Global Macro Trading Journal

[darkhorse]

Quote from dhpar:

are you finished?


p.s. nice to see plugging in two "fuck" words in your heroic post.
but you need to practise that more so it looks natural.

Yeah, I'm fuckin done

Not heroic, just something dashed off in less than two minutes... and I've been casually profane for a while now, for ex., so the response is cute but not grounded in much... glad the mood is back to joking though.

And by the way, how fuckin' spot on was that post and the follow on (yes now I'm just playing to the joke here...)

 

[darkhorse]

Quote from Daal:

Monish Pabrai provided a great example, he took comfort in sayings like 'volatility is not risk' from Buffett, so he kept buying a bunch of high vol stocks that the market was uncertain about, he got killed in a number on them(He trails the market since 2007 by several basis points). The market was right and whatever he was using as measure of 'true risk' was wrong. When the person is not a genius like Buffett this will happen MUCH more often than not so therefore when the market tells them something is "risky" they better pay attention even if the gurus tell them not to.

The fact that this simple point was argued against it was surprising to me, I thought it was common sense
Is there a trade idea here?No but if I the trader can't get the basics right then he will get a lot of other stuff wrong too

Now see this is what I'm saying. I think this is an interesting conversation / worthwhile topic of discussion, and was enjoying it before some peeps started getting all butthurt, and other peeps started hurling accusations of writing too much and dick-measuring.

Pabrai is an interesting case. I have a close friend of the classic value investing school, and he introduced me to Pabrai's book, "Mosaic," around the time it first came out.

My initial reaction to Pabrai's book -- and the guy was being touted as a new Buffett at the time -- is that "this guy is not NEARLY as smart as he thinks." There were all kinds of glaring red flags in Mosaic.

For the record, you can find my 2006 book review of Mosaic on this Amazon review page, in which I said, quote: I was disappointed by a few glaring instances of sloppy thinking here and there. For someone who vigorously highlights a commitment to latticework and the use of multidisciplinary thinking, some of the assertions in Mosaic were a bit breezy, with one or two real howlers thrown in. I do not highlight them because they indelibly mar the book, but because they were so surprising in an otherwise thoughtful text..

Pabrai's next book, The Dhandho Investor, was even worse. While I found Mosaic "worthwhile," Dhandho Investor was just a slopfest. Again the raw concepts were interesting, but the errors were so glaring... after reading Dhandho Investor, I emailed my value buddy and said "I wouldn't invest a penny with this guy."

My point here is two-fold:

1) Quality of thought process matters! An instance of sloppy thinking is like seeing a cockroach in the kitchen... there is rarely just one, and if you see multiple instances you know there's a problem.

2) The bad performance of Mohnish Pabrai is not indicative of the idea that volatility equals risk. Pabrai, like Whitney Tilson, is simply a shitty value investor who enjoyed a temporary moment in the sun.

I also think that a dedicated value investor could learn from guys like Pabrai and Tilson NOT by making vague, handwaving statements like "these guys prove volatility = risk," but instead by looking at their mistakes -- their blowups etc -- and specifically trying to isolate the logic missteps and process failures that created those mistakes.

I still contend that "volatility equals risk" is not a useful statement at all -- it is too vague and more untrue than true in most cases -- and that Buffett was far more right than wrong in his assertion that risk = potential for permanent capital loss.

For the investor or trader seeking to "get stuff right," a deeper understanding is warranted, and that means going below the surface.

Consider, for example, the following statement and question:

When considering a long-term value investment from the perspective of avoiding permanent capital loss, "risk" -- those factors which can facilitate permanent capital loss -- can take many forms. What might some of those forms be?

Then you can start attempting to answer the question, NOT by giving some blanket statement about what "risk" in a value investment or trade is universally, but by building out a list of the various boogeymen that could eat your capital:

* debt levels / credit-based business models that could prove fatal in a sufficiently hostile macroeconomic environment

* loss of the franchise / deterioration of the "moat"

* destructive industry economics (profit margins destroyed by race to the bottom)

* dangerous exposure to raw input fluctuations (commodity price inputs)

* opaque financials / questionable accounting practices

* reliance on a technology that may become obsolete etc.

