Are you having good ex?

best ex

Should the above not be vague enough for you I could always try to muddy the waters a little more and ask a few questions:

What is the best result when it comes to best execution?

Which client are you specifically referring to ?

MIFID has caused untold amount of headaches. I’m not here to re-hash them as I have probably already lost about half the people who clicked on this link.

Best execution could dimly be seen as a way for European regulators to clamp down on what they thought were cosy deals between broker and client where commissions, CSA payments, research budgets and benefits flowed between counterpart’s like fine wine at a bunga bunga party.

Admittedly there was largesse in the industry and some less than value added business practises. However from where I sat I wintessed MIFID bringing a great opportunity for the talented people that I worked day-to-day with to actually prove their worth. Both human and electronic (hi touch & low touch) trading standards have grown exponentially now that those teams responsible at the large brokers have the mandate to go and prove their worth. Rather than passively receiving flows from clients based on relationships or CSA agreements or what was known as “soft dollars.”

Soft dollars was an easy way to pay brokers for their overall contribution to you as a client. It was a recognition that its actually quite hard to value research provided on the universe of names that you are interested in. However to be critical it did not encourage the pursuit of excellence in a given area of broking.

What regulation has given with one hand it has also taken away with the other. Trading and execution standards have drastically increased with a laser like focus on costs, impact, trading styles and pre and post trade techniques that would make traders of old blush at their previous laissez fare style. PB financing agreements definitely seem more competitive but that is obviously hard to say on average across the industry due to the vastly different needs of all clients but from where I was sitting it seemed fair to me.

What has suffered is the research coverage. While it has always been a concern we are starting to hear more and more complaints from fundamental style investment firms where small cap names in particular are not receiving coverage from the large banks and therefore not only will they suffer and find it harder to grow but also the investments and liquidity in these names are declining. This too shall pass though as the finance industry has a way of adapting and providing value where value is sought. I envision an industry made up of small research providers similar to the law industry or medical practitioners, platforms like RSRCHXchange will continue to be a big winner here I feel.

I wont even talk about the regulatory cost pressure as that is well documented.

The main point here is what is best ex? As the title of this post was a salacious attempt to catch eyeballs – It seems appropriate to defer to the famous Judge Potter Stewart quote here ” Il know it when i see it.”

The two questions I asked at the start of this post is the best place to start. As I posed in a previous post The Art of Execution best ex is a very personal matter.

Dividing best ex into two separate problem areas -External and Internal costs, we can attack the problem from two angles.

External costs:

Best ex from an external costs perspective is all about aligning your trading with brokers that can serve as the best medium for what you are trying to achieve. Negotiating lower trading commissions is not just a process of demanding a certain rate but rather working with your broker pro-actively and trying to look forward and quantify what level of business you are “likely” to produce this year based on informed estimates from previous years. As always data… data…and more data is key here. Put it down on paper and treat it like a business pitch, the more information you know about the characteristics of your own business and how its likely to evolve in the future is gold dust to a broker who can then make a decision about what levels they can profitably facilitate your business. Brokers are not a charity and have the same business pressures you and I have, as I have said before work with them and they will happily work with you.

PB and financing arrangements if you are employing leverage to your strategies are also a significant form of external cost. Again this is going to be driven by your behaviour, understand what you have done in the past and are likely to do in the future and then provide the information and you will receive much more dialogue and assistance in driving down these costs. but the information is key as the brokers needs to know what they are working with- remember you are renting their balance sheet in an industry where having a safe balance sheet is key to their regulators.

Internal costs:

This is where the bulk of the work must be done. Like I said brokers are the medium to which you achieve your business goals. Therefore the more you focus on Internal costs the better. Focusing on internal costs does not mean reducing headcount or slashing back on the coffee machine. What it means is thoroughly understanding the strategies you are employing and what is the best result in terms of execution to your company and strategies.

The investment management, hedge fund or trading landscape is both diverse and narrow in its approach. What works for one company is very unlikely to work exactly the same for another. There is no one size fits all approach to take. How can you employ the same execution styles for a HFT firm as you do for an institutional long only equity manager. While they are both trying to increase returns and make money on their investments their approach to doing things requires two drastically different styles of execution.

Determining what best ex is for your style is key to overall success and should look entirely different to how your neighbour views best ex.

Time for a basic example here:

Firm A is a institutional deep value money manager and wants to buy a large block of stock in a tech company which got severely de-rated in Q4 2018. They view this as an attractive entry point in a name that got away from them the previous year and they have been working on for some time. They are likely to hold this name for at least five years and under the best scenario will never have to sell it.

Firm B a multi-asset manager in the hedge fund space employs a catalyst driven manager who views the same company in a positive light and thinks the market has overdone this name to the downside and is looking for a +10% re-rating in the name after what she feels should be better than expected earnings. She is not in the name for a long time but rather a good time so to speak and is looking to apply her timing, trading and position sizing skills to best effect.

How do you buy stock for both of these managers to achieve best ex ? ? What even is best Ex to both of these managers and importantly their underlying client base??

