Category: Uncategorized

I am not a consumer of the big, bold predictions and the surprise lists that roll in this time of year. They mostly serve marketing purposes, or as a call option on self-aggrandizement, or our desire, at some level, to be told what to do. But many people like them. Uncertainty—the kind investors face daily—is draining and unpleasant. These things help fill that void. And they give us a reference point against which to calibrate our own views, however uncertain those views may be.

But, at the end of the day, whether you like forecasting or not, we have to make a call. Especially if your process is trading-oriented. Buy or sell. Long or short. Beta or alpha. Bonds, stocks or cash. Investing and trading require us to try to look out around the corner, even if only a little bit, and even if it is only probabilistic. So, with that caveat, this is what I am currently seeing around the corner:

Sentiment

On the Economy. The US economy is steadily improving, but expectations are catching up. You can see this in the Citigroup Economic Surprise Index for the US, which is stalling here and appears more likely to revert than not. (A positive reading of the Index suggests that economic releases have been, on balance, beating consensus. So a lower positive number means less positive surprise. It doesn’t mean negative surprise until it crosses zero.)

 

On Positioning. The short-term positioning seems to reflect (1) increased recognition of the improving US economy, (2) belief that Europe will remain in recession but not produce a Lehman II, and (3) that expectations with respect to Emerging Markets have finally receded to a place where it makes it safe to put a foot in the water. You can see this in the price action, in some of the sentiment surveys/technical indicators and in the chatter coming from other traders and investors.

Lastly, the discussion of the fiscal cliff seems to have morphed from “I think they get a deal, but I will wait to buy because they are likely to disappoint us first” into “the market will rip as soon as a deal is announced and it is too risky to be out and miss the move”. This changes the payoff structure.

The longer-term positioning, however, still reflects a fairly negative outlook, which is positive. Many investors, still clutching their rear view mirrors, are still afraid to commit to equities. The scars are just too deep.

Then there are the policy bears. They believe government intervention has made all this artificial and at some point “we will all have to pay the piper”. They disagreed with TARP, said the Stress test wouldn’t work, thought QE would be inflationary, asserted big deficits would drive yields higher, believed austerity in Europe would be good for growth, and compared the US to Greece. They have been wrong, underperforming and are increasingly angry. Rather than admitting they were wrong, many are pushing out the timetable for their forecasts to materialize, or quietly walking them back and hoping if the transformation is gradual enough no one will notice. Because when you’re wrong it is hard (and reputationally costly) to change your views. And, behaviorally, constantly questioning your own views requires much more effort than settling into certainty.

This is what the inner monologue of the policy bears sounds like right about now: “if I get long after fighting it for so long and the market turns around my clients will think I am a fool with no process”. Plus, it always sounds smarter to be bearish. And sounding smart helps underperformers hold onto assets.

So, what do they do? They play light, wait to go short, or take repeated stabs at the short side with stops. The takeaway, though, is that at some point they will recognize that below the surface of the policy drugs there is a healing process: household deleveraging. We are already seeing the effects of it. And as this becomes clearer both scarred investors and policy bears will get dragged into the market.

On Monetary policy. Sentiment surrounding monetary policy has done a 180 over the past year or two. A couple of years ago it was very hard to make the case that QE wouldn’t be inflationary as long as the household sector was deleveraging, and that the market effects from it were predominately psychological. I still have the scars from those debates. Using technical jargon like ‘endogenous money supply’, in an attempt to recover some credibility, only got you more dismissive looks.

However, since then, markets have been (for the most part) coming around to this view, and consequently the half-life of a market reaction to the announcement of fresh monetary stimulus has fallen to about zero. This is new.

It has two implications. First, assets that have rallied from the flight into inflation hedges will continue to leak. It is not a coincidence, in my view, that the ‘evolution’ in the understanding monetary policy began right about the time gold and silver prices peaked last year. Ever since, the diminishing market impact of Fed announcements has become apparent to all, and the commodity complex has correspondingly stayed well below its 2011 highs. Yet virtually everyone is still calling for gold to make new all-time highs in the coming year.

