The Macro Trading Floor transcript – 11 October 2024

Alf (00:00.93)

Buongiorno everyone, welcome back to The Macro Trading Floor, speaking as always with my buddy Brent, how are doing man?

Brent (00:07.876)

Alfonso Peccatiello, I’m good. I hope Steve Cohen is watching this podcast and I want to congratulate him on the Mets last night. Unbelievable.

Alf (00:17.934)

Steve, if you’re watching, please let us know. I have something to talk about which goes beyond what Brent just said. Just joking. So what’s going on? For once, we’re recording this podcast with macro data already published. This is such a luxury. So we already had today the September CPI report from the US and the jobless claims. Quite an important set of data.

Let’s talk for a second about the easiest one I would say to disentangle this time which is the CPI. So we’ve had a slight bump higher compared to expectations on CPI. Year-on-year core was like 3.3 instead of 3.2. If you look under the hood or at least that’s my interpretation, the six-month analyze trend, so basically what’s going on over the last six months made it into an annual figure for core CPI is still pretty friendly around 2.6 % there and declining and shelter. Shelter inflation, which the Fed was extremely scared about that it was never gonna drop, it starts to act a little bit more friendly.

So if I look into the nuances of CPI, not a fantastic report, not a terrible report either. I think it just tells the Fed, you know you can go on and cut 25 basis point per meeting and it’s gonna be fine. Do you see it differently Brent?

Brent (01:36.08)

No, I think it looks the same. mean, if you look at super core, it still looks pretty high. And overall, inflation isn’t coming down that fast. Oil is kind of stabilized. But I mean, I think we’ve said this on the podcast before. I don’t think the Fed honestly cares between 2 % and 3 % at this point. They’re going to keep saying and talking about 2%. But if things stabilized in like a 2.7, 3.2 area because PCE is lower than CPI, I think they’re perfectly happy with that. And in fact, it kind of helps nominal growth. It helps the deficit story or the debt story. So yeah, to me, it’s a pretty benign number.

I feel like, I had said going into this number in my writings that I think whichever way the market moved, it’s kind of a fade. I just feel like CPI isn’t really the story anymore. We know inflation’s come down. It’s not deflation. It’s not rampant inflation. It’s just kind of in the Goldilocks zone. And in contrast though to some places like Switzerland where you’re actually going to have to start worrying about deflation again, but we’ll see what happens over in Europe.

Alf (02:46.712)

So the most important thing I think on inflation is that if core PCE, which is the Fed’s preferred measure of inflation, keeps having its historical wedge against CPI, that’s about 30, 40 basis point lower, generally speaking, because of its composition. If core PCE settles at 2.5%, I think the Fed is fine about it, mostly because if you look at long-term measures of inflation expectations, nothing has gone on after the pandemic, which is vastly different than before the pandemic.

If you draw a chart of 10 year breakevens, which in English with an Italian accent means market implied inflation expectations, let’s say on average over the next 10 years, well, those are in CPI terms around 2.45%. Again, take off the 30, 40 basis point wedge between CPI and PCE and basically you’re saying, the market is expecting the measure the Fed prefers for inflation, PCE, to average around 2 % for the next decade. Before the pandemic, this number was 1.8.

So basically, as long as the population, corporates, households, the private sector believes and prices that inflation will reasonably stay around 2 % for the next 10 years, I totally agree with you, Brent. They couldn’t care less if now it’s 2.5 or 2.6 or 1.8. It’s fine for them. Let’s see if inflation expectations are right but so far so good no proper risk premium in the inflation forward curve.

Brent (04:20.464)

And you know, just speaking of the US data, there’s something really interesting today I think that will matter for the next few months is, initial claims spiked. A lot of it was North Carolina and Florida, which is the evacuation and then the Hurricane Helena that already hit. And it sets up an interesting dynamic for the Fed because this has happened before, obviously, natural disasters.

