A few days ago at the Ira Sohn conference, the legendary (and he really deserves that adjective as opposed to the many other “CNBC qualified” legendary traders) Paul Tudor Jones gave a presentation called “Manic depressive trading in a volatility-compressed world.” It is unusual for Paul to have made the speech as he is more of the old school style hedge fund manger – let your results speak for themselves and stay out of the media. Over the years I have never once seen him on the business news giving his opinion about the market. Apart from a 60 minutes piece where he promoted his charity, Paul does not give interviews. In fact there is even a famous PBS documentary called “Trader” that was made about Paul in 1987. In the piece, he correctly forecasts the 1987 crash that was still months away. Yet it seems that Paul Tudor Jones hates the documentary and has subsequently bought all the remaining copies. Every now and then someone posts it to Youtube, but he must have bought the copyright as well because it is quickly pulled.
Paul Tudor Jones from the movie “Trader”</a> </div>
It was therefore quite unusual to have Paul speak at the Ira Sohn conference.
In the speech, Paul who has been trading for almost 40 years said, “Macro trading is about as difficult as I’ve ever seen it in my career.”
Traders often feel like the current environment is harder than it ever has been, and it is only with hindsight that the trades seem obvious. However, Paul Tudor Jones is not some spring chicken that has seen only a couple of different market cycles. He is one of the most experienced macro traders out there, so if he says that this the hardest environment he has ever seen, then we know that it is difficult.
I have spoken about the preponderance of hedge funds creating an environment that is akin to them standing around in a circle shooting at the target in the middle. The lack of public participation and the sheer number of hedge funds creates a situation where you need to fade the supposed “smart money.” Paul spoke about this as he described why the macro environment is so difficult right now:
Friday last week was one of the greatest days that Paul Tudor Jones can remember in macro trading as economic data (jobs numbers) were very strong , yet bonds closed up. He asks how can anyone possibly think/predict that bonds would close up on that day? This just goes to show that what’s obvious in macro is usually wrong.
As reported by the ValueWalk website, Paul went on to note:
What is the cause? Paul Tudor Jones says that central banks are the cause for this manic depression in markets…. Paul Tudor Jones says that “realized volatility in G7 equity, forex markets are all at multi-decade lows”
The JP Morgan G7 Volatility Index is hitting new lows for this move:
JP Morgan Realized G7 FX Vol</a> </div></p>
When you step back and look at volatility over the past few decades, we have only been this low in 1996 and 2007:
JP Morgan G7 Vol over the last couple decades</a> </div></p>
According to Josh Brown from the Reformed Broker website, Paul blames this collapse in forex volatility to “…lack of interest rate volatility, globally, for the current environment.”
He doesn’t see this interest rate volatility picking up until the end of the year. According to Paul, “… nothing happened in fixed income in first 7 months to this year, but investors will start to see changes in bonds when taper starts to end.”
When you read through recaps of Paul’s speech, it is increasingly apparent that he doesn’t do this very often. It is not a well thought out sales job like a Bill Ackman research presentation. It is more a rambling collection of thoughts of a seasoned macro trader. However, what often makes traders (as opposed to investors) successful is their ability to quickly shift sides. Therefore the greatest traders often seem to give the worst interview and speeches. They never seem to be willing to fully commit to any one side as their flexibility is the key to their survival. Quantum’s Stanley Druckenmiller was like this. His interviews were terrible because he was always open to being wrong and said very little with conviction. The best hedge fund mangers don’t have the confidence to scream at the top of their lungs “BUY, BUY, BUY” like Jim Cramer because they know that trading is a game of odds where they can lose at any time. They never allow themselves to get wedded to any idea that strongly.
Therefore the take away from a Paul Tudor Jones speech is much more difficult to summarize. For me, the important point to note is that the lack of volatility has created a difficult macro environment.
I have been meaning to write about my long bond volatility and long Yen volatility trade for the last little while. Paul’s bemoaning of the collapse in volatility gives me the perfect opportunity.
Long and wrong
I have been long US treasury volatility and Japanese Yen volatility for the past couple of months. The only way to describe these positions is that I am long and wrong.
Both calls have been terrible.
