Re: Investing - Bottoms Up (Hic!) Macro / Different Styles For Different Situations / Getting Paid To Wait.

1. Reflections on the Irrationally Inebriant Risk-On of 2023, 2. Reflections on how I have applied different investment styles over different situations, 3. How I am positioning my Family Office.

One of my pet peeves is when people use the misnomer “Bottoms Up Investing” when they really mean “Bottom-Up Investing”; the former connotes investing after imbibing copious amounts of alcohol, and the latter connotes Fundamental Analysis! That said, “Bottoms Up Investing” perfectly illustrates the Irrationally Inebriant Macro environment thus far in 2023, so this is where I will start.

The second part of this post is a thought piece on how I have applied totally different trading & investment styles over different Market Regimes, different Asset Classes & Strategies, as well as different Career Environments.

I end by talking about how I am shaping my Family Office’s Risk Profile to a “Getting Paid To Wait” profile.

2023: A “Bottoms Up” Macro Environment So Far

To me, the biggest sign of the market’s drunkenness is the unbridled lurch for Risk at this stage in the cycle, be it AI and Mega-Caps or the resurgence of BTC/Crypto.

I’ve never seen an aggressive Fed hiking cycle end well with such FOMO-driven Beta chase at this point in the cycle. Check out the last two times the Fed aggressively hiked into this zone:

A lot of folks want to explain how “it’s different this time,” but I hew to Michael Kantro’s camp. We’ve seen this story before, and I think this irrational grasp for Beta represents a last-gasp before a hard fall.

Welcome Back To The Big Chop

The other aspect of Irrational Inebriation is the cloudiness of market signals right now. One of my earliest posts this year was about the confusion of market signals and counter-signals, akin to the ripples and counter-ripples in a pond recently perturbed by a rock thrown into it:

Little did I know how prescient that framework would be and that overstaying one’s welcome in any trade would prove more hazardous than usual.

Welcome back to The Big Chop.

On the Macro side, this year has been challenging to call primarily because of this “Big Chop” regime I wrote about above. My bearish calls on Oil and bullish calls on the USD have had ephemeral days in the sun, but never lasting long before reversing course.

Oil Rip Instead of RIP Oil?

Because my long-term exposure to Oil is through self-liquidating Private Equity and thus very difficult and treacherous to hedge directly, I’ve exercised my bearishness primarily through

1. advising management to hedge more aggressively on spikes

2. indirect hedges like my CNH shorts.

I talked through my “CNY/Oil Doom Loop” thesis here with Jack Farley and Alexander Stahel and explained why CNH was my “chicken way to hedge Oil” to avoid exactly the short-term potential for volatile price action that we’ve seen this year:

Although I’ve been bearish Oil since April, 2022, the timing of this podcast proved to be an impeccable contrary indicator this time, marking the local low; that said, Oil appeared to run into a wall by end of week.

Source: Koyfin

I believe the Risk-On this week in everything including Oil has to do with the cooler-than-expected headline CPI, which led to aggressive liquidation in long USD bets.

The USD is driving everything right now in my opinion.

The circular reference I refer to here is ironic and stems from the self-defeating nature of this Oil spike which will obviously have an effect on the next CPI print. I believe Whipsaw Risk is high for Risk Assets as well as Fed Policy itself given the volatile and lagging nature of the Energy component of CPI:

Although I would rather be wrong on my Bearish Oil thesis due to my PE exposure, I remain skeptical of the fundamental sustainability of the current rally. Lakshmi Sreekumar of Capital One echoes several worry factors that I share:

For a detailed write-up of my fundamental concerns, see this previous post:

USD Wrecking Ball Wrecks Itself

As mentioned earlier, I think USD weakness has been the short-term driver of Risk-On across many asset classes this week.

My call for a resurgence in the USD Wrecking Ball has not panned out, plain and simple, and I was definitely surprised at the ferocity of the market reaction to the cooler CPI:

Several weeks ago, I pointed out that weakness in Asian currencies against USD would likely bleed into the last anchors of DXY and take EUR and GBP down:

Turns out that the exact opposite happened:

Source: TradingView

Although the ferocity of this week’s technical move gives me pause that I might be missing something, I continue to have doubts that other CBs (in particular the ECB and BOE) can truly out-hawk the Fed in a Higher For Longer (H4L) policy stance.

