When Prices Stop Making Sense | Systematic Investor | Ep.378
Summary
Market Outlook: A "messy" Fed with dissenting views heightens uncertainty, impacting signals, liquidity, and potential price reversals around announcements.
US Treasuries: Discussion focused on term premium, bonds’ diminished diversification role, and risks tied to fiscal dominance and financial repression.
Gold: Strong central bank buying, constrained supply, and a perceived decline in U.S. relative safety were cited as drivers of gold’s strength, with silver also noted.
AI: The AI productivity narrative supports growth, but rising debt issuance for data center buildouts raises bubble-risk concerns highlighted by Howard Marks.
Credit Markets: Despite tight spreads, leverage is elevated and cracks are emerging, including concerns over financing structures and fraud risks, with cross-asset ripple effects.
Trend Following: Momentum is pervasive across assets and time horizons; systematic trend strategies and overlays can make portfolios more adaptive, aligning with total portfolio approaches.
Asset Bubbles: Wealth effects, optimistic analyst expectations, and regime-change narratives can fuel bubbles, which may occur without classic signs like rising volatility or volume (e.g., gold, cocoa).
Tickers: No specific public company tickers were pitched or recommended in this conversation.
Transcript
Imagine [music] spending an hour with the world's greatest traders. Imagine learning from their experiences, their successes, and their [music] failures. Imagine no more. Welcome to Top Traders Unplugged, [music] the place where you can learn from the best hedge fund managers in the world, so you can take your manager due diligence or investment career to the next level. Before we begin today's conversation, [music] remember to keep two things in mind. All the discussion we will have about investment performance is about the past [music] and past performance does not guarantee or even infer anything about future performance. Also understand [music] that there's a significant risk of financial loss with all investment strategies and you need to request and understand [music] the specific risks from the investment manager about their product before you make investment decisions. Here's your host, veteran [music] hedge fund manager Neil's Krup Larson. Welcome back to the latest edition of Top Traders Unplugged, where each week we take the pulse of the market from the perspective of a rules-based investor. It's Alan Don here this week sitting in for Neils. Neils is away on his travels in the US and I'm delighted to be joined by Mark who's in Chicago today. Mark, how are you? >> Not too bad. It's uh a little early in the day, but it's and it's cold out here in Chicago. So, uh as what you would expect in December, but uh but but I'm ready to have a good discussion. Good stuff. I was there um about six weeks ago. It was pretty pretty pleasant at that stage, but yes, you would expect it to be getting chilly now. And appreciate you getting up early uh to make uh make time for this. Um so, we've got plenty to talk about. Um we've had the Fed out this week. Um we're recording on Thursday, so Fed was last night, so that's that would be a focus, but we've got a number of other interesting topics, but maybe um just to kick off and uh to leave time for the remainder of the conversation just to cover performance. So we're um a little bit aways through the month at this stage. Um the sockchen CTA index is down 78 basis points as of the 9th of December and the socken trend index down 62 basis points. Sochen CTA now down 2% on the year 2.06% and the sock gen trend uh close to flat down 0.16%. So not a whole lot I would say to talk about in terms of uh uh December performance market. any observations on performance this month or the general trajectory? Obviously, we've seen generally better performance over the last few months. >> No, absolutely. There we've seen a lot better trends in some key markets as we as we moved in to the end of the year, we're seeing performance for a number of CTAs that have improved over this period. But now that the Fed is done, usually now we're starting to get into holiday mode. And uh that has a big impact on liquidity. It has an impact on you know uh what signals you receive and you have to start making some decisions on whether you should follow all signals as we get closer to the holidays and you know trading volume starts to dry up >> for sure. Um now you mentioned we had the Fed done and it was an interesting um interesting meeting last night. Obviously the Fed cut rates 25 basis points which was broadly expected then to um 3 and a half to 3 and 3/4%. They did um uh announce um some some new liquid liquidity injections and T- bill purchases and there were a number of descents to the um 25 basis point cut on both sides. So what was your take uh overall on on the Fed Mark? Well, before we started this call, we were asking, you asked, "What kind of Fed are we seeing? Is it a hawkish Fed? Is it a dovish Fed?" And I said, my description, it's a messy Fed. And uh having to sense uh which in some sense I think is good. It shows that there's independence on the FOMC, but at the same times that means that the Fed is not speaking with one voice. And so that sends a really messy set of signals on what people should take away from what they've heard. Now, in general is is that I've looked at the Fed uh announcement dates very closely and what we found is is that while over a longer term, obviously interest rates will have a big impact on a lot of different models on stock markets on other markets because it it's the cost of capital. But at the same time is that right around the Fed announcements is that you you get some uh high uncertainty. When you have high uncertainty, you could have large reversals in price. And so for short-term models, it's sometimes good to actually avoid the Fed in this period of time. You might have an expectation of what the Fed is going to do going into the FO uh FOMC. They then do what is expected but then chairman Powell gets in front of an audience and you don't know what's going to happen and especially now is this is that uh with you get dissenting voices that say we got what was expected a 25 basis point cut but now we want to look forward and say what are the expectations for 2026. when you have the sense it's it's less clear what is the direction going forward and then if you look at the uh SEP which is their quarterly forecasts uh economic projections you've got a fairly wide set of uh expectations for 2026 we've got some thinking that there's going to be only u uh some are going to actually see hikes in 2026 some u one member thinks that there will be six cuts in 2026. So when you see that wide range, what you're what it's telling the market and what it tells uh in terms of signaling is that we're going to be in a high uncertainty Fed environment for 2026, which is means there going to be more risk if you trade in the interest rate complex. Um and and I think that that's that's even more problematic when you look at what is their forecast. One is is that that even though they're cutting rates, uh we're at a three-year low. Uh this is the third cut uh this year. We had 100 basis points in 2024. Yet the projected inflation for the PCE for the core is going to be at 2.6 for 2026. So that's not close to our 2% target. So So we're still going to be in a high inflation environment if as if you ask anyone that goes to a grocery store. And at the same time, they're saying that well, we're expecting that growth will not be 1.8% 8% which is on their last forecast but it's going to actually come in at 2026 at 2.3% which is much higher than uh than what we've seen in just the last last quarter. Yes, it's I mean it is an interesting mix of uh projections and comments and as you say a lot of uncertainty and I mean even you know we were chatting earlier you know before we came on was it a doubbish or or hawkish and and I mean my sense watching it last night was you know coming into the meeting there was an expectation maybe of a hawkish ease but maybe having considered everything the market concluded it was less so and maybe even a dovish is granted it is messy and I think a few points um you know obviously the next meeting is in January and we've had this you know um a lack of data and we will have a lot more data by by by the time January comes around but even Pal said himself that some of the data that comes through you know there will maybe technical factors that will distort it so that is another source of uncertainty as you say and then you know the SEP interesting they're forecasting higher growth but not translating into improved um unemployment. So they they seem to be buying into the uh product story productivity story related to AI etc. and and Pal was asked about that. He said he uses himself. He can see how how it could be uh productivity enhancing. So many dimensions to it and and obviously you know the um the the the news around additional T-bell purchases to ensure there are sufficient reserves in the system. You know we've gone from QT to some form of QE again. So um hard to model all of that systematically when there are so many kind of subtle messages coming from the Fed. Wouldn't that be fair to say? AB: Absolutely. And I think at very high level and some of what we like to do, I think on these calls is to talk about, you know, the the specifics of how to how to build models and how models work. But at the same time, you want to try to step back and say what's the high level of what you're trying to do. And when you're building systematic models, you're always thinking of signals versus noise. So how do you extract a signal? And in in the case for let's say a trend follower, it's usually going to be a price signal versus the amount of noise that you face at a given amount of time. Now noise can come into two forms. One is we'll call it the volatility which is measurable. So we could sort of say like well what's going on with the volatility of markets and then we can look at the strength of our signal divided by our our volatility. we could get a signal to noise ratio and we could sort of say like well now we can measure how strong that signal is relative to some scale. The problem comes in is is that you know when you think of risk it's not just the volatility which is measurable but it's also what is not measurable which is the uncertainty. So when you think about okay we have three dissenting opinions well how is that measurable? We we do have some data where we can look at descents and then see what happens in the future but that's uh but we have a very small sample uh the switch from uh when we look at uh you know we'll call it the new QE which we'll call it just more reserve balance management is that what they've said is that our quantitative tightening or QT may have overshot now we're going to allow for about a $40 billion into Treasury bills because we think that there has been some disruptions in the repo market. That's harder to uh we can hear the words, but it's harder than to translate that into measurable noise and then second into a measurable signal. >> I guess you can you can ignore all of that and just look at how the markets trade in the day I suppose the days after. As you say, it can be choppy. I mean, so far the dollar is a bit weaker. stocks were up, then they were down. Um, probably dollar weakness is probably the most notable feature in the last maybe 12 hours or so. Um, but as you say, there are kind of a number of different dimensions here. Um, and also, you know, the pal even mentioned the unemployment data as well, which I think is showing around maybe 60,000 on average, but they felt that in reality that might reflect, you know, job layoff. So, you know, even on the data side, you've got that that uncertainty as well. >> Well, that certainly was a uh another bomb that was dropped on us. Uh and you talked about Paul often sort of upsetting the Apple card, so to speak, is that if you said that, you know, job creation was overstated by 60,000 a month, then well, we've gone from a positive job market to something that uh uh is uh negative, certainly not very attractive. uh other labor market signals are are more mixed and they say that we have we'll say a balanced labor market. know when you add this all together uh it's you say Mark you're listening you talk you know it tells you this that what the only thing you should use is prices once again forget all this fundamentals forget of trying to determine what the Fed is doing or uh what's going on in the in the unemployment number just just just go back to prices and uh and that becomes the the key balancing act is is that how much other information should you use in models beyond on price. >> I mean, it's interesting. Um, you know, you could say, um, looking at the market here from a pure, you know, rates perspective and what's priced in, etc. Um, you know, are, you know, would you say bonds are decent value now? You know, say tenure yields are they've been stuck around 4.1 4.2% for a while. Obviously the um one of the notable things is the Fed funds has now come down to about the level of the two-year yields. I mean taking that perspective any any observations on do markets I suppose regardless of what the trend is does the fixed income market look reasonably priced at the moment? >> Well you can always use some simple rules of thumb and the simple rules of thumb is they say let's look at uh what real GDP is. Let's look with the expected inflation. So we got expected inflation that's going to be we'll so to say 2.6 or so even if you and then you add in real GDP for next year they're