Lets start by looking at some of the underlying motivations of each manager:

Firm A:

  • Eager to deploy cash in a name they like after sitting on cash reserves waiting for a pullback ( So time is an issue to some extent)
  • Looking to make a large investment in the name – likely many times the Average daily volume (ADV).
  • Unlikely to be employing leverage and therefore financing costs are not that much of an issue.
  • Looking to achieve a total return in the name over many years far in excess of what is likely to be the daily movements in the name over the short run.
  • Aware that merely sitting on the order book trying to buy the stock in that size will trigger off “reactions” in the market and likely to spoil their own agenda.

Firm B:

  • Eager to buy the name but has concerns over the current trend as feel might be counter trending a name.
  • Looking to add to a book of levered trades – investment is likely to be a fraction of Firm A- but on a levered basis will have an immediate impact on PNL should there be a decent move (in either direction)
  • Looking to make an absolute return over a short space of time of circa 10%.
  • Size of the order is not as much of a concern as she has specifically chosen this name as the ADV can comfortably accommodate her usual trading “clip size”
  • Likely to be out of this name directly after earnings and onto the next one.
  • Does not want to pay hi-touch rates as the duration and risk of the trade could mean losing up to 40bps of the already expected tight return and if goes wrong compound the error more.

Lets just remember that both of the above have underlying clients again all with a different level of expectations. So again I pose the question how do you approach both trades in the same way to achieve best ex?

Only through a deep understanding of the nature of your strategies and what the “proclivities” of your flow tends to look like can you then sit down and determine what best ex means to the success of your overall firm. The challenge here is most trading desks have been downsized for various reasons and a one size fits all approach has dominated under the assumption of costs management rather than focusing on what I define as internal costs.

Efficient trade execution is a process of give and take. You cannot eliminate trading costs. Well thats not true…you can …dont trade. But no matter what your average duration of a trade looks like whether its miliseconds or forever, you have to come to market sometime. In my mind best ex comes from designing a trading strategy that takes some costs in one area in order to minimise the costs in the other but all in an attempt to get the best out of the actual strategy and therefore help boost returns. That is the ultimate goal of the company and more importantly the underlying investors, which ultimately is the raison d’etre of MIFID.

Doing so in a one size fits all approach can certainly reduce noise and seem efficient as algos buzz away and “process” a large magnitude of flow and may appear like best ex.  But digging deeper and taking both a quantitative and qualitative assessment of your flow can lead to actual best ex that is personal to the unique goals of your strategies and overall company. Everyone is always looking for an edge, I am a big fan of Sir Dave Brailsford management style of seeking an edge in the marginal gains. Improving each of your processes to achieve even a 1% improvement leads to overall success.

MIFID has undoubtedly been a pain, but mostly a necessary one, I think the response so far from both the broker and buy side community has been strong in terms of redesigning the trading architecture and processes. In my mind stage one is complete and rather than standing on the air carrier and declaring “mission accomplished” now its time to really push forward an drill into execution strategies to improve each one individually. The tools, platform and skills are there lets make sure we use them appropriately.





















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The Art of Execution

Fair warning this is not a tweet ….I repeat this is not a tweet. Grab a coffee and settle in for a few minutes.

Having found some time on my hands I decided to document some thoughts on the state of play in the asset management industry specifically how it applies to trading. In my humble and for anyone who knows me, obviously very biased opinion execution trading has become an integral part of any asset management business. Conversely, although still seen as a cost it is in fact on the front line in protecting client’s assets in a world where returns have dwindled and squeezing every penny out of a trade has become more scientific and important. MIFID in my view while has been an administrative nightmare and logistical challenge has delivered a rapid change of approach to how trading is conducted. A much more scientific and professional approach has been adopted by both the buy and sell side and the reduction of related trading costs has been immense.

To some of us who have been around for more than a couple of years this is a big change and the temptation is to shake your head and tut tut at the state of play and lack of human interaction. To some it has been a de-skilling of dare I say it an art form developed over many years of long battles fought with order books, brokers and “the market” in general.  “Back in the war” a trader who was committed enough had to live a pretty high stress life and really immerse yourself in order book dynamics – there was an art to sniffing out whether you are the aggressor or is the bogeyman on the other side the aggressor and then adjust accordingly. That’s all trading in the short term is – who wants it more. The much vaunted “more buyers than sellers” has always raised a laugh and while obviously it’s silly it takes away from the important point of who is the “more motivated buyers than motivated sellers” or vice –versa.  Judging the panic or lack of panic in the opposing order is still a thing of beauty when executed correctly.

As with most industries you either adapt or die.

Now we have large trading volumes spread across the equity market mostly conducted by algorithms. The human element is gone or so most would say. But let’s not forget what an algorithm at its basest level is – a set of instructions designed by a human to process a task. We get lost in words sometimes and has been the case very much recently where big time money managers with great track records blame their poor performance on the “algos” like they are a living breathing thing. They are not – they are a set of instructions designed by a human. Understand that humans perspective and you will likely have a better clue of their algorithm and what it’s doing and why. Most of the brokers I have had relationships will attest to my very apparent reaction when they attempt to explain what their algo does and why it’s the best. A cloud comes over the room and I just want to know what the simple basis for what this algo does is. Is it trying to be aggressive or is it trying to be passive? Once I know that I know how to use it correctly, that is if I evn need to use it.

