11/29/2011
Hello family and friends, a belated happy Thanksgiving to each of you! It’s again been some time since my last update but I have little to apologize about with respect to the infrequency of my updates as I’ve been very busy. Those I haven’t talked to lately might ask what the hell I’m so busy with now that I’m long done with the CFA program and am not even considering applying to bschool like so many of my ambitious peers…
The answer is a combination of A) work on a hobby/project that will assess my own interest/capability in macro trading and will pave the road to a redirection in career trajectory or an exit to more interesting opportunities outside my current profession, and B) continued self education. A) I won’t go into as the topic far exceeds the scope of this update and will be a work in progress for the foreseeable future. B) primarily involves reading on my new kindle fire (thanks to my girl for this early Christmas present). The books I’ve been reading the last few months primarily deal with topics related to A) or focuses on economics and history, in particular, Chinese history.
I have no particularly strong near-term conviction on the market but my longterm allocation advice hasn't changed much: hold 15-20% physical precious metals (you don't want to be entirely F*cked by a larger MF Global / Lehman type debacle or worse.. some kind of extended bank holiday / sudden devaluation), 20-30% commodity and frontier/EM stocks (yes, I am aware this has been a bloody hold this year but I'm assuming most people aren't swing trading), 20% real assets such as income producing real estate / MLPs, and the remainder in liquid cash / bonds of non-developed countries.
Best Regards.
Book Review: Currency Wars: The Making of the Next Global Crisis
http://www.amazon.com/Currency-Wars-Making-Global-Portfolio/dp/1591844495
One very informative and thought provoking book I just finished reading is “Currency Wars: The Making of the Next Global Crisis” by James Rickards, a former lawyer/economist/investment banker. This New York Times Bestseller dives into the origins and factors shaping what many foresee to be the mother of all financial crisis waiting for us right around the corner, theories regarding the evolution and nature of complex systems, the history of currency wars / the gold standard, and some likely end game scenarios that the world is rapidly accelerating toward.
I was surprised at how Rickards was able to dedicate a portion of the book to a detailed account of his personal involvement with a recent national security mock exercise that explores international non-military means of warfare… one would think there are more restrictions on anything written about government projects, especially for something that had happened so recently. Given that Rickards himself has had a long career on Wall Street, I think some previous background in economics or experience with the financial markets may facilitate in the understanding of the wealth of information he serves up. However, let this not be a deterrent to anyone who considers picking this book up. Rickards writes with enough clarity and supporting background such that even an inquisitive college student may be able to gain a lot from a quick pass through.
Currency Wars provides many rebutting points against some typical arguments made by opponents of the gold standard. The vast majority of people who put their personal fates in the hands of the ruling financial elites will do themselves a service by exploring the content of this book – while I can’t promise Rickards will be able to unconvert those who religiously believe in Keynesian economic policies, I do believe that this book will kindle some doubt...
The recent bull market in gold arises from the metal’s historically proven ability to preserve owners’ wealth through phase shifts in economic systems, the type that usually destroys the real value of fiat-linked securities, be it stocks or bonds. For those who are primarily interested in the key takeaways from this book on the valuation of gold: Currency Wars arrives at price estimates for gold ranging anywhere from $2,600 to $10,000+ per ounce, dependent upon key factors such as the final coverage ratio (fiat money has historically been backed at around a 40% level), degree of flexibility permitted to central bankers to deviate from these ratios during times of emergencies, definition of money used in calculating a money-gold ratio and the way by which the global currencies in use today can be re-anchored to gold. Rickards concludes in his book that $3,500 / oz gold is a fairly conservative estimate which only takes into account the cheap US dollars being dropped by Ben-copter. As we start to include in our theoretical calculations, the cheap European and Chinese fiat which are also being flooding into the financial system in attempt to gain a competitive trading advantage for their home countries, this fair value estimate quickly jumps to $7,000+ / oz.
Overall, I enjoyed reading this well written and informative book. Now that I am done reading Currency Wars, I have started reading “The Collapse of Complex Societies” by Joseph Tainter, which was quoted a few times by Rickards. I hope to write a similar review upon my completion sometime in the coming weeks.
Wednesday, November 30, 2011
Friday, October 21, 2011
Investing vs Trading
10/21/2011
This weekend is rather important. If we see a bailout in Europe, then markets may get some more of a relief rally. If we don't have a bailout and the market is unconvinced of an orderly resolution to the situation , then bulls could get wrecked come Monday. Earnings have been pretty good to most companies thus far despite the obvious macroeconomic slowdown not just here in the US, but also in Asia, which is the captain of the boom boom commodity / BRICs story. This is a market with no clear trends; it is driven by difficult if not impossible to interpret events which are clearly dependent upon the often irratic decision making of the worlds' brilliant leaders.
Unlike the mid year when fundamental and technical analysis of the charts both pointed toward great likelihood of a sharp correction, I currently do not have nearly as much conviction on short-medium term views. This is one reason why I haven't sent as many updates lately - I don't want to waste my time writing or your time reading.
Right now, it's like guessing heads/tails from a coin-flip:
On one hand...We can see increasing unrest across the world (including here in the US with our occupy_insert_city movements) leading to further splintering of the braces holding together society, in addition to global slowdown caused by tightening in China and the slow motion trainwreck in Europe. This could easily break the back of the recent rebound and cause further panic in the markets.