And generally what happens is you get a big distortion in the economic data that goes on for quite some time. So initially you’re going to get some weak looking data, spikes in unemployment insurance, all kinds of shutdowns and crazy stuff. And people’s first reaction is that, oh that means the Fed maybe will be dovish. But in a time when there’s so much uncertainty around where a neutral is and they don’t totally know what they’re doing in terms of whether things are all that restrictive or not, it actually might not mean that they become more dovish because the uncertainty is too high and you can’t trust the data.

So if you’re data dependent and the data is garbage, then you’re more prone to actually do nothing than you are to take significant and powerful action in terms of rates. And after the initial wave of negative impact on data happens, then what you’re gonna have is like a shortage of workers in those areas. You’re gonna have rebuilds, you’re gonna have shortages of lumber, shortages of whatever in those areas. And you’re gonna have a positive impact on job growth and on construction spending and all that stuff.

So in the end, I think the most important thing to be aware of as like a more tactical person is that it’s really important to understand the Fed’s reaction function because I don’t think this necessarily makes them dovish, but it does mean that they’re going to have a whole buffet of data points to choose from. If they were to choose to be dovish, I’m sure they can find some data to support it, but I don’t think that’s going to be the case.

Alf (06:29.646)

I love the way you’re phrasing it because before you talked about Supercore, which is something we heard about Powell ad nauseum basically in 2023, because — we wanted to be hawkish, so the most evident and strong number to be dovish was Supercore. Look at it. Stickiest part of the inflation basket is running at 5, 6%. We should hike the hell out. And now he wants to be dovish. Do you want to know what Supercore annualized is? Well, it’s like 5%, four and a half percent or so.

So basically it hasn’t changed but he doesn’t mention it anymore, it’s gone. You don’t hear it anymore, no speeches, no Supercore, no nothing anymore. This is so important because I’ve had it from a lot of hedge fund clients today. Hey Alf, but you you look at this six month Core CPI, annualized and rent or shelter, but why are you not looking at Supercore? Look at it, it’s four and a half percent.

I mean, guys, I don’t choose what to look at. I’m just listening to Powell and Williams and Barkin and the guys who are gonna vote for where Fed Funds are and they are not mentioning super core anymore so who am I to look at it? This is a really strange world. Or in the words of my good friend Jim Lightner — if you’re listening Jim, hi — Listen to the game masters. As he always says, you know the game masters are saying no super core anymore guys look at something else.

Brent (07:45.348)

And I find that a frustrating thing in general in 2024 is that if you were around and say like 2002, there was the workhorse data. You look at the data and that was essentially the interpretation of the economy was based on that. Now we have about 500 different indicators for every single indicator. So you take payrolls, but then you can split it into 75 components and you could do that before, but people just didn’t do that. I think the confirmation bias wasn’t as strong back in those days.

But now whatever your view is, so if you’re the Fed and you want to cut, then you can find some stuff to support that. If you think recession is coming, you can look at the jobs number and say, well, ours worked, we’re lower, so I guess we’re in recession.

But in the end, I think the Workhorse data still says the same thing, which is we’re in the middle of a soft landing still, inflation’s sticky but not scary. And jobs growth is kind of like what you would expect if you were sitting around 2017, 2018. So I don’t feel like all that much has changed, but we’re gonna get a really big foggy patch here with the hurricanes and the election, of course.

Alf (08:53.656)

Yeah, yeah, we should move the discussion to the elections. It’s becoming very crucial. It’s in a few weeks and yet nobody talks about it. Nobody is a big word, but it doesn’t seem to me it’s yet the focus of the market. So let’s talk about it for a second. Well, there is a lot to talk about, but let’s start from trying to disentangle what are people pricing today for election results.

