Times are tough in Macro Land. The reason they are tough can be easily explained by a bet I’ve tried to make with a fellow (if rather politically dissimilar!) blogger. This wager, and the reasoning behind it, teach perhaps the most important lesson there is about trading macro. Let me explain. Here is where I posted the wager as a comment:
Bruce loves the tory party. He has some disagreements with them on specific points, but it’s clear these are lovers quarrels. He thinks George Osborne may be the best chancellor since WW2, which stands out amongst even my most conservative friends as quite an extreme position. I’m not here to judge, merely to use this clear and demonstrable love of the tories as the first building block in my explanation of what makes a good trade. You see, because of Bruce’s love of the Tories and his hope for them winning a majority, I thought he might be willing to bet with me at evens – the wager I offered him is that if they get one, I’ll buy him dinner, and if not, he’s to buy for me. Now, this is a bad bet for him, and the only reason I think he’d make it is because I identify that his perception is fundamentally at variance with reality in terms of the likelihood of an outright Tory win.
The thing is, that is the business of speculation. One has to find ways to stack the odds in one’s favour by identifying where perceptions are out of line. In 2014, market participants were convinced that the multi year global rally in bonds would reverse, as the US would inevitably hike rates. My perception was different. I could not understand the bullishness people had on the US economy, nor could I understand how people could so easily ignore the fundamental global forces pushing down bond yields: aging populations, inequality and the dominant influence of capital over government policy. I advised my clients to be long of European bonds*. The world turned out to be Bruce. The market completely misjudged the strength of the global forces pushing down bond yields, and incorrectly anticipated rate rises when none came. Because I identified a fundamental variance of perception, the fact that I happened to be correct (mostly luck) proved lucrative for the few who listened to me.
Contrast this to my main trading recommendation this year, which has been to be long BTP’s (Italian government bonds) because I believed that the market was increasingly positioned for Grexit / Eurozone breakup, and this was largely based on Europhobia (irrational pessimism about European institutions, which is weird as there are plenty of rational grounds for it!), a ‘Red Scare’ over Syriza, and a misunderstanding of how European financial institutions (particularly national central banks) work. The trouble is, I was wrong about positioning even though the scenario I envisaged has come to pass. The market, it turns out, was pretty happy to be long BTP’s, and of risky assets generally, so my trade is not doing so great.
So I need to find the next Bruce, the next false consensus driven by ideology. I have a few potential candidates I’m considering. The first is the widespread belief that the Federal reserve may raise rates ‘too soon’ and ‘choke off’ the US economic recovery. Given my belief that interest rates as set by central banks do not influence economic activity, except in general to reduce productivity by selecting against investments in productive activity in a recession, I would be happy to bet against those guys. The US yield curve is very flat indeed. I already have a steepener on in my paper portfolio, I am considering scaling that up and making it my next big view. Another long term view I have is that US tech stocks are fundamentally overvalued because their current valuations presume, effectively, that returns to capital do not diminish. US tech companies are incredibly capital intensive, yet trade at very high price/earnings multiples. This makes a degree of sense as technologies emerge, because those lucky few who invest early are able to make a killing (returns to capital are high whilst unproductive labour is replaced in the production mix), but far less sense as technologies mature and production is highly capital intensive. It happened to railway infrastructure providers. It’ll happen, i think, to internet infrastructure providers.
I’d be interested to hear whether any of you like either of those ‘fundamental views’. I’d be even more interested in Bruce taking me up on my wager, but hey ho, you can’t win ’em all!
*Specifically I counselled receiving 5y2y EUR swaps (entering into an interest rate swap contract that makes money if rates fall, ie, as a receiver of fixed rates and paying floating rates). If I had £10 for every time I made that recommendation in 2014 I would be richer than some of my clients would have gotten if they had actually listened!