The Macro Trading Floor transcript – 20 December 2024

Alf (00:00.728)

Buongiorno everyone Alf here, welcome back to The Macro Trading Floor. Hey Brent buddy, how are you?

Brent (00:05.61)

Hey, Alf, I’m good. Exciting times in the markets right to the finish line of 2024.

Alf (00:11.82)

Yes, we are, but not with a calm Christmas. I think Santa Powell forgot he was supposed to be Santa Claus and delivered quite, I would say, quite a hawkish press conference overall. I think there were a couple of sentences that were pretty impressive, if you ask me, but for sure markets reacted in stride. I mean, bond markets, stock markets, you had quite some vicious sell-offs. Let me start by asking you, before I tell my opinion, do you think that Powell was hawkish and how hawkish was he from a scale of 1 to 10?

Brent (00:47.22)

I do actually because going in, I had written a thing for those about to hawk, which is a horrible reference to an ACDC song, but expecting a hawkish outcome. And I got a lot of pushback basically saying, hey, everyone expects them to be hawkish. It’s going to be a hawkish cut. Everyone knows that. And then obviously you saw the market reaction.

And I think the divergence was that people were kind of leaning towards something hawkish, but people didn’t really have much of a position for it. And I think the two dots going from four cuts to two again, so people were saying, well, two cuts are already priced in. So like, who cares if the Fed goes to two cuts, but it doesn’t work like that. Because as soon as they go to two, then the market goes to one. So the market’s always going to be one step ahead of the Fed, whatever direction they’re going.

And all the details… It was interesting because a lot of times you get the dots in the statement and they show one thing, but then he kind of pushes back at the press conference and you get a whipsaw in the market. But this was just like hawkish on top of hawkish. So yeah, I mean, I thought it was very hawkish. I think the fact that inflation is sticky on a lot of measures is resonating with the Fed and, labor markets, you can slice and dice a lot of different ways right now, as has been the case for the last six months, like definitely not as strong as 2021, but obviously that was overheated.

And then the question is like, are we like 2018, 2019 or is something worse coming in the labor market? And just one more thing about 2018, very similar, Christmas Eve 2018 was the massive sell-off where Mnuchin had to come in and say liquidity was plentiful, which was a really strange comment because like stocks had been up a lot and they were down 10 % or something.

But anyways, we’re kind of getting like a little bit of a wake up call. And we talked about this a bit last week – that the Fed just doesn’t have your back anymore. So part of the reason that risky assets were exploding was you had soft landing plus Fed cuts, a dovish Fed plus a soft landing is like the dream scenario for risky assets. And now you don’t really have that. Not that the Fed’s gonna hike… But you have a lot of weird stuff going on in yields and none of it’s really great for risky assets.

Alf (03:08.726)

Yes. So I have to echo your opinion. I think this was the most hawkish Powell I can remember since a long while, I think since 2022. And there are two reasons why I would say he was really hawkish. The main message, I think, Brent was if you were assigning a high value to your Fed puts, basically the Fed providing comfort and downside protection to equity investors – because the idea was they were going to ease at the first sign of weakness, right? – now, Powell has told people that if they want puts, they can go and buy them themselves. So he’s not going to be there to provide all these puts.

And it came in the form of assigning the same weight to inflation upside risks that they assign to labor market deterioration. That’s quite the change of pace. I mean, they always told us for nine months that the job on inflation was done and therefore they were only worried about the labor market. I mean, that’s great for a stock market investor because as you said, it looks like a soft landing and the Fed is going to protect your downside, that’s perfect. And now they’re saying, no, no, no, you want some puts go buy them. You know, I’m not going to give them to you anymore. It’s a big change.

And the other thing that impressed me was, so in the dot plot, they have this neutral thing and they say neutral is three percent. OK, whatever. And then in the press conference, Powell says, yeah, you know, now we are we are remarkably closer, much more close to neutral than before. Dude, you’re still at 4.25, that’s like not so close to three, is it? And then later he says, yeah, but actually it was a closer call whether to cut at this meeting. What? I mean, you are at four and a half, you’re telling me in the dot plot, the neutral is three, you have a close call whether to cut at all, and then you tell me you’re remarkably close to neutral.

I mean, it seems like your neutral is not three, it’s actually more like three and a half or actually four. So it felt to me like the Powell dot for neutral, which I think matters a little bit more than what other people think in the FOMC is actually higher than 3%. I think neutral rates in the US according to Powell are higher, Brent. That’s my impression.