And there are two ways to do it. You look at a bunch of political polls and quick note to Elon Musk, what you read on Polymarket, on Kalshi is not a poll, Mr. Musk. It’s not a poll. It’s what people are paying to bet for one or another. It’s not a poll. But okay, fair enough. Or you can go on these betting markets, on these prediction markets where it’s not a poll, but people are putting money to basically trade these odds, Brent.

Yet a couple of people are saying, look, but what the hell, like Kalshi, which is one big market says a thing, and Polymarket says another one. So what, where should people look at and how do these things work in the first place?

Brent (09:58.258)

So I’m not going to get political because that’s not my thing and I’m Canadian and I dislike politics. So I’ll try to avoid the political side of this. But the thing is there’s so many differences between the prediction markets and the main ones people are referencing are Polymarket and Kalshi like you said, and Polymarket shows Trump as much higher odds than the other ones. There’s other ones like Betfair as well. And there’s a bunch of reasons.

So the first thing people say is it’s a liquidity thing. I disagree with that. Actually, the size is pretty big in these markets. Like some of them are like $500,000 a side, like on 0.5%. So liquidity in these markets is actually getting pretty big, but it’s not easy to arbitrage. So just to, I don’t want to go too in the weeds, but Polymarket is an offshore crypto based site. So you need crypto in order to go there. It’s financed by Peter Thiel. So there’s some, you know, more conspiracy theories that they’re trying to manipulate those odds. I’ll leave that one alone.

But in order to do the arbitrage, you would have to have a US resident on Kalshi, a non-US resident on Polymarket. And so it’s operationally difficult. And then you need a lot of capital. So if you were to do the arb right now, Polymarket versus Kalshi, you need about $2 million of capital to make like $55,000 gross.

And because you have to do both sides of the trade because you don’t know who’s going to win. And once you do that, you obviously then have to pay some kind of tax. But, there’s also a little bit of credit risk. There’s hack risk. Like you don’t know a hundred percent if you’re going to get paid. You probably will. But when you’re risking $2 million to make $55,000, even if the credit risk is tiny, it’s meaningful.

So I feel like because they’re not arbitrageable, I think you just have to look at the sum of all of them and kind of make your own decision. If you think Polymarket’s being manipulated, then just look at the other ones. I just look at the aggregate of all of them and kind of take the average. It’s not really going to change your view anyways, whether it’s 50, 53.

I think also another way of eliminating that issue is to look at momentum because really it’s the change in the odds that matters more than the actual number. So it’s unequivocal that Trump’s odds are going up now in the gambling markets. It doesn’t matter what market you look at. And I think that’s more important.

And like you said, it’s a weird one because the election is obviously could have massive impacts on many things, including fiscal policy and bond markets. But there hasn’t been that much of a run up trade so far because it’s a coin toss. So what are you really going to do? Like what you what people want to do is go with the momentum. And when it looks like somebody is going to win, put all those trades on.

So what we’ve seen this week, actually in our franchise, has been a huge uptick in interest just this week in terms of like — the obvious trades in my world are like Dollar China higher because of tariffs, sell Eurodollars, sell Aussie dollar, and then buying Mag-7 and buying crypto would make sense, and selling bonds. And all of those trades are working except for crypto right now, which has some weird other stuff going on.

And just one more thing on the election, and then I’ll pass it over to you, Alf, is I was watching Stan Druckenmiller on the Grant’s, he did a Grant’s conference this week. And he said, if Trump gets elected, we have the possibility of tariffs, possibility of immigration slowing down, which will restrict labor supply. And we have the possibility of animal spirits from regulation coming down. And we already have GDP at 3 percent. So that was kind of Druckenmiller’s thesis on short bonds.

And I mean, I think quite a lot of that makes sense. There is some debate over which candidate will be better or worse, but I think I find it’s more useful to understand what the common knowledge is and not try to figure out myself, like going through Kamala Harris’s 78-page policy proposal is less useful than just understanding what common knowledge is. And I think the common knowledge is that tariffs, immigration, and fiscal lean towards lower bonds if Trump wins. And basically everything that you say about a Trump victory, the opposite applies to Harris. So you know, that I think that’s the framework.

