The Macro Trading Floor transcript – 27 September 2024

Alf (00:01.194)

Hello, hello, and welcome to another episode of the Macro Trading Floor. Brent, I would say that the market sentiment this week is that our friends in China have taken on a big bazooka and they’re shooting stimulus. So at least that’s what the rumor is. If you look at Chinese stock markets, for sure that seems like what’s going on. But before I ask you to think about it, I’m going to say that the Chinese stock market is a very different thing from the Chinese economy in the first place. That’s my initial comment, but bazooka or no bazooka what do think?

Brent (00:34.535)

Hey, everyone. thanks. Looks like there’s about 9000 subscribers to the first podcast, which seems like a good start. So anyways, I look at this in so many different ways because first of all, it feels like Groundhog Day.

Since 2020, we’ve been talking about China reopening, China stimulus, lower rates in China. Like this theme has been going on and it’s sort of like this catnip for foreign investors that if you can catch the big reflation trade in China, obviously anyone that caught it in 2009, 2010, 2011 made crazy amounts of money. So there’s like a little bit of a Pavlovian thing here where you see China stimulus and you wanna buy anything that’s not nailed down. And then the reality of a balance sheet recession keeps on encroaching over and over and over. So it’s a bit Groundhog Day.

However, I will say, this one feels a little bit different in a couple of ways. The main reason being that the setup is just so apocalyptic, like the balance sheet recession and the, and we talked about this last week. And the question I was asking is like, how do you position for something that’s very well known and structural and should be kind of priced in? And now you have new information, I think, and so I think you can argue that the state of the underweights, the massive underweights in China, for example, and then just the general malaise about China, creates a good setup for the officials in China this time. And you also have the Fed cutting rates, which is different this time.

So to me, it actually feels different, whether it’s like a full -on global reflation trade, I mean, I think I would have to leave that to the economists and to you, Alf, to explain better than I could. But from a positioning behavioral standpoint, it kind of feels a little bit like the “whatever it takes” moment from Draghi to me. In 2012, the euro was going to zero, it was gonna break up, Italy was gonna go bankrupt. And then Draghi stood up and just said, listen, we’re gonna do whatever it takes.

And there was skepticism at the time, like, what can they do? They’re powerless. We’ve already seen they’re powerless. But they weren’t because governments have a lot of tools at their disposal. So if you interpret this as like the “whatever it takes” moment, which I’m more inclined to do, then it becomes more of a psychological green shoots process and it becomes less about like, okay, what are they actually doing on the ground with the local governments and bailing out the housing and the more macroeconomic details. And I think it comes more down to sentiment and underweights in China, and that could be what unlocks the upside, as opposed to an immediate turn in the real economy. But I’d like to hear what you think, because I actually don’t know.

Alf (03:34.606)

Well, the first thing is that you called me an economist and this is a big offence.

Brent (03:38.043)

No, I said economist and you. Ha.

Alf (04:01.454)

Fair enough, which probably means it’s a syllogism and I’m an economist. No, I’m not. Just kidding. And the second thing is, you know, it’s always hard to pronounce the famous sentence that this time is different. You know, this is the time because we have heard it like 10 times at least seriously since 2020 that China is gonna boom. This must be the 10th time, but maybe 10th time’s lucky. So why don’t we look at the details actually of what’s been announced, I would say, Brent, at least we can make more sense from a macro perspective out of this.

So first of all, what’s the problem? Well, the problem is that China is deleveraging a $50 trillion real estate market, $50 trillion real estate market. It’s very large. And the process is not trivial, as you can imagine. And the estimate is that households in China have lost about 16 trillion of wealth in the process. That’s just a gigantic amount. Also because Chinese households own a lot of their wealth in real estate. Okay, so that has been quite painful.

Now, when there is a balance sheet recession and you have property developers defaulting and households losing money and all that beautiful stuff, we have seen this already happening in Japan in the 90s. And the standard reaction from policymakers is let’s cut rates, and China is doing that. This was part of the announcement. They have cut again their benchmark money market rates. They’re now down to one and a half percent, guys. I mean, this is really, really a low nominal rate.

