, but it was a full day or two after the merger announcement, which is plenty of time for a trader to use his or her head and get in and make some money on it.

The recent terrorist attack — I mean, it was a cinch to macroplay because we had this interval where the market was just closed for four days while everybody was kind of waiting to sort things out, and you could see from the early movements in certain stocks, I mean, there was a handful of stocks that increased by 40% or 50% or more which were involved in obscure things like biometric fingerprint scanning and face-recognition systems, or something more mundane like baggage scanners or maybe even something as simple as building security doors for cockpits in airliners. Whereas, we knew all of the airlines were going to take a bath.

Take the retail sector. That took a pretty big hit when the stock market resumed. Why was that? Well, basically, it was macrowave thinking. It’s, like, well, consumer confidence was falling anyway. This is going to be a big blow to consumer confidence. We know from historical experience that during wars and conflict, people put off a lot of their retail spending, so those stocks would go down. So, in that Barron’s article I wrote, I pretty much named the sectors that were going to go down: hotels, gaming, leisure, insurance, airlines, retail, auto. And on the other hand, you could see that defense companies would probably do well, except for example, Boeing, which had its foot in both civilian aircraft and fighter jets. See, that’s a mixed bag. The reason is the kind of discerning facts you have.

So, to me, the whole trading environment is so much more enriched by having a macrowave perspective on this. One of the things I say in the book — let’s take the different kinds of investors, OK? You take the fundamentals for an investor. A fundamental investor just looks at finding the best companies based on whatever criteria they outline. You can buy the best companies in the world, but if they’re in the wrong sector at the wrong time, you’ll lose a lot of money.

A value investor. A value investor can go out and find wonderful value stocks, but if they buy a stock with a low valuation at the top of a market trend, they don’t have a dog that’s going to have its day. They’ve got a true dog and they’re not going to win.

You know, a technical analyst — if you just look at your Bollinger bands and your moving averages and the different buy and sell spots they’ll face on technical criteria alone, you can really be hurt by the condition of the sector fundamentals of the stock and at a macro level. Here’s the problem.

Eddie: So, what’s interesting about that, is that there is the event that causes something to happen in the price movement that is instantaneous, and that’s what everybody sees. That’s when people conclude, “Well, you know, it’s too late. I wish I’d bought call options or put options on that one, but it’s too late.” But you’re saying it’s kind of a ripple effect that traders can take advantage of.

Peter: Think of the advantage as a boulder being dropped in a pond. What most traders get involved in is the big splash. In fact, the most profitable area really is the ripple that may reach the shore which may be a mile away. I mean, another example I offer in the book is the earthquake in Taiwan.

OK, you get an earthquake in Taiwan. You know that Taiwan is a major producer of dynamic random access memory chips. So, right off the bat, you might want to try to short the Taiwanese chip companies, but you’ll probably have a problem doing that because of the up-tick rule. So, you can’t really make any money on that.

But the “chess” move might be to think, “Well, look, somebody’s got to benefit from this. Who would it be?” Well, the Koreans — Samsung and Hyundai — make a lot of DRAM, so they would benefit. Then, who else might get hurt? Well, it turns out that both Apple and Dell rely on Taiwan for either chip or computer assembly, and those stocks would be likely candidates to short. And of course, the title of the book is “If it Rains in Brazil, Buy Starbucks.” That’s a perfect example of what I call the macroplay. It’s the whole idea where you’ve got Brazil, which is the largest coffee-producing area in the world. A lot of people don’t know that actually because you’ve got all of the advertising for Colombian coffee and all of that stuff, and you don’t see “fine Brazilian coffee” so much in Starbucks.

In fact, when you have a drought in Brazil, you observe the coffee futures market going up fairly dramatically. That squeezes the profit margins of retailers like Starbucks. So, if you read on the back pages of the Wall Street Journal that rain’s come to break a drought in Brazil, you know that coffee futures are going to fall, Starbucks margins are going to go up, they’re going to make more money, and their stock’s got to go up. Then in fact with Starbucks, it’s particularly true because they’re notorious for always raising prices when costs increase, but never lowering them when costs decrease.

Eddie: That’s interesting. Now one of the things that fascinates me is that in order to develop the knack for identifying these relationships, I mean, you really have to be on top of industries, the leading companies within those industries, their competitive relationships, and the macroeconomic picture — right?