Alf (14:31.724)

Yeah, so if we have to think about what would be the trades that unfold in a Kamala win or in a Trump win, I would say in general, would say, look, Trump mix of policies is very inflationary because you’re talking about tariffs and lower taxes and deficits in an economy which is still doing okay-ish. So obviously you need to reprice some risk premium down the bond curve and you need to sell bonds. I mean, that’s pretty clear to me too.

And if Kamala wins, the story is different because the corporate tax rate is not going to be 21 % anymore. Not going to be 35 either, but she’s going to probably increase it somewhere to 28. And that’s a fiscal drag, right? So she will basically be, how can I say, a little bit more predictable and a little bit, a little bit more fiscal friendly, maybe redistribution friendly rather than fiscal friendly, but surely more predictable than Trump. And bond markets like predictability. So the term premium needs to come down. And so it’s positive for the long end of the curve and Trump is definitely not positive.

And then you think about Mexico and clearly Mexico is, you know, that’s okay under Kamala and does not very well under Trump. China is different though, Brent, because now it seems that it’s a bipartisan thing to hate China. I mean, whoever gets elected has a tough Chinese stance. How tough it is, well, Trump is tougher at least by words, although he was always looking for a deal. Even when he was president back in 2016, 2017, 2018, the idea was always to try and find a deal.

But bonds, I think, is the clearest. Bonds and then sector rotation in equities. I mean, as you said, if Trump gets elected, this regulation reduction, last time it was extremely positive for banks. Banks and small caps and industrials, and probably you can’t say the same for Kamala’s policies, right? I mean, not necessarily.

Brent (16:23.322)

Yeah, and I think in the end, Trump also leads to more volatility just because there’s so much uncertainty around the connection between his statements and his actions isn’t always all that tight. So there’s a lot of things being floated now. Some of them might be trials. But, you know, he has said things like global tariff on all imported goods to the U.S. He said 60 percent tariff on China. Now, whether any of those things happen kind of doesn’t matter initially because the volatility is just going to be high.

Whereas if Harris wins, I feel like you almost immediately settle back into like, okay, this is boring, Goldilocks soft landing. Nothing has really changed. Sure, maybe there’s a fiscal drag story ahead, but it’s really end of 2025 when the Tax Cut and Jobs Act expires. So you have some time and then, know, it almost ends up being–

So when you’re looking at markets, obviously what you’re trying to understand is what are the variables that actually matter? So, you you don’t want to spend a lot of time on current accounts if you’re trading FX, if current accounts don’t matter for FX. And similarly, I think if Harris wins, we go back to a world where you can almost just drop the politics from your framework because it’s just not going to be the massive needle mover that if Trump comes in, politics and policy will be number one ahead of everything else.

Alf (17:47.916)

Yeah, agreed there. So the other interesting thing I think we should discuss in elections is it’s very different if you’re the president of the United States and you have the House and the Senate, or if you’re the president of the United States and you don’t have both. It’s very different because you can deploy policies in a much more swift way, right? If you have a so-called sweep with you, of course you can go and do executive orders left, right and center. Ignore the fact that you have a House and a Senate, but in principle, it’s much easier to deploy aggressive policies under a sweep outcome than not.

And so an interesting outcome there, Brent, is I don’t know whether everybody knows this, but you don’t go and elect the whole Senate in the United States coincident with the US presidential elections. Not all the seats are up for grabs, basically, at the Senate. And so it’s a limited amount of seats which rotate and tend to rotate in line with the presidential election.

And so if you look at websites like Kalshi or Polymarket, you will see that on both actually, the odds of Kamala winning the Senate are very, not very low, but pretty low. Okay, so what I’m trying to say is that the odds of a democratic sweep are lower than the odds of a Republican sweep. And during sweeps is probably when you get the most vicious moves, I would argue.