And then the other thing you normally hear is some sort of financial engineering. So Japan did QE to try and fight the real estate deleveraging in the late 90s, beginning of 2000s, and China now is doing something else. It’s doing a Fed put, Chinese version, they’re basically saying, hello guys, do not short Chinese stock markets because you can lend collateral to this facility to go and buy stocks. Beautiful, it’s like the BTFP from the Federal Reserve, but Chinese version to go and buy Chinese stocks. I mean, it’s financial engineering, or let’s say interbank liquidity being thrown at the market against collateral to go and buy Chinese stocks.

Okay, the problem, both of these, cutting rates and doing the sort of fat put collateral part only work on the sentiment side, but when you look at the macro side of things are not doing much to address the real cause right which is the balance sheet recession itself. And how do you address it? Well there are two ways normally, the first is credit creation and the second is fiscal deficits. Now on the credit side something has been announced brand this time he has actually been announced. So chinese have put up about one trillion one or about 150 billion dollars roughly of new capital available for Chinese banks.

And this is important. This is the first step in the right direction if you ask me. Because what happens here is that banks have taken a hit from loan provisions and loan losses right from this defaulted construction developers and so on. And now you are filling a hole in their balance sheet. You’re giving them new capital. That’s good, right?

Also, banks create money by lending to real economy. If they are better capitalized, they’re more likely to extend credit to the real economy. Very good. There’s one problem there, that to extend credit to the real economy, you need a willing borrower. Like if a bank wants to make a loan, I’m sorry to break it to people, but there must be households and corporates asking for a loan. And during a deleveraging environment, that doesn’t really happen very often, right? It’s like a burn patient and you tell him, can you go close to the fire please? Because I really need you to get close to the fire again. And the guy was gonna be like, sorry, that’s not gonna happen.

Brent (07:12.615)

And if I can interrupt for one second, it’s kind of like the David Einhorn jelly donut situation where he explains it as, if nobody wants to eat jelly donuts, you can put one, two, or 5,000 jelly donuts on the counter, but if people don’t like jelly donuts, it doesn’t really matter how many jelly donuts you make. But anyways, go ahead.

Alf (07:32.736)

And he’s correct. And it’s exactly the same analogy here. And then there is the real fix. The real fix is fiscal for a simple reason. Fiscal is also money creation. It injects your money into the private sector by cutting taxes, sending checks at home to Chinese people. I don’t care how you do it, but you’re making people richer. Basically, you are throwing people money in the pocket directly without asking anything. They don’t have a say. It’s not like a Chinese guy can say, no, I don’t want your stimulus ticket. If it happens, it happens. It’s money hitting you.

And so that’s the most immediate way of, you know, making private sector balance sheet healthier again. And we haven’t seen anything fiscal announced. We have seen again them saying, yeah, we’re looking at fiscal, but we have heard them looking at fiscal for now a year without much happening.

So my summation of all of this is first concrete step in the right direction by injecting capital in banks. That’s good. Now we need to see fiscal, but I mean like proper big fiscal or probably this isn’t going to work. I mean, it’s gonna stabilize the bleeding, but it’s not gonna skyrocket earnings and kickstart again or jumpstart the Chinese economy unless you do actual fiscal.

Brent (08:45.647)

So, sorry, let me interrupt for one second, because you made a really interesting analogy to the BTFP. And really what that was, was the same kind of stabilization effort, right? They were buying ETFs. And then obviously the massive five trillion of fiscal came. So I think that’s a really, your analogy is really good, is that the financial engineering puts a bottom in potentially and can change sentiment a little bit, but it doesn’t change the reality on the ground.

And just one little thing that if people wanna dig into that, LQD was one of the ETFs that the Fed bought. And it was a really interesting kind of micro setup because it exploded, it gapped way higher obviously on the announcement, and it pulled back really, really perfectly right to where the gap had started. And then it ran, ran, ran. So people that are looking for… some way to get into China stocks, you can look at where the gaps were and try to buy the dip if you’re bullish around the gaps. Anyways, back to you, Alf.

