Daily Learning – July 26, 2017
Superinvestors Podcast with Jesse Felder of the Felder Report
Podcast #8: Raoul Pal on Putting Together The Global Macro Puzzle
Released July 12, 2017
Approximate Length – 1 hour 4 minutes
Overview; Hedge Fund titan Raoul Pal a former Goldman Sachs financial professional, hedge fund manager and global macro investor recaps his past history and current thoughts. This includes his exposure to investing legends like Louis Bacon, Julian Robertson, and Paul Tudor Jones. Raoul shares his lessons learned, his frameworks, and approaches to risks along what he sees coming over the next decade (spoiler alert – tons of pain for individual investors).
Raoul publishes a report “The Global Macro Investor” and CEO/founder of Real Vision TV.
He believes that when and where you start your investment career is super important as that initial exposure shapes your thoughts and perspectives for the rest of your career. Raoul started his career in 1990 during a nice banking recession with the savings and loans mess. That was after the period of the late 1980’s when Wall Street was in its glory years.
He couldn’t initially get a job in finance coming out of school. He got a job in tech data for news feeds, price feeds and charts. Started on a technical analysis product. This allowed him to learn and see markets in pictures (through the charts). And charts show the history of things financially in one picture.
This early exposure to bear markets made him a cynic. He was made aware that there can be a lot of problems and pain in financial markets. It’s not always gains and low volatility. This shaped his outlook tremendously. He was able to learn about the ups and downs. It always allowed him to question the common narrative coming out of Wall Street and the financial media. This was of big benefit throughout his career.
There is always a current narrative that most investors use to view the markets and what to buy and hold. Understanding this is important to understand because investors create false narratives all of the time like “don’t fight the fed” or “quantitative easing only drives up asset prices” or “quantitative easing will only be inflationary.” These are held out to be true by most people because they don’t do their own homework or question them.
The job that we have is to question these narratives. Is that really right? It proved to not be right with quantitative easing because at first commodities were going up and then they didn’t. Why didn’t they inflate commodity prices but yet they inflated equity prices? Something is not consistent with the narrative. So we need to look at these narratives all of the time and question them. Make sure they are true versus a false assumption.
An example of a real life narrative is the people who keep tweeting that the fed will never let asset prices fall ever again. But many of us were around for the Greenspan years and the Greenspan put. Those puts were just narratives and meant nothing. Where was the put when the markets crashed? It was a false narrative that people wanted to believe.
Stan Druckenmiller said he made some of his biggest money when he felt that central bankers made big mistakes. Narratives work for periods of time until they don’t.
Raoul Pal got his start in charts and technical analysis and he loved that approach of technical analysis. He started teaching traders the advantages of technical analysis which got his foot in the door teaching prop traders at Goldman Sachs.
He started to speak to hedge funds in the early 1990’s and was getting involved with trades with Tiger and various successful funds. From there his career took off in macro which is the way he thought of the world with technical analysis. Was at Goldman in the mid-1990’s through a few of the major crisis’ of the time.
He said he was lucky in his career. He was in the right place at the right time in the hedge fund space. Things often aren’t that easy anymore. It’s not where the opportunities lie all of the time. Even now, he couldn’t get a job at Goldman with his actual resume. They wouldn’t have hired him. But at the time, he was the right guy at the right time with the right mix of skills and experience. Many of those opportunities just aren’t there. The world always changes so new opportunities pop up and young people have to look for the new opportunities.
Sadly, finance is going the way of technology. So as technology goes, so does finance (which means more computers and fewer people). Technology is the new. There will be less human to human interaction. There will always be a place for the human touch, but you have to be an expert in something. The future opportunities will continue to shrink as baby-boomers yank money out of the markets and the world changes.
Out of all of this, there will be new opportunities as well. Eventually, the market will return to “return seeking” objectives rather than “asset accumulation” which has been the hot ticket lately for businesses. It won’t be an easy place to get in unless you have a tech background.
At 21 a friends father asked what I wanted to do and he said either a marketing or retail type industry or a bank. The father told him to go for the money in banking.