The “electronification” of the trading landscape and use of algorithms for executions has been vast. Why might this be the case? A variety of reasons come to mind:

Cost cutting: Asset managers and banks believe that using algorithms for doing a once human task is a cost saver. It’s hard to argue with this point on the face of it. In almost all industries labour has always been one of the largest costs of production and almost always been replaced by machinery where possible.  The finance industry was certainly no different and probably was one of the largest examples of largesse when it came to pay. I believe in paying for performance so in that respect I would argue that a lot of it was fair ….often mind boggling numbers but fair if they performed. Before I became a trader the desk that I serviced had somewhere close to 25-30 traders covering just large and mid-cap Pan Europe & UK, that’s not even counting the sales staff. That same desk probably has most likely less than ten now on a good day, at least 2-3 of which are likely to be grads. My most recent experience saw me conduct trading for over $200bln notional a year all on my lonesome and barely broke a sweat. So fair enough you have reduced headcount and most likely increased efficiency. However the costs don’t just go away I’m afraid. There is a huge tech spend associated with all this electronic trading. Data, its storage and use does not come for free either. While this is decimating the mid-tier brokerage industry the large or bulge bracket banks have responded in my view brilliantly to this changing landscape and invested heavily in their trading architecture, some more so than others but that an argument for a different day. It’s fair to say that there are 9 banks worthy of taking on large electronic trading volumes – five of which will be the eventual “winners”.

Consolidation of assets: While there were always mega pension or mutual funds back in the day – the growth in AUM of a concentrated bunch of asset managers has been mind boggling. We all know the names of the people I’m talking about – and they exist in hedge fund, ETF and pension fund space. While you will hear many complaining about how regulation has killed the industry most of the people at these mega funds must be crying out for “more more more” as the barriers to entry have increased significantly in the asset management industry. Had it not been for electronification of the industry all those traders I serviced back in the day would have merely moved from the sell side to the buy side and shifted that cost base from one to the other. Adapt or die, AUM of a large magnitude correlates pretty strongly to an enormous amount of continuous trading.

Success breeds imitators: All traders biggest problems over the last ten years on a day to day basis could often have been reduced down to “what the hell are the HFT crowd doing to me.” HFT or ELP’s whatever you want to call them nowadays have received a pretty bad rap over the years and while I don’t condone predatory behaviour or illegal trading practises I do wonder what everyone is complaining about. These guys are just doing what everyone has always done in trading. As referenced above they are sniffing out who is a more motivated buyer or seller and reacting accordingly. It just so happens they can do it a million times a day and not be tired. So they are exploiting an advantage over human traders. I really struggle to see the objection to them (again assuming it’s all legal practises). These guys made a killing and if sharpe ratio in its normal form applied to them (which it sort of doesn’t) it must be mouth wateringly large. Now that the light was shone upon them and the haters hated enough it’s a bit more difficult for them. Also the brokers have responded to try and design their algorithms to temper the worst behaviour from them. However the point being is that the rapid and frightening success of these strategies led most people to the forced conclusion of “if you cant beat them join em”. While most electronic trading is not even comparable to what HFT does the concept of using algorithms to execute being more efficient has stuck.

Style shift: Factor rotation, Risk parity and target vol for the most part require a large amount of continuous trading. While returns have not been on fire over the last few years this would suggest that you also need to ensure your cost base is low and nothing eats into a trading strategy more than inefficient trading costs. A typical long short equity portfolio that employs leverage has to contend with large financing costs at their friendly PB and execution commissions and that’s before they even think about what slippage they will experience between the signal to trade and the trade execution. While financing costs are usually the most expensive you also cant afford to pay the 15-25bps per trade that brokers used to garner on the hi-touch side you need to pay the much lower costs on the low touch side. This makes more sense when you look at the typical trading which is usually never big in any one name but rather made up of lots of little trades across a very diversified universe. What I’m trying to say here is that these type of strategies trade a lot but do not need nor can afford a hi-touch service.

ETF’s: Writing this the day after Jack Bogle passed away I couldn’t not mention the staggering growth of AUM in ETF’s over the last ten years. Jack Bogle has done amazing things for the average investor and truly made it easier and cheaper than ever for Main Street to participate in the market at the right price.  The mostly low management fees of these products and fervent focus on tracking error requires a large and continuous amount of trading. Again none of which would be possible under the old hi-touch model.

So these are some of the reasons why we got here. Now that we are here what do we do about it.

If we were in a world where returns were buoyant and everyone was crushing it and making money – I wouldn’t be writing this post because no one would care. We aren’t and haven’t been for some time. When returns diminish costs have to come down also. Never waste a crisis and all that. The work that is going on now under the hood in most asset managers to reduce costs will in the future pay dividends as long as discipline is kept as returns are unlikely to stay low for long. A good execution desk is worth its weight in gold to an asset manager and the end investors.  Don’t throw the baby out with the bathwater. Execution desks have always been sniffed at by “traders” as they are thought to just blindly execute like a monkey. I’m sure there are examples of this but in my experience it’s a skill like any other. It’s the same skills as portfolio managers possess just the time frame is different. PM’s must filter through the constant barrage of noise to identify an opportunity for a trade or investment. It’s the same for an execution desk only the one thing you don’t have is choice. You are handed a trade or bunch of trades that you did not devise of often in stocks or whatever asset you have never traded and you have to think quick and fast about what is the right approach to take with this trade given the incomplete information you have.