Alf (09:42.99)

No, no, you’re totally right. I think the analogy is more or less the same. And when you do financial engineering or you cut interest rates, all you’re trying to do is stabilize sentiment, which obviously was really bad. There was a great chart going out from, I think, our friends at Absolute Research, AESR, I think is the name of the research shop, Absolute Strategy Research. And they basically had a poll to their clients and they said, how many of you believe that China can hit their growth target of 5%?

The beauty of that, they’ve done this poll for like 10 years, right? So they have historical distributions. And right now there is basically not almost a single client that believes they can make it. So this is the amount of negative sentiment going on there. Now, and this is when Chinese authorities, I think, have done a good job at selling vol and putting a put there that is going to be a bit hard to break this time because, hello, you can post collateral, you can post govys or any sort of collateral and you will receive money to go and buy Chinese stocks. That’s very powerful, I think, right?

It doesn’t mean you can’t sell off, but now the bar is pretty high. So they’ve sold vol, and I think very successfully so, Brent. They’ve stopped out shorts, they’ve sold vol, all good. But now you need the economy to pick up, and we’ve seen first good steps, but it’s not final yet, I would say.

Brent (11:02.469)

And kind of putting together a few things that you said there, really the lesson from Japan in that analogy was there were some huge rallies, right? There was fiscal, there was monetary, there were huge rallies, but you always wanted to sell the rally eventually because the structural problems just dominated over time. But that didn’t mean that you couldn’t be long at times because like you said, the tricky thing with these situations is that it’s not really like free money to just be long China stocks because they’re going to keep going up. You know, they’re already up a lot.

So there aren’t necessarily going to be official buyers of China stocks here. But like you said, there’s a put. So like really the trade is probably selling puts on FXI, not investment advice and things like that because it’s a short vol trade. It’s exactly the same as when the MOF comes in and sells dollar yen. It doesn’t mean dollar yen is going to collapse. But what it means is it’s just so much harder for it to go up because if it keeps on going up, they’re gonna keep on selling and they’ll double down and they’ll do more.

So they always have the strong hand. They don’t always win, the governments, but they always have the strong hand. And I mean, honestly, they usually win. Like the Swiss National Bank is a massive exception to that. But in general, they basically stabilize the thing and then they just pray for the macro story and the real story to finally catch up.

So I think that’s a great point that you made is that it doesn’t mean that A shares have to go back to the 2015 bubble highs. All it means kind of really is that it’s going to be very hard for them to go down. And that creates like an interesting skew in the market because the puts are probably gonna be too expensive. Iknow they’ve gotten way cheaper, but they’re probably gonna be too expensive if you believe that there’s an official buyer at X level and you can, it’s pretty easy to figure out what that level should be.

Alf (12:59.416)

Yeah, I think that’s right. So people always confuse price action in markets and they extrapolate a certain state of the economy, but it’s not necessarily correct.

Now, let’s talk about the reverberation of a potential Chinese stimulus across asset classes because amongst my client base, there has been a lot of pointing to iron ore and copper and the Aussie dollar and all assets that are broadly correlated to macro China in general. And the argument is yeah, but you know, the Aussie dollar is breaking out and copper is rallying. So this must be a proper economic thing.

And look, I don’t know whether this is right or not. I only know that as a macro investor that was willing to short China — okay so you were, example, amongst consensus up until a month ago and you thought China was sucking and you wanted to short it — it’s much easier to actually get access to copper futures or Aussie dollar as a proxy for China to short and it’s more liquid and it’s easier to short than to actually be able to short Chinese equities. Not many people have that ability literally. So by proxy trading, they will go and short those instead. And so when you see them rallying, I am gonna guess that so far it’s mostly about people being caught offside exactly like they were caught offside on Chinese stocks. But maybe you have a different explanation, Brent.

Brent (14:26.117)

No, I think that’s right. I mean, the knee -jerk is always to these things is like the ultimate FOMO trade as a macro person is to miss the China reflation. And like you said, a lot of people are short those proxies. So the knee -jerk is to buy the proxies. And then the way it happens organically, if it works, is that the economic data slowly starts getting a bit better in China and then it just keeps on multiplying and it becomes less of a psychological and positioning thing and more of a real thing. And obviously that’s going to take a long time to figure out.