At Goldman in Europe taking with Julian Robertson and Paul Tudor Jones was like learning from the top guys. It was awesome. For some reason, the guys talked to me and I saw their trading styles. They all started with a chart, then they did their homework and applied their framework. Then how they built their portfolios and tried to discover the 3rd, 4th, and 5th level effects. The markets get the first and second orders rather quickly. But the deeper stuff is where the money is made in trade construction.
The greatest trade I ever saw was in South Africa with Louis Bacon. He was told to just sell all equities in South Africa right now for three straight days (about $1 billion worth). Hit every bid in the market. The dust settles. Several months later and he was told to buy South Africa and take the positions off. He asked what it was all about. Months of hold and days to get in and out to make what turned out to only be 6%. It was messy, complicated, hard.
He really made 56% on the currency, not the equities. There were two currencies (one was collapsing). So they made 56% on the currency and 6% on the equities. They thought through things on a much deeper level. One is thinking of a trade idea. Two is how to put on the trade.
He was at the epicenter during the collapse of Long-Term Capital Management. He was working for Nat-West. LT sold a ton of volatility because it was so far above the mean. Cut a year later. He is on a boat at a stag party. He was talking to another buddy who worked at another bank and asked how big LTCM was and he said about $10billion client. Then asked another buddy and another buddy all working at different firms and discovered that they had collectively about $15 billion just on the boat alone. That’s when he figured out that something is really dangerous and went back to the office and reported it. Shortly thereafter it all blew up. When it blew up he was at Goldman.
It was apocalyptic at one point. He left Nat West in 1997 for Goldman and warned them that LTCM was a volcano waiting to erupt.
Global macro is using global economics work and move asset prices. So if the economy is weak somewhere, you normally find that the bond market has interest rates falling and the equity markets are falling. Less housing is being built so maybe less copper is being bought. The price of credit is falling. Then you might find that agricultural commodities are falling because farmers are getting squeezed.
It’s all on a global basis which is a beautiful thing because we have the entire world in a moving 3D jigsaw puzzle that can never be solved permanently because it always changes and evolves. So you have to go back and resolve more puzzles. That’s why it attracts so many intellectual people because it is such a cool pursuit. It is incredibly infuriating, you get it wrong, you screw it up. But there is always the chance of getting the puzzle right and aligned and seeing the picture clearly. And when you see it all clearly, there is a whole world of opportunity ahead of you. It’s betting on economic shifts to generate changes in asset prices.
Global macro is always valuable. Because if you never understand how economies work, then you don’t understand asset price returns. There is a great podcast on LTCM itself on Real Vision. The reason they blew up is that they didn’t understand the macro and how the Asian crisis would take up liquidity and liquidity was a macro thing. So all of their trades fell apart because they didn’t understand the liquidity issue from the Asian crisis. So it always important to understand the macro.
Macro is always about looking for extremes in the puzzle and trying to place bets on those extremes as they revert back to the mean. So when you have one of the most over-valued stock markets in history, that is interesting. When you have one of the longest expansions in GDP/economy (second or third longest ever), that is interesting because when that ends, equities and asset prices follow. You need to be alert to that because when the business cycles ends, asset prices will follow suit.
There is a whole host of unusual things right now. The world is the most levered ever right now, so what does that mean? What happens when you have the business cycle end when there is a ton of leverage? That is a macro event/problem. Central banks are a global macro event because they are controlling the supply of money. How China plays into the world is global macro. We are in a tremendous time for global macro.
Right now global macro advisors are making very little returns because there are no trends yet. But when he trends develop, these managers will make some big returns and will capitalize on it.
Demographically we may have seen the peak in the U.S. With financialization. This could be a fantastic time to look abroad for investment opportunities. We have the largest segment of the population with the largest chunk of cash and investments all turning 70 around the same time. Within a few more years you have a ton of people that will turn 70 ½ which means they will get penalized if they don’t take money out of the money from taxes. The probability of this giant wave of retirees hitting at the same time is large and that will shift consumption and savings. It will shift how much goes into stock markets. There will be more sellers than buyers. And all of this is predictable. You should be looking ahead. If you are young, you want to look ahead. You don’t want to invest where everybody else is already invested. You want to invest in things get beat up and extremes happen. India has good demographics. China has bad demographics. Iran has a P/E of 5 ½ one of the cheapest in the world.