THESE are the kinds of things that represent "risk" -- i.e. risk of permanent capital loss -- in a long-term investment. The list is by no means exhaustive, that's just some shit I pulled off the top of my head.

But I think it demonstrates how nuance and subtlety are needed in defining what "risk" is, and why Buffett's definition makes sense (for investors) whereas the hand-waving generalization does not. If you invest in a business where the quarter to quarter earnings are volatile as hell but the franchise is impregnable, the economics are rock solid, and the business is a tank that will keep trundling along for decades, volatility is opportunity, not risk.

And of course, for traders, there is a whole other direction / potential list of factors and consideration in determining what "risk" is... but again, flat stating "volatility equals risk" obfuscates more than clarifies.

 

[darkhorse]

Quote from ammo:

the trading industry is filled with add types,lack of concentration improves the ability to watch several markets at once,unfortunately it more often than not causes one to skim thru articles,so it's not you ,it's the readers

Well I skim like a madman too -- I probably skim 95% of the information I come across, it's the only way to handle the volumes that I do, and a meaningful aspect of my alpha generating process is the ability to swoop down like a hawk on the key needles in the haystack -- but I don't bitch about the need to skim or demand that others start writing in soundbites :eek:

 

[darkhorse]

p.s. If guys like Pabrai and Tilson constitute evidentiary proof of anything, I would argue it's proof of the general assertion that value investing is hard. There are lots of ways to get it wrong.

I don't remember the study, I think Bruce Greenwald of Columbia cited it in one of his books, but I remember some striking findings that showed the vast majority of professed value investing fund managers have mediocre to disappointing results, and that the outperformance of value investing as a strategy, on the whole, is due to the outlier results of the truly talented few.

In this manner, I would argue, value investing has competitive environment characteristics similar to poker and global macro trading.

All are zero sum games, in the sense of a finite pool of alpha to drink from, and so those practitioners at the mass middle of the bell curve cancel each other out, with the fat tail talent outliers grabbing the lion's share.

For the average joe, then, the best advice is probably "don't try this at home," in the same way one wouldn't recommend a tourist wander into a $5,000 buy-in 5-10 no limit game.

 

[Daal]

Quote from darkhorse:


Consider, for example, the following statement and question:

When considering a long-term value investment from the perspective of avoiding permanent capital loss, "risk" -- those factors which can facilitate permanent capital loss -- can take many forms. What might some of those forms be?

Then you can start attempting to answer the question, NOT by giving some blanket statement about what "risk" in a value investment or trade is universally, but by building out a list of the various boogeymen that could eat your capital:

* debt levels / credit-based business models that could prove fatal in a sufficiently hostile macroeconomic environment

* loss of the franchise / deterioration of the "moat"

* destructive industry economics (profit margins destroyed by race to the bottom)

* dangerous exposure to raw input fluctuations (commodity price inputs)

* opaque financials / questionable accounting practices

* reliance on a technology that may become obsolete etc.

THESE are the kinds of things that represent "risk" -- i.e. risk of permanent capital loss -- in a long-term investment. The list is by no means exhaustive, that's just some shit I pulled off the top of my head.

Point is, stock market prices will factor in those considerations better than the most investors most of the time. Buffett might not have to be worried about 20% declines in his stocks, John from HR does

 

[darkhorse]

Quote from Daal:

Point is, stock market prices will factor in those considerations better than the most investors most of the time. Buffett might not have to be worried about 20% declines in his stocks, John from HR does

Ben Graham argued that most securities are not worth analyzing, and that potential outlier opportunities where the street has gotten something wrong are the ones you should put your back into.

If you don't believe that, you shouldn't be a value investor. And who cares about John from HR? He shouldn't be buying stocks in the first place.