In terms of reverberations, good word. It’s almost like you could make an argument that this could lead to a bit of a global reflation trade. China was a nothing burger in 1995. Like that when they entered the WTO in 2001 is when you know, people actually cared about China. The currency was pegged or it was devaluing in the 90s. But the similarity is the Fed cutting into like what looks like a soft landing, 3% GDP, there’s an argument over whether the labor market is, you know, going from overheated to balanced to crapping the bed, or if it’s going from overheated to just balanced. I’m more in the balanced camp, but we’ll see, obviously.

But say the labor market has returned to balance in the US, Fed’s cutting back towards neutral, China confidence is better, which may lead to better real outcomes. That’s kind of like textbook global reflation trade and China deflation export to the rest of the world kind of goes away. You get a little bit of a boost to 2 .5 % inflation right now, but if you believe something like trueflation, and the rent adjusted inflation metrics, then maybe US inflation is actually one and a half in real life.

And then you get a bit of a rebound in China, and then we’re going to stabilize at 2.3% inflation. The Fed cuts a couple of times. In 1995, there was a lot of fear in 96 about irrational exuberance. That was the famous Greenspan whiff in 96. And then stocks doubled from 95 to 98, basically.

So I mean, I think you have to at least have that on your bingo card. Not that the S&P is going to go to 10,000, but at least have on your bingo card that like we got through the worst seasonality of the year. Like week three of September is like a really bad time to be long stocks. And obviously it was, that was not the case this year.

So we’re getting past the seasonal bearish period. The macro story looks pretty decent. I mean, you get one okay, payrolls, 4.1 unemployment and 200k jobs. And man, Imean, things look pretty good. I don’t know. I mean, I know there’s a lot of people that will take the other side of that, but to me, it just looks like soft landing. So now you got the biggest issues in Germany revolve around China. So if sentiment improves on China, I that could end up being a ripper into the end of the year.

Alf (17:37.603)

Yeah, look, the most important thing in macro, I think in our discussion is to understand that more than being prescriptive about what should happen, we are looking at the set of cross asset pricing, rates, equities, effects, and macro data. And then we are saying, okay, where is that we think the balance of risk is mispriced? Okay, that’s what we are trying to do most times to generate what’s called positive expected value ideas. It’s not about being right, it’s about getting the market caught off guard basically.

And if you look at the front end of the bond markets right now, holy moly, man. I mean, there’s like a slew of cuts being priced all the way back to 3% neutral rate very fast. And all of that is supposed to happen while at the moment at least, the Atlanta Fed GDP growth, which has been a great forecast of actual GDP growth, is still saying that the third quarter is gonna be 3% in real terms. Holy crap.

So, you know basically, there might be a scenario, there might be, in which you get one labor market data, as you said, which is decent, not even too strong, but just decent. And then people might ask themselves, holy moly, man, we’re pricing all these cuts in the front end. Are we sure that the Fed has to go this fast? Are we sure the Fed can’t just go 1995 pace or 1998 pace, like three, four cuts and that’s it, and then pause a little bit? And so if people start asking themselves this question, well, then you have quite some repricing to do in the bond market in the front end.

And then the fun part that people say and then the bond market is gonna sell off and that’s gonna be negative for equities. But not necessarily because if the bond market sells off because nominal growth is stabilizing and it’s looking okay, there’s no reason really why the stock market should be selling off.

So we Basically, if you look at how the bond market is priced right now, you need consistently poorer data to justify that pricing. Especially if you want to put a little bit of tail risk that China is actually gonna do the right thing on fiscal. So, know, the bond market is a bit aggressive, I would say, right now, given the constellation of potential events ahead.

Brent (19:42.599)

And I mean, let’s zoom in a little bit. The Fed went 50, consumer confidence was horrible. Goolsbee was talking about more 50s, and yields are higher after every single one of those events. So to me, that means the bond market is kind of mispriced. I agree that the market’s long a lot of bonds. And I agree with what you said. I think you could probably be short twos and long spoos and make money on both sides.