they're projecting 2.3. So now you're at 48. Then and then you said well should there be a term premium associated with uh with the bond markets right now? If you think that there's a positive term premium, well then you you're sort of say like you're at a at a high fours at best and you know you would sort of say that uh the term premium was you was knocked down to something close to to to zero because the bonds were such a a good hedge. Now we're probably say having a different view on on on what is the role for bonds in a diversified portfolio and with high debt numbers is that the debt may not be the same type kind of safe asset. It may not be the same kind of hedge that we uh saw before. And this has been a recurring theme that when you look at 2025, you ask the question is what is a safe asset? Because a safe asset should be a diversifying asset. If bonds are not a diversifying asset, then what is and what should you do with your portfolio? Now um not saying that for every time a trend followers say that uh there's only one answer to the solution. It's always being a uh you know hold some some trend following assets. But this is an important point in time where if let's say bonds aren't providing the diversification that you thought well then you have to try to look at other diversifiers and try to find something else to be able to support your portfolio. >> Yeah. I mean it's interesting. I mean you talk about the term premium and obviously that is reflecting a number of things supply demand imbalances as you say the term premium kind of went to zero if maybe even negative when there was um a shortage of of safe assets. Now things have changed and positive term premium you know reflecting that change dynamic but also I guess you know big theme this year has been are we moving into fiscal dominance and then big picture could we have financial repression um you know obviously we've got a high level of debt to GDP in the US uh and the question is ultimately how does that get managed to you know the easy levers to pull are are inflation the infl your way out of it. But you know in the extreme default you know could be a possibility. It mightn't be an outright default but you could have you know if we got into some kind of fiscal crisis down the road you could have debt swaps or maturity extensions all of these kind of things. So in theory a the term premium should should start to capture those um I suppose um >> you know miscellaneous factors. Is that fair? Yeah. Absolutely. I think that uh uh if there's been a change in the relative safety of some assets, >> yeah, >> if it's change in the role of that asset within a portfolio, then that then there's going to be a term premium associated with that. Now, you know, and I think that uh we still have very large de deficits and in some sense the only way that you could solve those deficit problems outside of a default is that you can inflate your way out of that. Then at the same time is is that well how are you going to get an inflationary environment? Well you can engage in some kind of uh financial repression of keeping rates low so which reduce the financing costs >> and it's not so much that the US Treasury is going to default. It's a matter of uh relative safety because what does it mean to be a safe asset? Well, there's no there's no such thing as a truly safe asset. It's just a matter of what is safe relative to the set of all alternative safe assets and I and I think that uh I would argue that uh there should be a greater term premium in the US market and at the same time we'll sort of say why are we seeing such uh strong price movements in in gold and silver and some other commodities. So partially to do is because if relative safety in the US has gone down >> then the demand for other potentially safe assets should go up and if let's say the supply of of of gold is constrained because it's you know how much are you going to be able to mine in a certain period of time you don't create it by fiat. So consequently, you could have these strong movements in uh in gold because of a reduction in relative safety. >> I suppose you've got um maybe uh conventional approaches to to to to um to valuing bonds based on all of the known factors, but then we have these kind of tail risks uh that you have to think about um as well, which which we don't know how that will play out. But um but one thing that you did touch on there is kind of the the signal we get from from prices. Um and I mean I know this is something you wanted to talk about as a theme. I mean sometimes one thing I I grapple with obviously prices reflect the the the supply and and and demand uh balance or or the relative strength. you know, from a financial markets perspective, you've got the idea of, you know, the wisdom of the crowd and and and the price reflects that as well. But at times we also get hurting um and and and trends and and moves that maybe less wise. So I mean how do you think about those two conflicting interpretations of what the price is reflecting as in the wisdom of the c crowd at times but also prices getting distorted by by extreme sentiment irrational exuberance and hurting from time to time >> right well think about when we started out our conversation the argument was is that look at all of this data that's giving us a lot of noise so then you sort of say like well in a noisy world maybe I should just focus in on prices and and and I probably that's that's always been my go-to position and I've used a phrase that uh prices are primal that you know uh regardless of what happens with other data you always have the price is telling you where there's a some balance between supply and demand. I'm not really sure what that balance may be at any one point in time or whether it's telling me, but but prices are primal. Uh the problem is is that sometimes it's really hard to unpack what the primal price is. And to to break this in down a little bit deeper is that that prices are primal, but that's not the same as value. So I could have a price in the market at a given time, but that's not where the value is or that's not the true value of a given assets. It just tells us where there's a balance between supply and demand in a and a perfect example is this is that uh let's take a look at some of our our bubble prices. We have individual stocks that have, you know, had some tremendous moves. We've had, you know, gold have a significant move. We got silver that, you know, touched above $60 an ounce. Well, the price is telling us that there's a true supply demand imbalance. But does that price tell us what the value of gold is right now? Uh yes, it is because that's what people are willing to pay for. But at the same time, is is it is that its true price? That may not be the uh those may not be the same thing. And from a I mean from a trading systematic trading modeling perspective I mean with that observation what does one do with that? >> Well this is the reason why is is that when when you know we've talked about is this is that I can be a trend following person. I could be believe the prices are primal, but then I might also use some other indicators to try to tell me is is that whether something could be overbought or oversold to say to say is there an anchor with something that's called uh value and and and this is also why we try to smooth prices because at any one point in time this is that uh you may not want to take the actual price but you wanted to use some kind of smoothing mechanism that could be a moving average at the very simplest form. But there are other mechanism we have to try to say is is that because there's noise in just the price process, how do we smooth that process out so we can get a better signal? >> Yeah, I mean obviously prices reflect narratives as well, but but then price can be part of the narrative too, you know, and obviously we can have feedback loops, reflexive processes. um how do you factor that in and do you see that in current markets? >> Well uh you know I think that the narrative is is very interesting because there there's a recent paper that was written about uh narratives in the FX market and what they what they found is is that then prices follow narratives as opposed to lead narratives. So in some sense is that if you use some type of LLM Yeah. Or if you use some type of mechanism to try to s extract narratives within news stories, you could sort of see that that that the narrative starts develop and then there's a carryover in prices uh >> as we see uh the narrative develops. And this is the one thing that you know is really important for for people to think about when uh for trend following or any systematic price-based system is that there are trends in price. But what is causing those trends in price? It could be a a trend in fundamentals. It could be a trend in narrative. So that there there can be other uh it's prices move but there's a rationale for that move and that could be trends in in other uh it other mechanisms it could be uh you know a narrative it could be the fundamentals >> yes um I mean there's all manner of things obviously you know when when you get into that there's seasonals as well which will influence markets at certain times uh and and and structural factors etc. Um I mean quants know about this and and and can can adjust for that. Isn't that fair to say? Well, uh this is uh this actually becomes an important issue when you build models because every model has to to a degree a personality in the because when you start looking at all the different choices you make, the modeler has to start making choices and decisions of what to include or exclude in a model. So uh so a perfect example is right now when we're as we get closer to the end of the year what we see is is that you know volume starts to dry up. So that means is that there's more likelihood that a small change in uh in in trading in volume will have a big a bigger impact on price. So your signals are going to get noisier as liquidity declines. >> We also know that you know liquidity and and the quality of signals you know intraday is is U-shaped is that we get a lot of activity in the in the morning you have a lot of activity on the close less so in the middle of the day that has an influence on on the price signals. uh to get more specific is is that uh and and here's an example that I was grappling with in the last uh uh two weeks. You have the Thanksgiving holiday in the United States. So, you have that Thursday off. Okay. You know, other markets are still open. They're not they don't have a national holiday. So, what do you do about those prices? Then you have Friday which is uh a uh open market but usually a lot of people take that that day off so there's not going to be a lot of uh volume of trading. This particular uh November was the last day of the month. Okay. So now in this time do you use those prices because it's the end of month but they're probably and there's probably going to be more volume. But normally you might ignore prices that occur on a Friday after Thanksgiving. And just to make this more difficult for you in terms of how we have to deal with these problems, you had the CME 11-hour uh outage of the market. So you think that some of their servers overheated and so they actually shut down the market. So what do you do if a market shuts down for a period of time and you're inputting prices into your model? So do you follow just blindly whatever happens when the market sort of kicks back in? Do you try to smooth do you drop out signals? So there's a lot of nuances in how [music] you look at prices and what prices to use. [music] One of the interesting themes and topics that's obviously getting a lot of attention in [music] markets at the moment is is bubbles and are we in a bubble? Um [music] Howard Marx was out with a piece um addressing that. I mean he had written earlier in the year I think bubble watch and he had a follow-up to that. Um, we can touch on that in a minute, but um, it's certainly one of the big topics. I mean, it's been banned around so much at the moment, it's almost like a given um, that you know that tech stocks are in a bubble, people draw parallels with the 1990s, etc. Um, what's your perspective? >> Well, let's go back to when we talked about uh, prices as signals. This is that well if a price of a given asset goes up then actually and you're holding a certain amount of that asset well you know by uh by definition your wealth has actually increased okay so the question is is is that does do prices reflect wealth? Uh, and that's not always the case because if if let's say that you were holding a a certain amount of gold and the price has gone up to $4,000 a uh uh an ounce, do you feel wealthier or more importantly should you feel wealthier under that scenario? And uh I would sort of say that that you know uh a mark tomarket and an economist would say your wealth is determined by whatever the price is at a given point in time. If you believe prices are primal, it says that your wealth has increased. at the same time is is that if you use that wealth that's been created as collateral, well then what happens is that you could actually increase more leverage in the overall e uh uh you could you can gain more leverage and you could actually sort of make the overall economy more fragile. And that's one of the fears when you see these bubbles is whether in gold and individual stocks uh is is that it actually increases the market fragility. Now, now that being said is is that as more people, you know, talk about a bubble, you know, I've been, you know, uh I don't want to say worried, but I've been actually looking at the uh the data fairly closely for central bank uh behavior, and