From where I sit, many people have crowded into gold and silver (and oil—don’t even look at cotton!) on, inter alia, this flawed understanding of the monetary policy transmission mechanism and this will create selling pressure for quite some time. Will it be enough to offset the diversification demand from central banks and the income effect from the Chinese and Indian markets? This is a harder call, but I think the answer is yes—virtually certain if the recovery in the US gains traction and the Treasury curve steepens. It also bears recalling that central banks since the 80s have tended to be net sellers of gold when prices were low and net buyers when prices were high. So I wouldn’t count on central banks being there below the bid for too long if prices really start to drop. But it really is hard to say whether this will be a drip, drip, drip or something more sudden.

Here’s a crude chart of silver to illustrate how far it could fall if my hypothesis plays out. (I confess: I am Tourist TA.) That support from the parabolic breakout in 2010 would correspond to a futures price of about 20.

 

The second implication is that just as everyone has bought into the “impotence” of Fed policy, we are starting to see signs of it having an effect. There has been a lot of head scratching and soul searching in the economic community (including Fed governors) about the efficacy of monetary policy. Has the transmission mechanism structurally changed? Are there new features we don’t understand? It is that policy is not aggressive enough?

It seems to me the answer is very simple: pretty much no amount of QE will work until (1) the household deleveraging is mostly over and (2) people feel better about job security and prospects. It is on these two factors that most people set expectations and consumption patterns, not on base money quantities or things like NGDP targeting. Expectations, in turn, set risk appetite and risk appetite drives the endogenous money supply.

And on a small scale this is happening. Prepay speeds in the mortgage market have picked up, indicating more refis, and there is more activity in the primary housing market. Household formation has picked up, too, as young adults are increasingly getting out from under their parents roofs for the second time. The job market, for its part, seems to be grinding in the right direction.

The simple way to look at it is that the Fed’s aggressively accommodative policy didn’t directly cause these things to happen. But by facilitating the deleveraging process, it likely moved forward the date by which households will have their balance sheets sufficiently repaired to normalize their rate of consumption, with knock-on effects to the rest of the economy. We are not there yet, but we seem to be getting closer, fiscal drag notwithstanding.

Price action

I know, I know. Buy or sell? Okay, here are a few more concrete markets observations.

First, it really is a stock-pickers’ market. It’s a phrase I don’t like because it is overused by guys on TV who want to sell you there stock-picking services. Somewhat fitting I guess that just as everyone scrambles to go macro, stock picking seems to be working. On what basis do I say this? Look at the index of implied correlation of the elements of the S&P, to start with.

 

The implied correlation amongst S&P components has been heading downward all year. In case you can’t make it out, it falls from just above 80 percent last January to just below 65 percent in December. This tends to be both a bullish sign as well as an indication of less ‘macro’ and more ‘stock picking’.

Second, we have seen of late many of the crowded positions underperforming and many of the hated positions doing better. Precious metals and AAPL crop first to mind, but there are many others. And some of the hated positions, e.g. RIMM, NOK, X, have been perking up. I don’t know how long this lasts, but it is the theme for now and it makes no sense to fight it.

While I’m here, let me make a quick, behavioral point on AAPL. AAPL has been THE story stock in the market over the past few years. It has been our collective obsession. It has sucked all the oxygen out of every financial chat room and could do no wrong. I can’t speak to the fundamentals, which may or may not have changed, but I do know this: once the fever breaks on a story that is so beloved, sentiment usually doesn’t stop deteriorating until the pendulum has overshot to the other side. And I get no sense we are near that point yet. I still see virtually all knife-catchers and no momentum shortsellers, and until this changes, it is probably not safe to buy the fruit.

Oh, and by the way, if the stock continues to go down, even if there aren’t good reasons for it, convincing-sounding reasons will be found. In the near-to-medium term story follows price more than price follows story more often than we are inclined to think.

Simple technical analysis suggests AAPL could go back to the area it broke out from in January, when the AAPL fever really took hold. That would correspond to price of about 425.