Brent (05:13.95)

Yeah, it’s very interesting too, because in the context of a lot of other countries heading much, much closer to neutral, and like you said, I mean, most people I don’t think would think that neutral is above 4 % in the US. So a lot of his comments were like very hawkish and also raise the question or highlight the issue that nobody knows where neutral is. It’s going up from X to Y and we didn’t really know what X was and we don’t know what Y is.

So yeah, I think it was a very interesting meeting and now the onus is on, you know, I mean, if inflation just goes to 2%, we’re going to get the biggest bond market rally of all time, but it doesn’t look like it really wants to, right? I mean, inflation has been pretty sticky now for six, seven months and the easy, like Powell mentioned this a few times, the easy comps are falling out, so the base effect stuff means that inflation’s really more like around 3%, 3.5 % on a lot of measures.

Alf (06:16.622)

Yeah. So look, I think the bond market reaction is really interesting here because base rates at 4.25 are arguably not low. Let’s say many people wouldn’t tell you that base rates at 4.25 percent in the U.S. are accommodative. They would tell you they are a bit high, but not accommodative. Yet the bond market is basically reacting as if they are. Which is a big, big news.

Before recording, we were discussing this steepening behavior that the yield curve normally has late in the cycle. You know, when the Fed is approaching a bunch of cuts because the labor market is weakening, then yes, the curve steepens because the front-end yields go down so much. And so they outpace basically the long end. And that’s steepening, a bull steepening in that case, is effectively the market telling us that Fed cuts will be stimulative for growth and inflation down the road.

So the cuts are absorbed at the front end and then the curve is steeper at the long end reflecting that these cuts will work to stimulate the economy. Okay, that’s understandable. But now the market yesterday took off a lot of cuts. So we were pricing, we are still pricing for the entire 2025, 35 bips of cuts. That’s it. So we are basically pricing, we’re gonna stay around four and nevertheless, the curve today is steepening really aggressively.

So to interpret this, there are a couple of ways to think about it. The first is that the market thinks that even these few cuts that the Fed is doing now, Brent, they are already stimulating inflation and they will be stimulating growth and inflation down the road. So it’s a completely different approach where the market doesn’t need the Fed cut to 2 % to be stimulative. The market thinks that the Fed cutting to four or three and a half is already more than enough tto kickstart gross and inflation down the road, which is quite interesting.

Or it can be seen as a combination of inflation and fiscal risks building up in the long end. Because most of the steepening is really happening in 10 year plus, so 10 year, 20 year, 30 year bonds. So it could also be that the market is saying to the Fed, if you cut knowing there is uncertainty about tariffs coming and knowing the economy is already strong, we are really adding inflation risk premium to the curve basically, on top of the fiscal patterns. We really feel like we should be rewarded for inflation risk premium more at the back end of the curve.

But in any case, those are not things we’re very used to. For the bond market to react like this, it’s really strange.

Brent (08:52.404)

Right, yeah, there’s definitely a lot of weird stuff going on. So on top of what you’re saying… so normally when the yield curve disinverts, like I usually look at three month, 10 year, whatever, but whatever you look at, usually when it disinverts, it’s when we’re entering recession, it’s late cycle, and yields are going down. So generally what you see, like as the disinversion and that steepening happens, you’re usually seeing yields going down.

And this is one of the very few times when yields are actually going up. So I was just looking at the disinversion happened in a three month, 30 years, what I was looking at for whatever reason, but that happened a week ago. And so then I looked at the seven day change in the 10 year yield after the disinversion. And normally it’s negative because you’re heading into recession and your rate cuts are coming, exactly what you described.

And we’re up 34 basis points since then. And the only other time that happened was the repo crisis in 2019, which was like, basically under the hood, a lot of bad stuff was happening in the treasury market. And so it makes me actually wonder if, again, kind of combining what you said, that maybe there is this kind of double fear, there’s a fear that inflation is still strong, and they’re cutting into it, but then there’s also this fiscal concern, which is like, you know, they’re talking about cutting spending, but nobody actually believes that that’s possible or it’s going to happen.

But then today, Trump actually said he wants to just get rid of the debt limit. And so the debt limit is like this stupid circus that goes on every now and then, and they always raise it. But the one thing you could argue from a psychological point of view is that at least it requires some kind of conversation. It’s like a limiter in theory, even though it’s not a limiter because they just keep raising it.