what you find is that the central banks uh beyond their increases in marktomarket is that they've been just been strong buyers of gold. So, so and specifically certain central banks have been uh very strong buyers of gold and that's putting a lot of demand pressure. Also, you're seeing this is that a lot of buying is coming from certain uh areas of retail outside the United States. M I mean gold go I mean gold is an interesting case by itself but but more generally in terms of you know wealth effects uh and and some of the effects bubbles form I mean there's multiple dimensions to this obviously as you say when if the market goes up you know um values increase so there is a kind of a wealth effect for people who are stockholders um very often volatility goes down so so margin requirements ments are lower so people can lever up to the extent that they have levered portfolios that they need to add more risk to to to maintain the leverage. Um the stock value of certain companies goes up so their cost of capital goes down. Um so there's the reflexive process that that Soros talks about you know as long as there's no in the argument supporting all of this. Um, and I mean it it it maybe it's part of the explanation for the K-shaped, you know, economy. Obviously, people who own stocks, say in the US economy, the the wealthier cohort are feeling wealthier. Um, whereas people at the lower income levels are more challenged by the affordability crisis. So as you say per perhaps it it increases uh you know market fragility but also economic fragility if uh if the if the economy now has become more you know sensitive to the market the equity market if if it's more leveraged I think US households own about 40 trillion dollars of of US equity so if they if that market has a significant downturn those positive um wealth effects those positive re reflex processes go into reverse. Um any thoughts on that? >> Well, first is we do know that leverage is higher especially for for hedge funds. Now there could be other reasons for why there's higher leverage with hedge funds and it's it could be because they're more d uh especially the largest hedge funds are multistract, you know, pod-based. You know, they're better diversified so they could actually take on more leverage. But we're seeing that there's more leverage over overall in the economy. The latest research on bubbles uh and and this is from some uh professors at the Harvard Business School talk about that uh uh it's uh [laughter] it takes an academic to do this. It's closely linked to optimistic analyst expectations. This is optimism in fundamentals serves as a catalyst for greater optimism about the underlying assets and that increases the likelihood of a crash. So so the more uh uh the more optimistic analysts get then probably there's more FOMO and then that actually increases the likelihood of of a particular crash. Uh so so like yeah that seems to make pretty >> seems reasonable. Yeah, >> seems reasonable. In fact, they say like like it took a lot of research to figure that one out. But uh what you really uh what you really are worried about is this is that uh uh and this gets back to the issue of uncertainty is is that when it's harder to value an asset, then it's more likely to have a bubble because we don't know what is the true value. Okay. The other thing is that we're always worried about in uh in in bubbles is if there is a regime change or if there is a potential story of a regime change and you know we'll sort of say individual stocks is a little bit different but let's take a uh the issue with with gold. Is there a regime change going on with gold? Well, central banks are changing their behavior. That seems like a regime change. Yeah. >> Um a reduction in the safe asset of let's say US treasuries so that people are looking for other alternatives that could be a regime change. Um retail buying especially in some countries where they feel there's a high government uncertainty uh you know outside the United States. I don't want to say that's a regime change but uh but certainly is that that's adds to it. uh and a lot of the things that we learn about bubbles don't always uh you know hold true for example this is that uh you know uh retail demand in the US through ETFs is not as strong as what it as it has been in the past so this is not you know sort of retail driven gold increase >> and then when we look at some some of the other things in terms of uh uh speculation we usually expect is is that or the view is is that that it's the excessive speculation that drives you know bubbles uh prices into a bubble. Well, surprisingly is this is that we don't really have that excessive speculation in some of these uh markets especially is is that are you saying that e excessive speculation is coming from central banks in the case of gold? No. I actually did some close analysis of the cocoa market when it everyone talked about that being in a bubble and the view is always is that well bubbles should be more volatile. Bubbles should be driven by speculators. Bubbles will see more volume of trading because there's more churn in the market. There's more people entering in the market. In the case of for example Coco which is not you know we'll say representative of everything but it's an interesting case we saw that the commitment of traders show that large speculators were actually declining before a lot of the big move in the cocoa price. We saw that the volatility was actually you know declining not uh not increasing during that period. We also s saw that volume of trading was uh as the cocoa prices were getting higher higher were actually declining. So some of the uh we'll sort of say our conventional wisdom how we think bubbles behave don't always apply and that's what makes some of this so maddening to try to analyze. >> Well, one of the things you touched on is leverage and I suppose debt. But I mean with respect to the current um AI boom now we are seeing increasingly um debt issuance um in relation to the buildout of data centers etc. And that was definitely part of the focus of Howard Marx's piece um which I mean to simplify he saw as as kind of a part of a bubble narrative. didn't definitively say it's a bubble, but he kind of suggested that when you see this kind of debt issuance combined with rising asset values that in inevitably there there are issues. Um would that be your read on it too? >> Uh I think that there are things going on in the debt market that should give investors concern. uh we've we've had a number of different issue with first brands and some other uh uh you know factor financing that was problematic which you know we're not even talking about the AI issues is that what should be sort of uh relatively simple type of credit financing is is actually now looks like there may have been some kind of uh fraud. Now uh John Kenneth Galbrrath when he often talked about the issue is that when you have very frothy markets or when you have market extremes you have something called the the bezel. >> So it's combination of bezel with embezzling or fraud and I think that this is something that uh that's one issue we have to look at in credit markets right now. Second is is that when you find it even though credit spreads are extremely tight, we're seeing that the spreads now are reflecting the added risk in the case of let's say financing for uh data farms and and AI and and some of this is that that given it's a high uncertainty, we don't know what the payoff is going to look like in a traditional world that should become as equity financing as opposed to debt financing because debt financing and says you have to pay back that principle at some point and you're going to have to pay interest. So, so I think that uh the credit markets are uh at a market extreme and we're starting to see cracks in the behavior where we're seeing issuers trying to access credit markets or we see investors saying I don't know if I really want to uh pay uh I want to pay the uh the average price. I think I'm going to ask for a premium. Now, you sort of say like, well, if I'm a systematic trader and I trade mostly futures markets, why should I care? Okay, that's not I don't trade that stuff anyway. Well, I'll take take more of a holistic view on how you should look at uh at even a set of futures markets you trade. Markets are a complex system and so there's interactions across markets and assets and what you're having a situation especially if there's cracks in the credit market is that that'll ha ha have an impact on people's risk aversion. it will have an impact on where people will reallocate capital and what we'll sort of say from a network perspective. Uh there can be a movement of capital into more safe assets, treasuries or some other sovereign debt and so that's going to cause the systematic changes in prices which could be reflected in a lot of the models we look at. >> Yeah. I mean, just shifting gears, obviously we're talking about bubbles, boom bust cycles, and all of this is often a justification for momentum strategies, trend following strategies. The fact that these are recurring um patterns, recurring features of the financial market landscape, that they are moves that are somewhat um you know, unlin from fundamentals. But the way to play them is by focusing on the price as we've been saying. So yeah, is m are momentum strategies, trend following strategies the way to play these kind of market environments? >> Well, I think that there's uh it's interesting to look at the uh history of trend following momentum and I'll put those two together even though there are distinctions between trend follower which is more absolute versus momentum which is you know cross-sectional relative. That being said, this is that, you know, we'd probably sort of say that went into the early 80s is is that uh if you said you were a trend follower, you trade on momentum, you know, uh people would sort of think of you as almost a some form of uh Neanderthal and because the markets are efficient and certainly is is that you just haven't been aware of what all the advances in finance that we know about now. Now we're seeing a you know and even in the last couple of months I've you know read uh two interesting papers that looked at momentum and the interesting way or to to you know sort of cut through all of the research is that momentum is everywhere. It works you know across all time periods. There might be periods where it doesn't work for a period of time but if you look at you know very long history momentum works is is that you look at sub periods mostly it works it works on uh on you know markets countries industries f uh you know factor momentum uh individual stocks momentum is everywhere and as you you peel back the onion you're going to see that it's everywhere but that being said is is that we find out is is that uh some places momentum does better than in others. So we'll say beta and country momentum you know not as strong is what we're going to find in industry or factor momentum. So so when when there's factor tilts you know that that there could be momentum in that in that importance of that factor uh for industries there's much stronger momentum effect than what you'd find in in individual stocks. So what you'll find is is is that uh uh you know if you're a statistical basian you say momentum is everywhere but you could sort of like tilt your way you place your momentum bets and you could do better uh uh do better. Uh so stocks show for example intermediate persistence but not in the very short run. uh when we look at uh uh you know what what a lot of times for momentum strategies you lag one month because you you get sort of reversals in the very short run. Now the other thing what we find is is is that momentum is not just a price mechanism. So there's another interesting paper that looked at the history of momentum and what they showed is is that that that there are many there's momentum in news, there's momentum in fundamentals, there's momentum in in uh surprise effects in earnings and that each one of these are slightly different. They're not always always correlated. So the momentum that you see in price may not uh show up uh or it may not be fully correlated with the momentum that you might see in earnings. So that there are a number of ways in which you can exploit the idea of momentum and you say like well what is really going on here if it's so why does this persist and and you know we could sort of say that behavior is uh is adaptive in the sense that people take time to digest information. It takes time for people to gather or to process information. And because of that is is that there could be uh a piece of news or some change in news or regime takes a while for people to digest or gather their attention and so there can be an elongated response in prices. you're talking about the different ways momentum plays out and you see as you say momentum everywhere but it's not as strong everywhere. Um so in theory you can combine different sources of momentum in a strategy. I mean are are we would you be confident enough about those differences to say that they are significant or just um and and persistent I suppose you know as you say the fact that industry and factor momentum is stronger than country momentum and stronger than stock momentum. Do you think there are good reasons why that's the case and likely to continue to be the case? Uh well [laughter] I think so and I've been willing to bet my career on it but okay but but we'll we'll sort of say that there are a few things that you can sort of say that uh uh and and again we want to look at a higher level is that if an asset is higher to uh harder to value >> yes >> that