 

Finally, the other beloved sector that has just begun the beat-down process is the mortgage REITs. High dividends are a drug once you get used to them, and retail investors and high net worth individuals are in deep. With double-digit dividends it is easy to get lulled into believing that they will paper over any capital losses. However, the combination of reinvestment risk and a highly levered product means the cutting of dividends that we have just begun to see have a long way to go. And retail never leaves gracefully. (The closed-end muni funds will, I fear, have their reinvestment comeuppance pretty soon as well. The math there is brutal.)

The bottom line is that it makes sense to be balanced here, with a constructive bias. This is not the fat pitch for a directional view. But it does make sense to bet on balance sheet reparation, financial normalization, and continued recovery in the US, and against crowded story trades where the story may already have changed—no matter how much we may love them.

The majority of the financial industry is built on the proposition “if the investor just had better info, he/she/they would make better decisions”. Think about it: financial media, newsletters, online brokers, – hell, CNBC’s Cramer has built an entire platform on it. It’s a big lie. Investors want to believe this because it is empowering. The financial industry wants to sell it to us because it is enriching and aggrandizing.  But it’s wrong.

It’s not lack of information that holds us back. The binding constraint is emotions. This doesn’t mean information is not good. It is good, but only AFTER you’ve got your emotions harnessed. And very few of us have.

Hubris when things are going well, paralysis by analysis when they are not, impulsiveness when things are moving fast, impatience when things are really, really slow. This is a partial list of the behavioral shortcomings that make us suckers.

Most importantly, you, YES YOU, are not exempt from these flaws. This includes me too.

The difference between ‘you’ and the pros is that the pros have built systems to keep these demons in check (mostly)–whether they are conscious of it or not (Pros are incented to succumb to the self-aggrandizing belief that their superior intellects and info is their replicable “edge”. Also, selling this line helps them hang onto assets when performance flags).

Portfolio construction, sizing, stop losses/profit targets, technical analysis, asset allocation models, rules, decision by committee, all of these things reduce the frequency with which emotions slap us and take our lunch money.

Individual investors would add more value to their own portfolios if focused on building an investment approach that mitigated emotional impulses. Until this is done, ain’t nothin’ gonna work.

(The original Big Lie is the one called out by Barry Ritholtz: “..banks and investment houses are merely victims of the crash. You see, the entire boom and bust was caused by misguided government policies. It was not irresponsible lending or derivative or excess leverage or misguided compensation packages, but rather long-standing housing policies that were at fault”.)

The US Treasury this morning rid itself of the last piece of exposure it had to AIG, the insurer at the center of the 2008 financial crisis. Both the Fed and the US Treasury intervened heavily during the crisis, with the ostensible objective of stabilizing the system and circuit-breaking the self-reinforcing fear that was already rippling through the financial system.

As of today, taxpayers have been fully repaid. The Treasury reports a combined profit of $22 billion. Detractors have been quick to suggest/insinuate/allege the number isn’t real, the Treasury portion lost money, the government is making the number up, etc. When really pushed they nit pick at accounting concepts, broaden the argument, or bring up other second order issues.

What one has to keep in mind is many if not most of these detractors also claimed that the government’s intervention in AIG and other financial entities would not be effective in its basic objective of stabilizing markets.

The most common phrases were “$700b down a rat hole”; “bad money after good”. Pointing out that the money was loaned only served to damage the credibility of the person foolish enough to trot out the argument. It was a given that the money would be all lost. The only debate was over whether it would bring stability to the financial system.

As stability appeared, the argument evolved (i.e. goalposts moved). Those who once argued that it wouldn’t stabilize the system started shifting to discussion of the burdensome cost to the taxpayer. Once it became clear TARP would turn a profit, detractors alleged accounting games or invoked broader costs from Fannie and Freddie.

The bottom line is this: it worked wildly better than anyone could have hoped for–even for those of us who thought at the time it was the right course of action. Markets were stabilized, the private sector banking system was recapitalized at the end of the day with private sector money, and the US taxpayer pretty much got it for free—whatever you think the final bill will turn out to be. Anyone still trying to move the goalposts should be gently reminded that reality disagrees.

