After Louis Bacon closed Moore Capital this past week, both the FT and the Economist had interesting articles on the future of global macro investing. They struck almost opposite tones, each making good points about the current and future reality. Global macro will return, but likely in an unexpected form.
Stability killed the macro star
The glory days of global macro as we know it started when the Bretton Woods system collapsed in 1971, ending fixed exchange rates. Broadly speaking, there were two different groups of investors who entered this environment and profited immensely. The first was people with long/short equity experience in global markets and included George Soros, Jim Rogers, and Michael Steinhardt. The second group included people with a physical commodities and futures background. The Commodities Corporation trading firm trained and/or funded many macro investors including Bruce Kovner, Paul Tudo Jones, Louis Bacon, Michael Marcus, etc.
The dramatic changes in the institutional architecture of international trade and finance created a volatile playground for these investors. Exchanges developed new derivatives instruments for trading newly volatile currencies and increasingly global commodities markets in a high inflation environment. Global trade started to open up dramatically, and global supply chains spidered out in response to changes in policy and technology. Many investors made or lost fortunes betting on big equity moves like the 1987 stock market crash(shortly after Greenspan became head of the Fed), or the breaking of fixed currency regimes such as the sterling crisis of 1992, the Asia crisis of 1997, Russia in 1998, etc. There was also the emerging market debt crisis in the 1980s and the surprise interest rate hike in 1994.
After the 2009 global financial crisis, interest rates and inflation have been abnormally low. The euro crisis notwithstanding, markets have lacked volatility. With no volatility its hard for the traditional global macro style to work. Moore and his proteges have all closed down recently. The decline of the legacy macro investors is just one part of the broader decline of active management. Its been a long torturous capitulation.
Yet stability leads to instability. Long periods of calm tend to be followed by extreme volatility.
The future is global micro
Is there any future for global macro? That depends on what your definition of “global macro is” Making bold systemic predictions about surface level data is unlikely to lead to profits. Yet global macro’s main benefit is its flexibility to take long or short positions in any asset class anywhere in the world. Although trades in large liquid markets get the most attention, the analytical techniques of global macro can also uncover insights leading to lucrative opportunities less liquid frontier, emerging, and alternative markets.
The future of global macro will involving finding bottom up industry and company specific insights that fit with top down shifts: global micro. Steven Drobny mentioned this evolution in Inside the House of Money . Indeed most quantitative techniques of the original macro greats are commoditized. Analysts need to look beyond headline numbers numbers for less obvious global micro trends and second order impacts on tradeable assets.
Capital flows and valuations have a funny historical tendency to overshoot in both directions. Many investors build up leveraged positions based on stale fundamental inputs, and when they wake up to a new narrative taking over the market, they must rush to a crowded exit. What will be the next gestalt shift in which a new narrative takes over markets?
The next gestalt shifts
Don’t try to play the game better, try to figure out when the game has changed
Over coached football players do not respond well when a game takes an unexpected turn. Investors schooled in calmer markets may similarly struggle with renewed volatility.
Many of the classic macro bets(and blowups) involved major breaks in fixed currency regimes. Sometimes the big trade(or blowup) involved direct currency exposure. Other times it involved investments impacted by second order effects. Its possible that the big macro trades of the future will be more subtle, and play out over many years away from headlines before becoming obvious.
For the past few decades, global trade was getting generally more open. That is starting to reverse. The WTO dispute settlement mechanism will completely shut down next month because the Trump administration is blocking new appointments to the appellate body. Trump’s attitude is just an extreme manifestation of a global trend towards populism and trade conflict. At best, there will be a spaghetti bowl of bilateral agreements, instead of a large open multilateral trading system. Companies will need to dedicate more resources to supply chain strategy.
At the same time, emerging markets are starting to trade more with each other than with the developed world. Africa might become the world’s largest free trade area. China is attempting to facilitate more commodities trading without using the dollar. As China develops its own bond markets, it will invest less in US dollar based debt markets. As the world shifts to cleaner energy, oil producers will have fewer dollars to recycle into US capital markets. The relative importance of the US dollar and of major US companies is likely to decline.
Often policy changes have second order impacts on individual businesses because they alter competitive forces in their industries. Indeed its difficult to find an example of businesses that are completely immune to change in international trade policy.
Reality and narratives change at different paces. Narrative changes alter capital flows ultimately impacting valuations.
Here are some other speculations on what shocks or regime shifts might occur:
- I don’t have a strong view on inflation, but do find it concerning how few S&P 500 companies will do well if we encounter high inflation. Its commonly accepted wisdom that low inflation will continue. Yet most analysts are only considered demand driven inflation, and ignoring possible supply side shocks. There has been little investment in new production capacity for many key over the past decade. Note the conspicuous absence of resource companies in the top holdings of any indices. More insidiously, if certain prominent venture funded startups shifted from growth mode to harvest mode, and suddenly needed to make money, they would be forced to raise prices, impacting consumers directly (See: Cheap Stuff and Cheap Capital) . Alternatively, if we face deflation, then debt burdens on over leveraged companies and consumers will be a much greater drag on growth.
- If negative interest rates continue, they’ll force banks and insurance companies to find new business models, or slowly perish. If negative interest rates reverse, it will be a shock to a lot of overleveraged companies
- Pension funds are a looming disaster in many western countries. The government will overreact somehow when it becomes a social issue.
- Many investors, including pension funds, have rushed into illiquid alternatives such as private equity in search of higher returns. It is likely that those investments will fail to deliver the expected returns, and worse yet, they might be illiquid for longer than expected.
- ETFs have grown from obscure backwater to the default investment option for both institutional and retail. Many ETFS are invested in illiquid assets- creating the potential for a unique type of death spiral. The SEC recently made some changes to its filing requirements which might make it easier to preemptively find which ETFs are most vulnerable.