It’s still like, you know, like if you had no credit card limit, that’s different from having a $10,000 limit and then you raise it to 20, then you raise it to 30. You’re just going to keep hitting the limit, but at least it slows you down a little bit. So I wonder if there’s some aspect of people are just worried that another crazy round of MMT-style deficits may be around the corner and maybe not, but if they are, then we got to price it in a little bit.

Alf (11:16.748)

Yeah, I mean, on this debt limit, I agree it’s full circus. So the US doesn’t need the limit on its debt. I mean, if there is an entity that is going to put a limit on his debt, it’s actually market participants one day if they ever grow tired of this game. Although, as we’ve explained multiple times, the game works because the entire system is based on the dollar. That’s why it works. So everybody wants more dollar collateral. Everybody needs more dollar collateral. And that’s why it’s possible for the US to have twin deficits and all these beautiful things.

But if one day there is discipline to be injected there, it’s not going to be a debt limit legislation that does that. It’s going to be the market. So I welcome taking off the circus of my calendar when I have to mark “debt limit.” Okay, let’s see if the Treasury General account, how much dollars do they have? Are they going to find the deal before or after? Are we going to have a technical default? I mean, it’s more of an annoying circus than anything else.

But the one thing, an observation for our listeners is this fiscal thing is actually not only showing up in nominal yields at the long end, where a simple observation is Fed funds are 4.25, third year yields are 4.75. So the fact that you have base rates so high and then third year yields are even higher, basically pricing that these base rates are not enough to slow the economy or inflation down in the long run, it’s quite something.

And then there is another way to observe it, which is if you are an investor and you want to have duration, interest rate risk in your portfolio, then you can do it in two ways. You can buy third year bonds or you can receive third year swaps. These are your two ways to basically receive interest rates or expect interest rates to go down with a bet.

And so when you look at the differential between these two yields, the 30 year swap rate and the treasury yields, 30 year treasury yields today are trading over 90 basis points over 30 year swaps. So this is a premium Brent, that investors are requiring to actually buy the treasuries, to actually buy the bonds rather than do the same trade in swaps. So this is a thing called swap spreads, or if you’re not in the US, asset swap spread, but it’s the same thing.

And I mean, if you look at it, it has been going up steadily over time. The premium that investors are requiring to buy bonds rather than have swaps as a duration exposure is going up and up and up. Which yes, has to do with some regulatory constraint and balance sheet capacity, but also could be an indication that people are worried about the amount of collateral the US is going to issue. Especially because Bessent looks like he wants to term out debt. It’s something that he would like to do. But term out debt means issuing more long end bonds, which is very, very duration heavy, intensive product to absorb.

And the more you issue, the more the private sector needs to absorb it somewhere. I mean, banks, pension funds, insurances, et cetera. And they seem to be requiring a premium to do so, which also Brent could echo your feeling that these fiscal risks are getting now quite intense. And we also have an anecdotal evidence from your side that apparently not only professionals but also retail people at the deli shop are worried.

Brent (14:45.524)

Yeah, today I was down at the deli and some random guy was telling the owner of the deli how worried he was about the US debt and interest rate, interest payments on the debt. And normally I would see that as a reverse indicator. You know, normally like your friend says, it too late to buy gold? And that’s the highs in gold or whatever. But in this case, because we haven’t really had like that moment in the markets, I’m actually wondering if it’s maybe the start of something.

And then you also see… normally when the system starts to feel a little bit of pressure like this, so you see weird stuff going on in the bond market… check, you see starting to blow up and you see the dollar start to rip. So we’re starting to see Brazil blow up, we’re seeing the dollar ripping, we’re actually getting almost back to the highs in dollar yen.

So I don’t know if you have any thoughts on Brazil, but the thing is then what ends up happening is it creates a lot of negative consequences. Because like say for example in Brazil, because of the pressure from the US rates market, then dollar Brazil starts going up, people start worrying about Brazilian deficits, and then they have to start hiking rates in order to offset the currency weakness, which is bad for the economy, and then you go into this negative cycle. So what are you thinking about Brazil now that it’s actually kind of blowing up?