Because yeah, it’s just the velocity of change in yields isn’t going to be that epic. It’s going to be like a grinding pricing out of the cuts. It’s not going to be some huge inflation scare that’s bearish for equities. So yeah, I agree that you get 3% growth, 2.3, 2.5 % inflation. That’s five and a half percent nominal growth. Twos sell off, stocks go up, everybody’s happy.

Alf (20:37.006)

Maybe or maybe not. But given the balance of risks, I think it’s a good idea to look into structures like the one that you just discussed.

Hey, then I think that in this podcast, we always discuss trading frameworks, risk management. And I think this week we have to give it 10 minutes because it’s going to be a lot of fun. So a good guy, a great investor like Tepper showed up on CNBC and he said something very, very fun. So you wrote about it as well to your client base, but please summarize what Mr. Tepper had to say about Chinese stocks and how he’s managing risk around that.

Brent (21:13.735)

So first of all, I’ll say Tepper has had some absolutely unbelievable calls on CNBC. He doesn’t go on very often. His most famous one is from 2010 when everyone was bearish and he was like, liquidity’s plentiful, buy everything. And he was correct.

But this time he’s basically saying he’s doubling down on his China stock longs, China equity longs. And he made the greatest, the funniest joke. He said, I have these limits, and like he’s basically like shit talking risk limits, and he goes, I don’t have this VAR nonsense. I have value at what I can sleep at night. And so he said he’s exceeding his normal limits to go extra long Chinese stocks. And I think that’s interesting from a few points of view.

The first one obviously is just that he’s that bullish to me is interesting. I have a lot of respect for his direction. People tend to like complain about his football team’s performance, but that’s not correlated to his ability to make good calls on CNBC. But it’s also interesting because generally, like I think one of the great problems in trading is risk management because it’s underappreciated and it’s boring to talk about. So people just don’t read books about it. And people read Reminiscences of a Stock Operator or Niederhoffer’s book or whatever and are like, man, this sounds so exciting.

But those are kind of like how to, and also like how not to guides because there’s a lot of gambling involved. And so I was a little bit taken aback by this because it sounds like a little bit like too much risk. But honestly, he’s probably just saying that. And I mean, I’m sure his risk management is completely fine.

One fun fact is I did a client meeting with Tepper a few years ago. And there were more F -bombs in that one meeting than in all of the 25 years of all other client meetings that I’ve ever done. He’s a pretty interesting and fun person to talk to.

Alf (23:17.442)

An F -bomb guy. Well, in general, I think there is a bit of a discussion to make about VAR as a measure of risk. And yeah, we can go a bit into the theory here, but the fun part about VAR, I think, is that, it basically look at history, and then it pretty much looks at the worst possible scenarios, but it doesn’t really tell you how much you’re gonna lose. It only tells you with what probability you’re gonna lose X, Y, Z, looking at past events.

Is this the only measure of risk you should be looking at, not really. So in the hedge fund space, you get a lot of investors asking me, for example, what risk limits are you using? And clearly, if you only say VAR, they’re not happy about it. They want to hear a lot more. What’s your drawdown policy and how do you look at correlations between your trades and so on and so forth. So something to defend Teper as in like VAR is not the only thing, but the thing that I don’t like frankly is to say, look, I have a risk framework, but I’m going to make an exception to my risk framework, basically.

Which I hope he’s saying only because it’s television, so he needs to entertain, which is fair enough. I don’t like exception to risk processes because why do you have a process in the first place if you have to make an exception unless it’s a review of your process? So you have reviewed your process and you figured out the process is something that can be improved, but you don’t do this on the fly because you want to take more risk. That’s not how the process should work, right?

Brent (24:41.125)

Yeah, so I think you can have an exception process, but I agree that you can’t just say like, I love this trade, so I’m gonna triple my normal risk and risk blowing up. There’s kind of this tension all the time between maximizing returns and minimizing risk of ruin. And essentially you want risk of ruin to be zero and you want returns to be as high as possible. But of course there’s a tension there.