As mentioned high trading costs are cancer to a trading strategy. They eat into returns that we have already established are on the low side with a ravenous appetite. So many strategies on paper have an equity curve that goes from bottom left to top right in a nice trending fashion until you factor in trading costs.

There are two different classification of trading costs in my opinion – those that can be controlled at the broker level and those that are an in-house problem. I often say to brokers that is a YP or a MP (Your problem or My problem).  Too often I feel asset managers have made trading costs a broker problem. Purely focusing on driving down commission costs and declaring victory over trading costs is only half the battle won. Controlling these costs come down to negotiation and having a strong working relationship with a broker. The old combative relationship between brokers and clients are long gone – you are partners whether you like it or not – brokers are the necessary medium you use to achieve the results you want- don’t forget it, work with them and they will happily work with you.

The much bigger impact a trading desk can have is to identify the role they play in driving down the in-house costs (an MP) to a trading strategy and as I keep referring to adapt or die. Your role has become less about waging that war with the market day in-day out and more of a strategist. You need to identify the characteristics of your flow or trading over time and then employ or match your trading strategy to those of the alpha signal or generator.

For very basic examples there are often two distinct styles of investing- let’s say that X PM  has a value orientated approach to equities while Y PM has a momentum approach to equities. Is it good enough to simply receive orders from both PM’s and route to a broker algo and work the same way? Clearly not – one style demands an approach that will likely be more aggressive in trading than the other. One style earns its alpha from capturing short term gyrations and trends – so you better make sure you capture as much of that often fleeting trend as you can. A momentum strategy is inherently of the belief that stock ABC is going up/down at a faster rate than stock XYZ so you better get on the train quickly to capture that. Employing an aggressive liquidity seeking type algo for these trades makes sense in theory right? The very widespread adoption of momentum strategies (definitely a post for another day) would suggest that if you don’t aggress someone else will.

Conversely a value type strategy can often be described as being contra or early to the party. So often a good value strategy is picking up unloved stocks or selling ones that have strayed too far from their thought to be intrinsic valuation, either way at the heartbeat of the alpha is usually swinging the opposite way from the crowd currently. Do you stand and buy these names?  No, you employ a much less aggressive style and let the stock come to you, it’s more likely than not that there are currently more motivated sellers than buyers in this name.

Obviously this is not going to “work” in 100% of the trades that you do – but show me a strategy that does and I will show you a liar or a fool. What you are attempting to do is win the marathon not the 100 metre dash. If you can control your in-house trading costs and achieve a smooth profile over the long run that is worth more to any strategy than a blind squirrel who finds a nut every now and then.

This is all well and good and a very simplistic approach to take correct? Where it goes wrong is in two ways: first off the PM doesn’t know their own style and you don’t have enough data captured to make an informed opinion on what their style is. Simple remedy to this is to talk it over with PMs and identify a basic plan that sounds like the right approach to take over time. The next part is important …DATA DATA DATA. Yes I know it’s boring and hard to do, methodical tasks are often just that.  But you have to collect a variety of nuggets of data every single time you come to market. Without that feedback you are shooting in the dark. The data may show inconsistent results but not just my guess but my experience is if you capture and measure correctly over time the correct approach screams out from the spreadsheet. Also pro tip – don’t need a fancy off the shelf very expensive TCA package – you can build in house in excel very easily depending on your requirements.

Problem number two that many face is do you have the stomach to stick to a strategy over time and do you have the buy in from the business? If you lack A then you will almost certainly lack B and if you have A it doesn’t mean you have B. PM’s, the CIO and the business managers must be involved and behind this approach and take a more active approach in treating the execution desk as vital to the goals of the organisation and the underlying clients. Best ex is not just about broker selection it’s about managing both the YP’s and the MP’s in a pro-active and efficient manner. The more importance and focus put on in-house trading costs the better returns will be in theory –(it won’t correct a failing strategy- it’s not a miracle worker)  which is all around just better for business.

The main point here is that a good desk must match their trading style for each order to the characteristics of the alpha signal or generator and over time you will achieve a smooth slippage profile or to put simply you can control and put structure around the in-house problems. You do this by adapting to the new environment and changing how you do things – you have graduated from foot soldier to general, focus on what strategy best suits your organisation and its goals.

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Timing is everything II

A quick one for once …..

I wrote before how timing is everything – obviously hard work is a major factor of success but timing is everything both good and bad.

Imagine if you will you became president of America. “Ugh” is probably your first thought but lets play pretend here and assume you had to do it. We all have ideas in our head of what we would like to do to ” change the world”, I would argue that you can do much more in times of crisis than times of posterity.

I am by no means advocating support for Donald Trump ( neither am i advocating resistance FYI ) but if you look objectively at it which time in history would you prefer to become President of the US ? Now or 8 years ago when Obama came into office.

On the face of it 8 years ago seems like a horrible time to come into office. The world was literally reeling from a global financial shock to the system, massive social unrest and the treasury was holding a gun to the head of congress looking for $800bln of tax money to bail out the fat cats on wall St and so on and so on.

Now Donald Trump inherits an office in charge of an economy at near full employment, despite what he says which is trucking along nicely- not killing it but not doing badly either.  Where some of the biggest arguments of the last year or so has come from whether they should let transgender individuals use which ever bathroom they associate with – hardly a bear market pre-occupation.