Alf (16:08.908)

Yes, it’s pretty much blowing up, I would say. So one comment about Brazil, these people are great at barbecue and picanha is great, but it has nothing to with markets. Then the second comment I have on Brazil is: so the market is living on a narrative where Lula is expected to want to juice up the economy ahead of elections. The elections are in October ‘26, so that’s a long way to go. It’s almost two years.

But people are assuming that Lula will be quite easy on fiscal spending, basically, to juice up the economy before elections already next year. Now, because in Brazil you already have core inflation, I think a bit north of 5%, people are, investors are like, dude, no, you cannot do this. Are you kidding me? You cannot do more fiscal spending on an economy running at 5 % core inflation.

And so this plus the fact that Lula has appointed his friend to be the new Brazilian central bank president, you know, makes investors quite worried about the prospect of Brazil losing independence on monetary and fiscal and, you know, they’re adding risk premium. The extent of this risk premium has become quite impressive. So there is a product, Brazil is very cool when it comes to access to financial markets and sophistication of the hedge funds out there. There is even a product to trade the expected Brazilian central bank rates in a year or two years from now.

So like the SOFR or the Sonya or the Euribor Futures, they also have something like that in Brazil. So Brazil has hiked 100 basis point at the last meeting. The base rate for reference is over 12%. And now in a year from now, we’re expecting rates to be above 15%, 15 and a half was the rate at which we closed yesterday.

So what the investors are doing is the typical bond vigilantes trade. Sell the bonds, sell the currency, sell any asset that is denominated in Brazilian real. This is the bond vigilantes trade Brent. So when somebody says the bond vigilantes are at action in the US and bonds are selling off, but the dollar is going up… I’m sorry to break it to you guys, there are no bond vigilantes. These are only people selling bonds. That’s not enough to have the whole risk premium trade going on, right?

Brent (18:24.138)

Well, the weird thing about the US too is that because the US dollar is safe haven and because it responds to yields, crazy shit happens. Even when the US got downgraded, the dollar actually went up and people bought treasuries – which is like… what? – in 2011. So a lot of weird stuff happens. So I think, yeah, if you see the vigilantes here, really, it just goes through the bond market and then the dollar reacts and then you get all these consequences.

And there tends to be a lot of sort of feedback loops too, because then in Brazil, you know, when Salika is 15%, then people start putting their money, taking their money out of risky assets, out of the stock market, putting it into fixed income because you get the inflation protection in Brazil and all that. So you start to see all kinds of stuff.

And I feel like you’re seeing it even in gold and silver too, which is again, kind of like shows maybe we’re at the front edge of a little bit of a liquidity issue. Like I’m not gonna say some kind of crisis or anything, but it does feel like everything’s a little bit kind of sketchy right now to me. Like if liquidity is plentiful and Lula is saying whatever he’s saying, people are just like, I’ll just buy Brazil because I want the carry. You know? It’s not always like X equals Y in these situations.

And I think what the move in Brazil is showing, and the move in dollar yen overnight, which is pretty gargantuan. I think we’re up 500 points in 12 hours or something or something like that. Maybe not quite that 400, I guess. But again, it’s kind of showing that… and Powell actually emphasized this in the press conference that the U S is like this island of stability and the balance sheets, consumer and corporate balance sheets are great and everything’s awesome in the US.

And then you start looking around and you’re like, holy shit, like New Zealand just printed a negative quarter GDP and they revised the quarter before that down like one and a half percent. You got Canada, government’s falling apart, the cataclysmic tariffs might come. You start looking around the world and it’s like the US is this safe haven bastion of strength and everything else looks really, really sketchy.

Alf (20:43.32)

Yeah, which actually brings me to one thing we should discuss. I mean, okay, Brazil is an idiosyncratic case. I mean, they’re really pushing this fiscal monetary problem and it’s a very idiosyncratic event-driven situation. China, we might also discuss how idiosyncratic it is, right? I mean, its real estate deleveraging is a very specific case.

But instead, if we focus on like Canada, Europe, New Zealand, Australia, even down the road… When you look at these countries, you have to wonder next year, how will the central bank behave in these places, Brent? Because now they’re facing a hard situation. They’re facing a situation where in places like, for example, the UK or Australia, even Canada, you have core inflation, which is still a little bit above the central bank targets in general. Then you have a depreciating currency versus the dollar because the Fed is out-hawking anyone else.