there will be more likely to be persistence or momentum okay because if we can't you know understand what the value is and it's going to take us time to figure out what true value is. So there's more likely to be persistence. Okay. >> Okay. >> Uh when we bundle stuff together so individual stock there could be a lot of noise. But if I look at the industry there may be actually trends. >> If for example is that those assets were uh it's harder to uh or there's less analyst attention there's more likely to be persistence. So, you know, if there's no analyst following in in a small cap stock, you know, there could be a strong reaction, but there's probably going to be more uh persistence in some of its behaviors. So, if you sort of classify uh assets or strategies or factors uh based on some guiding principles, you could sort of say there there may be some strong theoretical reasons for why persistence may occur. >> Yeah. I mean if we were to think about say momentum as in trend following futures trend following versus momentum as opposed to applied to stocks whether it's single stocks or baskets um I mean at a high level are the mechanisms by which it works the same obviously they won't necessarily work in the same period same environments are they good diver good good compliments from that perspective is that part of what you're saying >> uh they can be good compliments but you require different uh uh different approaches to different types of asset classes. A perfect example would be is is that uh we know that there's persistence in uh or uh you know after earnings announcements. We also know that there's probably you know these uh periods of punctuated information that might cause a change in prices. So when you know that that that has a different influence in how you should trade if let's say that you know that for example is is that uh you get earnings announcements uh you know four times a year and we know that it could be punctuated where there's a lot of focus on those four periods of time and there could be strong revisions in the business based on that. There could be short-term you know earnings momentum afterwards you know because of bad news or good news. So you have to take into that account if we look at for example uh you know sort of commodities is that we know for example there are certain seasonality uh you know associated with uh with certain markets but again it's harder to make valuations you don't have the same punctuation of earnings. So so in some cases you might have uh [music] a different signaling approach or a different way to approach those markets. >> [music] >> pivoting a little bit away from um [music] prices, momentum, bubbles. Um I mean what comes with with that to an extent is uncertainty. I know that was something um you wanted to talk about shocks, uncertainty, dealing with that in in optimization etc. >> How does this factor in? >> Well, let's go back to what we originally started with. We always talked about signal versus noise. And so so the noise is always your uh your risk or the uncertainty. And so I you know um not saying I I need to get a better life but I was looking at some book on stochastic optimization. Okay. So so I keep it right next to the bed at night. So he's tossing and turning. I think I'll just I'll flip through a few pages of stochastic optimization to sort of like calm me at the end of the day. Uh but the author of this book is is actually made a really insightful uh uh comment and actually made me sort of like you know jump up and say like wow I you know I've thought about this but I didn't put it in a precise way. He talked about all the types of uncertainty that might exist and you know I won't go through you know all of them but let me just list the names and then you start I want you know all of our listeners should start to think about this. He said there's observational uncertainty, there's there's prognostic uh or forecasting uncertainty, there's experimental noise variability uncertainty, there's transitional uncertainty, there's inferential uncertainty, there's model uncertainty, there's system uh systematic exogenous uncertainty, there's control implementation uncertainty, there's algorithmic noise uncertainty, and there's goal uncertainty. And so you listed all of these types of uncertainty. you say like I never really sort of like categorized it as such but all of those have have influence on the signals that we have and how we re uh react to that. So for example is is that you know and and I'll just give one uh you know simple example to uh have you know listeners think about it. So we had the CME you know uh outage in the market. Okay so there was a period of 11 hours where there wasn't no trading then we start up again. Okay. So if you're a modeler or if you're looking at prices now the market starts up after an outage you didn't know what it was uh what what the cause was. Now you're at month end had this period of time the market started up surprised it wasn't disruptive but if in real time you had to make a decision what do you do what do you do with the uncertainty that you're now facing is that the market was closed down for a period of time that you didn't expect it was supposed to be closed down. So what do you do about that? Or as we get into the holiday period, let's assume there's very low volume in certain markets. This is it. Well, should you treat those prices the same as you would in other parts of the year? Or let's say the third uh you know third example is that if uh and this is one that's a real life is is that if you looked at uh copper prices in New York versus Lond London copper prices there's a big divergence between the two prices. A lot of that had to do with uh tariffs for a period of time. So how do you use those prices and how do you trade something when you have the uncertainty across those different prices because of these regime or structural changes. So uh those are just some examples but you know even when we talk about observational uncertainty is is that well if we have Paul's telling us that our uh unemployment numbers or employment numbers were off by 60,000 a month well how do we how do we do do that or even now they find that there's measurement problems with a lot of the fundamental data because people don't respond to the surveys. that they're asked to respond, you know, concerning unemployment. Well, if people don't answer the surveys, well, then how do we know that there's not more uncertainty in those prices? So or even now what they find out is is that consumer confidence we have is that if you break it up between Democrats and Republicans, you get very different views in terms of you know the survey results based on politics. Or another example would be is that uh if you look at expectations in fiveyear 5year forward prices it looks like they're fairly well anchored at around 2 and a.5%. If you look at consumer surveys, it shows that they're all over the map with people thinking and that inflation is much more rampid. Those expectations are unanchored and that has a big impact on consumer behavior in a way that you know you wouldn't think. So, so there's a lot more uncertainty going on in many different types. >> Good stuff. Um just one topic I wanted to get to before we get to wrap up and it's certainly um something I was talking to Neils about last week and it's been very topical. It's uh the total portfolio approach. Um obviously since Kalper has announced they were moving to a total portfolio approach. It's definitely been in the headlines in the investment world to a greater extent. So, how do you link the TPA with other approaches to asset allocation or even simple benchmarks like 6040? >> I'm still trying to figure that out. So uh so uh and then for uh for those listeners who may not be familiar with this is that they're starting to been doing in the consulting world a number of firms uh I think that the new uh head of at Kalpers was uh came from New Zealand was a a believer in total portfolio approach and so we'll sort of say a traditional approach that you would have if you're a a pension and an endowment is is that you try to uh you set up you know sort of uh a diversified portfolio across different assets. You pick, you know, sort of what you think that the weights you should have in stocks, bonds, alternatives, maybe real estates, uh you know, other types of alternatives. And then what you do is you have your uh the uh staff actually try to hit that model portfolio which is supposed to be diversified across all assets. And the total portfolio approach says that well you need to be a little bit more nimble. You need to s not be constrained by you know a sort of fixed waiting strategy but you allow for more of adjustments in the assets you hold to reach some overall goal of you know the return or controlled volatility. And so a total portfolio approach would be is that allow for flexibility to reach longer term goals. Now, I don't know if there's a single definition with that, but I think that uh uh that's one way to to depict that. And I don't want to set up a straw man here, but I think that people are trying to uh feel their way through alternative approaches because I think that they're finding that the uh at the simple simple case that the 6040 stock bond portfolio, it it may not provide the diversification you need and that you need to be need to think uh a little bit deeper on how you should build a portfolio. >> For sure. I mean, and I think this is a I mean, a good segue into, you know, how trend following and systematic strategies blend. I mean, it's something I've looked at myself. Um, if you um let me try and remember what I was looking at. I I think it was a 7030 portfolio stock bond. if you added a I think it was a 30% overlay to the sock genen trend index you achieve um a 4% tracking error which is what um Kalpers are trying to achieve with their um um TPA approach. So it's a very quick and easy way to move a static portfolio into something that does automatically respond to market conditions. Obviously trend following achieves a lot of what TPA is trying to do already. I mean if you think about a trend following program you know it's already deciding should we go long crude or heating oil or a combination um and and also looking at the energy complex relative to the metals complex. So these are the kinds of issues where strategic ass allocation came short because you know in strategic ass allocation had allocations to everything. Um now they want to try and weigh you know where are the strongest where are the best riskiest returns but as I say isn't that what trend following quant strategies already do. I think you're absolutely right in in in the sense is that there are things that we could do in terms of overlay in terms of being nimble and adjusting which occurs in trend following that could improve portfolio performance. Uh you know whether there uh the TPA approach I think is still needs to have more definitive definitions and make distinctions between strategic asset allocation. But that being said, as I think the idea of being able to say like let's adjust our portfolio based on what might be uh uh the market conditions maybe an improvement then fixating on on set weights when those weights you know uh should respond to changes in uh in uh volatility and and correlation coariance. >> Absolutely. Um I mean one of the interesting things about TPA it's they still have a reference portfolio effectively a benchmark which I think in the case of Kalpers is 7030. It does leave open the question where does that come from? Why is that the the appropriate benchmark? I mean they're not they have cracking our flexibility uh from that but um yeah why 7030 I guess it comes from some consultants somewhere but uh any thoughts on that? Uh well that's the uh uh I get to use the word primal again. So we always say prices are primal but we'll sort of say you know uh diversification is primal to portfolio construction and to start with you might sort of say total portfolio approach is a a corlary or a variation but you need to start with a strategic asset allocation somewhere and and yes uh and then you sort of say how do I adapt or adjust to changes and should I be more adaptive to my strategic asset. allocation and the answer is yes. If that's total portfolio approach then and then I can be comfortable with that. Uh I think that we just need to sort of uh better define what where we're starting from and what it what this process of TPA is. >> Yeah, for sure. No, I mean I think um there is a lot of debate in markets. Is TPA genuinely something different or is it just a new label or maybe a combination of the two? But I think that's something that uh that we may be talking about uh for a bit longer to come. But um we've just run over the hour a little bit. So I think that's a natural uh point to to wrap up. Um Niels will be back next week um back at the helm and uh we'll be recording our Christmas specials uh soon as well. So keep an eye out for those. But uh from all of us here at Top Traders Unplugged, um thanks for tuning in and we'll be back again soon with new and [music] more content. Thanks for listening to Top Traders Unplugged. If you feel you learned something of value from today's episode, the best way to stay updated is to go on over to iTunes [music] and subscribe to the show so that you'll be sure to get all the new episodes as they're released. We have some amazing guests lined up for you. And to ensure our show continues [music] to grow, please leave us an honest rating and review in iTunes. It only takes a minute and it's the best way to show us you love the podcast. [music] We'll see you next time on Top Traders Unplugged.
