Global Macro Trading Journal

This is another reason for me to scratch my head when I see good fund managers in Brazil attacking the stock market, saying they are skeptical of the rally, that they dont think it can last. You already need a pretty good reason not to own a certain percentage of your assets in stocks, even if the market is a little overvalued (as the Damodaran model shows, timing wont help you). Thats what we are seeing in the US as people who are skeptical stay in cash and bonds and lag the market. As they keep doing that, they either get fired by their clients or (if they are managing their personal money), they suffer that Damodaran effect of having the timing cost you.

But when the market is cheap, then its just nuts to stay out of it.

Now, I understand that emerging markets have more of a boom bust cycle in them and they tend to carry higher risks (debt default, inflation etc). But the way to play these boom bust cycles is to buy when sentiment is poor and prices have collapsed, you then sell when sentiment is widely optimistic and prices are up (along with valuation) a ton

Its possible that these managers will make good predictions that the bust will come sooner this time around therefore, one should exit a lot sooner, but the problem is, when valuations are low, the hurdle is a lot tougher to beat.

If you are trying to 'valuation time' a stock market, its a lot easier to do that when the expected future return is 2-3%, than when its 12-15%, there is less of a upward drift to battle against.
 
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'Valuation timing' is similar to shorting (specially when you consider the career risks for the folks that are running OPM), shorting a cheap market with high expected returns, where prices lagged everything for a long-time and sentiment is bearish, is just a poor strategy imo. Even it works
 
As I have very costly learned in my trading/investing career, waiting for something cheap to get cheaper is a high wire act. Timing is already difficult, when you try to time cheap things, its just gets even more difficult
 
Of course, the real reason these managers are doing that is because they were bearish and they missed the bottom. The 'reasons' they bring up is just to justify that mistake. We saw that in 2009, all the brillant people who predicted the crisis, missed the bottom and failed to reasses things quickly enough. Then they just trashed the markets for years until they couldn't take it anymore and either switched to bullish or just went quiet (or blamed the whole thing in the Fed)
 
So the strategy that I use to macro trade and/or compound wealth is to own a diversified mix of stocks, government bonds, real estate, gold and cash in a "All-Weather" (aka Risk Parity) type portfolio, then use that portfolio as margin to put in specific trades that have the potential to boost the returns from the expected 5%-8% (with ~15% drawdowns) to over 20%, while still keeping drawdowns limited (The trades would only be the high conviction trades that are unlikely to be wrong).

But it looks like more and more that central banks are ending the risk parity free lunch by pushing bond valuations to extreme levels. At these points, bonds (and I'm referring to long dated government bonds) stop being a good hedge and end up a "return free risk" with the potential for significant capital losses in case rates spike. That looks to be the case in Switzerland, the EU and Japan. The US still has some juice left in terms of yields but on the other hand, it has (IMO) a much better central bank that is much more likely to hit its inflation and economic targets, so a 10 UST bond at 0% is just a pipe dream. It aint going to happen. So its possible that US bonds have reached the point where they stop being a good hedge and just add volatility to a passive portfolio while providing very little returns.

So it looks like more and more that other hedges will be necessary to protect a portfolio and create a risk parity effect (of returns above the risk free rate with limited drawdowns). Cash (pure or very short-term goverment/corporate bonds) are certainly a good option and I had to cut back in some of my UST exposure to raise cash levels in reponse to the poor price action.

But I'm looking for other options. Long-term stock shorts are another option but they are so hard, I hate the idea of being short risk assets long-term but in a extreme scenario like we are facing I might be forced to do that. Right now I do occasional shorts on SPY when I feel like its going to drop, that way I can take my 35-50% long stock exposure and protect it a bit by having a 10-15% short along with it. Kinda like the long short funds do but using SPY.

Gold I believe its still likely to be a good hedge but the price action is telling me its not so time will tell. So far I have been wrong

Comments on this dilemma are welcome
 
The assumption you are making here is that for a risk parity portfolio, you must be invested in negative covariance assets to lower volatility of the portfolio.

What if the hedges actually selloff in market turmoil?

IMO cash/TBill and etc are the go to. Cash is a position. Sure it doesn't yield much, that's the tradeoff one gets for knowing a defined return(0). The liquidity of cash allows for fast deployment if your thesis is wrong.

You are likely overthinking this: If CB actions globally have changed the market/macro, why maintain a portfolio that no longer applies under current mkt conditions? Adapt.
 
Here is an old article I already wrote about but its worth revisiting
Buffett's secret: 1.4-1.6 leverage applied to low beta stocks

http://www.econ.yale.edu/~af227/pdf/Buffett's Alpha - Frazzini, Kabiller and Pedersen.pdf

If you control for those factors Buffett has no edge.

Leverage is an interesting thing because it can get you in trouble but if applied correctly (like Buffett does) it can help one compound wealth a lot faster. I mentioned before how having cash can 'yield' returns for an investor when asset prices fall (and their expected returns rise) as that deployed cash gets invested at more attractive prices. But even when you run out of cash (you are fully invested), you still have "ammo" left to benefit from bear markets in stocks and bonds. That ammo is leverage. Of course, we dont have access to things like deferred tax liabilities, insurance floats or corporate bonds like Buffett does (notice that these debts are by and large, non-recourse type loans, or at least, you know when they have to be repaid). As a retail trader/investor we have less attractive forms of leverage such as margin leverage, futures markets, options etc.
They are inferior because you can be liquidated before a specific date and daily marks on prices can influence what happens to your future (unlike the ones from Buffett that the due date can be spread out over time and minimizing risk).
But there are other forms that can be attractive if one wants to use that ammo
-Deep in the money call options (I mentioned recently on the options forum)
-If you own your real estate, taking out a loan against it

There could be others, if anyone know, feel free to post

I dont think its time to use that ammo by any means but its something to consider if risk premiums go from contracting almost every day, to expanding almost every day
 
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2055431&download=yes
This paper shows similar ideas in a global scale. Low beta stocks have an edge
"In terms of the investment theory, it is clear that the directive to invest in capitalizationweighted portfolios as a core strategy is ill-advised. The performance of these portfolios is dominated by the presence of relatively volatile and over-valued growth stocks"

I think there is a benchmarking/indexing craze (bubble?) going on with the S&P500. Everybody and their mothers measure their results against that index, as a result, lots of the time, in order to avoid withdraws/being fired/lagging the market, people chase the ETF, futures, options in order to mitigage underperforming risk. That combined with the tendency of market cap weighted index to lose against other indexes (fundamentally weighted or low beta names) makes me think the way to beat the S&P500 going forward should be quite simple: just be out of it. Indexing to the S&P500 is very popular right now, which makes me think its probably not a good idea to be involved in it
 
https://www.ft.com/content/64ca3e5c...amp=published_links/rss/markets/feed//product

FT on Brazil. The spending control law has passed on its first round (of 2) yesterday with 366 votes (309 were needed), that even though some representatives avoided showing up in order not to be criticized in their states. The government estimates they have about 380 supporters in the lower house. They need 309 for constitutional changes and ~256 for passing regular bills. Brazil is going from a political shitshow to being more stable and hardworking than the US (where Obama cant get the republicans to do anything he wants). There are some serious chances important reforms will be implemented in the coming years. With that big of a base, a lot of unpopular but necessary reforms can pass
 
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