Iran may sound crazy but so did Poland years ago when it was sort of part of the Soviet Union. You need to understand how things change over longer periods of time. Agriculture is cheaper than it has ever been right now. Farmers are aging and they will have to sell the farms at cheaper prices because they can’t afford to run them any longer. There is a big opportunity over the next 30 years for farming because nobody wants to do it.
You always want to do things that nobody else wants to do and farming is a store of value that nobody wants to do. So there are always opportunities out there and they won’t all be in the United States. They will emerge globally.
Trade framework and investing always starts with a chart. Look at every chart in the world for irregularities. Markets don’t go to zero unless the result is civil war. Understand the business cycle and economic cycles. I use the ISM in my framework which is the guide. It is a great forecaster to GDP. Then demographics and debt and other things come into focus.
So if we look at India, we can use it to apply the framework. I first cross out all the countries with bad demographics. I cross out the one with bad debts. What materialized was a map of the world that had a bit of South America in it (a tiny bit), most of Africa and the old spice routes of India. Spin the globe with India in the middle and look at the countries around it, those countries have the best demographics, the highest savings, the lowest debt to GDP, the lowest debt to household income levels. They are like the perfect scorecard. But they also have gas and oil and natural resources and financial centers. That made me go “WOW”. I can see the jigsaw puzzle with India in the middle of it.
Now we have a false narrative of the monetary issues and how they are taking away the freedoms of the people. But this is something different. India is going to leapfrog everybody with fingerprints. You can buy things with your fingerprints or pull up medical records with your finger prints. They are going to leapfrog the world. That was a signal for me as an opportunity with layers.
That’s where Iran came from. I looked at all the stock markets and Iran was the cheapest. There is a news narrative but they have a self-sufficient economy that is growing well with smart people. The world cut them off. They fit perfectly into my models. India and Iran always trade together. The narratives on Iran are almost all false.
It’s a lot of fundamental analysis, just on a macro basis. It’s actual research for pricing and valuations. Occasionally you get something like Bitcoin, which means you have to take everything you know, spin it on your head and take a leap of faith. Those are different. There are less of those around. I’m not sure of the narrative right now.
Most of the world is about relative value which is what Paul Tudor Jones taught me is to look at relative value charts. The price of one thing versus the price of another. Because the price of wheat and gold has had a relationship for thousands of years. You can get charts going back a thousand years. You can price assets against one another on a relative basis.
We have a propensity to own things that are cheaper than another and over time people will make that switch. The ratio of real assets to financial assets has never been more distorted. If you go back from 2007 to 2014, the price of art has never been more expensive. And modern art never as expensive than old masters. It was crazy. Crazy distortions in cars.
If you ever saw the movie the Dirty Rotten Scoundrels Michael Caine drives around in the convertible Rolls Royce. A Bentley was three times the price even though they were the same cars.
Art, wine, cars, property, is ludicrously expensive at the high end. It’s precious metals and industrial metals which is different. Financial assets are really high compared to most things.
Price to rent levels are back to peak levels. Either the rest of the world is really cheap or financial assets are super expensive and it’s probably that financial assets are super expensive.
You need to have a long time frame. I learned over my career at hedge funds that you had to manage your monthly P&L which meant that you need to manage your trades in 2-week cycles. The best traders in the world are those that have their trade horizons match their idea horizons. If your idea horizons are macro themes, that is a long time horizon so your trades have to match that time horizon. You only get a new data point every three months. So if you are being judged monthly or over two weeks, that’s quite a conflict.
The great advantage I have now rather than when I was managing money for other people is that I can match my time horizon with my trade ideas which are longer time frames. That is my true arbitrage and true alpha. Nobody else is competing with me. I was long the dollar since 2012 and haven’t made a single trade to alter that trade.
If you have a time horizon that isn’t 2 weeks or 2 months, that is a huge advantage over everybody else. That’s why Wall Street and hedge funds are a shrinking industry. The people taking on risk are basically the baby boomers and pension funds with retirement savings. So they are forcing hedge funds to take less and less risk. So the returns are collapsing. The real opportunities for a millennial is that you have time horizon.
