🐿️ Ears: Jim Leitner. An options and macro masterclass + listen to Janet the game master!
🐿️ Ears: Jim Leitner. An options and macro masterclass + listen to Janet the game master!
In conversation with Bilal Hafiz of Macro Hive
March 29th, 2023. (8 minute read). The purpose of the ‘🐿️ Ears’ podcast / video reviews is not to replace enjoyment of the full show / episode. In fact, it is hopefully a form of long form recommendation to take that valuable hour (or more) out of your day.
Episode Link (YouTube). Episode Link (Audio). Run time: 70 minutes. Recorded Wednesday 22nd March (just before the FOMC meeting).
This 🐿️ considers himself to be a complete Jim Leitner groupie. For those not familiar with him, you can find his impressive bio here. Jim runs his own family office and has nothing to sell. He generously (and selectively) shares his thinking on the podcast circuit. Always a must watch.
He is a regular guest of Kevin and Patrick on The Market Huddle. Links to previous appearances here → Feb 2021, May 2021, Jan 2022, May 2022. I have rewatched all of these at least a couple of times and pick up something new every time. I was excited to see him come onto Bilal’s Macro Hive show again.
Jim takes generalist macro investing to an artform. He has traded most asset classes in most geographies and still has this extraordinary (and infectious) hunger for knowledge. To my mind, he is also the king of trade construction. He expresses most of his trade ideas via options. Those that write off an options-focused approach to investing have not been following Jim Leitner! Utter legend. Would be the round 1 draft pick for the 🐿️’s fantasy trading desk.
🐿️ key takeaways below:
Now is a great time for macro investing. Global central banks are no longer all doing the same thing as they have done in the last decade + period since the GFC.
The emerging multi-polar world will kick up plentiful opportunities in non-mainstream geographies.
Jim is thoughtful on the forward outlook for inflation (volatile) and the shifting labor vs capital dynamic, with big implications for asset markets.
Current problems with the banking system may be fixed with the Fed’s balance sheet, not necessarily with a lower Fed Funds rate.
Carry trading could be about to make a comeback after a quiet post GFC period.
In terms of trade ideas, keep an eye on the Brazilian Real and “higher for longer” US interest rates.
Janet Yellen is the new “game master”. She should be watched like a hawk!
Podcast Notes
Implications of an emerging ‘Multipolar World’ in geopolitics.
Individual countries now looking out for themselves first, not permanently looking over their shoulders at the global hegemons (US and China).
Example: Indonesia bans tin exports so that more of the value chain stays in Indonesia.
Will it happen again in Chile with copper?
Does India become a manufacturing exporter?
You now need to think about idiosyncratic bets in macro. Example: Could Brazil lower its policy rates (currently 13.75%) in the coming year even if the Fed does not? Absolutely! (Jim seems pretty bullish on Brazil for Lula’s second administration - his policies “do well in attracting capital to the country”).
Plenty of opportunity in FX / FX Options in “second tier large countries” (e.g. Czech Republic, Poland).
Inflation.
Central bank policy does not work on supply side of the economy (they can hammer demand side only).
Markets (inflation swaps) are under-estimating the volatility of inflation going forward. Big implications for asset markets.
For 40-50 years, labor has not participated in productivity gains (look at median wages vs. productivity). The gains have all gone to corporate profitability. Sands are shifting. Corporate profits as a percentage of GDP have probably peaked. Expect some mean reversion (with an associated negative impact on equity markets).
Competition needs to be re-established in markets (“the [US] defense industry had 50 suppliers in the 1950s - it now has 5. Same thing with hospital chains and assisted living chains”).
Declines in democratic governance are correlated with underperforming equity markets. Politics, not valuation is the problem for equity markets.
Expect pushback from politics NOT valuations! Valuation based on Excess CAPE Yields (‘ECY’) are actually not that stretched (only “half a standard deviation expensive”). Valuation multiples are not giving you a strong directional signal (to be bearish US equities). Other things are.
Current Banking Crisis.
Now is not a repeat of 2008. Fed has learned to use its TWO different policy instruments (interest rates to address inflation and its balance sheet to address liquidity issues).