Brent (19:13.852)

You know what, actually, I think that’s a good point because I was talking about it as this binary thing, but it’s not really binary. What you have to do is lay out all the options, which is basically blue sweep all the way to red wave. And then in between you have Harris winning, but red in the Senate or whatever. And then you have Trump winning what blue in the house or whatever.

And so those are actually quite different things because a blue sweep or a red wave are the more volatile and more interesting ones, which is kind of like the clearer policy path. And then the mixed ones are probably less volatile, less aggressive policy changes and less market reaction. So that’s a good point, actually. If I was making one of those matrixes, which I guess I should probably make at some point, you really need at least four categories. You can’t just have Harris win Trump win, you need like the sweeps and then the mixed bag results.

And like you said, I think it’s a cool thing that you can actually track the odds of those on the gambling markets now. So I feel like the gambling markets have really come of age in the last whatever seven or eight years, where normally, for example, you would look, you would always go to either like whisper number on Bloomberg or whatever, to get the whisper for non-farm payrolls. And now I just go to the prediction markets and you see like, okay, market’s expecting 142K, it was at 165K before. And so you can get the path and the point of the estimate from that.

And normally, obviously, it’s gonna coincide with what the economists are saying, but that’s not always the case. Like around the last Fed meeting, the market was priced way more for 50 basis points than the economists. And there’s a bunch of reasons for that, mostly just economists forecasts are stale a lot of the time, but it really is useful to understand what all the boxes are on those prediction market screens.

Alf (21:17.772)

Yeah. Okay. Now it’s time to move from politics to more politics. But this time we’re to talk about China and why the hell am I talking about politics? Because I am really surprised and really interested in what’s going on in China.

So here’s a small timeline of what happened. China announces a bazooka, very vaguely detailed set of policies. The FXR, the Chinese stock market goes up like 25 % and you have these pictures of people that are standing outside broker houses in China trying to get an account to buy the frenzy and you have an inverted skew. I mean, this is beautiful. Where calls are more expensive than puts. Sorry, what? Calls on a risk asset are more expensive than puts right now in China.

Well, okay. So craziness all over the place. All good, until China is supposed to deliver some fiscal details. And they say like, oh but it’s great, we’re going to do 200 billion yuan, something like that. So that’s like throwing some peanuts at monkeys. And so the market says, wow, what is that? It’s like a water gun. This is not a bazooka. This is like a water pistol. Fuck you. And so they go and they sell stocks and the Hong Kong is down like 10 % in a session.

Okay, so at this point, what happens is super interesting, Brent, I think, because immediately, like two days later, you have China saying, whoa, whoa, guys, guys, guys, on Saturday, we will have a fiscal press conference. Okay, so why do I find this interesting is, China is behaving like a Western policymaker type of bunch trying to chase and convince markets of something. This is something I’m very used to see in Europe, right? Where you would have Draghi saying, whatever it takes, and then the market would rally, and then if the market didn’t believe him, he would say, hey guys, I said, whatever it takes, okay? So I’m really gonna buy all the BTPs I can.

And this is something where the market basically is in the lead, and the policymaker tries to convince the market that something is gonna happen. And I’m not used to see China doing that, frankly. And now we have this binary event on Saturday. So are they gonna do fiscal? How much fiscal are they gonna do? Good questions.

Brent (23:42.116)

Yeah, it’s set up so interesting because positioning got very, very huge, really fast in everything like China stocks, Aussie copper, selling puts on an A shares ETF, like all that stuff just got crowded so fast. And then everyone got kicked in the teeth because they didn’t announce anything good.

And now I feel like it’s interesting because now we’re kind of almost at the other side of the pendulum where people are like, this is BS. They’re not going to do anything. But first of all, I think there’s one distinction that’s really important is that China’s stocks and the Chinese economy are just two completely different things. So I think it’s useful to think of the Chinese Chinese stock market more as like an altcoin or a meme stock where it’s just a number on a screen that goes up and down. And it, you know, like you said, everyone’s lining up to open accounts because they think the government has their back.