 

[darkhorse]

Quote from darkhorse:

I'm not nearly as committed, in either direction. Don't disagree w/ you on Philly Fed etc... it's just been a characteristic of this market the past few years to extract "max frustration" whenever possible. A new push to intermediate term highs -- followed by a hope-dashing collapse just when bulls thought they'd won -- would fit that bill, and if folks were genuinely freaked out about yesterday's macro data, I'm skeptical TLT would be down 130 bips today.

p.s. Plus it would be a chance to "wash and rinse" all the guys who thought the key levels were in

"Grim" ISM consistent w/ Philly Fed:

http://online.wsj.com/article/SB10001424052702304211804577502250352691034.html?mod=europe_home

Operation Wash N' Rinse now halfway to completion... attractive short opps to arise post-holiday trading

 

[Ghost of Cutten]

Quote from darkhorse:

Ben Graham argued that most securities are not worth analyzing, and that potential outlier opportunities where the street has gotten something wrong are the ones you should put your back into.

If you don't believe that, you shouldn't be a value investor. And who cares about John from HR? He shouldn't be buying stocks in the first place.

He isn't a value investor. He's "global macro trading for a living". And in global macro there is no way to calculate 'value' with any degree of certainty, so mark to market is a significant component of risk. For trades, there is no 'intrinsic value' issue - if the price goes significantly against you, then you were wrong.

Even in pure stock investing, sufficiently large macro events can totally invalidate value calculations. For example, if the banking system collapses, or the central bank hyperinflates, or a socialist government nationalises everything and shuts down the stockmarket, or if major war breaks out. Therefore even in pure Buffett-style value investing, mark to market prices are a major component of risk.

Even with a stable macro environment, we can easily postulate circumstances where capital needs to be raised. Buffett could find himself sued into oblivion if one of his employees did something naughty, for example. Us mere mortals may need money for personal reasons, or simply to pay the bills each year. In which case, the market price of your total portfolio is extremely important.

There is a further risk - if your holding falls significantly, they can be taken over at bargain prices. You then have no way to hold on for the long-term, because you got forcibly sold out at the takeover price.

To say that market quotes are not your risk, you have to say that if everything Buffet owned went to a total market value of 1 cent, he would be no worse off than if they stayed broadly in line with their intrinsic value. Since this is clearly nonsense, the claim is wrong. Berkshire would go broke if all its assets had a market price of 1 cent, there would be no way to pay the staff bills or this year's insurance claims. Market quotes therefore matter in any risk assessment. They may matter less to people with deep pockets and long-term holding ability, but they still matter to a degree - and the larger the price move, the more the impact market prices have.

Back in the 'real world' - as a trader, any value investing portfolio you have, must be kept to a moderate portion of your total account. You have to be able to withstand a 50% drawdown in your value picks, and it not affect your normal trading performance in any significant way. So, this places a practical cap of about 30-40% of assets in value stocks at most. If you had say 50% of your net worth in value picks, and say another 10% in cash, that means a bad bear market could easily cut your net worth by about 30%. So, you can only rely on the 40% in trading capital, and 20% of your value stocks, for a total of 60% of net worth available for trading. This would reduce your earning power by a factor of 6/9 compared to someone who just sits 10% in cash, and 90% in trading funds. Those value picks had better be damned good to justify cutting your trading size by 1/3.

And if you don't cut your size, then your value stock portfolio will become exponentially bigger every time you have a trading or value stock MTM drawdown. This will increase your blowup risk significantly.

There's no free lunch. Having a value portfolio is either a massive increase in risk for a trader, or (if he cuts trading size/capital to compensate) a serious drag on trading performance. For that reason, I'd say the best strategy for traders is to avoid value investing except on rare occasions where there is exceptional opportunity, and then limit the commitment to about 30-40% of total net worth, and definitely no more than 50%.

 

[Ghost of Cutten]

Quote from darkhorse:

p.s. If guys like Pabrai and Tilson constitute evidentiary proof of anything, I would argue it's proof of the general assertion that value investing is hard. There are lots of ways to get it wrong.

I don't remember the study, I think Bruce Greenwald of Columbia cited it in one of his books, but I remember some striking findings that showed the vast majority of professed value investing fund managers have mediocre to disappointing results, and that the outperformance of value investing as a strategy, on the whole, is due to the outlier results of the truly talented few.

In this manner, I would argue, value investing has competitive environment characteristics similar to poker and global macro trading.