And so if you are the central bank of New Zealand, okay, great example. So what are you gonna do next year? Are you gonna try and mimic the Fed to protect your currency and therefore not to avoid it weakening more and hence importing more inflation? Or are you gonna say, look at my GDP, it’s looking horrible, I should actually detach from the Federal Reserve, I should cut rates, which will weaken my currency aggressively and which will make interest rate differentials very, very wide. So this is quite the question for next year. Your answer?

Brent (22:11.048)

Yeah, and there’s a point, it’s some kind of nonlinear, but like saying Canada, the pass through from the exchange rate’s pretty significant and it’s pretty fast because of the tight relationship between the US and Canada. So if dollar Canada goes to 150, then you got a problem on the inflation side and you want it to cut because of XYZ, but now you can’t.

So yeah, then the curves all around the world start shifting up because there’s not really a limit to how much the central banks can diverge from the Fed. But like you said, it’s basically a strategic decision of are we going to risk inflationary currency weakness and just like do our own thing? Or are we going to actually kind of take it easy now because we’re worried that the currencies, our currency is too weak?

So Japan’s another example there where around 160, the Ministry of Finance intervened last time. But the problem is that if US yields are going up fast and Japan, you know, BOJ last night was pretty dovish, then at some point the release valve just becomes a currency. And then if the release valve’s a currency, then the problem is then rates become a problem. And you can’t be so dovish because your currency is so weak that you have an inflation problem in Japan, which is like something they would have dreamed of 10 years ago, but now it’s potentially could turn into a nightmare.

Alf (23:33.974)

Yeah. So my answer to my same question is I think that mostly central banks will try to take care of their own economies. I mean, I think if you really force them to choose, they will have to take care of the domestic weakness in their own economies. And so they will have to detach from the Fed. And if they do detach from the Fed, then in the FX market, we’re going to see some fireworks. Because if they are forced to detach from the Fed, there are two things going on here.

The first is, their domestic fundamentals suck. Otherwise they wouldn’t be forced anyway to detach in a dovish way, which is already bad for their currency. Second, the dollar is probably stronger because the Fed remains hawkish at that point. So I think some of these currencies are quite exposed.

And I mean, you know better than I do in FX. What’s the sentiment around this? For sure. Nobody wants to be short the dollar here, but how bad is the sentiment around certain currencies like, I don’t know, the euro or the New Zealand dollar or the Aussie dollar or Canadian dollar? And is that really like, can you see it in option prices? How bad is the sentiment around these currencies? Is there more to go?

Brent (24:41.238)

Well, the thing is we actually passed the extreme because the most dollar bullish period was kind of like mid to end of November. And then the euro dropped and then the euro has been flatlining for about a month. So people now who had like a lot of options positions and stuff, a lot of them have burnt off. And then dollar people didn’t want to touch it because they thought BOJ might hike.

And then EM it’s like, it’s expensive to be long dollars in EM. And so the positioning actually hasn’t been that extreme. And then in Australia, people have been waiting for the China Stimmy and every time that happened, they react and buy Aussie. So I don’t think the positioning is actually that extreme. And the interesting thing in China is like, if you look at a chart of yields in China, it’s unbelievable. They’re absolutely collapsing. It’s a crazy situation.

Now there, the currency is essentially pegged or give or take a percent or two. So you haven’t seen much reaction in the currency, but it does create pressure because it’s just a lot more economical to own dollars against all these currencies because you’re just getting a massive head start.

Switzerland’s another one where if you look at where Dollar Swiss is now, you have about a 3 or 4 % cushion from the yield advantage and Vols are only 7 % or something. So relative to the volatility of G10, which isn’t that high, you’re just getting an enormous pickup being long dollars. And I don’t think it’s that crowded, honestly.

Alf (26:16.002)

Yeah, that’s an interesting observation. I also don’t have the feeling that these currencies are so negatively assessed by investors on the downside. I think in FX, there’s going to be quite a lot of fun next year. So if you’re an FX trader, finally, it might be fun for you.

Let me ask you one trading behavioral question. I think we’ll take different sides here, but it’s interesting. So how do you try and see whether retail has joined the crowd? Or I should say like the late money is in a trade and therefore you should maybe fade or take the other side of it? One of the things that for me has worked the best is to leverage my Twitter followership, come out with a poll, and when I think there is something that can be really like overcrowded, ask Twitter in a poll.

