Pragmatic Capitalism

Practical Views on Money, Finance & Life


We got a ton of good questions on Friday so I am just taking a few and I’ll stockpile the rest for future weeks.   If you want to ask another question in the comments here then feel free to leave it and I’ll see if I can get around to it at some point during the day….Thanks for all the great questions.

From Student:  “I seem to get two contradictory ideas from pragcap. On the one hand, it is essential to understand the monetary system and the BSR in order to formulate a macro view. On the other hand, you yourself at times mention your algorithm (which you keep private) that you use for trading, which would suggest you yourself are buying into trading over “buy-and-hold,” thus in a way perpetuating financial engineering. How do you respond to this criticism and what do you truly think is the best way to make money and succeed in the financial markets – is buy and hold dead?”

CR:  I get this question a lot because I am somewhat vague about my approach and because I tend to cover a broad set of topics rather than keeping the focus on one sector or market.  You can see my top down macro multi-strategy approach in more detail here.   In essence, I view the world through a 30,000 foot lens.  Now, you have to understand the monetary system and how all these pieces come together first so if you don’t understand the monetary system there’s not point bothering with a top-down approach in the first place….So this approach is based on a progression of understanding.   You have to understand the overall system and how the pieces influence one another, then you have to understand the individual pieces and then you have to decide how the pieces will move markets in a particular way and how you can benefit…..It’s a lot to digest and I’ve spent thousands of hours refining the approach and I feel like I am still working at it every single day….

I like to pretend I am staring down at the ocean trying to gauge the storm clouds and how they’ll shift the waters below.  If you want to know where the boats are going you just need to navigate through the storms and following the winds/currents.  It’s all based on a risk management approach and the idea that if I can understand the risks and which way the water generally flows then I don’t need to be terribly precise about my micro approach.

Once I am comfortable with the macro I decide exactly how to implement the micro approach.  This all depends on the market environment to some degree.  I essentially use what is called a core and satellite approach.  I have core pieces that are not unlike a buy and hold approach.  And then the strategies I trade around this.  My algo that I mention on occasion is one of these.  The reason I trade multiple strategies is because nothing will always be working.  For instance, I use a specific event driven strategy that has been my best overall strategy, but it completely died in summer of 2008 and through much of 2009.  It became unusable because of the strange market environment.  That happens.  So it’s better to carry more than one weapon into battle because you never know when one will jam up on you.

Of course, finding the micro approaches are incredibly time consuming and intensive so it’s not for everyone.  In general, I am a big fan of lazy portfolios for the average investor because it’s too difficult to find good money managers (and the really good ones aren’t accessible) and trading your own portfolio is incredibly difficult and a full-time job….

Several readers:  “Is your algo still expecting a correction? This move feels like partying like it is 1999 or am I missing something? Is this a blow-off top or will the market move up for the rest of the year / next 2 years?”

CR:  Speaking of my algo….This is one of my multiple strategies and it’s generally a contrarian approach based on the idea of eliminating my emotions entirely from a component of my portfolio.  It’s based on many different market and economic indicators and is fully automated.  It works in different increments in a sort of dollar cost averaging trading approach and generally fires off what turns into one 8 week trade.  It’s not intended to pick tops and bottoms, but adds exposure when the environment becomes negative and reduces exposure when the environment becomes positive (ideally).  In other words, it’s meant to do exactly the opposite of what your instincts and herding behavior would have you normally do.  This is why it’s automated.  “Trade like a robot” is the approach.  Robots don’t have emotions and if you can take your emotions out of the game then you’re a step ahead of everyone else.

Currently, the algo is still firmly bearish and points to a “reduce exposure” environment for the tepid investor or an outright short for the more aggressive investor.  This strategy comprises one of the multiple strategies though so it is never representative of an “all in” or “all out” type trade.  I find shorting to be an outrageously difficult way to make money so short positions should never comprise the majority of one’s portfolio.

Several Readers: “If Mr. Beranke, and the Fed are wrong, and we have a sudden surge in inflation, what can they do to stop it in its tracks, or maybe back it off to reverse the damage? Or, would they just say “OOPS”.”

CR:  As I’ve been saying for several years now, a sudden surge in inflation will likely come from one of two places – an oil price shock which will likely drive us into recession and cause a bust with an ensuing price decline.  OR, we’ll get an economic boom and prices will rise because employment is surging, output is booming and the economy is generally well out of the doldrums.  I don’t think the Fed would say “oops” in this situation.  I think they’d say “see, we told you we had this under control!” and then everyone will start calling Ben Bernanke the New Maestro even though it was the fiscal stimulus that saved our skin in the balance sheet recession.   And if that really does happen they’ll go through the standard motions of raising rates and probably unwinding their portfolio with the belief that QE caused inflation, etc.   I see the likelihood of a 70’s stagflation as very unlikely unless we get an oil price shock like the 70’s (which can’t be entirely discounted, especially given the situation in the Middle East).

Several Readers:  “Furthermore, some perspective on the yen and the japanese…..are they now finally going down, now their current account disappears? They are the guys who everyone that I prime on MMT/MMR always point at, saying they will be the first falsification of the optimism that MMR may induce. They say japan is out of options.”

CR:  I talk to several traders in Japan fairly regularly who love to joke around about the BOJ sending bond traders to their deaths by suicide.  Japan is an autonomous issuer of the Yen.  So there’s no such thing as Japan “running out” of Yen.  It can’t happen.  They won’t default unless they essentially choose to (that would be a political decision and a very stupid one – kind of like US politicians choosing not to raise the debt ceiling).  Now, they could default in the form of hyperinflation, but this is the big problem in Japan.  They can’t get inflation up no matter what they do!  And they’ve tried.  There are lots of theories as to why this is, but it’s more important to understand that the theory around Japan defaulting because of their debt:GDP ratio or “unsustainable debts” is wrong.

Traders shorting JGB’s (Japanese Government Bonds) have been impaling themselves for 20 years now.  It’s not unlike the US Treasury market right now.  And why is this?  Well, it’s because the BOJ is the price setter in the Japanese bond market.  So when they want rates to remain low they declare it so.  Just like the Fed.  There are no bond vigilantes like in Greece and there’s no one to force Japan into default….If you’re confused on all of this I would recommend the section of the website on the monetary system and the video series as an introduction….

That’s enough for today.  I’ll get around to some of the others later in the week or for next week’s series….Hope this is somewhat helpful….


Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC.Orcam is a financial services firm offering asset management, private advisory, institutional consulting and educational services.He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.
Cullen Roche

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