Beginning of a Fertile Time for Global Macro Investing
Fortress Group’s Michael Novogratz, tennis legend turned philanthropist Andre Agassi and social impact investor Bobby Turner on Wall Street Week video and text (via newsletter below).
Beginning of a Fertile Time for Global Macro Investing
“Don’t confuse brains with a bull market.” – legendary investor Humphrey B. Neill
You’ve likely heard that timeless quote about investing before, and with the market trading at such great heights, it bears repeating. However, there is also a derivation of the quote that global macro investors might want you to meditate on right about now:
“Don’t confuse stupidity for a manipulated market.”
There are bad investors who have made a lot of money in the last six years, and plenty of great investors during that time frame (especially over the last two years) who have not been able to replicate their above-average results of the past. The stock market has tripled from its March 2009 lows, and among the best performing investors have been those steadfastly holding index funds. Macro active managers attempting to time various markets have underperformed, largely thanks to the powerful force of unprecedented central bank intervention following the financial crisis.
David Tepper of Appaloosa Management famously said, to paraphrase, “don’t fight the Fed, just buy stocks,” after the FOMC lowered interest rates to 0% and began QE after the financial crisis. That simple-yet-brilliant advice, which has led to the Tepper’s apotheosis, provided the roadmap for 200% gains in five short years. For active managers, there simply haven’t been many lasting divergences or trend-changes to exploit as asset prices have drifted higher in concert. While it could be considered naïve to ignore sources of “distortion” in markets, it’s also been understandably hard for some investors to stomach such a straight-forward and superficial approach when they have made careers out of out-smarting passive investors through contrarian thinking.
Investors suffer from chronic recency bias, meaning they cognitively overemphasize recent results rather than maintaining perspective on a longer time-frame. Over the last several years, with most markets trending in one direction, you have heard more than ever about the panacea of indexing. Investing in market indexes certainly should be part of any individual’s long-term financial plan, but to think active management is dead and buried is a fallacy.
With six years of ZIRP and several rounds of massive quantitative easing (QE) like the world has never seen before, most would agree asset prices (from stocks to bonds to real estate to art) right now are fairly-valued to over-valued. The greatest distortions have been seen in fixed income markets, distortions created intentionally by central banks in order to encourage greater financial risk-taking and, theoretically, growth. Some bond yields in Europe are even trading in negative territory—yes, you have to pay the government interest for the privilege of lending them your money. The way we think about money has been flipped upside down, and with it the way we have had to think about investing.
The problem for active investors is that markets can stay irrational for a long time, especially if dovish monetary policy remains constant. While most believe assets to be at least slightly over-priced, there is no cause to alter a bullish mindset if policy does not change. Right now the US still has 0% interest rates while world central banks keep their foot on the pedal of monetary stimulus, prompting Tepper to renew his famous analysis at the recent Ira Sohn conference, where he said “don’t fight four Feds.”
The difference now is that US monetary policy, with a new Fed Chairperson and improving economic conditions, is starting to diverge from the rest of the world. The Fed has withdrawn from QE and cast an eye toward raising interest rates. While it remains to be seen when the first rate hike will come, we have seen over the last two weeks that many investors, especially in fixed income markets, would prefer to be early to exit the train rather than late thanks to concerns about liquidity in a Dodd-Frank regulatory world without prop desks at big banks.
This week’s guest on Wall Street Week, Michael Novogratz, is a prime example of a great investor who has found the recent macro investing environment challenging. However, he sees the winds changing. “I see us moving into an era that’s spectacularly fertile for macro investing as the US comes out of quantitative easing.” Financial pundit Josh Brown recently also recently wrote about how all three pre-conditions for active manager outperformance are present.
The real question now is about the timing of the Fed’s first interest rate hike. Odds are now hovering around 50% for a hike in 2015. Novogratz thinks it will happen in September, Jeff Gundlach thinks it won’t come until 2016, while Peter Schiff said at the SALT Conference he thinks we are actually headed inevitably toward QE4! While the latter, a dooms-day pundit and gold-bug, holds a minority opinion, there are signs that the Fed is anxious about how the market will react to the withdrawal of the powerful ZIRP drug. If Marty Zweig was alive to reprise his role as a panelist on Wall Street Week, he might be inclined to use that nasty “c” word (crash) in regards to the market’s potential reaction to rate hikes.
The real lesson in all this is there are no absolutes in investing. Indexing is a valuable tool, but not a be-all, end-all for all market cycles. Macro investing is, at its core, a form of speculation, which carries a greater inherent level of risk. However, active management can become a necessary tool for generating returns when broader markets get somewhat tapped out. We have endured a period where extreme policy measures have constructed a straw house of reflated asset prices, and in order to live in that house long-term investors have to be willing to embrace active management as a hedge against an inevitable return closer to index equilibrium.
We’ll leave you with a great quote that Novogratz delivered during this week’s show:
“[Macro investing] is a cross between analysis and pre-cognitive intuition where you gather data points and then [make] a guess – it’s an “I think” proposition. Trusting that intuition is the hardest part of this business. The [investing] greats have such a discipline to their life and process that allows them to trust intuition.”
The best investors build a process that will endure over a lifetime, and have the courage of convictions to never deviate from it. Going all-in on indexing or more speculative active management based on what you hear at an investment conference or read in a newspaper is not a wise strategy. A more sound investment plan involves constructing a consistent methodology emphasizing risk management through a balance of active and passive principles.
Novogratz on WSW embedded below