On the other hand... I can just as easily (and perhaps slightly more so), see the precarious situation stabilizing somewhat as we get into the end of the year. Rates easing in Brazil and other countries may lead to a rebound in stocks and redirect some of the substantial money flow away of bonds. This, in conjunction with further exceptional measures measures by the fed could just be what the market needs to reflate the risk assets that have been pounded down so quickly and so much these last few months.
Those who talk to me more frequently know I have been very busy with projects... Recently I have been thinking much about investing versus trading.
Investing versus Trading
It is one thing to be able to trade the markets and make money off the local tops and bottoms of each market, it is another to be able to just hold onto a set of fundamentally sound views, ignore the short term fluctuations and know that the long term results will trump the shorter term fluctuations caused by inevitable market cycles & often irrational investor behavior. In a way, buy and hold type investing is akin to sitting down at a poker table, but only commiting to playing the best of hands that give the highest probability of winning. Upon commitment to playing a hand, one will continue to play that hand forward as long as ones original thesis remains sound, through the noise, and through the final showdown, when the strength of ones hands trumps all others sitting at the table, including those who overplayed their bluffs or who have simply miscalculated. My longer term views are taken from and consistent with that of the best investors in the world. I give much of the credit to those with decades of investment wisdom, proven by their long track record of success through different market cycles.
My views for the longer term (3-5 yrs) are unchanged:
- I still believe in the emerging markets and commodity story (especially for Agriculture).
- Is gold a bubble that is going to pop? I don't think so, at least not yet. I still believe in precious metals (particularly platinum, a very thin market which is being overlooked by a short-sighted investment community, and is now trading right around production costs and at a historically high discount to gold, which has potential to lead to a supply crunch in the future given that mining companies do not have the cash flow to increase their future production!).
- I strongly dislike developed country fiat currencies, particularly the dollar.
- I don't have to reiterate how much risk there is to bond investments in an era where paper is being trashed.
Then there is trading. Unlike investing, trading is being willing to play many more hands with small edges, and most often this does not require one to always have the strongest starting hand, but does require an understanding of others' strategy and playstyle, a willingness to adjust ones own strategy to produce the optimum counter play. Pots are often won without showdowns. Can one predict what other people are going to do based on their recent behavior and logical deduction? Can one read bluffs or bluff others sitting right across the table, while he/she is giving the stare down?
Becoming a good short term investor / trader takes precise timing, a good strategy(s) ones can believe in, and an intimate understanding of the market, the participants, and most importantly --- the ability to properly assess risk and reward. This is much easier said than done. In fact, it is extremely fken difficult to do. Most short term traders / funds fail. However, this also means the few who have figured out how to come out ahead repeatedly can often reap tremendous returns.
Those who know me for a longer period can see that my skill at trading /poker has improved much over the years. The old me who sits down at a poker table without a strategy / concept of odds, nor the discipline to fold a great hand to an even better hand... he doesn't show up as much anymore. But I'll be the first to admit that my game play is still miles away from the point where I can survive on my game play. Whether I get to that point, we shall see =). But one thing I am certain on is that just like hold'em, winning at trading is not about just being lucky.
Tonight, I am flying to China for a week. Good food, family, and stories await.
Best,
Sunday, October 16, 2011
It's 4am and I'm having a Christopher Colombus / John Nash moment
10/15/11
No, I'm not on drugs nor have I been drinking. Update: I been working on a systematic macro trading strategy for a number of months now and today I definitely made a lot of progress in my gameplan, not to mention a real breakthrough in my strategizing. Apologies to friends and family for often going MIA and also to any remaining readers of my blog (Which should total about 2 people now, given my complete lack of dedication). I hope to do better with blogging but right now a beautiful mind meets the new world... zzzzzzz
No, I'm not on drugs nor have I been drinking. Update: I been working on a systematic macro trading strategy for a number of months now and today I definitely made a lot of progress in my gameplan, not to mention a real breakthrough in my strategizing. Apologies to friends and family for often going MIA and also to any remaining readers of my blog (Which should total about 2 people now, given my complete lack of dedication). I hope to do better with blogging but right now a beautiful mind meets the new world... zzzzzzz
Thursday, September 29, 2011
Deflationary Forces 9/29/11
9/29/11
Deflationary pressures are taking hold right now as stocks, commodities, and most other asset classes save but bonds have been sold off given the three looming problems: 1) European debt crisis 2) China's attempt to halt inflation has also hit the global growth story... just look at the breakdown in copper and other industrial commodities. 3) US remains in stagnation with Bernanke temporarily unable to conduct further monetary easing beyond this underwhelming operation twist; the gridlocked congress is unwilling to provide further fiscal stimulus ahead of the '12 elections. Thus most risk assets are stuck in this fear-gripped bear market - traders are selling into rallies, bearish sentiment / cost of insurance continue to climb, spreads for riskier debt lower in seniority blowing out, the pension & insurance community forced to invest further out on the yield curve in an attempt to scrape up a bit more yield, the time value of money is being driven to zero while the overlevered/overindebted like the PIIGS in Europe are shitting their pants.