If you legitimately want to change things – and I would argue that if you take Trump at his word ( a hard thing to do admittedly ) then it seems much easier to change things in a crisis than in times of relative prosperity.

“Never waste a good crisis”

I find it inconceivable that DT will actually be able to change anything – because at the moment no one is feeling enough pain to consider it completely broken. It would seem that Hank Paulson had the right idea 8 years ago – he sensed the urgency in the air and he took advantage – he gave politicians almost no choice and he got what he wanted. DT needs an environment of crisis to achieve the things he wants to do in my opinion and it will take him time to realize that.

Politicians move slowly – businessmen do not. Businessmen are adept at applying pressure at the right time to get what they want – in this respect I think DT will actually welcome with open arms a weak business environment – the sooner he realizes that the better.

Im not saying he will create weakness in the economy on purpose ( as I doubt he is capable of doing it anyway) but I certainly think if things started moving to the downside he would be wise to not stand in its way….. risky strategy but so is doing nothing for four years.

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Trade the narrative but dont buy into it


Narratives are all around us – none more so than the equity market in which I am but one of many participants. Narratives or as many of the synonyms above like- tales, stories, portrayals etc etc can be very entertaining and powerful things. One of the first things I try to look at when looking at markets is – “whats the narrative?”.

We use narratives in the equity markets because its much easier than going into detail on the given topic, if I were to blog about the many different factors making up not just the domestic equity markets but also the global equity markets then I fear I would have to include many pictures of sideboob or some salacious headlines littered through this post just to keep your attention – a la Daily mail style.

What is much easier is narratives. What I am interested in, is when narratives start to intermingle, change or stop dead in their tracks. For examples of this its easier to just stick the US equity markets, after politics probably one of the biggest circuses in town- laden with narratives.

Just in the last few years we have had some of the following narratives:

  • Monetary policy is inflating the stock market
  • The FED will step in whenever it gets ugly
  • Low oil prices will provide a boost to the consumer and bump in inflation
  • Rebounding oil prices will cause a drag on the consumer and deflation
  • Structural investment will make America Great again
  • Donald Trump will bring back manufacturing jobs to America
  • Tax reform will be a boost to stock market
  • Trumpflation, Trump Bump, Trump Trade

All these sentences have been uttered to describe why the equity markets have been going up over the last few years, but whats most interesting is the eternal optimism of equity markets – especially in the US.

One of the most powerful narratives since the GFC has been QE, monetary policy and the FED all combining to provide protection on the downside and squeezing asset prices higher to stoke inflation. My bet is that if you asked most equity participants to write down the mechanics of structurally how QE was operated and how that actually translated into a squeeze in equity markets you would be met with a lot of blank paper. However that was the dominant narrative and the engagement of this narrative ranged from those who downright accepted that in theory it worked, those who grudgingly accepted the policy and did not want to “fight the fed” and there were those who just got carried out fighting the narrative altogether.

Whats very interesting is that despite QE ending over two and half years ago the narrative prevailed long after. The FED tapered and eventually simply stopped outright purchases and some time later even eased themselves into a tightening cycle. How frightening – we needed a new narrative, and bloody quickly. If you look at the price action in 2016 this is what a “narrative-less” market looks like. Completely sideways, basically there was nothing to excite in either direction.

As I argued in the following blog post  What has monetary policy done for you lately? we needed to convert from a state of monetary policy holding up equity markets to fiscal policy. (See below excerpt from said post)


And boy did we transition sharply. No sooner was it confirmed that the supposedly populist candidate Donald Trump was to be the next President of America so too did equity markets quite literally buy into the “hype”, “narrative”, “tale”, “story”. Quite literally by the open of the equity market the next day equity prices were rising and rising quick smart. Small cap equities – a proxy for the “rise of the middle class” under President Trump rose an astonishing 22% straight through till End of November and for now is still maintaining those highs.


The narrative is pretty clear –

Through a combination of tax reform, infrastructure investment, immigration control and most importantly regulation reform Donald Trump will make America great again and unleash growth that has been held down for years.

Now another rule I like to follow in equity markets is that the markets just dont give a damn what you think. You can slap your forehead and give me all kinds of economic theories as to why Donald Trump will not achieve anything, first of all most of this is to do with your own biases. Most people I know dont like DT. Its a fact that the majority of voters didn’t actually like him in that he lost the popular vote. Your opinion on DT quite literally has nothing to do with anything. What matters is will he do what he says he wants to do – and then will it work ??

Equity markets so far have traded the narrative – the big question is have they bought the narrative, i.e. how long are they willing to be commited to this narrative before things start to come unstuck. The market is long equities – how long they are is anyone’s guess and it often ranges between styles etc.

One of the more popular styles out there is Risk parity- I am no genius on this strategy but I think its safe to say that with the increase in bond volatility relative to historic norms and the massive slump in equity volatility relative to historic norms this is a potent combination for those managers following RP to be turbo long equities and not too bothered re bonds, if I were a risk manager at a certain Connecticut based risk parity led hedge-fund with gods money under management I would be feeling extremely uncomfortable at the moment at definitely out of my comfort zone.

What could cause this narrative to become unstuck. Like I say – I would prefer to align myself with the narrative BUT be prepared or wary of triggers that can unhinge it or indeed re-enforce it. Narratives need maintenance after all.  What triggers am I looking at/for?