This is a chart of spreads between 3M and 10Y yields for multiple geographies. Note that the disparity for the US is the widest, which suggests that

1. the Fed has out-hawked everyone else so far on the front-end

2. the market expects the fastest easing ramp by the Fed as well.

Color me highly skeptical on the latter point.

Source: Koyfin

Why? See chart below and focus in on the GDP’s of the US vs. Euro Zone, China, Japan, Germany, France, Italy, UK, etc.

China and Japan are in outright stimulative mode. But based on Europe’s numbers, do you really think the ECB and the BOE can really hew to H4L for longer than the Fed? I don’t.

The degree of Yield Curve Inversion (above) seems to price in rate trajectories that are incongruent with the economic resiliency of the respective economic zones (below):

The technicals, however, still look admittedly horrendous for DXY, EUR, and GBP, so outside of my HKD and CNH shorts, I am not getting too aggressive. I initially flipped out of my CNH to protect against a total puke on 7/13 but reinstated my position (and then some) the very next day after both JPY and CNH held support and Oil failed resistance.

Different Market Regimes Require Different Trading Styles

The biggest realization for me this year is that we’re still stuck in the Macroeconomic Pond of The Big Chop characterized by confusing ripples and counter-ripples that I started this missive with.

The Big Chop requires more adroit counter-trend trading in stark contrast to the last 2 years, which benefited trend-following trading. In contrast to The Big Chop of 2023, my bullish call on Oil in 2021 and bearish calls on Risk Assets/Oil and bullish call on USD in 2022 all had long trending runways that benefited from letting profits run and less frequent trading.

Per my comments about trading the Big Chop, I intend to be more nimble than usual in this tape because of the “Bottoms Up” Macro. Like Druckenmiller, I reserve the right to change my mind quickly as market conditions change. You can call me Drunkenmiller to celebrate this year’s Irrational Inebriation.

Different Asset Classes/Strategies Also Require Different Trading Styles

Note that my commentary above is most applicable to directional Macro trades and less applicable to more Idiosyncratic Value-Driven/Special Situational positions (most of my long Risk exposure).

Because I straddle the worlds of Macro and Micro, I constantly ponder the tension between having a disciplined stop-loss strategy (crucial for leveraged products) vs. adding to a position on weakness (more applicable to buying Value/Distress).

To me, leveraged directional Macro trades like Futures or Leveraged FX need to be traded very differently than Micro trades like Idiosyncratic Value-Driven/Special Situational Equities. With Macro trades, I focus much more on technicals for entries and exits even though the thesis might be grounded in fundamentals. I don’t like to catch falling knives in Macro, and I tend to cut losses more on weakness than add, which is diametrically opposite to what I do in the world of Idiosyncratic Value, where I often buy or sell puts on panic selloffs and will often add on weakness.

On the Idiosyncratic side of things, while I never comment on specific names, this year presented some great contrarian opportunities during the Regional Banking Crisis that allowed me to capitalize on severe dislocations in related financial companies that were proverbial “babies thrown out with the bathwater” that had no similar forcing functions to crystallize balance sheet losses like Silicon Valley Bank.

I have zero Passive Equity exposure and have always pursued Alpha through Idiosyncratic Value/Special Sits. This benefited me greatly in 2022, but it has been a drag on performance this year given the massive Beta chase, especially in Mega Cap Tech.

I favor taking concentrated Idiosyncratic bets (often through option structures) and typically try to hedge with Beta instruments (which clearly has been profit-dampening this year). That said, I believe my Idiosyncratic exposures have relatively limited downside with asymmetric upside — especially if we avoid a Hard Landing. I have serious doubts about this which is why I hedge tail risks.

Different Career Environments Also Require Different Trading Styles

Different Career Environment further accentuate the Asset Class/Strategy-driven differences in trading styles.

In the early days of my career trading commodities on the GSCI (Goldman Sachs Commodity Index) desk at J. Aron/Goldman Sachs, I was purely a technical trader — by necessity, because I had to be a generalist across ~22 different commodities.

The nascent GSCI desk then had two primary mandates:

1. make markets in various GSCI-linked products ranging from futures to structured-notes and to arbitrage those positions against the underlying commodities

2. take targeted proprietary views on any number of the underlying commodities by over/underweighting hedge ratios in our arbitrage book.