Peter: Well, there’s two kinds of things I teach really in the book that would be very valuable for traders, and in some sense, they’re two separate skills. The one which we’ve been talking about is the art of the macroplay, which is to look at specific kinds of events, whether it’s rain in Brazil or the terrorist attack on the towers in New York or Hurricane Andrew. I mean, those kinds of catastrophic events or weather events, all will move stocks in ways which generate profit-making opportunities. So that’s a whole kind of one mindset.

The other, though, is whole notion of the macrowave investing, which is paying attention to the ebb and flow of all the economic indicators that matter, the CPI, the PPI, the jobs report, retail sales, things like that, understanding a calendar event and how they might move the markets on any given day. That’s really important. And than even more broadly, having the most fundamental understanding of how fiscal and monetary policies work.

I mean, in the wake of the attack on the Trade towers, Alan Greenspan intervened in the markets in a way which is almost unprecedented. He injected huge amounts of liquidity into the market. Now why did he do that? I mean, traders have to know that because it has implications for how quickly the market will rebound, and more importantly, what it might do to rates of inflation and interest rates and stock prices over a longer-term period. At the same time, when George Bush talks about injecting $40 billion more into the economy and increasing military expenditures, the subtext of that is we no longer have a budget surplus, we have a budget deficit. And that’s going to have huge implications for the market trend.

So, this kind of news, most traders just look at that and they kind of move on to what happened in individual stocks or ignore it, or their eyes glaze over it, when in fact, that’s the environment they’re trading in. It’s like living in Minnesota and going outside without checking the weather before you dress.

I might add in this regard, over the next year-and-a-half to two years, there’s nothing more important than developing a macrowave consciousness. Because the events that occurred on Sept. 11, 2001, are going to ripple through this economy, in some cases rip through this economy and the markets, for several years to come.

Eddie: You know, one of the things that was interesting that you stated earlier is that it seems as though in order to take advantage of a potential trade off of this stuff, you first have to have some kind of big event that produces an easily observable spike in the market.

Peter: It doesn’t have to be a big event. It just has to be an event. It can be, for example, a patent resolution in the biotech industry. A company may lose its patent, and then, say, a generic company could see its stock go up.

Eddie: And then you see the effect of that occur, and then you say to yourself, “Okay, this stock just jumped up 20 points.” And that’s when you start asking yourself, “Hmm. What other effects is this going to cause in other stocks or other sectors.”

Peter: Let me give an example from the terrorist attack.

Eddie: Before you do that, if you can, wherever possible, talk about it in the context of any trades that you’ve done.

Peter: Well, on Tuesday morning at 5:30 a.m. PT, I was preparing, basically, to move what I had into cash. I was engaged in a semiconductor play, and I had anticipated based on what I was seeing, a fairly good move in semiconductors, but then over a period of a couple of days, most of the macroindicators had deteriorated and we were in a position where the best thing to do was to get into cash. Because I myself don’t like to do a lot of stock trading, not because I have anything against stock trading, but my time is better spent. I like to look at the market in the morning for an hour and the closing. I can’t sit at my terminal.

But anyway, before the attack, I was ready to go to cash for a couple of days or a couple of weeks and just kind of let things settle.

Eddie: By the way, is there a typical length of time that you’re in a trade?

Peter: I like to swing trade, anywhere from a couple of days to a couple of months if I’m getting any kind of sustained action. In terms of my style of trading, I’m a technical analyst. First, I start with the technical analysis, and then once I identify targets, I run them through a fundamental screen.

Eddie: On the morning of the terrorist attacks, were you short on the semis, or were you long?

Peter: I was long. I mean, basically, I was playing actually — to be really specific — I had a pretty good position in ^CNXT^. Conexant had been looking pretty strong amongst the semiconductor stocks over a period of about a week or so. Even though some of them weren’t doing that well, I felt that stock was in a pretty good position to make a reasonable move. It was a case of when. Well, I like to watch a sector, and then I like to pick a few stocks in that sector and see what happens.

So, anyway, the attack happens, and the market closes, and I (along with the rest of America) am basically trapped in positions which, when the market opens, are guaranteed to lose a bunch of money. So, from a macrowave perspective, the question I asked and answered in the article I wrote for Barron’s before the market opened was basically how do we think about this? What’s going to happen when the market opens? There is some obvious stuff. I mean, obviously the airlines and the insurance companies were going to take a pretty good haircut. But probably the airlines were going to do worse than the insurance companies because based on historical events, the insurance companies are much better able to raise premiums in the wake of these disasters, and their overall monopoly has some market power. So, we knew they were going down. We knew that hotels, gaming, leisure — anywhere from hotel rooms in San Diego to casinos in Las Vegas — were going to take a hit, OK? So, that’s pretty obvious so far.