All are zero sum games, in the sense of a finite pool of alpha to drink from, and so those practitioners at the mass middle of the bell curve cancel each other out, with the fat tail talent outliers grabbing the lion's share.

For the average joe, then, the best advice is probably "don't try this at home," in the same way one wouldn't recommend a tourist wander into a $5,000 buy-in 5-10 no limit game.

This would also argue against trying to value invest if your full-time gig is being a trader. How many people are top in two separate sports? How many poker pros are chess grandmasters also? If only the elite can thrive, and your best skill is trading, it is incredibly unlikely that you will also be good enough to seriously outperform through value investing as well. Also, as a good trader, your hurdle rate will be massively higher than most pro value investors. If you can make 20%+ with <20% drawdowns as a trader, then very few value investors are able to compete with those numbers. Even if you are somehow a Soros and Buffett rolled into one, you have a limited amount of study time per week. A pure trader, and a pure value investor, of equal ability to yourself, will be doing at least twice as much work on their specialist field each week as you are able to. There's really no realistic way to compete on the same level.

So, it's probably best to stick to your knitting, and only step outside your speciality if a truly exceptional opportunity presents itself (e.g. late 2008/early 2009). This has the nice side-benefit of making you into the equivalent of a super-patient investor who is fully in cash at the depths of every bear market.

 

[darkhorse]

Quote from Ghost of Cutten:

This would also argue against trying to value invest if your full-time gig is being a trader...

So, it's probably best to stick to your knitting, and only step outside your speciality if a truly exceptional opportunity presents itself (e.g. late 2008/early 2009). This has the nice side-benefit of making you into the equivalent of a super-patient investor who is fully in cash at the depths of every bear market.

Yes, I generally agree. For a skilled trader, the ROIC hurdle rate will be very high. There is little point in accepting lower percentage returns per annum, unless the core strategy is at max capital capacity.

With that said, I strongly favor the idea of having a side pocket type fund capable of making deep value investments in post-crisis periods (having toyed with something along these lines for a while, then crystallizing the concept via HFMW).

The beauty of such a strategy is that

* The side fund can be kept at minimal cash balance most of the time, so dormant periods do not hurt in absolute dollar terms

* The demanding threshold in and of itself is likely to produce outperformance for the periods when meaningful capital is invested (you don't bother unless the value landscape is in the 95th percentile or better of excellent opportunity)

* If an extreme value landscape arises, capital can be swept in from the main trading funds AND raised from investors (who understand the concept and believe in the managers), perhaps on an even larger scale (if the capacity of the trading strategy is, say, $100MM, the capacity of a special opportunity value fund might be $500MM or even $1B)

* In the event of an extreme post-crisis opportunity, the trading landscape may well have shifted (temporarily) in favor of long-term buying anyway

Quote from Ghost of Cutten:

How many people are top in two separate sports? How many poker pros are chess grandmasters also? If only the elite can thrive, and your best skill is trading, it is incredibly unlikely that you will also be good enough to seriously outperform through value investing as well.

I do disagree with the above, though.

The poker / chess metaphor is unworkable because poker and chess both require thousands of hours of experience to master unique combinations and patterns that apply to each specific game.

Chess grandmasters are known for 'chunking,' where they see not single chess pieces on a board, but whole positional elements referenced against a library of tens of thousands of position chunks in their head.

Top poker players are similar, in that their ability to make the right decision instantly in complex situations arises from having seen such-and-such situation before, or some subtle variation of it, with thousands of such reference points.

As such, the conceptual skillsets of chess and poker do not overlap. There is no way to avoid the intense commitment to seat time, plus deep study and analysis, for each individual game.

Macro trading, short-term trading, and value investing are not so disparate as poker and chess though -- rather than functioning as wholly separate disciplines with intense memorization and experience demands for each, they exist at different points on the same continuum. You can sit in the same seat for all three. It is thus more realistic (though still by no means easy) for a great global macro trader to also be a great value investor.

Not to mention there is overlap, too, in terms of the cross discipline of asset allocation -- in a sense global macro is the king of all the disciplines, because if you recognize a high quality value environment, you can hire deep domain value specialists to put your allocated capital to work for you (a specialty of Soros).