Stocks - it goes without saying that it has not been a good environment for equities. If this was only about European debt woes and US stagnation, emerging market and resource sector stocks will have held up better, but throw on top of that the sharp contraction in global trade => the result has been a very ugly two month period that has yielded double digit percentage losses for these markets. Although volatility in the months ahead may yield even better entry points for these markets (particularly if the shoe drops in Europe), I think if one takes a longer term horizon to investing (>3 yrs), chances are good that gradual rebalancing from cash into the stocks of growth countries such as Brazil, Russia, Turkey, South Eastern Asian countries (thailand / indonesia / S Korea) is a good bet. Very few investors will be able to call the exact bottom on this leg down but some very astute macro investors with great track records are now taking notice of these opportunities and predicting a cycle of easing interest rates to alleviate the situation in the heading into 2012.
Commodities - unlike 2-3 weeks ago, commodities have sold off hard in the latest round of market turmoil. The precious metals market has not been spared from this deflationary liquidation (the lack of global liquidity again making 'king dollar' the current safe haven over gold); this was caused by too many speculators simultaneously liquidating at what may be a short term top in this long term bull market, the rate and impact of the unraveling was undoubtly exacerbated by margin hikes (Silver sold off from $38 to mid $20's in only 3 days!). My favorite precious metal, platinum, is now trading at a discount to gold not seen since the early 90's. I continue to believe that platinum is great buy and hold investment that will retain its real value as financial assets implode and global currency devaluation continues.
Currency - The strength in the dollar is primarily due to A) a global decrease in dollar reserves due to decrease in global trade and B) investors more willing to park their money in dollars rather than Euros in the shortterm, despite the long term state of the US private and public balance sheet remaining untenable.
Bonds - calling the top of this great bond bubble has been a losers game similar to shorting netflix on the way up - how much more upside is there to investing in bonds? If the 20 yr US treasury yield goes from the current 2.76% level to the 1.76% level currently seen in Japan, that translates to appreciation ~+16%, a drop to to the 1% yield level leads to a 30% appreciation. Should yields ever hit those levels, the corresponding correction in other asset classes would be very dramatic and a global deflationary state would be the likely result (perhaps if China's multi-decade bull market suddenly came to a grinding halt). What kind of situation could allow the 20 year bond yield to remain suppressed at these levels is hard to imagine... an extremely strong US dollar relative to other currencies? Continued secular move toward higher allocation to bonds for the wave of retiring baby boomers? On the other hand, if the yield were to rise to a level more commiserate with the level of inflation and which is also justified by history, let's just say +5% to 7.76%, the resulting loss to a bond holder will be 50%; if a dramatic fall in the value of the dollar forces the fed to raise rates by 10% in a move parallel to that of the 80's, the resulting loss to holders of these longer duration bonds would be > 70% . These low yield levels are very interesting.
Cash - why hold cash in portfolio? should be obvious by now.
Best,
Deflationary pressures are taking hold right now as stocks, commodities, and most other asset classes save but bonds have been sold off given the three looming problems: 1) European debt crisis 2) China's attempt to halt inflation has also hit the global growth story... just look at the breakdown in copper and other industrial commodities. 3) US remains in stagnation with Bernanke temporarily unable to conduct further monetary easing beyond this underwhelming operation twist; the gridlocked congress is unwilling to provide further fiscal stimulus ahead of the '12 elections. Thus most risk assets are stuck in this fear-gripped bear market - traders are selling into rallies, bearish sentiment / cost of insurance continue to climb, spreads for riskier debt lower in seniority blowing out, the pension & insurance community forced to invest further out on the yield curve in an attempt to scrape up a bit more yield, the time value of money is being driven to zero while the overlevered/overindebted like the PIIGS in Europe are shitting their pants.
Stocks - it goes without saying that it has not been a good environment for equities. If this was only about European debt woes and US stagnation, emerging market and resource sector stocks will have held up better, but throw on top of that the sharp contraction in global trade => the result has been a very ugly two month period that has yielded double digit percentage losses for these markets. Although volatility in the months ahead may yield even better entry points for these markets (particularly if the shoe drops in Europe), I think if one takes a longer term horizon to investing (>3 yrs), chances are good that gradual rebalancing from cash into the stocks of growth countries such as Brazil, Russia, Turkey, South Eastern Asian countries (thailand / indonesia / S Korea) is a good bet. Very few investors will be able to call the exact bottom on this leg down but some very astute macro investors with great track records are now taking notice of these opportunities and predicting a cycle of easing interest rates to alleviate the situation in the heading into 2012.
Commodities - unlike 2-3 weeks ago, commodities have sold off hard in the latest round of market turmoil. The precious metals market has not been spared from this deflationary liquidation (the lack of global liquidity again making 'king dollar' the current safe haven over gold); this was caused by too many speculators simultaneously liquidating at what may be a short term top in this long term bull market, the rate and impact of the unraveling was undoubtly exacerbated by margin hikes (Silver sold off from $38 to mid $20's in only 3 days!). My favorite precious metal, platinum, is now trading at a discount to gold not seen since the early 90's. I continue to believe that platinum is great buy and hold investment that will retain its real value as financial assets implode and global currency devaluation continues.