But in the end, if you look at like the history, the Chinese stock market and the global economy are just two completely different things. So first of all, I think that’s important because the fiscal side is what drives the real economy and the great reflation trade, if there’s going to be one, is going to come from the fiscal side, not from the monetary side.

So if you look at Chinese stocks, that’s fine. You can play the intervention. You can say, I’m selling puts because they’re going to be on the bid, which is reasonable. But in the end, that means nothing for copper or for the Australian dollar or for bonds or reflation. What actually matters is can they actually do something that flows through to the real economy?

So on Saturday at, well, it’s 10 a.m. in Beijing. So that’ll be 10 p.m. New York on Friday, but Saturday morning in Beijing, they’re gonna announce something, the Ministry of Finance, and expectations are in the two to three trillion range from what I’ve seen. 3 % of GDP would be 3.6 trillion. So 3.6 trillion is big. That’s clearly big. Two to three is big, but maybe kind of expected.

And then if they don’t announce a number, which is possible because there’s all these phases and committees and different aspects to the way that they’re, the way that they plan the economy, it’s possible they might even not even say a number. And if they disappoint, then we’re just going to unwind everything in the real side. So like copper and Aussie and all that. And then China stocks might still be supported because they can still have like team China on the bid.

One thing that I find a little tiny bit alarming is it’s rare for people to say the trade here is to sell puts, especially in equities. Just generally, that’s a scary thing to do. Selling equity puts has very negative, very scary skew, generally. And if you look at the trades that have gone through on the data on Bloomberg, like, ASHR is one of the main ETFs for China A shares. And the 26 and the 23 puts are the most active, and most of them expiring in like, say, January, February.

A lot of people are going to be short those puts, which is a little tiny bit scary because that means that even if eventually China does intervene, there could be some crazy negative gamma convexity down there because naturally that was the trade that made sense. Like buying calls doesn’t make as much sense because they’re not necessarily going to drive the stock market higher. What they’re saying is we’re putting in a floor, and then we’re gonna hope that like the meme stock buyers in Beijing will all open accounts and buy the indices or buy K web or whatever.

So I find it super, super interesting. And I think everyone in macro will be glued to, I don’t know, Twitter, I guess, or Reuters on Friday night New York, Saturday morning, because in the end we’ve had so many of these, like, I think I wrote something like, fool me once, shame on me. Fool me 127 times, shame on me or whatever. I said that backwards, George Bush style.

But the point being that people have been fooled so many times on Chinese stimulus that if this thing is not exciting on Saturday, it’s just gonna be a total wipeout. Because everyone that did the trades is just gonna be like, this is stupid. Why did I do this? I’ve tried this since the reopening in 2021 and zero COVID ending and all the protests. We’ve tried this trade so many times that people’s fuse or leash on the trade, I think is going to be very short if they don’t deliver.

Alf (28:29.88)

Yeah, I tend to agree on all, one small caveat from my side. The Chinese real estate deleveraging so far is estimated to have caused about 10 trillion dollars of damage to the Chinese economy. OK, so that’s a huge number. The Chinese real estate market is fifty, five zero, trillion dollars worth, before the deleveraging. Now it’s a little bit less, I would say. So because…

Brent (29:00.838)

Now, not to put you on the spot, but is that bigger than the US real estate market or no? I would have no clue.

Alf (29:05.326)

Yeah, yeah, yeah. The Chinese real estate market before the leveraging was the biggest single asset class in the world. I mean, if think about it, it’s the second largest economy in the world who has played casino leverage with households and corporates for the last 10 years. So it could make sense. It is actually the biggest asset class in the world, right?

Brent (29:22.448)

I mean, sure, I understand like population adjusted, it’s easier for them to have a bigger market, but still, I’m still surprised given the, you know, the rural stuff. Wow.