And a good example of why VAR can kind of be stupid sometimes is in 2012, I had a big dollar yen position at the bank I worked at and the risk manager came running over and they were like, we stress tested this — and say it was a hundred bucks just to make the math, we’ll use a hundred million dollars — I was long dollar yen. And the risk manager comes over and they’re like, we stress tested this and it looks like your maximum two day loss could be as much as like $1 .8 million. And I was like, I’m not sure that could be possible.

And then I realized the Fukushima earthquake had happened in the look back that they were using. So that was like, whatever, let’s say it was a 15% drop in dollar yen I don’t remember exactly. I’ll put a chart up to show how wrong I am, but whatever. Say dollar yen dropped 10% in two days. So that was part of their look back.

But then to their credit, what we had there was an exception system. So they would come over and say, okay, you’re breaking the VAR limit. And then I would essentially write a paragraph saying, okay, I’m long a hundred dollar yen. My stop loss is 60 points away, maximum gap risk, even if there’s an earthquake and a nuclear accident, you can still get out within a hundred points. So I’m actually only risking whatever. At the time dollar yen was 80. So I was risking $1.2 million or something.

Alf (26:27.374)

80? How old are you, Brent? Like, 95?

Brent (26:29.063)

That was 2012, dollar yen went to 75. So I think to me, as a risk management framework or process, you have the process and obviously like Tepper runs the fund so he can do whatever he wants. But I mean, being able to do whatever you want can actually be bad too.

Like I think I was honestly a better trader when I was a bit younger because I was scared of my manager and then as you get older, you’re less scared of your manager because you’re the most senior person and everyone just trusts you. And that can actually be a negative because then you can override your system without any rigorous kind of plan or whatever. So for me, you have your process and then you have an exceptions process and you go, okay, I’m making an exception because of this, this and that. And then someone in risk management approves it and, you know, off you go.

Alf (27:24.366)

Fair enough. Okay, so now before we talk about another super cool part of a trading framework and this is you should stay with us because I’m going to put a link as well, at the end of the YouTube or the podcast wherever you’re listening. You should try this interactive trading game yourself. It’s so fun.

Before we talk about it, just one very quick announcement from my side. Actually, my fund is live. It has a name. There will be a link as well below if you want to go check out stuff. Enough with it.

Now, the name of this guy who made up the game is, and I am sorry if I am killing it, his name is Victor and his surname is something that I cannot pronounce. I’m gonna really try my best to get it to you. But Victor used to be one of the guys who set up, the surname is Agani with an H, Victor Hagani. Okay, so Victor is a very smart guy who set up LTCM.

Everybody knows what LTCM is. He was one of the founding partners. And so, you know, they grew huge. They made a ton of money and then they blew up pretty much. Right. And so since then, Victor has been writing a lot and doing a lot of consulting, but now he set up a firm which does wealth management, which is diversified beta, completely different than the alpha attempt at the hedge fund. Right.

And he’s been writing a lot of interesting stuff about how hard it is to generate alpha. And he not only writes about it, but he makes you play games to prove the point, which is super cool. So we’re gonna put a link here to his website, but specifically to this game and this game Brent, mean, come on, this is the best I’ve ever seen. It goes something along the line of that and you can play it, but just try to follow along, okay, because it’s really cool.

So the game goes like the crystal ball challenge. And it says something like, you know, what if we give you one day in advance, the front page of the Wall Street Journal or the Federal Reserve Meeting announcement, we’ll give it to you one day in advance so you know the future. So cool. And now at this point, we’ll also give you the ability to go long or short, the S&P 500 or the third year treasury bond future. So you can go long stock, short stocks, long bonds, short bonds, and you know already what’s gonna be happening one day in advance.

And you can go long basically or short in advance and you can hold the trade for one or two days. Basically, that’s all you can do, right? And then he says, look, we didn’t pick the dates when the price action was weird after the announcement. It’s actually like randomized dates and big events and big moves. And there you go. Here is the announcement and you know them before. Go and play. You start at a million dollars. You have 15 attempts of that, which is not a lot. You can hold the trade for one trading day, but you have a notice period. You know already what the news is.