Currency - The strength in the dollar is primarily due to A) a global decrease in dollar reserves due to decrease in global trade and B) investors more willing to park their money in dollars rather than Euros in the shortterm, despite the long term state of the US private and public balance sheet remaining untenable.
Bonds - calling the top of this great bond bubble has been a losers game similar to shorting netflix on the way up - how much more upside is there to investing in bonds? If the 20 yr US treasury yield goes from the current 2.76% level to the 1.76% level currently seen in Japan, that translates to appreciation ~+16%, a drop to to the 1% yield level leads to a 30% appreciation. Should yields ever hit those levels, the corresponding correction in other asset classes would be very dramatic and a global deflationary state would be the likely result (perhaps if China's multi-decade bull market suddenly came to a grinding halt). What kind of situation could allow the 20 year bond yield to remain suppressed at these levels is hard to imagine... an extremely strong US dollar relative to other currencies? Continued secular move toward higher allocation to bonds for the wave of retiring baby boomers? On the other hand, if the yield were to rise to a level more commiserate with the level of inflation and which is also justified by history, let's just say +5% to 7.76%, the resulting loss to a bond holder will be 50%; if a dramatic fall in the value of the dollar forces the fed to raise rates by 10% in a move parallel to that of the 80's, the resulting loss to holders of these longer duration bonds would be > 70% . These low yield levels are very interesting.
Cash - why hold cash in portfolio? should be obvious by now.
Best,
Thursday, September 22, 2011
9/9/2011 - the fed gave but the market wants more
9/22/2011
Hello All,
I’ve been very busy lately with work and other projects I’m involved with outside of work so haven’t been able to write any summaries or update my blog. I'll try to make more time for this.
Markets have gotten hammered the last few days as almost every market has been sold off hard, with the exception of USD and US Bonds. Hit especially hard have been commodity /growth related sectors and emerging markets (investors fleeing the less liquid areas). First off, I’d like to acknowledge and highlight the fact that treasuries / fixed income area have been the biggest winners this year as global growth estimates are being dialed down and the fed has gone forth with its “operation twist”, which translates to buying longer dated bonds. Those who were more heavily weighted toward bonds have done very well as this trade has outperformed pretty much every other market out there this year. I have a friend who doesn't work in the investment industry but is an independent thinker (and a good poker player), he tells me he owns a fair number of bonds in his 401k and has been reminding me of how well that's doing. The beautiful thing about investing vs any other activity is that one does not need a fancy degree, nor some certification, nor a job in finance, nor any of the other things that wall street thieves tout to the public while the public is being robbed, to be a good investor. One needs only look at their returns to determine how one has done; investing is one of the most objective activities / professions because performance does not lie. Performance is crystal clear. So hat's off to that!
Recall that my advice to inquiring family/friends this year has been to remain mostly in cash with exception to a portion in precious metals and another portion in commodity / frontier markets (latter turning out to be mis-timed). Such an allocation will have allowed an investor to avoid the impact of the recent selloff, and thus leave the investors with plenty of cash for redeployment from a much lower level once the market is done puking. However, an allocation to more bonds and perhaps offsetting short positions (unfortunately not possible in most 401k plans that only offer a few shtty alternatives) would have done even better versus your typical cookie-cutter portfolio allocation recommended by some fee-focused hindsight trading investment advisor who typically gives advice that lag by 1-3 quarters.
More recently, I’ve been fairly bearish on this market as the market has struggled to rebound a bit after falling off a cliff starting the end of July, a rebound which many prominent investors have called unsustainable, and correctly so. I believe a break below 1100 at this point is a reasonable downside target for the current decline and afterward, 1040, the next target.
- Investors woke up yesterday and are now cognizant of the fact that there is only so much more the fed is willing and currently able to do, especially with the GOP telling Bernanke to stay away from manipulation of the markets. The probability of hardcore QE3 (not this QE2.25 twist crap) is inversely proportional to the S&P level, with my estimate of that probability rising to north of 90% should we slump into the triple digits again (another 12% drop from current levels).
- The fed action does nothing to help the real economy. Interest rates are already at all time lows (10 year rates closed at 1.72% today!!!), I don’t know of any businesses that will suddenly decide to invest and create new jobs just because rates are a bit lower. No, companies will only invest when there is favorable conditions for investment, and most importantly, DEMAND. With government handouts slowed, poverty increasing, and inflation trends moving up, what company in their right mind would want to invest? What bank would want to make loans?? How much more bang for the buck do you think this policy action has, especially for homeowners who are already underwater with negative home equity on their mortgages? I don't know what the fed is really thinking but I’ll tell you what I believe this does do - it will make it even harder for people to get a safe level of return from their money and hurt many pensioners / endowments / insurance companies who now have to move further out the interest rate curve, take greater risk, just to maintain an adequate level of investment income.
- The GOP is standing in the way of Obama’s fiscal proposals as election season is right around the corner, and they want to make Obama a one term president. I suppose the opposite of the ‘wealth effect’ is the ‘poverty effect’… the poverty in this country and around the world is hitting new highs even as the wealth of the super rich continue to compound (see Forbes richest 400 list that just came out, gee, I wonder where these billionaires are banking their billions from…).