So, go ahead. Today is the right day to say it. Thank you Tim Geithner. Thank you Ben Bernanke. Thank you Hank Paulson. We were wrong. You were right.

It is easy to see Silvio Berlusconi as an egocentric and ageing clown figure desperate to stay relevant—_­­especially when looked at from outside Italy. But this would be a mistake. He is no Donald Trump. His message is real and should be heeded, both in Rome and Berlin, even if his odds of winning are nil.

Let me be clear: It would be a disaster if Berlusconi were to return to power. Even if you support that part of Italy’s political spectrum, you should recognize that Berlusconi is too polarizing a figure inside of Italy, and too compromised a figure outside of it to manage the country effectively in what will surely be a progressively more difficult economic and political landscape.

The reality is that economic contraction is weighing on the Italian people. And when people are in pain, they tend to look for someone to blame. It is in our nature. Witness Greece.

Berlusconi is tapping into this. Increasingly, Italians will blame austerity and Germany for the persistent and deepening economic contraction that the process of internal devaluation is visiting upon them. In fact, as I started to write this, the FT came out with a survey providing evidence that this is more than just conjecture. Say what you will about ‘Berlusca’, but he has always been the consummate salesman, one with a keen sense of the issues that resonate with the Italian people. Once again, he seems to be one step ahead of the curve.

And it doesn’t matter how much Germany is actually to blame. Nor does it matter if less austerity—within the context of Italy’s real financing constraints—will meaningfully change Italy’s growth path (I don’t think it would). What matters is that this perception in Italian eyes is real and this sentiment will only grow, especially when stoked by the months of campaign rhetoric that now lie ahead. The forces unleashed are centrifugal. Moreover, Italy is not the only EZ country in the pressure cooker.

Fair or unfair, if Germany wants to keep the single currency together, it must hear the Italian message that Berlusconi is tapping into and find ways to accommodate it. Big decisions await. And this is going to be one for the ages (and, actually, the aged). 

The chatter over who will the next Treasury Secretary has heated up now that the election is behind us. Given that the position will likely be—as things stand right now—central to the nation’s next four years, the attention is understandable and warranted.

Much of the talk seems to focus on the traditional discussion about the attributes a Treasury Secretary should typically have. Wall Street or Main Street? Public sector background or private sector background? I think this approach leans us in the wrong direction. Instead, we should focus on what we need now. And today’s context is fiscal and political, not financial and technocratic.

The last four years, actually five, were about financial repair. The Treasury Secretary was in triage mode, trying to fix the plumbing of our financial system and trying to support an environment that would allow balance sheets to heal ASAP. You wanted someone with deep financial expertise.

Today, as I see it, our future challenges will be predominately fiscal, not financial. Fiscal issues are profoundly political. And the only path to sound fiscal policy runs straight through Capitol Hill.

We all know, at some level, we need a deep fix of our entitlement commitments. We simply promised too much. I am tempted to repurpose Churchill’s famous WWII phrase: “Never was so much owed by so many to so few”.

We also have a revenue problem. Revenue as a share of GDP is just too low by historical standards. And, unlike spending to GDP, Rev/GDP, because of the way the math works, will not improve that much as the cycle improves (Revenue is positively correlated to GDP through a cycle, whereas counter-cyclical stabilizers make spending negatively correlated to GDP through the cycle).

Revenue is a difficult issue, not just for fundamental reasons, but also for behavioral ones. Two jump to mind. One, taxes are painful. We perceive immediate pain in exchange for future, often intangible benefits that are hard to perceive. And this often makes taxpayers resentful and, at times, indignant. The second problem is our resentfulness makes us susceptible to almost any economic theory that allows us to stave off paying more taxes. The phrase “never get in between someone and what they what to believe” comes to mind here.

Lastly, we need structural reform to compete globally. The last 20 years of credit expansion made us flabby. The faux prosperity that came from household leverage and financial engineering papered over declining competitiveness. Many of the relevant issues lay beyond a Treasury Secretary’s remit. But many of them, such as corporate tax reform, do not. And these issues too are highly political.