When Prices Stop Making Sense | Systematic Investor | Ep.378
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Transcript
Imagine [music] spending an hour with the world's greatest traders. Imagine learning from their experiences, their successes, and their [music] failures. Imagine no more. Welcome to Top Traders Unplugged, [music] the place where you can learn from the best hedge fund managers in the world, so you can take your manager due diligence or investment career to the next level. Before we begin today's conversation, [music] remember to keep two things in mind. All the discussion we will have about investment performance is about the past [music] and past performance does not guarantee or even infer anything about future performance. Also understand [music] that there's a significant risk of financial loss with all investment strategies and you need to request and understand [music] the specific risks from the investment manager about their product before you make investment decisions. Here's your host, veteran [music] hedge fund manager Neil's Krup Larson. Welcome back to the latest edition of Top Traders Unplugged, where each week we take the pulse of the market from the perspective of a rules-based investor. It's Alan Don here this week sitting in for Neils. Neils is away on his travels in the US and I'm delighted to be joined by Mark who's in Chicago today. Mark, how are you? >> Not too bad. It's uh a little early in the day, but it's and it's cold out here in Chicago. So, uh as what you would expect in December, but uh but but I'm ready to have a good discussion. Good stuff. I was there um about six weeks ago. It was pretty pretty pleasant at that stage, but yes, you would expect it to be getting chilly now. And appreciate you getting up early uh to make uh make time for this. Um so, we've got plenty to talk about. Um we've had the Fed out this week. Um we're recording on Thursday, so Fed was last night, so that's that would be a focus, but we've got a number of other interesting topics, but maybe um just to kick off and uh to leave time for the remainder of the conversation just to cover performance. So we're um a little bit aways through the month at this stage. Um the sockchen CTA index is down 78 basis points as of the 9th of December and the socken trend index down 62 basis points. Sochen CTA now down 2% on the year 2.06% and the sock gen trend uh close to flat down 0.16%. So not a whole lot I would say to talk about in terms of uh uh December performance market. any observations on performance this month or the general trajectory? Obviously, we've seen generally better performance over the last few months. >> No, absolutely. There we've seen a lot better trends in some key markets as we as we moved in to the end of the year, we're seeing performance for a number of CTAs that have improved over this period. But now that the Fed is done, usually now we're starting to get into holiday mode. And uh that has a big impact on liquidity. It has an impact on you know uh what signals you receive and you have to start making some decisions on whether you should follow all signals as we get closer to the holidays and you know trading volume starts to dry up >> for sure. Um now you mentioned we had the Fed done and it was an interesting um interesting meeting last night. Obviously the Fed cut rates 25 basis points which was broadly expected then to um 3 and a half to 3 and 3/4%. They did um uh announce um some some new liquid liquidity injections and T- bill purchases and there were a number of descents to the um 25 basis point cut on both sides. So what was your take uh overall on on the Fed Mark? Well, before we started this call, we were asking, you asked, "What kind of Fed are we seeing? Is it a hawkish Fed? Is it a dovish Fed?" And I said, my description, it's a messy Fed. And uh having to sense uh which in some sense I think is good. It shows that there's independence on the FOMC, but at the same times that means that the Fed is not speaking with one voice. And so that sends a really messy set of signals on what people should take away from what they've heard. Now, in general is is that I've looked at the Fed uh announcement dates very closely and what we found is is that while over a longer term, obviously interest rates will have a big impact on a lot of different models on stock markets on other markets because it it's the cost of capital. But at the same time is that right around the Fed announcements is that you you get some uh high uncertainty. When you have high uncertainty, you could have large reversals in price. And so for short-term models, it's sometimes good to actually avoid the Fed in this period of time. You might have an expectation of what the Fed is going to do going into the FO uh FOMC. They then do what is expected but then chairman Powell gets in front of an audience and you don't know what's going to happen and especially now is this is that uh with you get dissenting voices that say we got what was expected a 25 basis point cut but now we want to look forward and say what are the expectations for 2026. when you have the sense it's it's less clear what is the direction going forward and then if you look at the uh SEP which is their quarterly forecasts uh economic projections you've got a fairly wide set of uh expectations for 2026 we've got some thinking that there's going to be only u uh some are going to actually see hikes in 2026 some u one member thinks that there will be six cuts in 2026. So when you see that wide range, what you're what it's telling the market and what it tells uh in terms of signaling is that we're going to be in a high uncertainty Fed environment for 2026, which is means there going to be more risk if you trade in the interest rate complex. Um and and I think that that's that's even more problematic when you look at what is their forecast. One is is that that even though they're cutting rates, uh we're at a three-year low. Uh this is the third cut uh this year. We had 100 basis points in 2024. Yet the projected inflation for the PCE for the core is going to be at 2.6 for 2026. So that's not close to our 2% target. So So we're still going to be in a high inflation environment if as if you ask anyone that goes to a grocery store. And at the same time, they're saying that well, we're expecting that growth will not be 1.8% 8% which is on their last forecast but it's going to actually come in at 2026 at 2.3% which is much higher than uh than what we've seen in just the last last quarter. Yes, it's I mean it is an interesting mix of uh projections and comments and as you say a lot of uncertainty and I mean even you know we were chatting earlier you know before we came on was it a doubbish or or hawkish and and I mean my sense watching it last night was you know coming into the meeting there was an expectation maybe of a hawkish ease but maybe having considered everything the market concluded it was less so and maybe even a dovish is granted it is messy and I think a few points um you know obviously the next meeting is in January and we've had this you know um a lack of data and we will have a lot more data by by by the time January comes around but even Pal said himself that some of the data that comes through you know there will maybe technical factors that will distort it so that is another source of uncertainty as you say and then you know the SEP interesting they're forecasting higher growth but not translating into improved um unemployment. So they they seem to be buying into the uh product story productivity story related to AI etc. and and Pal was asked about that. He said he uses himself. He can see how how it could be uh productivity enhancing. So many dimensions to it and and obviously you know the um the the the news around additional T-bell purchases to ensure there are sufficient reserves in the system. You know we've gone from QT to some form of QE again. So um hard to model all of that systematically when there are so many kind of subtle messages coming from the Fed. Wouldn't that be fair to say? AB: Absolutely. And I think at very high level and some of what we like to do, I think on these calls is to talk about, you know, the the specifics of how to how to build models and how models work. But at the same time, you want to try to step back and say what's the high level of what you're trying to do. And when you're building systematic models, you're always thinking of signals versus noise. So how do you extract a signal? And in in the case for let's say a trend follower, it's usually going to be a price signal versus the amount of noise that you face at a given amount of time. Now noise can come into two forms. One is we'll call it the volatility which is measurable. So we could sort of say like well what's going on with the volatility of markets and then we can look at the strength of our signal divided by our our volatility. we could get a signal to noise ratio and we could sort of say like well now we can measure how strong that signal is relative to some scale. The problem comes in is is that you know when you think of risk it's not just the volatility which is measurable but it's also what is not measurable which is the uncertainty. So when you think about okay we have three dissenting opinions well how is that measurable? We we do have some data where we can look at descents and then see what happens in the future but that's uh but we have a very small sample uh the switch from uh when we look at uh you know we'll call it the new QE which we'll call it just more reserve balance management is that what they've said is that our quantitative tightening or QT may have overshot now we're going to allow for about a $40 billion into Treasury bills because we think that there has been some disruptions in the repo market. That's harder to uh we can hear the words, but it's harder than to translate that into measurable noise and then second into a measurable signal. >> I guess you can you can ignore all of that and just look at how the markets trade in the day I suppose the days after. As you say, it can be choppy. I mean, so far the dollar is a bit weaker. stocks were up, then they were down. Um, probably dollar weakness is probably the most notable feature in the last maybe 12 hours or so. Um, but as you say, there are kind of a number of different dimensions here. Um, and also, you know, the pal even mentioned the unemployment data as well, which I think is showing around maybe 60,000 on average, but they felt that in reality that might reflect, you know, job layoff. So, you know, even on the data side, you've got that that uncertainty as well. >> Well, that certainly was a uh another bomb that was dropped on us. Uh and you talked about Paul often sort of upsetting the Apple card, so to speak, is that if you said that, you know, job creation was overstated by 60,000 a month, then well, we've gone from a positive job market to something that uh uh is uh negative, certainly not very attractive. uh other labor market signals are are more mixed and they say that we have we'll say a balanced labor market. know when you add this all together uh it's you say Mark you're listening you talk you know it tells you this that what the only thing you should use is prices once again forget all this fundamentals forget of trying to determine what the Fed is doing or uh what's going on in the in the unemployment number just just just go back to prices and uh and that becomes the the key balancing act is is that how much other information should you use in models beyond on price. >> I mean, it's interesting. Um, you know, you could say, um, looking at the market here from a pure, you know, rates perspective and what's priced in, etc. Um, you know, are, you know, would you say bonds are decent value now? You know, say tenure yields are they've been stuck around 4.1 4.2% for a while. Obviously the um one of the notable things is the Fed funds has now come down to about the level of the two-year yields. I mean taking that perspective any any observations on do markets I suppose regardless of what the trend is does the fixed income market look reasonably priced at the moment? >> Well you can always use some simple rules of thumb and the simple rules of thumb is they say let's look at uh what real GDP is. Let's look with the expected inflation. So we got expected inflation that's going to be we'll so to say 2.6 or so even if you and then you add in real GDP for next year they're they're projecting 2.3. So now you're at 48. Then and then you said well should there be a term premium associated with uh with the bond markets right now? If you think that there's a positive term premium, well then you you're sort of say like you're at a at a high fours at best and you know you would sort of say that uh the term premium was you was knocked down to something close to to to zero because the bonds were such a a good hedge. Now we're probably say having a different view on on on what is the role for bonds in a diversified portfolio and with high debt numbers is that the debt may not be the same type kind of safe asset. It may not be the same kind of hedge that we uh saw before. And this has been a recurring theme that when you look at 2025, you ask the question is what is a safe asset? Because a safe asset