That’s why if you are younger you can invest in India and sit on it through the ups and downs and over the next decade or two make 10X which the baby boomer can’t do. That’s the opportunity.
The daily routine is looking at charts and my own research. It sounds terrible but I don’t read the research of others. I don’t do that because I want to have a clear head. People pay me for this research and it is flattering that people pay me for my thoughts but I can’t regurgitate what others are thinking. I look at my charts. I use twitter a lot because it gives me a sense of what is going on currently.
I do read news stories though to help connect the dots. I do read the Economist as they do a good job of helping to connect the dots. I do speak with people and have roundtables with macro guys and family offices. We try and think through things together.
Real Vision has done a lot of work on the pension crisis. The Federal Reserve has even put out some research a couple of years ago showing that the correlations and demographics in the equity markets and they suggested that by 2025 based on this correlation that the markets can trade down to an 8 P/E. That is just a function of baby boomers needing to sell off equities. I see massive longer term risks and it is so contradictory to the current narrative. It is the biggest most predictable story that few people dare talk about.
The pension crisis is this. Baby boomers have the most allocation to equities that they have ever had. Because they didn’t save enough money and spent too much. They were told to just give it to some guys on Wall Street who will magically turn it into a fortune covering up their behavioral problems. Therefore you don’t need to save money, you can just borrow money and it will all pay off in the end and will work out. But it won’t work out. They didn’t save enough, they borrowed too much, and they can’t pay it off.
But the point being, they are taking more and more risks. They are the dip buyers. They have to. They are in the home stretch and are coming up short on their needed numbers. They have no choice. Wall Street has them fooled (again) which is hilarious. We will see during the next phase of the business cycle, the economy go into recession and the equity market get cut by more than half as it always does. But it is going to cut in half on the eve of the retirement date of all of these baby boomers and they will never be able to buy the dip ever again as they will get crushed and take a permanent loss of capital.
So it is one of the most important stories right now. If you look at the labor force participation rate it is one of the key drivers for everything in the U.S. Right now including consumption patterns the Fed balance sheet, inflation and everything else like consumption of gasoline. And the nice thing about the labor force participation rate is that it is easily forecasted. It’s just demographics put forward unless a big chunk gets wiped out.
Less and less people will be part of the labor force and less and less people will consume, and consume oil, less investors in the stock market. That’s why I am a huge deflationist over time because I will follow the demographics. I do not see a way out of this.
I don’t believe that all central bankers are complete idiots like many others think and believe. I think they are aware of these issues and they are doing whatever is in their power to do the best they can trying to do things.
If you know a meteorite is about to hit the earth, the last thing you can do is tell everybody because it will just result in panic. So look, it’s an exact rerun of Japan. Japan was just lucky because the rest of the world like China, Europe, and the U.S. Could help support it. When the U.S. Goes down, there is nobody else ready to support it. China is too old demographically, Japan can’t do it, Europe can’t and India will still be too small.
So I’m sure the central bankers know but they aren’t mentioning it. They intuitively know what is driving down rates and why consumption is falling. In the heat of the battle they are talking about inflation but inflation is exactly predictable by demographics. We know where it is going. That’s why Japan is doing the same. Maybe they would make different choices if they had to do it all again.
In the end, I’m not sure they have really thought it through or know how to control these powerful forces.
Central bankers may not be able to control inflation the way they think they can (against the demographic trends). We just don’t have the people to grow through this. What happened in Japan is that wages went up a bit, but labor input including robots balance out. Inflation started when this large group of people hit their 20’s. The baby boomers were 29 by 1979 and were buying houses, cars, clothes, furniture and all bought things at the same time. The prices of everything went up at the same time. It is the opposite right now.
Millennials are not prolific investors or savers or even consumers. But you can’t expect the millennial to invest now at all time highs and think it is going to work out for them right now. You will just compound their losses over time. You need the baby boomers to take the losses.
Somebody needs to figure this out pretty quick. It would be better if we took the pain sooner and quicker than drawing this out by deferring the pain to the Millenials.
More notes at the podcast notes on the Felderreport.com.