The other large issue area that will continue to be important is international relations. Economic policy long ago stopped being a domestic issue area. The world is getting smaller, our trading partners are getting wealthier, global competition is fiercer than ever, and the world’s international economic infrastructure is at the leading edge of an overhaul to reflect these emerging realities. This overhaul matters critically to us, as raw imposition of our will is no longer a viable alternative.

The ideal candidate, therefore, is someone who meets these basic criteria:

–Has the strong trust and confidence of the President. No freelancers or peacocks need apply.

–Excellent political skills. Well respected by Congress.

–Knows where the bodies are buried on Capitol Hill; knows where are the hot buttons are for the key players.

–Strong international experience and knowledge of the international political landscape, plus diplomatic ability.

It may be controversial to suggest at this point in time that deep financial expertise is not a principal criterion for Treasury Secretary. And the assertion that it doesn’t really matter whether a particular candidate has or hasn’t met a payroll might not sit well with many. But, if you believe, as I do, that the next four years will be all about fiscal and structural issues, and that our ability to shape international economic relations will only grow more important, than we have to get past the backward-looking temptation to root for a financial wizard or green-eyeshade type. We need a politician, one with international street cred.

Who might that be? Well, it is easier to look at the presumed front runners and say who it is not. But when I look around, the far and away best candidate is one who probably doesn’t want the job: Hillary Clinton.

I just wrote this note to a friend of mine on where I stand. I don’t talk that much about my trading, and I tend to post a lot less when I am in California (opportunity cost is very high here), but I thought the note below might be a useful follow-up to the Toxic Migration case I made a few weeks ago.

Dear X,

I am riding the equity calls I bought a week or two back, and actually added to them late last week. I closed out my USDMXN short yesterday. And I got scared out of my EUR position before today’s move (emotions got the better of me. Bad process on this). I rebought silver in much smaller size and sold that this morning. The copper chart had been shaping up since 8/21. This had added to my bullish bias, and had me looking for a place to get long. The slight pullback after the breakout of 3.50 gave me my chance, so now I am long copper futures and riding it. Entry pt was about 3.50.

I think the tail risk reduction was the impetus for all of this and it has triggered the post-Labor Day underperformance anxiety we talked about. I thought it was going to happen before Labor Day, but it didn’t. Now the bears are back on their heels and worried about career risk. Moreover, the ECB and the Fed haven’t put their cards on the table yet. They are more powerful when we have to guess which cards they are holding. For these reasons—unless we get truncated by Sept 12^th—we should continue to run. I don’t know what the odds are for Sept 12^th and I suspect there are workarounds anyway (more lifting by the ECB), so I am going to continue to run with my positions.

Best,

Mark

It’s not as fun to be bullish. Bears are smart. Bulls are wide-eyed optimists. Bears have data. Bulls tell stories. Bears make money when everyone else is in pain. Bulls make money when everyone else already claims to be a genius. In short, many of us get more satisfaction being bearish because the psychic payoff is greater: we calibrate our own self esteem not by our victories in absolute terms, but in our victories relative to others.

So, with personal biases disclosed, let me lay out the bullish case. I don’t want to get carried away. For one, I know that if the market goes down in the next five minutes there will be all kinds of snickering from the cheap seats. Bearish calls gone wrong aren’t as easy to ridicule as bullish ones. Plus, we’re at 1400 on the S&P, not 1250. (And, yes, I know the VIX is at 14.)

The serious reason not to get carried away, however, is that world growth is not good. And it is not poised to turn around for a while, I suspect. US growth is anemic, and it feels like an achievement at the moment to be the tallest midget. Europe is in recession and this will persist for the foreseeable future. China is slowing cyclically and downshifting secularly, and China sets the tone for Asia (and, arguably, for emerging markets in toto). Moreover, the developed world is wracked by deleveraging, and the combination of globalization and excessively generous government promises pose potentially lethal structural challenges that we haven’t shown any appetite for addressing.

So, wait, how is any of this bullish? It’s not, but there is a long-term reason and a short-term one that make things less dark. Let me start with a question: Where do you think the S&P would be trading if we could take a European Lehman II off the table? My guess is meaningfully higher. Without financial contagion it becomes much, much harder to push the US into recession. And the fiscal cliff, while a real risk, is likely to be handled differently this time around much for the same reason we in the markets have fairly well discounted it: disaster myopia. We are much more prone to make a new mistake than to repeat our most recent one.