  • We already have evidence that its not going to be cake walk for DT. His relationship with Paul Ryan the speaker of the house and Republican seems to be strained. It could well be fast becoming a reality of that old cliche of an “outsider” who is trying to change things is going to experience a lot of frustration. I think DT got his first taste of ” how we do things around here” last week when he tried to rush through amendments to the ACA and his own party halted him in his tracks – despite spending the last 8 years railing against Obamacare.
  • Then we start hearing quotes from same Paul Ryan suggesting that obviously they are open to tax reform but it may take considerable time. Well of course it will take time to implement this – unfortunately that’s not what markets want to hear – we bought equities in November and now we need another oomph to get this thing moving again or we will look elsewhere.
  • The theme that DT tends to act hastily, off the cuff, without thought has always been an overhang – from his late night tweets to his sometimes off comments in a presser. So far this has only emboldened him and seemed to make him more appealing to his die hard supporters, everyone loves a “character.”
  • I literally know nothing about Geo-politics outside of the headlines- but guess what?- so does about 99% of the population, his latest move to sanction a fistful of rocket launches on Syria in retaliation for a chemical attack by Assad on his own people certainly seemed to me like a hasty act. I will not rule out there may well have been good motive or strategic rationale for doing it, but for sure it seemed out of the blue and hastily arranged. Also see his supposed tweets upon the very same subject : (obviously I am not going to scroll through DT’s timeline for verification of these tweets- so if its “fake news” then ok- Ive been duped )


  • Yes a lot of the right are gun toting nuts that like to talk tough, but I also think they bought into the idea of why should Americans be solving international disputes – especially when its unlikely most people could confidently locate Syria on a map if asked on the spot. A lot of Trump’s campaign had a theme of isolationism and putting America first – this resonated with people and I think its something that his support will give him a pass on this time, but will not tolerate him getting into any kind of protracted war down the road. Sadly he may have already forced himself into one but this remains to be seen. But its a trigger and I will be looking for signs of waning enthusiasm form his core support.
  • If his relations with the media take a sudden change for the better it would be a trigger for me too, it probably means something is coming that he needs positive publicity on, it would make me ultra cautious of risks to the upside.
  • If the same people that are standing in opposition of him start to make positive noises about tax reform or repatriation of profits to US from corporate’s abroad then again this is a trigger to the upside- a re-affirmation of the narrative if you will.

About this time I usually like to wrap things up by saying something like “to make a long story short”  but the whole point of this post is that I have tried to make the short story long.  Knowing the buzzwords of the narrative and simply repeating the mantra in your head will not get you anywhere- knowing the narrative and understanding the mechanisms behind it will put you in a much better position to trade the narrative but not get sold on it.

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Be long change

“To sum up, it is not volatility that scares good investors, its the opposite – calmness. Calmness indicates you are with the herd, and while that can be comforting at times, it ultimately leads to some very scary moments and dealings with wolves.”

This is something I wrote previously on the topic of volatility (Volatility- The punishment for Group-Think) and how I believe it is the ultimate force to correct group-think in financial markets especially.

I cant help but the note how currently the inverse of that statement is true, if volatility is the punishment for group-think , then lack of volatility is the punishment for anti-group think or contrarianism.

I will often be found grumbling like a cantankerous old man about the dangers of selling vol. I dont like it as a “strategy” full stop and I will probably never be convinced otherwise.

However, I am of course completely wrong . As a strategy over the long term selling vol has proven to be very profitable. See below return profile of a hypothetical put option writing strategy ( CBOE S&P500 PutWrite Index). Any strategist, PM, Quant etc would dream to have a pnl curve that goes from bottom left to top right with relatively very little interference in between. Sure there have been periods of drawdown but over the long term its hard to argue its merits. If I was correct, there would be no insurance companies in the world.


However, I am still not a convert. it matters very much at what point on this hypothetical pnl curve you enter the mix. Lets say you started to employ this strategy but a few years ago , like say 2011/2012 – why 2011 you ask ? well that is roughly when XIV US entered the mix. An ETF that replicates a short VIX strategy. It too has been very successful as per below. Price appreciation has gone again from bottom left to top right with a little more vol in between but never the less it got there.


You can tell from the above chart how it now matters more where upon you join the pnl curve when implementing a strategy. Just put your hand up against the screen and cover years 2015 and 2016. The pnl curve still looked very handsome until all of a sudden a big draw down occurred …twice in succession I may add.

I could use the old cliche of picking up pennies in front of a steam roller but I prefer to think of it now as being “short change”. Shorting vol is an admission that nothing is going to change and therefore I do not want positive exposure to change but rather seek to profit from stagnant behavior. If you are to think of it like this then the last few years makes a lot of sense.

How has vol continued to trade lower over the last few years when all around us we are often witnessing terrible economic problems, political uncertainty and massive change?

The only possible explanation I can give is despite all these issues that are going on in the real world, the financial world, or those in charge of fiduciary responsibilities have taken the view that come what come may the central banks have broad enough shoulders (or indeed will have to have) to absorb “any” economic shocks. As recently as a few months ago when the largest German bank was in a perilous situation in the market the over riding message was that the Bundesbank/ ECB  or German government would step in and save the day should anything go seriously awry. This is probably the case, but the ease at which people let that thought escape from their mouth without the slightest thought for the implications of this I find fascinating.