should be a diversifying asset. If bonds are not a diversifying asset, then what is and what should you do with your portfolio? Now um not saying that for every time a trend followers say that uh there's only one answer to the solution. It's always being a uh you know hold some some trend following assets. But this is an important point in time where if let's say bonds aren't providing the diversification that you thought well then you have to try to look at other diversifiers and try to find something else to be able to support your portfolio. >> Yeah. I mean it's interesting. I mean you talk about the term premium and obviously that is reflecting a number of things supply demand imbalances as you say the term premium kind of went to zero if maybe even negative when there was um a shortage of of safe assets. Now things have changed and positive term premium you know reflecting that change dynamic but also I guess you know big theme this year has been are we moving into fiscal dominance and then big picture could we have financial repression um you know obviously we've got a high level of debt to GDP in the US uh and the question is ultimately how does that get managed to you know the easy levers to pull are are inflation the infl your way out of it. But you know in the extreme default you know could be a possibility. It mightn't be an outright default but you could have you know if we got into some kind of fiscal crisis down the road you could have debt swaps or maturity extensions all of these kind of things. So in theory a the term premium should should start to capture those um I suppose um >> you know miscellaneous factors. Is that fair? Yeah. Absolutely. I think that uh uh if there's been a change in the relative safety of some assets, >> yeah, >> if it's change in the role of that asset within a portfolio, then that then there's going to be a term premium associated with that. Now, you know, and I think that uh we still have very large de deficits and in some sense the only way that you could solve those deficit problems outside of a default is that you can inflate your way out of that. Then at the same time is is that well how are you going to get an inflationary environment? Well you can engage in some kind of uh financial repression of keeping rates low so which reduce the financing costs >> and it's not so much that the US Treasury is going to default. It's a matter of uh relative safety because what does it mean to be a safe asset? Well, there's no there's no such thing as a truly safe asset. It's just a matter of what is safe relative to the set of all alternative safe assets and I and I think that uh I would argue that uh there should be a greater term premium in the US market and at the same time we'll sort of say why are we seeing such uh strong price movements in in gold and silver and some other commodities. So partially to do is because if relative safety in the US has gone down >> then the demand for other potentially safe assets should go up and if let's say the supply of of of gold is constrained because it's you know how much are you going to be able to mine in a certain period of time you don't create it by fiat. So consequently, you could have these strong movements in uh in gold because of a reduction in relative safety. >> I suppose you've got um maybe uh conventional approaches to to to to um to valuing bonds based on all of the known factors, but then we have these kind of tail risks uh that you have to think about um as well, which which we don't know how that will play out. But um but one thing that you did touch on there is kind of the the signal we get from from prices. Um and I mean I know this is something you wanted to talk about as a theme. I mean sometimes one thing I I grapple with obviously prices reflect the the the supply and and and demand uh balance or or the relative strength. you know, from a financial markets perspective, you've got the idea of, you know, the wisdom of the crowd and and and the price reflects that as well. But at times we also get hurting um and and and trends and and moves that maybe less wise. So I mean how do you think about those two conflicting interpretations of what the price is reflecting as in the wisdom of the c crowd at times but also prices getting distorted by by extreme sentiment irrational exuberance and hurting from time to time >> right well think about when we started out our conversation the argument was is that look at all of this data that's giving us a lot of noise so then you sort of say like well in a noisy world maybe I should just focus in on prices and and and I probably that's that's always been my go-to position and I've used a phrase that uh prices are primal that you know uh regardless of what happens with other data you always have the price is telling you where there's a some balance between supply and demand. I'm not really sure what that balance may be at any one point in time or whether it's telling me, but but prices are primal. Uh the problem is is that sometimes it's really hard to unpack what the primal price is. And to to break this in down a little bit deeper is that that prices are primal, but that's not the same as value. So I could have a price in the market at a given time, but that's not where the value is or that's not the true value of a given assets. It just tells us where there's a balance between supply and demand in a and a perfect example is this is that uh let's take a look at some of our our bubble prices. We have individual stocks that have, you know, had some tremendous moves. We've had, you know, gold have a significant move. We got silver that, you know, touched above $60 an ounce. Well, the price is telling us that there's a true supply demand imbalance. But does that price tell us what the value of gold is right now? Uh yes, it is because that's what people are willing to pay for. But at the same time, is is it is that its true price? That may not be the uh those may not be the same thing. And from a I mean from a trading systematic trading modeling perspective I mean with that observation what does one do with that? >> Well this is the reason why is is that when when you know we've talked about is this is that I can be a trend following person. I could be believe the prices are primal, but then I might also use some other indicators to try to tell me is is that whether something could be overbought or oversold to say to say is there an anchor with something that's called uh value and and and this is also why we try to smooth prices because at any one point in time this is that uh you may not want to take the actual price but you wanted to use some kind of smoothing mechanism that could be a moving average at the very simplest form. But there are other mechanism we have to try to say is is that because there's noise in just the price process, how do we smooth that process out so we can get a better signal? >> Yeah, I mean obviously prices reflect narratives as well, but but then price can be part of the narrative too, you know, and obviously we can have feedback loops, reflexive processes. um how do you factor that in and do you see that in current markets? >> Well uh you know I think that the narrative is is very interesting because there there's a recent paper that was written about uh narratives in the FX market and what they what they found is is that then prices follow narratives as opposed to lead narratives. So in some sense is that if you use some type of LLM Yeah. Or if you use some type of mechanism to try to s extract narratives within news stories, you could sort of see that that that the narrative starts develop and then there's a carryover in prices uh >> as we see uh the narrative develops. And this is the one thing that you know is really important for for people to think about when uh for trend following or any systematic price-based system is that there are trends in price. But what is causing those trends in price? It could be a a trend in fundamentals. It could be a trend in narrative. So that there there can be other uh it's prices move but there's a rationale for that move and that could be trends in in other uh it other mechanisms it could be uh you know a narrative it could be the fundamentals >> yes um I mean there's all manner of things obviously you know when when you get into that there's seasonals as well which will influence markets at certain times uh and and and structural factors etc. Um I mean quants know about this and and and can can adjust for that. Isn't that fair to say? Well, uh this is uh this actually becomes an important issue when you build models because every model has to to a degree a personality in the because when you start looking at all the different choices you make, the modeler has to start making choices and decisions of what to include or exclude in a model. So uh so a perfect example is right now when we're as we get closer to the end of the year what we see is is that you know volume starts to dry up. So that means is that there's more likelihood that a small change in uh in in trading in volume will have a big a bigger impact on price. So your signals are going to get noisier as liquidity declines. >> We also know that you know liquidity and and the quality of signals you know intraday is is U-shaped is that we get a lot of activity in the in the morning you have a lot of activity on the close less so in the middle of the day that has an influence on on the price signals. uh to get more specific is is that uh and and here's an example that I was grappling with in the last uh uh two weeks. You have the Thanksgiving holiday in the United States. So, you have that Thursday off. Okay. You know, other markets are still open. They're not they don't have a national holiday. So, what do you do about those prices? Then you have Friday which is uh a uh open market but usually a lot of people take that that day off so there's not going to be a lot of uh volume of trading. This particular uh November was the last day of the month. Okay. So now in this time do you use those prices because it's the end of month but they're probably and there's probably going to be more volume. But normally you might ignore prices that occur on a Friday after Thanksgiving. And just to make this more difficult for you in terms of how we have to deal with these problems, you had the CME 11-hour uh outage of the market. So you think that some of their servers overheated and so they actually shut down the market. So what do you do if a market shuts down for a period of time and you're inputting prices into your model? So do you follow just blindly whatever happens when the market sort of kicks back in? Do you try to smooth do you drop out signals? So there's a lot of nuances in how [music] you look at prices and what prices to use. [music] One of the interesting themes and topics that's obviously getting a lot of attention in [music] markets at the moment is is bubbles and are we in a bubble? Um [music] Howard Marx was out with a piece um addressing that. I mean he had written earlier in the year I think bubble watch and he had a follow-up to that. Um, we can touch on that in a minute, but um, it's certainly one of the big topics. I mean, it's been banned around so much at the moment, it's almost like a given um, that you know that tech stocks are in a bubble, people draw parallels with the 1990s, etc. Um, what's your perspective? >> Well, let's go back to when we talked about uh, prices as signals. This is that well if a price of a given asset goes up then actually and you're holding a certain amount of that asset well you know by uh by definition your wealth has actually increased okay so the question is is is that does do prices reflect wealth? Uh, and that's not always the case because if if let's say that you were holding a a certain amount of gold and the price has gone up to $4,000 a uh uh an ounce, do you feel wealthier or more importantly should you feel wealthier under that scenario? And uh I would sort of say that that you know uh a mark tomarket and an economist would say your wealth is determined by whatever the price is at a given point in time. If you believe prices are primal, it says that your wealth has increased. at the same time is is that if you use that wealth that's been created as collateral, well then what happens is that you could actually increase more leverage in the overall e uh uh you could you can gain more leverage and you could actually sort of make the overall economy more fragile. And that's one of the fears when you see these bubbles is whether in gold and individual stocks uh is is that it actually increases the market fragility. Now, now that being said is is that as more people, you know, talk about a bubble, you know, I've been, you know, uh I don't want to say worried, but I've been actually looking at the uh the data fairly closely for central bank uh behavior, and what you find is that the central banks uh beyond their increases in marktomarket is that they've been just been strong buyers of gold. So, so and specifically certain central banks have been uh very strong buyers of gold and that's putting a lot of demand pressure. Also, you're seeing this is that a lot of buying is coming from certain uh areas of retail outside the United States. M I mean gold