And you please go and play that game Brent, but I’m just gonna say something from my end which is, wow if that is humbling. Like you know already the news, but go and play the game and figure out how hard it is to actually still make money.

Brent (30:29.543)

And I think the great thing about that website is simulations like this are super useful because they drive home concepts that you might read about or think about, but when you see them actually in real life… So like another thing that’s really useful is if you take your win rate and your average win and your average loss, and then create a random sample of 252 days and then plot your P and L, and you see like, even when my win rate is good and my, you know, I make more money on my winners than my losers, there’s still some years where you lose money.

And to me, that kind of simulation really internalizes what variance means. And this simulation that you’re describing really helps you internalize, it just doesn’t always make sense. Like, you know, and I think that’s a really important thing for people to remember is that it just, sometimes it just doesn’t make sense.

Like it’s not just like something bullish came out, so everything’s gonna go up and you ride it for three days and get out. There’s so many other factors, like endogenous factors within the market, like positioning and where the narrative is and all kinds of things like that, that it’s just not so first-derivative as like good news equals let’s buy. And these kind of simulations really hammer that home.

Alf (31:46.584)

Brent, can you explain for a second this variance concept? Because once you posted a chart, made me laugh so much, because I mean, just a small anecdote. In the hedge fund industry, there is this beautiful thing that people really want you to, they want to watch on the fences, okay? They basically say, I really like your strategy, I like your risk management, whatever, but make a good first six months and then I will allocate.

Which makes me chuckle so bad because the first six months, it says nothing about the ability of anyone to make any proper alpha, it’s mostly variance. But you had a chart on a similar thing, like a positive edge, and still the variance could bring you down. Can you explain a bit the concept, which I think is really important?

Brent (32:35.751)

Sure, I mean, it’s very similar to in a sport, like I’ll use basketball, that the good team doesn’t win every time. And in fact, the good team can still lose seven games in a row. And there’s so much variance. And it’s the same issue in poker as well, is that you can play perfectly and still lose money. And I think it’s really hard to understand that, that you can be losing money and your process can be fine. And there can be this disconnect.

And what you’re talking about with the managers, it’s the biggest problem with becoming a PM or launching an ETF is this path dependence of people want returns right away, but returns have high variance. So therefore there’s a lot of luck involved in the ultimate… Everything is self -reinforcing, because if you have a really good first year, then they believe in you and they give you more capital and then that makes you strong psychologically. And there’s a lot of reflexivity in the trading process or the investing process.

But if you come in and it’s like super low vol for four months and you lose two and a half percent and they’re like, this person doesn’t really know what they’re doing. But there’s no way to assess people that quickly. However, there’s also like no simple alternative system to just looking at what people are doing and and evaluating them because you can’t have someone sit there for 10 years to get like a statistically significant track record.

So I think that’s one of the biggest problems and Moubaussin has written a lot about this is assessing luck versus skill. I mean, there are people out there that say that Warren Buffett is just the luckiest person because if you have a million asset managers over 70 years, one of them is going to do what Buffett did. Now I don’t really believe that, but I don’t think I can believe that as someone that does macro.

So I think just understanding how important variance is in your process and normally you can do that with data with historical data of your trading or investing really helps you know that okay, this is actually something bad going on in my process or you know what, shit happens and I lost money and I just keep doing what I was doing.

Alf (34:47.598)

Preach.

Guys, I think that for this week we’ve bombarded you enough with China and reflation and trading and Tepper and go play the game on the website. We’ll put it below. It’s really cool. Go play the game. There is also a coin toss game, even cooler. It’s a coin skewed your way and you have to size positions. It’s amazing. Just go and play around and see how position sizing and variance are so important to your trading much more than you think.

Or than I think or than Brent thinks.

Brent (35:19.501)

And thank you to everyone that subscribed. Thanks for listening. Thanks for watching. And happy Uptober to all our crypto friends.

Alf (35:27.487)

Oh and if you’re watching on YouTube, do subscribe to the channel so you don’t miss the show. Ciao guys, talk soon.

Brent (35:33.297)

Thanks, Alf. Thanks, everybody. Ciao.