This dogma that central banks have it covered is a frighteningly lazy state of conscious for any money manager to employ, it would also go a long way to describing how this pro-longed but unloved equity rally has endured for so long. You will find few people who agree in entirety that all will end well when discussing the behavior of global central banks, most are begrudgingly going with the flow out of fear of taking on the central banks. The phrase “don’t fight the FED” has been in imprinted on most investors mind for many years now. Most agree that it will all end in tears – they just dont know when.

The power of the market has been all but deputized to the central banks. I cant think of a more dangerous scenario than when hundreds and thousands of people, investors, professionals, etc etc all defer responsibility to a small group of individuals often totally unsuited to managing anything in the real world. The role of financial markets is really often quite simple- ebb and flow back and forth to find a valuation for a given asset class at a given time. Handing this power over to central banks implicitly or tacitly is like building a dam, it will stem the tide for as long as possible, but one day the crack will appear.

I cant think of a better scenario where I would like to be positioned with positive exposure to when this situation changes. Like everyone else, I dont know when the shoe is going to fall, if I did I would be an exceedingly rich man already, but by putting myself on the side of change I stand a greater chance of not being squashed by the steamroller and picking up vastly more than pennies.











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A brief foray out of hibernation

I will try to be brief here but a few bearish charts to look over and just have a think.

  • Corporate buybacks
  • Capital goods orders
  • Restaurant performance index
  • US personal savings

First a lot has been said about corporate buybacks and how there are the only source of capital holding up equity markets. This is usually the throwback from a frustrated bear who cannot put any rhyme or reason on the seemingly teflon like nature of the stock market. Every time the market looks vulnerable to a sell off low and behold the invisible hand steps in and lifts the market back to new highs. Most have attributed this to corporate buybacks. Its true to say that Corporate buybacks have been a strong feature of this rally. Sadly its also true to say that corporations are the worst stock traders in the market and this cycle since the GFC has been no exception.

Two charts below show a number of things to worry about. If you subscribe to the theory that the “only thing keeping this market up is buybacks” then look at the drop off in activity over the last three months. I have no doubt the pending elections in the US have something to do with this as companies adopt the wait and see approach for whats in store for them come November but its a stark withdrawal of capital that was sitting on the bid and in my view makes us very vulnerable to a sharp sell off very soon.

(Chart courtesy of Bloomberg)capture

To say that buybacks are out of the norm and the only thing holding up the market is to ignore the pretty strong history that buyback activity has enjoyed please see the activity levels preceding the GFC and the resulting lower levels of activity after the GFC. Corporations only buy back stock when they are expensive ( it is after all only a way to engineer the appearance of a rising stock price nearing the end of a cycle)



Another reason buybacks may be down is that companies are noticing the below drop off in capital goods orders. See below 2016 cap good orders vs  the 3 y avg, doesn’t look great does it ? FYI the S5INDU index of cap goods stocks are trading higher than 3 yr avg – like 20-25% higher…….



Although i have referenced capital goods above I dont really view the US a manufacturing based economy anymore, that ship sailed long time ago ( and it was built elsewhere!), i do however often think that it is a country where over 50% of the people serve the rest in some way related to food, drink entertainment etc etc . the restaurant performance index is not looking to healthy either despite a few decent months in Q1 this year it would appear it wasn’t the best summer season for them.


If it was not the best summer season and restaurant performance is declining that would suggest tips and wages are probably declining too, that will make it just that bit harder for the average US consumer to finance two things: Their shiny new car and the loan or financing that came with it ( despite probably purchasing it for almost zero financing and cheap petroleum) and perhaps also their hefty student loan. Chart A below shows the stunning performance of auto sales recently ( up approx 14% on avg)


Now if you put all that together and mix it in with a toxic energy drink like a new presidential regime in a few weeks and the uncertainty that can have on markets for a period of time, it may well explain how the US consumer has changed it ways slightly. They are not spending with wreckless abandon and actually starting to dare i say save money. US personal savings has some way to go to get back to an “average” level but a pronounced bounce off the lows – currently 5.7 – average of 8.5ish




None of this scream growth- some of it certainly in my mind screams correction- if it were me I would be eyeing puts on industrial’s and mid caps. All of this disappears out the window if some grand scale fiscal policy gets announced – but we all know how long something like that takes in this day and age.

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What has monetary policy done for you lately?

Monetary policy has dominated our thoughts in financial markets for longer than I care to remember now, at first no one really knew what quantitative easing was. Then slowly but surely we all learnt that all it simply meant was that the FED and respective central banks around the world were prepared to underwrite risk in order to calm the waters and hopefully propel us out of what was a financial shock of large magnitudes.

To not give the central banks any credit in actually providing a very meaningful safety blanket in a time of great stress is to be at the very least lacking in imagination. It’s true we cant say for certain what would have happened had the US banks not been “saved” or if AIG’s liabilities had not been explicitly underwritten. To say that the market would have cleared and found a way is in a way half true – it would have …….eventually – but no one has any kind of idea what kind of wrecking ball would have obliterated the global economy had these ostensibly civil servants not stepped in.

How it was managed in terms of fairness was of course horrible, you could count on one hand the amount of bankers who can be easily accused of largesse and ignorance whose lives are worse now than they were back then. The public did bail out the institutions and those in charge of those institutions paid very little in terms of penalties excluding Iceland.