- EM / Frontier market stocks - growth is clearly slowing down across the world due partly to higher interest rates (to deal with the inflation problem caused by Bernanke) in emerging markets and partly do decelerating economic activity in developed countries. Keep your eyes out for the turning point in many of these highly attractive markets as these will be the areas of growth once we put the European situation behind us. I think we will look back 5-10 years from now and see what a bargain Brazil, Russia, Indonesia, Thailand...etc markets, are at these prices.
- China – stocks market in china has clearly broken down into bear market territory. The glut of bad loans, higher inflation, property bubble has been cited repeatedly by a few renowned short sellers with very strong track records over the past year. Most investors do not expect a hard landing in China and with China consuming so much of the world's resources in its infrastructure buildout, a stumble by China could throw one hell of a wrench into global growth. One famous emerging market investor recently said that he doesn’t believe in soft landings, “there can only be hard landings or no landing”.
- Europe – a slow motion train wreck happening before our eyes. I can tell you that the panicky bank and liquidity runs is really picking up as some of these large global financial companies are entering crisis mode. Cost of insurance on some of these banks are starting to spike and there are murmors of security auctions going on as these banks try to quickly raise cash right as liquidity is leaving the system. Should Greece default and this continue to cascade into a bigger global financial disaster, I do believe coordinated central bank action awaits. However, I think it is better not to catch a falling knife before this is resolved…
- Stronger Dollar - the removal of the Japanese Yen and Swiss Franc as safe-haven currencies now makes the dollar more attractive among the candidates in teh trash cash category, so we’re seeing the dollar cross move higher, and taking the air out of the sails of many risk assets. Even gold is being sold off along with everything else due to 1) stronger dollar 2) too much late entrants now being punished 3) forced liquidations from investors who over-levered themselves or need to raise cash. That said, I still recommend that one stick with the physical precious metals allocation (my favorite play being platinum), this is a longer term bull market that will resume once the greedy and impatient latecomers are flushed out.
My Recommendation: Same long term allocation as before. Hoard your cash. Hide your gold. As the economic situation unravels, more money will inevitably be pumped into the system, and this should help prop up asset prices at the lower end, but not at current levels. Be patient, think for yourself, ignore economists/research that have proven wrong, and don’t be scared to get greedy once everyone is scared shitless.
Happy investing and good luck to everyone.
Thursday, September 15, 2011
Potential Legendary Trade in the Making - Bill Ackman's HKD call
9/15/2011
In the world of finance and history of investing, people are immortalized by their A) Extreme Failure or B) Extreme Success. A) Extreme Failure may be the topic of my next post... perhaps focusing on the recent UBS rogue trader incident.
B) Extreme Success... on the other hand, can be achieved via consistency - batting singles over a number of decades until the consistency pays off and people have no choice but to recognize the eye-popping cumulative results achieved over time. Warren Buffett, Peter Lynch, and a number of other legendary fund managers come to mind. These are gurus who are recognized toward the end of their careers, when their long term track record have taken them to a level that clearly separates them from the rest of the pack.
Extreme Success can also be achieved by hitting homeruns (these two are not exclusive btw). It goes without saying that simply having one killer year / trade does not make one a legend. Investors strike gold on single positions all the time in their portfolios, but most do not do so on a scale that capture the attention of the financial markets. To garner the attention of the markets and earn the fame that comes with owning a "legendary trade", one has to swing with sufficient size and/or be the first to highlight something completely unforeseen by the masses.. I'm going to focus only on those who were actually able to profit from their contrarian positions (let's exclude Meredith Whitney types for now). Examples of legendary trades include George Soros "breaking the Bank of England", John Paulson's Subprime trade, Chanos's short on Enron, Tudor calling the crash '87, David Einhorn's short on Lehman Brothers, Tepper's binge on distressed financials...
The current chaotic macro environment is a result of the world arriving at many key junctures and the increasing size of the financial markets is likely to be fertile ground from which previously unknown investors will emerge or one which will enhance the reputation of those who are already well known. Although Bill Ackman is relatively well known within the financial world for his trades on MBIA and Target, my opinion is that he has yet to reach the same level of fame attained by the legends above. This is because the legendary trades above all coincide with key events that reshape the investment landscape on a global scale; most single name bets do have enough significance to make the list - note that exceptions can be made for Enron and Lehman because Enron became a symbol for corporate fraud and the fall of Lehman Brothers is recognized as the domino that started the onset of the global financial crisis.
In my opinion, Bill Ackman's recent bullish bet on the HKD has the potential to elevate him to the same level as these other financial markets hall of famers because:
1) Global Significance - a repegging, depegging, or floating of the HKD may be a hugely significant historical milestone that marks the continued displacement of the USD as the dominant global currency of exchange.
2) Size - he has taken a sufficiently large enough position for his fund to very meaningfully benefit from this trade should this play out as he anticipates.
3) Being First - he will likely be given the lion's share of the credit for calling this trade (smaller unknown investors who are managing relatively insignificant amounts of money may have seen this coming before Bill but will be overshadowed).
