Global macro investing has a few unique characteristics (This will be a continuously updated post given the importance of this topic and the difficulty to be complete at one shot. Looking for updates in the future):
1. It would be silly to talk about t-statistics in global macro investing. The breadth, or the times that you can place bets, through global macro investing is very small. Generally, there is no way to measure statistical significance here. Instead, you have to do thorough investigation to magnify the odds of winning in each situation.
2. As a result, unless you are really sure of the probability of winning (e.g., 90%), it helps not to place the bets, even if the alternative is zero yield cash investments.
3. As another result, you should not be overly greedy by leveraging up too high. If a strategy with limited leverage can make 20% during a short period of time within a year with little or even negative correlation with the market returns, stay with this strategy instead of leveraging up n times. Otherwise, a sudden market swing against you could deal a disastrous blow, and you may lose a lot of money instead of making a lot of money, even though you get the strategy perfectly right. After all, a consistent 20% each year would easily put you within the category of legendary investors.
4. Global macro investing requires patience. Once committed, you should give it at least six months to a year to work out. And you should leave yourself the flexibility to hold the line in any reasonable cases in this horizon. For the same reason, you should also resist the urge to time the market by increasing the bets substantially within a short period time in the hope of achieving astronomical returns. This is related to the discussion in point 3.
5. Determining the right instruments, as well as the right leverage, is at least as important as determining the right strategy.
6. If you are doing both longs and shorts, you do not have to rewind the positions at the same time.
7. Global macro investing is more about the ability to analyze and interpret the information than collecting new information. After all, most of the relevant information is publicly available and is released to most people at the same time. The ability to synthesize the information and draw the correct conclusion is crucially important and is a personal gift.
8. Debate and discussion are very helpful in global macro investing to certain extent. At the end of day, you have to put the money at where your mouth is. Frequently you will find people all hold on to their own believes, right or wrong, without ever being able to be persuaded. And most people are all cheap talk, with no ability to invest and make money. It is better to force them to make the investment decision according to their believes and see about the outcomes. After all, you should only invest when you have strong believes in global macro investing, and at the same time, you cannot always miss opportunities while others can consistently make money. Too much debate is a total waste of time. There is an old Chinese saying: whether it is a horse or mule, the easiest way to tell is to take it for a ride.
9. People who make correct global macro calls are generally generalists, not specialists or experts. In the last two years, there was a bit soul searching in the annual meeting of America Economic Association why few economists foresaw the Great Financial Crisis. The investment industry should have done the same thing. But the fact of life is that those few economists may be able to call the Crisis even if they are not economists. They are just insightful generalists with common sense who can synthesize information well and be courageous enough to point out the nakedness of any emperors, and they just happen to be economists. In general, people’s tendency to consult experts, unless there are generalist experts like Roubini, would yield nothing valuable in terms of preparing for global macro events, be it risk management or speculation.
How do these characteristics fit in the context of the simple global macro strategy that I advocated a couple of weeks ago? There I suggested investing 100% in long-term U.S. Treasury bonds and short selling 100% equities. Let’s use ETFs to illustrate. iShares has TLT for long term T-bonds and IVV for S&P500 index. When I suggest the strategy, TLT is at about 104 and IVV is at about 110. If you have 1 million dollars, you can buy 1 million dollars of TLT and short 1 million dollars of TLT.
People may ask what information that I have that other people do not have. My response, related to point 7, is that all the information that I have is available to most people. But information cannot tell its own story, especially to the people who are blind to it even if it is under their noses. For example, in March, I have already told many people that double dip is almost a sure thing by the end of Q1 2011 without substantial further stimulus. The pundits have only come out recently to argue for a likely double dip. I have only less, not more, information than them, but that does not mean that they can predict better.
I would not place this bet until very recently after I am quite confident about the direction of stock markets in the next six months. Once getting into position, do not necessarily try to leverage up further, even if markets seem to drop quickly like at the start of the last two-week period. No markets go up or down in a straight line and the reversal effect could be quite nasty if you leverage up too much at the wrong time, like on last Friday of August 28, 2010. Limited leverage would help you hold the line and wait patiently for the expected returns in the next six months. I choose the above two instruments because they do not have minimum investment requirement, are fairly liquid and have plenty of short availability, and can help leverage up to a reasonable amount without excessive risks. Whenever TLT appreciates by about 10% from 104 or whenever IVV drops by about 10% from 110, you can start to rewind either position depending on your judgment and risk appetite. Of course the chances are that much higher returns may be achieved than 20%. So you can wait to rewind either position at much higher returns.
So far, you would have made about 4% returns from this position, which is not too bad for two weeks of time. There will be more to come in the next few months. The GDP is quite in inline with my prediction of a range of 1.8-2.2 and then subtracting some for the reasons that I mentioned in my global macro call. Fed has very limited effective options (other than inflation targeting) by now and the market just wants to find an excuse to relieve itself at some point.
Even though I have had the luck to predict the market direction correctly in the last few years, it would impossible to get a significant t-statistic from my calls unless I keep doing this until maybe my death. And even there, it is just a MAYBE.
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