Having market-making franchises often gives trading desks leeway/cushion to take propriety trading shots — especially at a big shop like Goldman Sachs where it’s sometimes difficult/impossible to separate market-making “flow” PNL from true proprietary trading PNL, which is much more difficult to generate.

However, because our GSCI business was nascent in the early 1990’s, we had very little market-making flow PNL, and we had to earn our keep through proprietary trading ideas with no franchise cushion. We therefore had to be very disciplined in our risk-taking, especially given the highly leveraged nature of the products we traded.

Once I transitioned to the “Buy-Side” world of Hedge Funds, where we only “eat what we kill” with no “flow” cushion, I gave a lot of thought to how best to maximize my chances of winning given the higher bogey for consistency.

My brief stint at Harvard Management exposed me to the world of Relative Value/Event-Driven strategies as an alternative to purely Directional investment strategies (which I sometimes refer to as “Greater Fool” strategies that require a “Greater Fool” to provide you a profitable exit), and I found that these kinds of strategies had better-defined Exit Strategies that made it easier to achieve more consistent outcomes than Directional strategies. I made this the cornerstone of my investment approach at Canyon and then at my own firm Akanthos.

I wrote a missive in 2021 that sheds some light into this thinking:

The Transition To A Family Office

Now that I’m in the third phase of my career, where I’ve retired from Hedge Fund management and am no longer an active fiduciary (outside of the oversight of my Oil Private Equity), I find both newfound disadvantages and advantages.

The greatest disadvantage I have is one of my own choosing — less degrees of freedom in terms of the choice of strategies and instruments to play with. By giving up my prime broker relationships, I also gave up institutional access to many OTC asset classes like High Yield Bonds and Bank Debt, Convertible Bonds, Credit Default Swaps, Swaps, etc. That said, the rewards of simplifying my back office, accounting, and tax needs outweigh the disadvantages.

One thing that I’ve done to fill the void of inaccessible strategies is to allocate some of my money to External Managers. This required letting go of the inevitable “Must Do Everything Myself” syndrome one acquires after nearly three decades of being a professional money manager. This was hard for me to do at first, but after four years of being out of the Hedge Fund business, I’ve settled into a comfortable groove of allocating part of my net worth to External Managers/Private Investments who can access strategies that are orthogonal to my own skill sets.

I wrote about how I think of Orthogonality here:

Getting Paid To Wait

The last point I want to make is the Big Picture Risk Profile I want to achieve overall for my Family Office.

As a former Convertible Arbitrageur, I think of the world in terms of Optionality — a special kind of Optionality that also allows you to Get Paid To Wait. This is the primary advantage of Convertibles over Options.

For my Family Office, I want to create a Risk Profile that resembles a Convertible Bond (minus the Distressed part of the profile), characterized by:

• Positive Carry

• Positive Convexity (Limited Downside With Equity-Like Upside)

In other words, I want to Get Paid To Wait for Optionality.

Source: Akanthos Capital Management, LLC

Even though I’ve given up trading Convertible Bonds directly, I’ve been able to create a Replicating Portfolio that resembles this Payoff Structure:

• Building a T-Bill Ladder that generates Positive Carry with a Risk-Free Bond Floor

• Allocating to a basket of Hedge Funds/Private Investments that offer Asymmetric Upside/Downside

• Having a concentrated portfolio of Idiosyncratic Value/Special Sits, hedged with Index/ETF options and FX hedges

Being A Pelican

The biggest advantage I have by far as a Family Office Investor is the freedom of not having to do anything and not having to answer to LPs. Having to reinvent yourself every single month from a PNL standpoint was the most soul-sucking aspect of the Hedge Fund grind, and I’m very happy to be free of that pressure.

The best part about crafting a “Getting Paid To Wait” Risk Profile is that it allows me to bide my time and be a Pelican:

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I hope that this piece explains to you how I think about the world from a Big Picture investment standpoint.

Although I primarily comment on liquid Macro markets (because I am extremely risk-averse when it comes to running afoul of regulatory issues of influencing securities prices — unlike many in social media), my primary engines of wealth creation are on the Idiosyncratic side as well as External Managers/Private Investments.

As always, I share these experiences and Macro observations in the hopes that they can help you think about the Big Picture.