But, eight years on we are still dealing with the hangover from the Global financial crisis GFC, but in my opinion things are a lot BETTER than they “could” have been. Had these civil servants not stepped in you can assume that we would still be in the eye of the storm of the credit crunch.

If you remember what the credit crunch was, as it is not mentioned much nowadays – it was a large scale withdrawal of people & institutions circulating or “lending” cash to those with ideas for how to put that cash to work. It was a point blank reversal of the economic engine that spurred growth in the first place. On the contrary now we are in a position where liquidity is probably the highest its ever been yet no one wants to borrow.

No one wants to borrow is of course a silly thing to say – companies will borrow but sadly for appallingly wrong reasons, money is cheap now relative to history, when something is cheap in my opinion it has lost its value or more importantly it loses its power. Money has always been power and therefore borrowed money was usually put to good use, to generate more money and therefore more power. Now money is cheap and abundant – so why not just piss about it with it. Using borrowed money to fund buybacks or any kind of financial engineering to bloat your share price is the largest manifestation of this. Not only are you putting money to work in a very inefficient way but you are also wasting the opportunity to invest and grow.

So QE although in theory should be credited with at least a very valiant attempt by  central banks to free up funding for the whole economy to function properly in practice it had unintended consequences that almost rendered it useless. Maybe you could say that in practice it delayed the market clearing process and that remains to be seen.

How did QE help the average man on the street however, or more important how did monetary policy help the average man on the street?  Well for starters a lot of the people who were laid off through the GFC have been hired back. US employment numbers are back to where they were roughly before the GFC. This is not to say that all those who were laid off have been re-employed on similar terms, maybe they are under employed or maybe they are simply working for flat or lower wages than before. When I look around for other signs of benefit to the economy their is only one real sector where i can see a standout benefit.

Zero or close to zero rates have helped in allowing the consumer in the US in particular to get themselves back on track. US auto sales are performing considerably stronger than normal. A lot of US autos are sold on finance agreements, its considerably easier when rates are near zero to tempt in buyers with better deals now than before, also when those zero % finance deals are complimented by cheaper gasoline prices it gives the consumer a lot of confidence that they can afford this new car over the next X period of years.  See below chart in blue the 25y average sales per month of autos, and now see 2016, on average its a 14% pickup in demand, over the 5y average its even bigger.

FYI today’s sales numbers are approx 25% higher than during the period of the cash for clunkers programme enacted by the US govt to in an effort to help the US auto industry back in ’09.



What has monetary policy done for you lately though? We are all sitting here obsessing over if/when the FED will next raise rates. This is doing no one any good. The FED’s communication policy has become a little redundant and now working counterfactual to its original intentions. Instead of giving businesses and consumers guidance on the path of rates and clarity of thought we now are stuck in this “will they wont they ” scenario that feels never ending.

What all this is saying is that our obsession with monetary policy is coming to an end, it is in fact the only exit strategy I can think of  and that is a sharp transition to fiscal policy. The timing couldn’t be better – for better or worse whether you like either candidate or not the US will have a new president in circa three weeks. It’s time for some shock and awe tactics from the so called leader of the free world.

In such a divided and frankly bizarre election campaign the only real takeaway message has been that its time governments started listening to what the people want. In any normal realm DT would not have got this far and certainly Bernie Sanders could not have threatened the DNC leadership by advocating ostensibly socialism.  Certain candidates have done very well to get this far by using just usual standard political gesticulating. HRC’s message has not been particularly radical but by hook or by crook she is where she is. DT has got there by going full populist and appealing to the base desires of the electorate, promising a return to days of old for the american worker.

None of this will happen without FISCAL POLICY. Its time to think big, go big or go home.

QE for the people is a bad terminology and advocates in its simplest form a straight deposit of cash into the public’s bank account. I couldn’t think of a more useless or fruitless endeavor. People may think they just need extra money in their bank account but really they will just do what companies have shown to do and that is piss it up against the wall on a larger tv or a new set of curtains etc etc. none of which is creating anything of value.

In order to make something stick people need to see money being spent around them, this starts a process of creativity and engineering a new economy. People need to be exposed to the potential for opportunity in order to take risks. Fiscal policy can be described as easily as employing someone to dig up a hole and fill it in again, but when you embark on large scale infrastructure projects or at the very least in the US cases regenerating and repairing previously built infrastructure you set in motion a chain reaction of mini economies or micro businesses popping up to take advantage or service the grand plan.

Look at Apple and its IOS infrastructure- they created the infrastructure and the people generated a micro economy around it, sure apple probably benefits the most but so have hundreds and thousands of other people who have piggybacked onto the infrastructure to create a living for themselves.

Why is the timing right? Regime change always helps, commodities in general – the building blocks for large scale infrastructure are back to lowest levels in quite some time, see the Bloomberg commodity index (heavily weighted by oil obviously) which by the way will change fierce quick if something like this got announced ( be long base metals).




In Summary not just because I’m bored of hearing about it or talking about it,  Monetary policy has had its day in the sun and will always remain relevant but its certainly time for us all to think FISCAL policy. If half the pressure that was put on central banks over the years to “do something” was applied to your local or federal government I wonder how the world will look by the time the next presidential cycle rolls around.


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