Bill Ackman - Long HKD <--- It is a long presentation but I thought it was very well-presented and convincing trade. I really enjoyed it. To summarize:
- fundamentally, it makes sense - Hong Kong's economic well being is increasingly more tied to the Asian economy and its economic / political integration with China makes for a strong case that it will only be a matter of time before they eventually switch to a RMB peg, peg to a basket of global currencies, or free floating of the currency. Continued peg to the dollar at this current level makes little sense when the fundamentals of Hong Kong (overheating) is so different than that of the US (I happen to believe in stagnation or stagflation for this country).
- limited downside - purely directional bets without a clear floor can be dangerous when they move against ones direction. I like the fact that a) continued medium-longer downtrend of the relative USD will force the HK authorities to act, regardless of what they are saying in the nearterm. b) if instead, deflationists win out and the world blows up from a china hard landing or if we return to a real strong dollar policy backed by more than rhetoric, could Hong Kong be forced to revalue in order to remain trade competitive as some other contrarian investors believe? Possibly... but my opinion is that the current momentum and direction of the HKD/USD exchange rate gives some room for one to get out of the trade by converting back to USD or to take a small loss even if a sudden devaluation happened instead (if done via options).
- asymmetric payout: IMO, this has the hallmark of a great trade because one does not have to risk much to potentially make HUGE returns, especially because this is implementable via derivatives. This is key because without a superb payout ratio, one would not be able to leverage as much without risking a blowup (small-timers can do so, but when you're running a multi-billion dollar hedge fund, such a gamble could put you in the infamous league of Extreme Failures). If one makes a number of these black/white swan trades and if even a small number of them play out, it would more than make up for all the duds. I liken this type of trade to be very much like sitting at the poker table as last to act, with an apparently losing hand that has very few outs, but your opponents with made hands have raised far too little to force you out of the pot with extremely attractive implied odds. You know that if you don't catch the card you need, the amount of additional money you just lost is controlled and small. However if you do happen to catch the one or two cards, you have the opportunity to take down a MONSTER sized pot and send more than one player packing.
- cheap cost: similar to the long CDS trades from the subprime blowup, this has a relatively cheap cost of carry. Out of curiosity, I called a few market making FX desks yesterday and asked for quotes on HKD/USD call options. It is unfortunate that no liquid traded vehicles on this pegged currency (correct me if I'm wrong), so only qualified institutional or very wealth individual investors can put this in the OTC (over the counter) market with select banks. I was quoted offer prices of ~3.5-4% for a 3 year ATM call option, which corresponds to low-mid single digit implied vol.
Why so cheap? Answer: a huge part of an options price is derived from the implied/realized volatility of the underlying asset. For a currency that has been pegged to the USD since 1983 and has traded within a relatively tight band through the last few market crashes, you can see why the sell side market makers don't use a higher vol in their models.
How is the street hedging out their risk? One sell side guy sales person told me, "HK retail investors invested in structured note type products have sold these options, any losses from an actual change in the peg rate will be financed by loss of investors' principle. These investors are picking up nickels in front of steam rollers"
Of course, I been told that the street has seen more interest in this idea since Ackman went public with it two days ago and the price of the options have gone up. However, this is definitely something to still consider / keep an eye on as I believe Ackman's bullish call on the HKD has the potential to be considered a legendary trade down the road...
In the world of finance and history of investing, people are immortalized by their A) Extreme Failure or B) Extreme Success. A) Extreme Failure may be the topic of my next post... perhaps focusing on the recent UBS rogue trader incident.
B) Extreme Success... on the other hand, can be achieved via consistency - batting singles over a number of decades until the consistency pays off and people have no choice but to recognize the eye-popping cumulative results achieved over time. Warren Buffett, Peter Lynch, and a number of other legendary fund managers come to mind. These are gurus who are recognized toward the end of their careers, when their long term track record have taken them to a level that clearly separates them from the rest of the pack.
Extreme Success can also be achieved by hitting homeruns (these two are not exclusive btw). It goes without saying that simply having one killer year / trade does not make one a legend. Investors strike gold on single positions all the time in their portfolios, but most do not do so on a scale that capture the attention of the financial markets. To garner the attention of the markets and earn the fame that comes with owning a "legendary trade", one has to swing with sufficient size and/or be the first to highlight something completely unforeseen by the masses.. I'm going to focus only on those who were actually able to profit from their contrarian positions (let's exclude Meredith Whitney types for now). Examples of legendary trades include George Soros "breaking the Bank of England", John Paulson's Subprime trade, Chanos's short on Enron, Tudor calling the crash '87, David Einhorn's short on Lehman Brothers, Tepper's binge on distressed financials...
The current chaotic macro environment is a result of the world arriving at many key junctures and the increasing size of the financial markets is likely to be fertile ground from which previously unknown investors will emerge or one which will enhance the reputation of those who are already well known. Although Bill Ackman is relatively well known within the financial world for his trades on MBIA and Target, my opinion is that he has yet to reach the same level of fame attained by the legends above. This is because the legendary trades above all coincide with key events that reshape the investment landscape on a global scale; most single name bets do have enough significance to make the list - note that exceptions can be made for Enron and Lehman because Enron became a symbol for corporate fraud and the fall of Lehman Brothers is recognized as the domino that started the onset of the global financial crisis.