Well, to me the bellwether for how bad this was going to be was going to be what happened to two sectors — retailing and autos — when the market opened. I wanted to watch those in particular because those were my proxies for consumer confidence. In fact, they took a dive. I mean, those were the ones that I wasn’t quite sure what the size of the move would be, but I knew that if it was a big move, we were in really, really big trouble.

Then on the positive side, you know, the easy analysis is the defense industry. But you’ve got to distinguish between a Boeing, which makes civilian and jetfighter aircraft, and some of the other companies which are more strictly defense industry. We want to watch those. We know from past experience that these stocks may not necessarily rise, but we know they perform better relative to market — food, drugs and tobacco — and in fact, you can begin to track some of that movement in the European stock markets to see how that was going.

Oil is a complicated one because when this kind of event happens, there was an initial spike in the international oil market, but the most subtle macrowave take would be it’s also true that if this were to increase recession fears, than you’d see an offset in the price of oil over fears of recession. So, that would be a wash. It would be more dangerous to speculate in, say, oil and gas exploration because of those offsetting effects.

And then you get some interesting things, like a “chess” move might be Sprint PCS, because in some sense, the big heroes of the whole crisis besides the individuals, were cell phones, which were used to report events from the aircraft and also, more importantly, the other circuits were just jammed. And plus, everybody now uses cellular phones as a security device.

Eddie: That’s an interesting one. Up until the point where you talked about cell phones, I thought, “Well, that’s logical. But for cell phones to benefit — that’s kind of counter-intuitive to me, to reason that cell phone companies are going to benefit from this, because of increased usage. I would have thought that it would have been the opposite, because a lot of cell phone infrastructure was destroyed in New York. Either the opposite or neutral, and I wouldn’t be able to argue with you because you’ve thought it through. It’s just interesting to derive that connection.

Peter: To me, it was one of the most interesting macroplays. One of the initial beneficiaries was Nokia. Some of the other handset people didn’t do too well. That would be kind of like if you were betting that sector, you’d kind of have to look at the technicals and the fundamentals to see which horse you wanted to ride. I mean, Ericsson’s kind of a basket case, but Nokia’s in pretty good shape, if you were going to extend your play, say, beyond Sprint PCS, to one of those software manufacturers.

But again, that would be like a swing trade. Nokia, I don’t know what it did today, but it got a pretty good bump, but then the whole market trend is so down. I mean, the trend today started out like at 12. I’ve never seen that, and you’ll probably never see it again in your lifetime.

And then, of course, the individual plays, which are sort of obvious to market professionals who do their homework, they’re looking at companies like ^INVN^ and ^MAGS^, an Israeli-based company, ^VSNX^ and ^VISG^. These are companies that make things like airliner security devices, 3-D baggage scanners, face-recognition technology. Meanwhile, these companies all got a 40% – 50% pop, and they were up before the markets even opened because of early morning trading. If you were first in, you might have been able to grab something.

Eddie: While you were talking, some of the lightbulbs are beginning to flash off in my head. It’s kind of like a lot of the people that are new to this business, they start out thinking logically, the way that you’re thinking, but it’s a different kind of logic. You know, back when we were in the midst of the bull market in early 2000 and late 1999, I would have these people that knew nothing about the market getting into the market and saying, “Qualcomm has this deal with China. It’s going to be exclusive. I’m buying more Qualcomm.” You can’t argue with it. It makes a whole lot of sense. The stock’s going to keep going up and up and up, but of course, everybody’s talking about it. It’s already factored into the stock.

Peter: Then it’s time to trade, huh? (laughs)

Eddie: Yeah. (laughs) Exactly. But your reasoning is kind of like using the big event kind of like a pivot point, kind of like we talked about earlier with the rock that dropped into the pond causing the ripple effect. That’s kind of like your starting point. The event happens, and then you start reasoning through. It’s kind of like a thinking man’s form of trading.

Peter: Let me put it to you this way. Let’s suppose you pose a question to a group of traders. What’s going to happen in the stock market the day the stock market resumes trading? I would say, pretty much, 80% – 90% would say the market’s going to go down. I would say maybe 70% – 85% would say, “Well, airline stocks and insurance companies are probably going to take a hit.” Then maybe 50% might get hotel and gaming. But then after that, the numbers steadily dwindle, and I can assure you that most of what I’m talking about, if not all, is already internalized by the best traders in the world. But what I’m trying to reach with that book is the 50% – 85% of the traders out there that don’t have a macrowave perspective or don’t know the art of the macroplay. After the fact, a lot of these things will seem obvious, but the beauty to me is the fact that there are occasions where it takes the market an hour or a day to deliver on the ripple from the event and that, in the trading world, is an eternity, and a huge opportunity to make a lot of money on it.