go I mean gold is an interesting case by itself but but more generally in terms of you know wealth effects uh and and some of the effects bubbles form I mean there's multiple dimensions to this obviously as you say when if the market goes up you know um values increase so there is a kind of a wealth effect for people who are stockholders um very often volatility goes down so so margin requirements ments are lower so people can lever up to the extent that they have levered portfolios that they need to add more risk to to to maintain the leverage. Um the stock value of certain companies goes up so their cost of capital goes down. Um so there's the reflexive process that that Soros talks about you know as long as there's no in the argument supporting all of this. Um, and I mean it it it maybe it's part of the explanation for the K-shaped, you know, economy. Obviously, people who own stocks, say in the US economy, the the wealthier cohort are feeling wealthier. Um, whereas people at the lower income levels are more challenged by the affordability crisis. So as you say per perhaps it it increases uh you know market fragility but also economic fragility if uh if the if the economy now has become more you know sensitive to the market the equity market if if it's more leveraged I think US households own about 40 trillion dollars of of US equity so if they if that market has a significant downturn those positive um wealth effects those positive re reflex processes go into reverse. Um any thoughts on that? >> Well, first is we do know that leverage is higher especially for for hedge funds. Now there could be other reasons for why there's higher leverage with hedge funds and it's it could be because they're more d uh especially the largest hedge funds are multistract, you know, pod-based. You know, they're better diversified so they could actually take on more leverage. But we're seeing that there's more leverage over overall in the economy. The latest research on bubbles uh and and this is from some uh professors at the Harvard Business School talk about that uh uh it's uh [laughter] it takes an academic to do this. It's closely linked to optimistic analyst expectations. This is optimism in fundamentals serves as a catalyst for greater optimism about the underlying assets and that increases the likelihood of a crash. So so the more uh uh the more optimistic analysts get then probably there's more FOMO and then that actually increases the likelihood of of a particular crash. Uh so so like yeah that seems to make pretty >> seems reasonable. Yeah, >> seems reasonable. In fact, they say like like it took a lot of research to figure that one out. But uh what you really uh what you really are worried about is this is that uh uh and this gets back to the issue of uncertainty is is that when it's harder to value an asset, then it's more likely to have a bubble because we don't know what is the true value. Okay. The other thing is that we're always worried about in uh in in bubbles is if there is a regime change or if there is a potential story of a regime change and you know we'll sort of say individual stocks is a little bit different but let's take a uh the issue with with gold. Is there a regime change going on with gold? Well, central banks are changing their behavior. That seems like a regime change. Yeah. >> Um a reduction in the safe asset of let's say US treasuries so that people are looking for other alternatives that could be a regime change. Um retail buying especially in some countries where they feel there's a high government uncertainty uh you know outside the United States. I don't want to say that's a regime change but uh but certainly is that that's adds to it. uh and a lot of the things that we learn about bubbles don't always uh you know hold true for example this is that uh you know uh retail demand in the US through ETFs is not as strong as what it as it has been in the past so this is not you know sort of retail driven gold increase >> and then when we look at some some of the other things in terms of uh uh speculation we usually expect is is that or the view is is that that it's the excessive speculation that drives you know bubbles uh prices into a bubble. Well, surprisingly is this is that we don't really have that excessive speculation in some of these uh markets especially is is that are you saying that e excessive speculation is coming from central banks in the case of gold? No. I actually did some close analysis of the cocoa market when it everyone talked about that being in a bubble and the view is always is that well bubbles should be more volatile. Bubbles should be driven by speculators. Bubbles will see more volume of trading because there's more churn in the market. There's more people entering in the market. In the case of for example Coco which is not you know we'll say representative of everything but it's an interesting case we saw that the commitment of traders show that large speculators were actually declining before a lot of the big move in the cocoa price. We saw that the volatility was actually you know declining not uh not increasing during that period. We also s saw that volume of trading was uh as the cocoa prices were getting higher higher were actually declining. So some of the uh we'll sort of say our conventional wisdom how we think bubbles behave don't always apply and that's what makes some of this so maddening to try to analyze. >> Well, one of the things you touched on is leverage and I suppose debt. But I mean with respect to the current um AI boom now we are seeing increasingly um debt issuance um in relation to the buildout of data centers etc. And that was definitely part of the focus of Howard Marx's piece um which I mean to simplify he saw as as kind of a part of a bubble narrative. didn't definitively say it's a bubble, but he kind of suggested that when you see this kind of debt issuance combined with rising asset values that in inevitably there there are issues. Um would that be your read on it too? >> Uh I think that there are things going on in the debt market that should give investors concern. uh we've we've had a number of different issue with first brands and some other uh uh you know factor financing that was problematic which you know we're not even talking about the AI issues is that what should be sort of uh relatively simple type of credit financing is is actually now looks like there may have been some kind of uh fraud. Now uh John Kenneth Galbrrath when he often talked about the issue is that when you have very frothy markets or when you have market extremes you have something called the the bezel. >> So it's combination of bezel with embezzling or fraud and I think that this is something that uh that's one issue we have to look at in credit markets right now. Second is is that when you find it even though credit spreads are extremely tight, we're seeing that the spreads now are reflecting the added risk in the case of let's say financing for uh data farms and and AI and and some of this is that that given it's a high uncertainty, we don't know what the payoff is going to look like in a traditional world that should become as equity financing as opposed to debt financing because debt financing and says you have to pay back that principle at some point and you're going to have to pay interest. So, so I think that uh the credit markets are uh at a market extreme and we're starting to see cracks in the behavior where we're seeing issuers trying to access credit markets or we see investors saying I don't know if I really want to uh pay uh I want to pay the uh the average price. I think I'm going to ask for a premium. Now, you sort of say like, well, if I'm a systematic trader and I trade mostly futures markets, why should I care? Okay, that's not I don't trade that stuff anyway. Well, I'll take take more of a holistic view on how you should look at uh at even a set of futures markets you trade. Markets are a complex system and so there's interactions across markets and assets and what you're having a situation especially if there's cracks in the credit market is that that'll ha ha have an impact on people's risk aversion. it will have an impact on where people will reallocate capital and what we'll sort of say from a network perspective. Uh there can be a movement of capital into more safe assets, treasuries or some other sovereign debt and so that's going to cause the systematic changes in prices which could be reflected in a lot of the models we look at. >> Yeah. I mean, just shifting gears, obviously we're talking about bubbles, boom bust cycles, and all of this is often a justification for momentum strategies, trend following strategies. The fact that these are recurring um patterns, recurring features of the financial market landscape, that they are moves that are somewhat um you know, unlin from fundamentals. But the way to play them is by focusing on the price as we've been saying. So yeah, is m are momentum strategies, trend following strategies the way to play these kind of market environments? >> Well, I think that there's uh it's interesting to look at the uh history of trend following momentum and I'll put those two together even though there are distinctions between trend follower which is more absolute versus momentum which is you know cross-sectional relative. That being said, this is that, you know, we'd probably sort of say that went into the early 80s is is that uh if you said you were a trend follower, you trade on momentum, you know, uh people would sort of think of you as almost a some form of uh Neanderthal and because the markets are efficient and certainly is is that you just haven't been aware of what all the advances in finance that we know about now. Now we're seeing a you know and even in the last couple of months I've you know read uh two interesting papers that looked at momentum and the interesting way or to to you know sort of cut through all of the research is that momentum is everywhere. It works you know across all time periods. There might be periods where it doesn't work for a period of time but if you look at you know very long history momentum works is is that you look at sub periods mostly it works it works on uh on you know markets countries industries f uh you know factor momentum uh individual stocks momentum is everywhere and as you you peel back the onion you're going to see that it's everywhere but that being said is is that we find out is is that uh some places momentum does better than in others. So we'll say beta and country momentum you know not as strong is what we're going to find in industry or factor momentum. So so when when there's factor tilts you know that that there could be momentum in that in that importance of that factor uh for industries there's much stronger momentum effect than what you'd find in in individual stocks. So what you'll find is is is that uh uh you know if you're a statistical basian you say momentum is everywhere but you could sort of like tilt your way you place your momentum bets and you could do better uh uh do better. Uh so stocks show for example intermediate persistence but not in the very short run. uh when we look at uh uh you know what what a lot of times for momentum strategies you lag one month because you you get sort of reversals in the very short run. Now the other thing what we find is is is that momentum is not just a price mechanism. So there's another interesting paper that looked at the history of momentum and what they showed is is that that that there are many there's momentum in news, there's momentum in fundamentals, there's momentum in in uh surprise effects in earnings and that each one of these are slightly different. They're not always always correlated. So the momentum that you see in price may not uh show up uh or it may not be fully correlated with the momentum that you might see in earnings. So that there are a number of ways in which you can exploit the idea of momentum and you say like well what is really going on here if it's so why does this persist and and you know we could sort of say that behavior is uh is adaptive in the sense that people take time to digest information. It takes time for people to gather or to process information. And because of that is is that there could be uh a piece of news or some change in news or regime takes a while for people to digest or gather their attention and so there can be an elongated response in prices. you're talking about the different ways momentum plays out and you see as you say momentum everywhere but it's not as strong everywhere. Um so in theory you can combine different sources of momentum in a strategy. I mean are are we would you be confident enough about those differences to say that they are significant or just um and and persistent I suppose you know as you say the fact that industry and factor momentum is stronger than country momentum and stronger than stock momentum. Do you think there are good reasons why that's the case and likely to continue to be the case? Uh well [laughter] I think so and I've been willing to bet my career on it but okay but but we'll we'll sort of say that there are a few things that you can sort of say that uh uh and and again we want to look at a higher level is that if an asset is higher to uh