And I receive about 4,000 or 5,000 replies. So the sample is quite wide. And ask them, where do you think XYZ asset will be in three months? Okay, so give them a defined asset, defined time horizon, and then go and calculate a one standard deviation negative answer, two kind of median answers, and a one standard deviation positive answer. Just give them the distribution of rational outcomes basically.

And so when Twitter votes on the one standard deviation tail, either of the two Brent, when you see that the votes cluster to more than 35 percent in the tail, oh it means it’s crowded. It’s 100 percent hit rate on my book. First in 2022, I asked whether the Fed could hike above like one and a half percent or something, which that was the one standard deviation. And like 50 % said no way, no way, cannot hike, impossible. Then, well, of course they ended up hiking above that.

The second time I asked was the other way, can 10-year treasuries be, when they were at 4.75%, where will they be in three months? Huge tail on “above five.” So my mother, my dog, your mother, everybody said the treasuries should be above five. Needless to say, they were much lower after three months – in December at the end of the year.

So I generally take that overconfidence about the tail realizing as one way to measure how crowded it is. But what do we say about the deli guy? I mean, what is the deli guy? Is the deli guy the taxi driver? How do we assess that?

Brent (28:52.662)

Yeah, there’s two ways. So the first thing is I see what you see, which is at the mega extremes, it’s a signal. The one thing I feel like you have to be careful with is confirmation bias. Because sometimes you can find things that look like a signal when they’re actually not. But I feel like when I’m just like, I’m agnostic and a signal comes to me and it’s extreme, like what you’re describing, I think those mega standard deviation signals are amazing.

The other one is the shoeshine boy thing. If the non-financial market people are asking you about something, that’s a huge indicator because it takes a lot for, you know, gold has to be up 30 % before your brother-in-law is gonna text you to say, it too late to buy gold or whatever. And actually I tend to post those things on Twitter and the hit rate’s really high.

So I’m always listening on the subway and all that just for like what people are talking about. Like in ‘06 it was like, it’s impossible to find an apartment in New York and whatever. So I feel like that stuff has value, but if you already have a view, you’re gonna get confirmation of it if you look hard enough. So the best thing is like something that you don’t even care about like quantum computing or whatever, and you hear people talking about it on the subway and you’re like, okay, yeah, now I can sell QUBT or whatever POS is out there.

Alf (30:24.824)

Yeah, I think it’s the most important thing is indeed not try to concoct something to validate your priors, right? And this is something else that I want your opinion on because it interests me for my hedge fund strategies next year. So we’re discussing with the guys here at the fund. We were saying, OK, of course, the best possible trade for a macro investor is when you have a narrative, a macro narrative that you believe in, and then the market is completely off versus your narrative, right?

So they’re offering a symmetric payouts versus a narrative that you have. So that’s great. Everything ticks, you put it up, you size it right and you own it. You can be still wrong, but it ticks all the boxes. Okay, what if, Brent, you are really 50-50 on something, you don’t have a macro narrative, you really don’t know, you’re indifferent, as you said, okay? Completely indifferent. But the market has pushed the pricing of something to a level which is objectively offering asymmetry. Then what?

Brent (31:29.91)

Yeah, that’s such a tricky one because there’s two things. One is like, the thing’s down a lot, I gotta buy it. Which is not what you’re describing, but I think that’s what people tend to look at is like, look at commodities versus S&P. Oh it’s at 30 year low, I need to buy it. But then is there a reason it’s at a 30 year low?

But I actually am more in the camp of playing a lot, like just taking a lot of positive expected value bets is the way. So the only question is like, you get enough of them? So if you have a short time horizon, you can get millions of them. And then so going into like some number where I just from talking to everyone, I know everyone’s short dollars and I don’t really have a view on the number, but I’ll go in long dollars just because I think there’s going to be, you know, a 1% move versus a 0.2 % the other way.

So I do like those, but I think… ultimately, like the election is a good example of a bad one where I mean, even though I had a view and I lost money on the election, where, you know, if you’re a macro person, you don’t get enough elections. So even if it’s positive, EV, like what you want with positive EV is something that you can run a thousand times, right? You don’t want to a coin toss that pays two to one and you bet your life savings on it and you only get one flip. What you want is to find like zillions of them.

And that’s why I like events and, and central banks and economic data and all that, is that if you have like a 60-40 edge, which would be a lot, but if you have a 60-40 edge on that stuff, then you get 100 to 200 reps a year and then your edge will be in excess of the variance. Whereas if you take three bets a year, variance is gonna kill you.