In my opinion, Bill Ackman's recent bullish bet on the HKD has the potential to elevate him to the same level as these other financial markets hall of famers because:
1) Global Significance - a repegging, depegging, or floating of the HKD may be a hugely significant historical milestone that marks the continued displacement of the USD as the dominant global currency of exchange.
2) Size - he has taken a sufficiently large enough position for his fund to very meaningfully benefit from this trade should this play out as he anticipates.
3) Being First - he will likely be given the lion's share of the credit for calling this trade (smaller unknown investors who are managing relatively insignificant amounts of money may have seen this coming before Bill but will be overshadowed).
Bill Ackman - Long HKD <--- It is a long presentation but I thought it was very well-presented and convincing trade. I really enjoyed it. To summarize:
- fundamentally, it makes sense - Hong Kong's economic well being is increasingly more tied to the Asian economy and its economic / political integration with China makes for a strong case that it will only be a matter of time before they eventually switch to a RMB peg, peg to a basket of global currencies, or free floating of the currency. Continued peg to the dollar at this current level makes little sense when the fundamentals of Hong Kong (overheating) is so different than that of the US (I happen to believe in stagnation or stagflation for this country).
- limited downside - purely directional bets without a clear floor can be dangerous when they move against ones direction. I like the fact that a) continued medium-longer downtrend of the relative USD will force the HK authorities to act, regardless of what they are saying in the nearterm. b) if instead, deflationists win out and the world blows up from a china hard landing or if we return to a real strong dollar policy backed by more than rhetoric, could Hong Kong be forced to revalue in order to remain trade competitive as some other contrarian investors believe? Possibly... but my opinion is that the current momentum and direction of the HKD/USD exchange rate gives some room for one to get out of the trade by converting back to USD or to take a small loss even if a sudden devaluation happened instead (if done via options).
- asymmetric payout: IMO, this has the hallmark of a great trade because one does not have to risk much to potentially make HUGE returns, especially because this is implementable via derivatives. This is key because without a superb payout ratio, one would not be able to leverage as much without risking a blowup (small-timers can do so, but when you're running a multi-billion dollar hedge fund, such a gamble could put you in the infamous league of Extreme Failures). If one makes a number of these black/white swan trades and if even a small number of them play out, it would more than make up for all the duds. I liken this type of trade to be very much like sitting at the poker table as last to act, with an apparently losing hand that has very few outs, but your opponents with made hands have raised far too little to force you out of the pot with extremely attractive implied odds. You know that if you don't catch the card you need, the amount of additional money you just lost is controlled and small. However if you do happen to catch the one or two cards, you have the opportunity to take down a MONSTER sized pot and send more than one player packing.
- cheap cost: similar to the long CDS trades from the subprime blowup, this has a relatively cheap cost of carry. Out of curiosity, I called a few market making FX desks yesterday and asked for quotes on HKD/USD call options. It is unfortunate that no liquid traded vehicles on this pegged currency (correct me if I'm wrong), so only qualified institutional or very wealth individual investors can put this in the OTC (over the counter) market with select banks. I was quoted offer prices of ~3.5-4% for a 3 year ATM call option, which corresponds to low-mid single digit implied vol.
Why so cheap? Answer: a huge part of an options price is derived from the implied/realized volatility of the underlying asset. For a currency that has been pegged to the USD since 1983 and has traded within a relatively tight band through the last few market crashes, you can see why the sell side market makers don't use a higher vol in their models.
How is the street hedging out their risk? One sell side guy sales person told me, "HK retail investors invested in structured note type products have sold these options, any losses from an actual change in the peg rate will be financed by loss of investors' principle. These investors are picking up nickels in front of steam rollers"
Of course, I been told that the street has seen more interest in this idea since Ackman went public with it two days ago and the price of the options have gone up. However, this is definitely something to still consider / keep an eye on as I believe Ackman's bullish call on the HKD has the potential to be considered a legendary trade down the road...
Monday, September 12, 2011
Djokovic vs Nadal, don't ignore the new trend!
9/12/11
Djokovic vs Nadal at the 2011 US Open was an exciting match that was very well played by both tennis greats. It also turned out to be another profitable event to bet on as I again put my money on recent trends rather than unfounded popular assumptions. Admittedly, I am a very casual tennis fan who only watches the finals/semis of major tournaments so clearly I don't know much beyond what I read in the news and the few matches I have previously tuned into.
That said, I am a Nadal fan because I really respect his nitty gritty chase-every-ball-down style of play. I'd likely have been rooting for Nadal if Federer had made it there. It is clear that the story of the last few years has been the increasing vulnerability of the aging Federer, whose once dominating presence in the sport of tennis has been shaken by Nadal's rising stardom. I still recall the day before the 2010 US Open when I got into a semi-heated debate with my British coworker about the growing rivalry at the time, ... "Nadal is nothing compared to Federer. The guy (Nadal) is only good on clay, everybody knows that! Federer is simply unbeatable and he will have no problem getting a few more majors added to his long list of achievements before he retires... this is no rivalry. You want to bet on this?". Then, the trend was a confident Nadal repeatedly proving his ability on other surfaces prior to the US Open and adding to his string of impressive victories by repeatedly stunning Federer on sports biggest stage. I gladly put my money where my mouth was and was able to profit off my misinformed coworker who failed to do his homework, and thus failed to identify a continuation of the trend at the time.