The basis for taking Lehman II off the table is the slow but steady migration of Europe’s toxic assets from the private sector to the official sector. This is a big deal. By the time this is over (and I think it will end by a number of countries leaving the single currency), the overwhelming majority of the bad debt will be in the hands of the EFSF, ESM, ECB, IMF, and in national banks that are de-facto (probably soon to be de-jure) nationalized. With each round of intervention, the private sector sells to the official sector. And the official sector won’t be subject to marginal calls/forced selling when the Schatz hits the fan.

The Lehman bankruptcy had such a nasty impact on markets because at that point in time the toxic assets were in the hands of hedge funds, investment banks, the prop desks of investment banks, and in their hands on a massively leveraged basis. Once the selling started it fed on itself because the funding of those positions got taken away. That’s not going to happen with the official sector holdings of peripheral European debt. With private sector investors much less leveraged and virtually clean of this toxic debt, the contagion impulse from Europe—whenever the dismantling of the euro happens—will be much weaker. Again, I am not suggesting the end of correlation, nor that the contagion impulse will be zero, nor that the economic impact on the defaulting countries won’t be very painful. I am merely saying that it won’t trigger anything close to a repeat of the wholesale portfolio liquidation we saw in 2008. And because many at some deep dark level still fear precisely this kind of repeat, the realization that this is not a realistic scenario will be a positive for risk taking.

The shorter-term consideration is that the recession in Europe and the slowdown in Asia are largely discounted. This wasn’t the case at the beginning of the year. We are finally starting to see the bad European growth numbers come in in line with forecasts, rather than continuing to surprise to the downside as they have for the past 18 months. And in Asia, while people are still hoping against hope that China stimulus will swoop in and save the day, it is become clear that the days of 10 percent growth are over and making the 7.5 percent target the country has set for itself this year will be an achievement. Again, I think there is more slowdown to come in China, and there are still people who will be caught off sides by this. But my unscientific sense is that the market has priced in as much as two thirds of the slowdown we are going to see from China.

The bottom line is that given the growth scenario that the market has been pricing in, the budding recognition that the progressive migration of the system’s toxic assets to official balance sheets will take Lehman II off the table, and the light levels of risk taking amongst the big players (who have been playing not to lose rather than to win) we would need to rekindle financial meltdown risk very hard and soon to send markets down in a sustained and meaningful way.

I am reluctant to wade into the polarized waters of politics. But there is an important point about Paul Ryan’s nomination I haven’t seen made (hard to believe, I know).

We all know the next four years will be about fiscal issues. And the sense, increasingly, is the Democrats could be forced at gunpoint to compromise on entitlement spending. There are no indications, however, that the Tea Party Republicans would be willing to come off their ideological stance against raising revenue.

So, if Obama were to get reelected, it is hard to imagine that the more ideological elements in the Republican party would suddenly have a change of heart and soften their current stance.

We know as well that compromise, eventually, is the only way out. One of Romney’s strongest selling points to moderates has been that he would have a much better chance than would Obama of cracking the log-jam of the anti-tax right. Now, by bringing on board Ryan, Romney’s odds of dragging them into a compromise just went up a lot further.

Ryan knows this group of house member well, he carries enormous credibility on fiscal matters with this group, and he knows where the political bodies are buried on all the hot-button issues. This political reason, for me, is the most compelling one for Romney to bring Ryan on board, even if I personally think the supply-side baggage and excessive faith in efficient markets that he brings with him are ill-suited for the problems we face and are about three decades past their sell-by date.

The first hint: everybody is now a global macro investor (or wants to be).

Here’s the backdrop:

1.    Global Macro hedge funds performed poorly since about mid-2010. Performance continues to be lackluster (paragraph nine);

2.    The category is now in net redemption mode;

3.    Some, like Moore Capital, are preempting investor discontent by returning money to them;

4.    Most seem to be doing their best to milk the 2 percent management fee for as long as investors allow.

How did we get to this point?