Alf (33:17.976)

Yeah, we came to a similar conclusion, which is we should probably, when we don’t have a narrative, we should probably size those purely asymmetric payoff bets without a narrative behind, way less. Because this will allow us to take more of them during the year, enlarging the sample. And therefore, if the payoff is really asymmetric, then at least you can take more of them with the smaller sizing, but making sure that you can at least provoke your luck. I think this was more or less the thing.

Brent (33:47.988)

Right, right, exactly. Increasing the surface area or whatever. And that’s kind of a similar question to the one… a lot of times I’ll put out a view based on like, you know, something’s overextended and some correlation of whatever, a bunch of factors. And someone will say to me, okay, yeah, but what’s the catalyst? And a lot of times I’ll just say, I have no idea, dude. It’s just, this is the setup and I’ll tell you the catalyst after I make the money.

Alf (34:06.242)

I love it. Okay, this is what I have to say. So December 8th was a Sunday sitting at my place and writing a piece for clients. I was observing a bunch of stuff like the skew in stock markets was like really depressed. I mean, like you could buy puts relative to cost really cheap. So you see all this stuff and credit spreads are like 30 years tights and stuff like that. Okay.

So objectively, if you can have this set up a hundred times and you don’t know the catalyst, you just close your eyes and you buy protection during exactly this setup, probably you will have positive EV at the end of the thing. OK? But you need to be able to repeat it a hundred times, of course. So, well, I said, OK, this looks decent. Let’s buy some out of the money puts here. Just spend some little premium on this thing.

OK, 25 emails. “But yeah, but, but, but why should stocks go down? Like, what’s the catalyst?” In the article I wrote, you know, guys, it can be anything. It can be Trump being aggressive. It can be… Powell being super hawkish, ended up being the thing. But I gave like five or six different things anticipating the questions, Brent, because I know that people always want the type A macro trade, which is what I described before this conversation, which is you have a macro narrative, you have an asymmetric pricing, and you end up being proven right on your narrative. And great on the setup of your trade.

That’s what everybody wants, but it doesn’t always work like that. Sometimes you just find this thing and then people are like, what the catalyst will be? I don’t have any clue what the catalyst will be. I ended up being right because Powell woke up and wanted to have blood on the streets yesterday, apparently. But yeah, it takes a lot of discipline too, I guess, to put these trades on when you really don’t have the narrative behind.

Brent (35:58.55)

Right, and if you look back at some of the great crashes like the flash crash, the crash of ‘87, the cable flash crash in the pound, and they do these reports on them like the Treasury and academics do the reports, they don’t even know what the catalyst is after the fact. You know, a lot of times things just move because there’s an exogenous thing that’s some BS thing and there’s an endogenous setup within the market and everything unloads.

So yeah, I’m not a huge, like obviously like you said, it’s great if you can forecast a catalyst, but I would definitely say to people, you don’t need a catalyst in advance for the trade because a lot of times even ex ante, people don’t even know what the catalyst was for the move.

Alf (36:41.23)

Okay, guys, we spent almost 10 minutes talking about trading psychology because it was way too much time. We didn’t do that. But I would also like to take a second to thank you guys for listening to us the entire year. I’m guessing this will be the last episode because next week it’s Christmas in Italy, Brent. So I’m going to pass on recording.

Brent (37:03.131)

Yeah, and Boxing Day in Canada.

Alf (37:11.084)

There you go. So, guys, this has been great. And as always, just renewing the invite. If you want to talk to us, open a Bloomberg and send us a Bloomberg, send us an email. I mean, very happy to engage with you and thanks for all the feedback on the podcast. I guess the YouTube version has been something that people pushed for, so we made it happen. Brent does the charts, so he does most of the work anyway. Thank him.

Brent (37:31.592)

I do love making charts. Yeah, I second that. Thank you everybody for listening. Thanks for the feedback. Thanks Alf. This has been a fun experience so far and looking forward to 2025.

Alf (37:42.444)

Happy New Year, Merry Christmas, it panettone, talk soon.

Brent (37:43.99)

All right. Happy Hanukkah, too. It starts, think, the same day as Christmas this year.

Alf (37:49.548)

See you next year. Ciao.

Brent (37:50.486)

All right, thanks everybody. Ciao.