Sport rankings are ephemeral by nature as yesterday's victors frequently become unseatedly without warning due to a host of unpredictable factors, which includes the emergence of a new star from relative obscurity. A few years ago, most people who didn't watch tennis would not know about the Novac Djokovic - I happened to see him play live at the 2008 US Open against Marin Cilic and honestly, I could not see him as championship material at the time. He couldn't even get past Andy fricken Roddick.
Fast forward to today's US Open. Anyone who has been paying attention to recent tennis results would know that Djokovic has had an absolutely stellar 63-2 season. Djokovic's rise to number 1 is further confirmed by his recent victory over Federer in the semis just two days ago and more importantly, his 5 consecutive victories in 2011 over a deflated Nadal (which includes major finals victories at Wimbleton and the Australian open). Let's not mention that the fact that Nadal has been more injury prone (even recently wincing in a post-match interview). Pre-match, I was told the odds were around 60-40 in favor of Djokovic, which I believe to be more than fair odds for the Djoker given what we know above. Although it would be great for the sport if Nadal were able to suddenly reinvent himself against his newfound kryptonite, I doubt it could happen today. To put this in stock terms, this year has been a true breakout for this Serb's stock and way too many Nadal fans were expecting a reversion back to the mean for this particular rivalry... show me some evidence outside of wishful thinking! Fortunately for my British coworker, he has since caught on to the well established trend of Nadal's lead over Federer but unfortunately for him, he once again failed to identify the newer trend... "Federer is done. Nadal is extremely good. He used to beat Djokovic all the time and it's about time this string of losses end. I'm confident Nadal will pull out ahead today, especially with these odds. You want to bet on this?"
Of course I do, and did.
Now that this year's US Open has come to a conclusion, my wallet is bit thicker. My sights are now set on the Mayweather vs Ortiz boxing match this weekend...
Djokovic vs Nadal at the 2011 US Open was an exciting match that was very well played by both tennis greats. It also turned out to be another profitable event to bet on as I again put my money on recent trends rather than unfounded popular assumptions. Admittedly, I am a very casual tennis fan who only watches the finals/semis of major tournaments so clearly I don't know much beyond what I read in the news and the few matches I have previously tuned into.
That said, I am a Nadal fan because I really respect his nitty gritty chase-every-ball-down style of play. I'd likely have been rooting for Nadal if Federer had made it there. It is clear that the story of the last few years has been the increasing vulnerability of the aging Federer, whose once dominating presence in the sport of tennis has been shaken by Nadal's rising stardom. I still recall the day before the 2010 US Open when I got into a semi-heated debate with my British coworker about the growing rivalry at the time, ... "Nadal is nothing compared to Federer. The guy (Nadal) is only good on clay, everybody knows that! Federer is simply unbeatable and he will have no problem getting a few more majors added to his long list of achievements before he retires... this is no rivalry. You want to bet on this?". Then, the trend was a confident Nadal repeatedly proving his ability on other surfaces prior to the US Open and adding to his string of impressive victories by repeatedly stunning Federer on sports biggest stage. I gladly put my money where my mouth was and was able to profit off my misinformed coworker who failed to do his homework, and thus failed to identify a continuation of the trend at the time.
Sport rankings are ephemeral by nature as yesterday's victors frequently become unseatedly without warning due to a host of unpredictable factors, which includes the emergence of a new star from relative obscurity. A few years ago, most people who didn't watch tennis would not know about the Novac Djokovic - I happened to see him play live at the 2008 US Open against Marin Cilic and honestly, I could not see him as championship material at the time. He couldn't even get past Andy fricken Roddick.
Fast forward to today's US Open. Anyone who has been paying attention to recent tennis results would know that Djokovic has had an absolutely stellar 63-2 season. Djokovic's rise to number 1 is further confirmed by his recent victory over Federer in the semis just two days ago and more importantly, his 5 consecutive victories in 2011 over a deflated Nadal (which includes major finals victories at Wimbleton and the Australian open). Let's not mention that the fact that Nadal has been more injury prone (even recently wincing in a post-match interview). Pre-match, I was told the odds were around 60-40 in favor of Djokovic, which I believe to be more than fair odds for the Djoker given what we know above. Although it would be great for the sport if Nadal were able to suddenly reinvent himself against his newfound kryptonite, I doubt it could happen today. To put this in stock terms, this year has been a true breakout for this Serb's stock and way too many Nadal fans were expecting a reversion back to the mean for this particular rivalry... show me some evidence outside of wishful thinking! Fortunately for my British coworker, he has since caught on to the well established trend of Nadal's lead over Federer but unfortunately for him, he once again failed to identify the newer trend... "Federer is done. Nadal is extremely good. He used to beat Djokovic all the time and it's about time this string of losses end. I'm confident Nadal will pull out ahead today, especially with these odds. You want to bet on this?"
Of course I do, and did.
Now that this year's US Open has come to a conclusion, my wallet is bit thicker. My sights are now set on the Mayweather vs Ortiz boxing match this weekend...
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