I’ll give you one more example. It’s an example where for ethical reasons, I did not allow myself to trade it…much to my loss (laughs). The other thing I do in my life is I’m an energy expert, going back to 1986 when I wrote another book called “The Dimming of America,” which predicted large-scale electricity shortages after the ’90s, which, in fact, we turned out to get.

Eddie: That’s right!

Peter: Now if you had a macrowave perspective on the California electricity crisis, you would have, beginning back in ’96, begun to track that market, and you would have wound up making an absolute fortune shorting California Edison and Pacific Gas and Electric and going long on the likes of Enron, Dynergy, Reliant, Duke Power and Calpine, and maybe alternative energy producers like Astropower, which makes photovoltaics.

I guess what I’m suggesting is that a lot of this information would be helpful for people who want to focus on one or two sectors, and get to know everything about those sectors and the companies in them, and then as events happen randomly, be able to capitalize on that. You can’t know everything about everything, that’s for sure.

Eddie: You know, one of the contributors to our site, Dr. Paul Ruggieri, he’s not only a surgeon but he’s been a trader for many years, and his main focus is biotechnology stocks. He sort of looks at stocks from a similar perspective, although his reasoning process and the process that results in him making his trade decisions has to do with events in the cycle of the FDA approving a drug.

Peter: Good. Yeah, you’re watching trials, and you bet on that. I’ll tell you this. You can get burned very badly on that whole trial process because sometimes the trial can come up, and the drug doesn’t go your way.

Eddie: See, what happens a lot of the time is that the stock will move up in anticipation of a positive or maybe a negative approval. But what’s interesting is that he’s noticed that there are different patterns — and again, like you, they’re kind of counter-intuitive — their stock is, many, many months before the final judgment, is already moving because people are accumulating, and then it drops, even when the news is good.

Peter: I actually talk a lot about that in the book. I mean, you know the rule: Buy on the rumor, sell on the news.

Eddie: Exactly.

Peter: That’s what separates good traders from bad.

Eddie: What about that big biotechnology event that happened with Clinton and Tony Blair?

Peter: I actually said that in my book. That’s the kind of thing, unfortunately, that would have been difficult to anticipate that they would have said something as stupid as they did, which is basically to suggest that you couldn’t patent the genome. I mean, that had huge implications for royalties in that industry. Those kind of pronouncements, there’s new discoveries, there’s trials. I mean, the big one is the patent, kind of when one company gets protection from a patent or loses a patent, there’s a whole chain of downstream companies that win or lose from that.

Another thing, from a technical point of view, this kind of thinking can actually give content to trend. If you’re watching a stock, when you see heavy accumulation in that stock and a nice upward move for no apparent reason, then go find out what the reason is. If you look hard enough, you’ll see something coming. And if you don’t see it, the reason the stock’s going the other way, there’s some insider trading going on or some insider news out there. It’s like an early warning system to get out.

Eddie: This has been one of the most fascinating interviews I’ve ever done. This is pretty interesting stuff here. Is there anything else that you think that we haven’t covered that you’d like to cover?

Peter: Well, there’s a couple of things. First of all, people who go to my website, which is, and I’ve got my Barron’s piece online, which is useful in the near-term, and then I’ve loaded one of the chapters from the book on how the market moves in relationship to catastrophe. So, that’s useful.

Chapter 11 of my book is useful because it basically will show clearly how two different kind of traders might go about the business of preparing themselves each week for the market. It’s simple things like reading Barron’s. Anybody who doesn’t read Barron’s and trades — again, I don’t want to call them foolish — I’ll just say that they’re substantially increasing their risk. I mean, Barron’s moves more stocks in different directions than any publication on the planet, and if you don’t believe me, just ask Cisco. They’ve never recovered.

Eddie: We’ve seen that a lot. Yeah.

Peter: I like to look at IBD‘s “Big Picture” every day, which is a good thing to do.

Eddie: Well, we hope you’ll become regular visitor to our Website as well.

Peter: I will be doing that. I’ve been looking at your Website and I’m very impressed with the content and the analysis. But the point is to plug into the flow of information. If you don’t do that, you not only lose more than your shirt, you might lose more than your hat.

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