Nothing new under the sun

It all feels eerily reminiscent of the summer of 2007, when weird things started to happen in the US money markets, and certain of the more decerebrate funds started to implode. This time round the proximate cause of panic seems to be forced selling by Archegos Capital Management, a vehicle “managed” by ‘Tiger Cub’ alum Bill Hwang, formerly a hedge fund manager for Julian Robertson (whose own Tiger Management closed back at the height of the first dotcom bubble in early 2000). A million years ago, the term ‘hedge fund’ used to mean something: it meant that risks were, to an extent, hedged. But for at least the last two decades it has taken on another meaning: anything goes, and damn the torpedoes.

For at least a decade we have limited our ‘hedge fund’ exposure to one specific strategy, namely systematic trend-following. Here is what we wrote on the topic of systematic trend-following funds in The Spectator of 21 May 2011:

In the 1983 comedy Trading Places, two unscrupulous commodity brokers wagered that they could take a vagrant off the street and turn him into a successful trader. The film was a hit, symbolic of a more innocent age when interference in ordinary people’s livelihoods by gambling financiers was the exception rather than the rule. What is less well known is that its plot was essentially true.

Also in 1983, the commodities trader Richard Dennis set out to show that anybody could trade provided they were taught properly. His partner, William Eckhardt, disagreed, and a wager was born. Dennis placed classified ads in the back of the financial magazine Barron’s. Experience in trading was not necessary. He ended up with two classes of what he called ‘turtles’, named after a visit to a Singapore turtle-breeding farm. Dennis believed that he could grow traders in the same way that turtles were nurtured.

In short, he was right. He hired fewer than two dozen novices. Jerry Parker was among them. He now runs Chesapeake Capital and is believed to be worth upwards of $700 million; $1,000 invested with fellow turtle Tom Shanks’s Hawksbill Capital in 1988 would now be worth north of $100,000. Turtles Paul Rabar, Mike Carr, Howard Seidler and Jim DiMaria all set up successful investment firms. So what did Dennis teach them?

Old City hands will tell you that there are only two ways to look at financial markets. One of them is fundamental: what is happening to the economy, to interest rates, to inflation? The other is technical: what is happening to market prices? The City tends to favour fundamental analysis — which may be one reason why collectively we’re in such a mess — and most commentators distrust technical analysis. But the reality, known to Dennis and his turtles, is that price is the only metric worth trusting. Everything else is subjective, fundamentals included. And this is the system that Dennis taught, a trading strategy that today goes by the title of ‘systematic trend-following’. Unlike many trading approaches, it requires no special understanding of a given market — indeed, many successful trend-followers swear they prefer to trade ‘blind’, without even knowing precisely what they are buying or selling, just its price.

Trend-followers are not hugely interested in macroeconomic analysis. They use Wall Street research, if at all, to bolster wonky chair legs. What does interest them is catching a ride on big market trends. And in this approach today’s traders are following a path laid down by one of the most successful stock traders in history — Jesse Livermore (1877–1940), whose nicknames included ‘the Boy Plunger’ and ‘the Great Bear of Wall Street’. Livermore managed to make and lose several fortunes. But he was no creature of lengthy bull markets. After the 1929 crash, he ended up worth $100 million. Happily for the aspirant investor today, his approach to trading is as relevant as it ever has been. As Livermore said himself, ‘There is nothing new in Wall Street. There can’t be, because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again.’

The beauty of trend-following is that it requires just two things: greed and fear on the part of other investors. As the market oscillates between those extremes, prices form trends, the direction and intensity of which reflect which emotion has the upper hand over investors’ psychology.

The principles of trend-following are not complex. Most of them are concerned with determining how much risk to take on each trade — whether buying shares or ‘shorting’ them. This is known as position-sizing, or risk management. An appealing feature of trend-following is that it is typically a low-risk strategy. Another attraction of trend-following funds is that they ordinarily have little correlation to the stock market. A good example can be seen in David Harding’s trend-following fund Winton Futures, one of the largest hedge funds in London. During 2008, a year in which most conventional investments collapsed, it delivered positive returns of over 23 per cent.

Trend-following might be the perfect antidote to Wall Street machismo and excess. It flies in the face of traditional theories about efficient markets. But it does require iron psychological discipline in buying or selling when signals say the trend is about to change direction, even if fundamentals say otherwise. In Jesse Livermore’s words, ‘The game of speculation is the most uniformly fascinating game in the world. But it is not a game for the stupid, the mentally lazy, the man of inferior emotional balance, or for the get-rich-quick adventurer. They will die poor.’

Nothing much ever changes permanently in the financial world; stick around long enough and the patterns of human inanity start to repeat themselves. Perhaps the only surprise here is that the blow-ups occurred in the stock market and not in bonds, which are far more egregiously mispriced. Grant’s Interest Rate Observer of March 19^th 2021, in a piece ominously entitled ‘Fixed-income powder keg’:

Now in progress is a speculation on a new, overdue (say we) bear bond market. The risks attending suppressed interest rates, stifled interest-rate volatility, fiscal impecunity, untimely financial regulation and decades-long abuse of the reserve-currency privilege have long lain dormant. It took the bug to crystallize them.

Miniature bond yields are on the road to extinction, we are about to contend. Leverage and overregulation may deliver a propulsive charge to that negative price action. Complexities abound, but the root of the problem is simplicity itself: The supply of bonds is greater than the demand for bonds at prevailing artificial interest rates.

Never before has peacetime government borrowing approached today’s volumes, and not since the Treasury-Federal Reserve Accord of 1951 have the nation’s monetary and fiscal functions been so intimately intertwined. Resurgent money growth, the bond market’s own structural flaws, the prospect of an unscripted new inflation and investor expectations, conditioned by two generations of shrinking interest rates, complete the fixed-income tableau.

Happily, as index- and benchmark-unconstrained investors on behalf of our clients, we aren’t obligated to own overpriced and vulnerable bonds. So we don’t. But, mindful of the burgeoning inflation and market risks, we invest selectively and opportunistically instead in cash-generative listed ‘value’ businesses unencumbered by debt; in the monetary metals, gold and silver, and related businesses possessing genuine ‘value’ characteristics; and in systematic trend-following funds that are, perhaps uniquely, utterly uncorrelated with the prices of stocks and bonds. Life isn’t just about waiting for the storm to pass – it’s about learning to dance in the rain.

Tim Price is co-manager of the VT Price Value Portfolio and author of ‘Investing through the Looking Glass: a rational guide to irrational financial markets’. You can access a full archive of these weekly investment commentaries here. You can listen to our regular ‘State of the Markets’ podcasts, with Paul Rodriguez of ThinkTrading.com, here. Email us: info@pricevaluepartners.com.

Price Value Partners manage investment portfolios for private clients. We also manage the VT Price Value Portfolio, an unconstrained global fund investing in Benjamin Graham-style value stocks and specialist managed funds.