Let’s start with the really bad one. The Japanese Yen volatility has collapsed over the last few months. Here is the Yen 3 month ATM implied rate:
JPY 3 mth ATM Implied Vol</a> </div>
This is due to the fact that after the big move from 75 to 100, the Yen has basically gone sideways for the last year:
USDJPY Rate</a> </div>
The FX rate has been amazingly stable. It is as if the Japanese government had decided that they were going to move it up to 100 USDJPY and peg it there.
My other long volatility trade has not worked out either. The US Treasury market has also been remarkably quiet. Have a look at the Merrill Lynch Option Volatility Estimate MOVE Index which measures the implied volatility of the Treasury market:
MOVE Index</a> </div>
This is also chugging along the bottom of the range.
As Paul Tudor Jones noted, there has been precious little interest volatility which has translated into muted FX moves as well.
My long premium positions are slowly decaying against me and the vega is pushing it well offside.
The question is should I give up? Do I throw in the towel on my ideas?
At the risk of looking like an idiot that throws good money after bad, I am going to increase the size of both of these positions into this dip.
I know that doubling down should be reserved for lunch, but this is not the same as fighting with the market by adding to a trade with an open ended loss. There is a limit to how low volatility can go. At this point, the market has just become dumb complacent.
The world is becoming more unbalanced. Debt is piling on at a fierce rate. Meanwhile Central Banks are lulling everyone into a sleep that is usually reserved for when after you eat way too much Kentucky Fried Chicken.
I am sticking to my belief that the next crisis will not originate from the equity market like in 2008, but instead will come as the result of the worlds’ Central Banks losing control of their bond markets.
The only solace that I take in my terrible long volatility positions is that at least I knew enough to stay away from being long the VIX as well:
VIX Index</a> </div>
It would have been nice to have been smart (bold) enough to short the VIX against my other two long positions, but I just don’t have the stomach to play that game.
The world is so unbalanced that eventually the Central Bank repression of volatility will make for some explosive moves. Right now investors are willing to believe that the Central Banks have it all under control, but I am not so confident.
Everyone loves to cite the old Warren Buffett line about being fearful when others are greedy, but I much prefer the true classic line that my old boss loved to use:
“Buy your straw hats in winter.”
Volatility is being given away as everyone thinks that the Central Banks will be able to continue to steer this big ship through the channel without slipping into deflation or inflation. I am not nearly as confident and think that it is only a matter of time until there is a big accident in financial markets. I have to pay very little for this insurance and I intend to be fully covered in the case of a claim.
Quick note on Draghi and the ECB
Just a quick note on Draghi and the ECB. Yesterday Draghi finally did it. After months of hinting of further easing, he finally bit the bullet and committed to easing next meeting.
Or did he?
The market is definitely interpreting Draghi’s comments as the all systems go signal for easing. Have a look at this index that measures the market’s implied one year change in the ECB rate:
ECB Priced Moves next 12 months</a> </div>
The market has priced in 13 basis points of easing over the next 12 months.
When I read his comments, I was not so sure that the had fully committed to easing next month. Everyone was excited about the headline that “Draghi is comfortable with acting next time,” but if you read the full comment, it is not so clear. According to the Guardian Draghi said:
I would say that the governing council is comfortable with acting next time but before we want to see the staff projections that will come out in early June,“ Draghi told a press conference. ”There is consensus about being dissatisfied with the projected path of inflation. So there is a consensus with not being resigned to expecting this,“ he said. ”We have a consensus about action, but after seeing the staff projections in early June.”
The market did not seem to care about the caveats that Draghi attached to the commitment. I need to be careful about disagreeing with the market’s assessment though. I might be talking my book a little too much when I start quibbling with Central Bank legalese.
However, at this point, the market has fully priced in the good news, so there is not much point in acting. Not only that, but numerous ECB officials have indicated that there will be no QE and that any easing will be conventional discount rate reductions (maybe even to negative rates).
The ECB is mistakenly assuming they can affect the economy through conventional methods. In a debt deflation liquidity trap reducing the cost of credit does not solve your problem.
The ECB is continuing to make mistakes by not understanding the dynamics of their over indebted economy. They are making the same mistakes as Japan did in the previous two decades by not being bold enough. Their stock market will suffer the same fate as the Japanese stock market did during this time and slowly deflate.
I am staying short Eurostoxx.