harder to value >> yes >> that there will be more likely to be persistence or momentum okay because if we can't you know understand what the value is and it's going to take us time to figure out what true value is. So there's more likely to be persistence. Okay. >> Okay. >> Uh when we bundle stuff together so individual stock there could be a lot of noise. But if I look at the industry there may be actually trends. >> If for example is that those assets were uh it's harder to uh or there's less analyst attention there's more likely to be persistence. So, you know, if there's no analyst following in in a small cap stock, you know, there could be a strong reaction, but there's probably going to be more uh persistence in some of its behaviors. So, if you sort of classify uh assets or strategies or factors uh based on some guiding principles, you could sort of say there there may be some strong theoretical reasons for why persistence may occur. >> Yeah. I mean if we were to think about say momentum as in trend following futures trend following versus momentum as opposed to applied to stocks whether it's single stocks or baskets um I mean at a high level are the mechanisms by which it works the same obviously they won't necessarily work in the same period same environments are they good diver good good compliments from that perspective is that part of what you're saying >> uh they can be good compliments but you require different uh uh different approaches to different types of asset classes. A perfect example would be is is that uh we know that there's persistence in uh or uh you know after earnings announcements. We also know that there's probably you know these uh periods of punctuated information that might cause a change in prices. So when you know that that that has a different influence in how you should trade if let's say that you know that for example is is that uh you get earnings announcements uh you know four times a year and we know that it could be punctuated where there's a lot of focus on those four periods of time and there could be strong revisions in the business based on that. There could be short-term you know earnings momentum afterwards you know because of bad news or good news. So you have to take into that account if we look at for example uh you know sort of commodities is that we know for example there are certain seasonality uh you know associated with uh with certain markets but again it's harder to make valuations you don't have the same punctuation of earnings. So so in some cases you might have uh [music] a different signaling approach or a different way to approach those markets. >> [music] >> pivoting a little bit away from um [music] prices, momentum, bubbles. Um I mean what comes with with that to an extent is uncertainty. I know that was something um you wanted to talk about shocks, uncertainty, dealing with that in in optimization etc. >> How does this factor in? >> Well, let's go back to what we originally started with. We always talked about signal versus noise. And so so the noise is always your uh your risk or the uncertainty. And so I you know um not saying I I need to get a better life but I was looking at some book on stochastic optimization. Okay. So so I keep it right next to the bed at night. So he's tossing and turning. I think I'll just I'll flip through a few pages of stochastic optimization to sort of like calm me at the end of the day. Uh but the author of this book is is actually made a really insightful uh uh comment and actually made me sort of like you know jump up and say like wow I you know I've thought about this but I didn't put it in a precise way. He talked about all the types of uncertainty that might exist and you know I won't go through you know all of them but let me just list the names and then you start I want you know all of our listeners should start to think about this. He said there's observational uncertainty, there's there's prognostic uh or forecasting uncertainty, there's experimental noise variability uncertainty, there's transitional uncertainty, there's inferential uncertainty, there's model uncertainty, there's system uh systematic exogenous uncertainty, there's control implementation uncertainty, there's algorithmic noise uncertainty, and there's goal uncertainty. And so you listed all of these types of uncertainty. you say like I never really sort of like categorized it as such but all of those have have influence on the signals that we have and how we re uh react to that. So for example is is that you know and and I'll just give one uh you know simple example to uh have you know listeners think about it. So we had the CME you know uh outage in the market. Okay so there was a period of 11 hours where there wasn't no trading then we start up again. Okay. So if you're a modeler or if you're looking at prices now the market starts up after an outage you didn't know what it was uh what what the cause was. Now you're at month end had this period of time the market started up surprised it wasn't disruptive but if in real time you had to make a decision what do you do what do you do with the uncertainty that you're now facing is that the market was closed down for a period of time that you didn't expect it was supposed to be closed down. So what do you do about that? Or as we get into the holiday period, let's assume there's very low volume in certain markets. This is it. Well, should you treat those prices the same as you would in other parts of the year? Or let's say the third uh you know third example is that if uh and this is one that's a real life is is that if you looked at uh copper prices in New York versus Lond London copper prices there's a big divergence between the two prices. A lot of that had to do with uh tariffs for a period of time. So how do you use those prices and how do you trade something when you have the uncertainty across those different prices because of these regime or structural changes. So uh those are just some examples but you know even when we talk about observational uncertainty is is that well if we have Paul's telling us that our uh unemployment numbers or employment numbers were off by 60,000 a month well how do we how do we do do that or even now they find that there's measurement problems with a lot of the fundamental data because people don't respond to the surveys. that they're asked to respond, you know, concerning unemployment. Well, if people don't answer the surveys, well, then how do we know that there's not more uncertainty in those prices? So or even now what they find out is is that consumer confidence we have is that if you break it up between Democrats and Republicans, you get very different views in terms of you know the survey results based on politics. Or another example would be is that uh if you look at expectations in fiveyear 5year forward prices it looks like they're fairly well anchored at around 2 and a.5%. If you look at consumer surveys, it shows that they're all over the map with people thinking and that inflation is much more rampid. Those expectations are unanchored and that has a big impact on consumer behavior in a way that you know you wouldn't think. So, so there's a lot more uncertainty going on in many different types. >> Good stuff. Um just one topic I wanted to get to before we get to wrap up and it's certainly um something I was talking to Neils about last week and it's been very topical. It's uh the total portfolio approach. Um obviously since Kalper has announced they were moving to a total portfolio approach. It's definitely been in the headlines in the investment world to a greater extent. So, how do you link the TPA with other approaches to asset allocation or even simple benchmarks like 6040? >> I'm still trying to figure that out. So uh so uh and then for uh for those listeners who may not be familiar with this is that they're starting to been doing in the consulting world a number of firms uh I think that the new uh head of at Kalpers was uh came from New Zealand was a a believer in total portfolio approach and so we'll sort of say a traditional approach that you would have if you're a a pension and an endowment is is that you try to uh you set up you know sort of uh a diversified portfolio across different assets. You pick, you know, sort of what you think that the weights you should have in stocks, bonds, alternatives, maybe real estates, uh you know, other types of alternatives. And then what you do is you have your uh the uh staff actually try to hit that model portfolio which is supposed to be diversified across all assets. And the total portfolio approach says that well you need to be a little bit more nimble. You need to s not be constrained by you know a sort of fixed waiting strategy but you allow for more of adjustments in the assets you hold to reach some overall goal of you know the return or controlled volatility. And so a total portfolio approach would be is that allow for flexibility to reach longer term goals. Now, I don't know if there's a single definition with that, but I think that uh uh that's one way to to depict that. And I don't want to set up a straw man here, but I think that people are trying to uh feel their way through alternative approaches because I think that they're finding that the uh at the simple simple case that the 6040 stock bond portfolio, it it may not provide the diversification you need and that you need to be need to think uh a little bit deeper on how you should build a portfolio. >> For sure. I mean, and I think this is a I mean, a good segue into, you know, how trend following and systematic strategies blend. I mean, it's something I've looked at myself. Um, if you um let me try and remember what I was looking at. I I think it was a 7030 portfolio stock bond. if you added a I think it was a 30% overlay to the sock genen trend index you achieve um a 4% tracking error which is what um Kalpers are trying to achieve with their um um TPA approach. So it's a very quick and easy way to move a static portfolio into something that does automatically respond to market conditions. Obviously trend following achieves a lot of what TPA is trying to do already. I mean if you think about a trend following program you know it's already deciding should we go long crude or heating oil or a combination um and and also looking at the energy complex relative to the metals complex. So these are the kinds of issues where strategic ass allocation came short because you know in strategic ass allocation had allocations to everything. Um now they want to try and weigh you know where are the strongest where are the best riskiest returns but as I say isn't that what trend following quant strategies already do. I think you're absolutely right in in in the sense is that there are things that we could do in terms of overlay in terms of being nimble and adjusting which occurs in trend following that could improve portfolio performance. Uh you know whether there uh the TPA approach I think is still needs to have more definitive definitions and make distinctions between strategic asset allocation. But that being said, as I think the idea of being able to say like let's adjust our portfolio based on what might be uh uh the market conditions maybe an improvement then fixating on on set weights when those weights you know uh should respond to changes in uh in uh volatility and and correlation coariance. >> Absolutely. Um I mean one of the interesting things about TPA it's they still have a reference portfolio effectively a benchmark which I think in the case of Kalpers is 7030. It does leave open the question where does that come from? Why is that the the appropriate benchmark? I mean they're not they have cracking our flexibility uh from that but um yeah why 7030 I guess it comes from some consultants somewhere but uh any thoughts on that? Uh well that's the uh uh I get to use the word primal again. So we always say prices are primal but we'll sort of say you know uh diversification is primal to portfolio construction and to start with you might sort of say total portfolio approach is a a corlary or a variation but you need to start with a strategic asset allocation somewhere and and yes uh and then you sort of say how do I adapt or adjust to changes and should I be more adaptive to my strategic asset. allocation and the answer is yes. If that's total portfolio approach then and then I can be comfortable with that. Uh I think that we just need to sort of uh better define what where we're starting from and what it what this process of TPA is. >> Yeah, for sure. No, I mean I think um there is a lot of debate in markets. Is TPA genuinely something different or is it just a new label or maybe a combination of the two? But I think that's something that uh that we may be talking about uh for a bit longer to come. But um we've just run over the hour a little bit. So I think that's a natural uh point to to wrap up. Um Niels will be back next week um back at the helm and uh we'll be recording our Christmas specials uh soon as well. So keep an eye out for those. But uh from all of us here at Top Traders Unplugged, um thanks for tuning in and we'll be back again soon with new and [music] more content. Thanks for listening to Top Traders Unplugged. 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