First, a bit of history. Pre-crisis, there were three basic types of global macro players. There was Old School Macro. Think George Soros. There were many others. These guys placed massive, fundamentally-driven bets and would come back in X months’ time to see if they broke the Bank of England or whatever. They tolerated huge P&L swings. These were the guys who made global macro sexy.

Then came New School Macro. These guys mostly grew up in the investment banks, either as prop traders or flow traders, or both. Their motto is risk management über alles. These funds—though they are loath to admit it—are driven by risk management much more than by fundamental ideas. They have tended to inhabit the more liquid end of the investment spectrum and manage drawdowns aggressively.

Lastly, there has been the steady growth of Tourist Macro. These are the guys whose expertise was in another market sector, such as credit (e.g. John Paulson) or long-short equity (e.g. David Einhorn), who became enamored of a macro view (short Europe, long gold, short US Treasuries, etc.) and placed big bets, Old School style. The common denominator was that they were bottoms-up guys who got seduced by top-down ideas. And below these marquee managers there is no shortage of erstwhile bottoms-up guys who have been assiduously trying to rebrand themselves as global macro thinkers or strategists.

After the crisis, several things happened. One, Old School Macro quietly went away. Some blew up. Many discovered that the new class of hedge fund investor couldn’t stomach the P&L volatility that came with their style. Others converted to family offices to avoid, inter alia, the hassle of defending their positions to fund-of-fund MBAs armed with sharp ratios.

Two, New School Macro came into its own. Performance in the crisis was good, most of them didn’t “gate”, or lock-up investors when the crisis hit, and they held out the promise of managing drawdowns aggressively. All this, plus the strong instinct to chase returns, made New School Macro look pretty good when investors gazed at them through their rear view mirrors.

The inflows into New School Macro and the nature of the fundamental events unleashed by the crisis increased massively the popular focus on macro issues. This, in turn, fed the growing trend toward Tourist Macro. Everyone constantly talked global macro. Everyone wanted to be global macro.

Why does this matter today?

The attention on and inflows into global macro, coupled with the risk management style of the New School, has produced the choppy (rip, then air pocket; air pocket, then rip) market with high correlations across asset classes that we have come to know all too well in the past two years. Why? Because New School global macro feels enormous pressure to take risk and justify management fees. They need to be involved when the market is moving—especially when the S&P is going higher (“You are getting paid to take risk. So, take risk”). But they also have promised their investors that they will manage their downside aggressively if their positions turn against them.

Having to be in the market, but not being able to stomach drawdowns is what has led lots of large players to stop in at local highs and stop out at local lows; broadly the same positions, broadly at the same time. It has been hugely frustrating for them. But this is largely where the high-correlation choppy market has come from.

How can an investor take advantage of this?

This dynamic will persist until the strategy falls enough out of favor that the big inflows of 2009-2010 flow back out (which has started to happen), or other investors emerge that can “arbitrage” the herd.

The way to arbitrage the herd is to be able to keep your bat on your shoulder for months at a time if necessary, and deploy capital in the assets you fundamentally like when the dislocations from the global macro chop fest eventually materialize. And they will materialize. Then, when you do commit, widen your stops so as to increase your staying power.

It sounds simple, but any professional hedge fund manager will tell you (perhaps only after the application of sufficient sodium pentothal) that running less than say 30-40% of targeted VAR (or whatever your risk benchmark is) for any meaningful length of time is next to impossible if you are clipping 2 percent management fees.

(Lastly, a pro tip: When a global macro investor tells you he expects to see greater market “differentiation” going forward, he is really saying the global macro equivalent of “it’s a stock-picker’s market”.  Caveat emptor.)

Apologies to interested readers for the extended absence. I have been self-indulgently enjoying the longest vacation I have ever dared to take, in my favorite place on the planet earth. And, guess what? It didn’t suck.

I did, however, continue to accumulate things I want to write about, and hopefully I will start to pump them out in the coming days.

I will start today with a piece on why Global Macro hedge funds are struggling. Stay tuned.