Alf (29:27.426)

Yeah, it’s huge. It’s huge. It’s just gigantic. So now when people say, but I think they should do like 3 % of GDP and that should be fine, like three, four trillion. Well, it’s better than nothing. Don’t get me wrong. But to give you a reference of what China did in 2008 and 2010, this is a two year cumulative. So of course, like you need to give it some time to unravel in this case. But they did back then the equivalent of 20 trillion yuan. Okay. So in two years, 10 trillion yuan a year, about one and a half trillion dollars.

And if you say one and a half trillion dollars as a deficit now in the U.S. everybody says it’s huge, right? I mean, you go around and say the U.S. is running more than a trillion of structural deficits and so on and so forth. If you ask me, because China’s deleveraging, China should at least match that to be taken very seriously.

So if you do one to one and a half, that’s seven to 10 trillion yuan, which is way more than what the market is expecting. Now, I’m not going to say they do that. I don’t think they will. But if they want to really come up strong, they need to give us a number above five, seven trillion one. I doubt they will. But let’s see.

Brent (30:39.846)

Right, and that’s the thing, if it is a whatever it takes moment, like you said, I mean, they understand what they’re doing in terms of what markets, how markets work. So if it is a true whatever it takes moment, then maybe they’ll just deliver something absolutely bonkers on Saturday.

Alf (30:55.766)

Maybe, maybe. Hey, the last thing we should talk about is as always, we do a bit of a trading framework or something about risk management. And today we should have a five minutes chat about seasonality. It’s the most loved and the most hated thing by institutional traders that I know. So what’s your take on seasonality?

Brent (31:14.102)

Oh man, I don’t know if I can squeeze this in in four minutes, but I’ll give the speed run. So it’s such a fascinating topic because if you data mine, you can find seasonality all over the place and it doesn’t necessarily mean anything. And that’s why people a lot of times just say seasonality is fooled by randomness and it’s bullshit and all that.

However, I take the other side for three main, well, two main reasons. The first one is that as a market maker, I’ve just seen the flows. So there’s seasonality in dollar yen around fiscal year end and you can see it in the charts. If you make a spreadsheet, you can see it. And if you sit at a Japanese bank, you see the flows and you say, I guess that’s why dollar yen goes up every fiscal year end, because every single asset manager and everybody’s buying dollar yen or cross yen.

So, or a more micro version is that two days before the end of the month, corporations buy dollars and you can see it. If you back test it, you can see it. And if you sit on a desk, at a bank, you can see it. And there’s many, many other things like this that are real flows that are seasonal, and those flows distort markets. And sometimes the flows are bigger than the specs that are trying to take the other side.

The second reason that I believe it is that there’s just a lot of empirical evidence that it works out of sample. There’s studies on Sell in May and Go Away that go back 300 years that show it works, and it still has been working. I mean, people were talking about it when I started in 1995 and it still generally works.

And I think you have to understand it’s probabilistic. So like nothing works every time, obviously, but over the course of time, you’re putting the probabilities in your favor if you understand seasonality. And another empirical evidence tidbit is we published a seasonality almanac at Spectra. And if you just did all the trades in 2023 and 2024, and there’s a lot of them, there’s like 250 trades, the hit rate’s amazing, the skew is amazing. And so like those trade, that’s 250 trades out of sample published in advance that made money.

So I think there’s a lot of evidence. And the other evidence is that a lot of systematic hedge funds run seasonality strategies. And that tells you everything you need to know. If it didn’t work, they wouldn’t be doing it. So.

Alf (33:31.119)

Correct.

Brent (33:33.606)

That’s like my super speed run view on seasonality. I think it’s important, but it’s much more powerful if you understand the why versus just data mining a bunch of seasonals and saying like, I noticed this thing happens. If you can’t explain it, I feel like the probability of it working out of sample is much lower. If you can explain it, then the probability of it moving or working out of sample is much higher.

Alf (33:58.318)

Correct. So first of all, a more theoretical standpoint, seasonality is actually a recognized risk premium. So as there are other alternative risk premia out there, I don’t know, momentum, carry and others, seasonality is a risk premium, which means if done properly, you are getting paid for something. It’s not a fluke, it’s not fooled by randomness, you’re getting paid for some good reason.

If you can identify, Why are you getting paid? Why is there that seasonality quirk? Most likely, you’re getting paid for something. It doesn’t mean you will make money all the time. That’s not what we’re saying here, but it means it’s a risk premium. It means it’s something that has a, if you put a probability distribution of all your trades about seasonality, as Brent said, you will have the mean of distribution, which is positive. It means you have a drift in your distribution and you’re getting paid and compensating for bearing a systemic risk premium in this case.

Now one example I can make as well, I mean, if you work at a bank like I did, regulators are very, very, very, very heavy on you, right? So what they will say is, at the end of the quarter, at the end of the year, we want to see a balance sheet that looks like this. And if you have this amount of bonds or this amount of repo-funded transactions, this amount of leverage we’ll penalize you, we’ll make you pay some taxes, you know, your leverage ratio will be higher, something along the lines of that.

So what do you do? Guess what, Brent? A few days before the end of the quarter, maybe like two weeks before, but around that you will try to collapse all your very leverage intensive trades. You will, you have to because otherwise you’re going to breach some regulation.

So if you can explain the reason why that seasonality exists, then probably seasonality is something you can trade. Very different to be able to monetize that because in some cases, again, if you want to be on the other side of the trade, well you have to have some ability to play around with balance sheets, for example. So it’s not always easy to monetize, but it does exist.

Brent (35:56.7)

Right, and I think like the reason the premium exists is that you’re providing liquidity to people that need it. So people need to buy dollars and if you’re willing to sell, then you’re earning a premium for that.

Alf (36:08.492)

Yeah, it’s as simple as that. Now, I suggest that we close the podcast with two things. The first is that we are all looking for Spectra Markets Almanac Seasonality ETF. Can you make one?

Brent (36:24.274)

So you know what’s funny is I have actually looked into this and the amount of work relative to the margins on ETFs makes me question it. The other thing that I find with launching an ETF, because I have seriously considered it, is that there’s so much path dependence because if you have a bad run, you don’t accumulate the AUM and people just look at the track record for one year.

And so if you have an unlucky year, which is possible in a probabilistic thing that’s full of variance, then you don’t get the money. And so I’ve definitely considered it and I may actually end up doing it, but there’s some issues around the technicalities of having an ETF that make it somewhat frustrating for some people because if you have a bad year initially, it’s very hard to get off the ground.

Alf (37:16.504)

So I love this because I’m experiencing the same on the hedge fund. I’m having, you can imagine how many people telling me, wow, we really love your framework and we love your risk management and stuff and the strategy, but we’ll watch you for the first six months and then we will decide. I’m like, I’m sorry, what will you do? You’ll watch me for the first six months. It’s like, if you ask me to throw some darts, it’s basically the same thing. It’s six months, it’s complete luck. But anyway. This is how the industry works. I’m not going to change it. You’re not going to change it. So it is what it is.

And finally, the last thing to say is, as always, that you should read what Brent writes every day. It’s on SpectraMarkets.com. And also, if you want some free trial for what I write, you’ll find the link at the bottom of the podcast.

Brent (38:09.21)

And I’m a totally unbiased subscriber to Alf’s stuff. I subscribed before, long before I knew him or before we did the podcast. So I am happy, happy customer.

Alf (38:15.886)

He liked my Italian accent, that was it. Guys, thanks for listening, thanks for watching. We’ll talk again next week.

Brent (38:23.6)

All right, thanks, Alf. Thanks, everybody. Ciao.