The job of a bank is “maturity transformation” (deposits into loans, benefitting from the (positively sloped) shape of the curve). In a world in which CBs are hiking rates to combat inflation, banks have a hard time and need to be smarter about hedging. Some of the smaller banks demonstrated complete incompetence.
Tighter lending standards and reduced loan growth is inevitable. At some point things normalize again (“we have already seen the immediate reaction to the crisis with the shift in the 5s/30s yield curve - they have started to normalize”).
With this turmoil in bank sector we are probably closer to the peak in rates that where we were in the run-up. The threat of a 50bps hike may have even been a trigger!
Risk Management and Options.
Jim believes in OWNING options not ‘using’ them. He likes to be long convexity and have his maximum loss/ drawdown PRE-DEFINED. He is not a fan of selling options.
No such thing as a “costless trade” (i.e. funding a long option position via the sale of another option). Earning income by selling options became fashionable in the low interest rate environment. Not a great idea (cue some great 1987 and LTCM blow up stories!). “Cheap spread trades can always get cheaper!” Lack of liquidity (continuous markets) kills you - no chance to get out.
He does do cash (non option) trades, but it is infrequent. Only when dealing with illiquid markets (e.g., Italian rates where he uses futures as options so illiquid).
The benefits you get from the convex payoffs in options is ‘paid for’ by the requirement to be accurate about the timing of your directional bet (as options have a maturity). Over the past 4 years at Falcon, they have, on average, made 150% on option trades that go right and lost 82% on the option bets that were wrong (he does cut a few of his losers).
He does not gamma/delta hedge his option trades. “My strength is thinking about directionality and where things are going to end up”. He is not as interested in betting on the direction of implied volatility. 🐿️ note: Bilal makes a great point at the end of the show when talking about the number of buyside hedge fund clients that still obsess with gamma trading when their focus is primarily directional. He believes it is a function of their background (typically as options market makers on the sell side). I have seen this a lot too and completely agree. I would add that it is most often the ex-market maker that is overkeen to sell “expensive” volatility. Like Jim, this rodent does not sell vol.
Jim is a big user of digital options [which can be structured for retail investors with tight put and call spreads]. He bets when he sees that the market pricing a probability that he disagrees with. No need to get distracted by ‘the greeks’ and the math. There is also no need to worry about the market maker’s edge (which they capture via the volatility trading).
US dollar and the “carry trade”.
After the past 10 years of US asset outperformance, foreigners are under-invested in their home markets. The capital is going to flow back.
Carry trading has been pretty dull since the GFC (limited interest rate differentials etc). The move in to a multi-polar world is seeing rate differentials come back and some big divergences (e.g., LatAm versus Asia) to potentially take advantage of.
“The old school trick of carry trading 40 years ago was to not get caught out by a currency devaluation!”. These days, cross-border capital flows are more accurately tracked and analyzed. It’s a more sophisticated game.
Leitner Philosophy.
You should spend at least a third of your time ‘exploring’ rather than doing (books, articles). The balance exploiting that learning.
Too many traders trade too much. You should only trade when you have “learned something new”.
Read constantly, and build a decent network around the world to bounce ideas off.
Jim’s Favorite Current Trades.
Short USDBRL. Jim clearly loves the (long) Brazilian Real trade (though concedes his implementation was flawed as he did not buy long enough option maturities). 🐿️ note: For those that do not trade currency options, USDBRL exhibits a very high correlation with Brazilian equities (e.g., EWZ, iShares Brazil ETF).
US interest rates ‘higher for longer’. He thinks that the market is pricing too many cuts by the Fed. He does not see inflation dropping rapidly enough and Powell will use the Fed balance sheet to address liquidity issues (instead of lowering Fed Funds). 🐿️note: Jim has been arguing this for a while. At the time of the interview I heard on The Market Huddle in May 2022, he was expressing the view via digital options/ narrow put spreads on Eurodollar futures (now SOFR). The trade is illustrated below. He would have paid 1-2 cents for the position (max payoff = $0.25 on the ‘digital’). Fair to say he absolutely crushed it! 🐿️ note: Jim references the post-SVB carnage in the money markets in the conversation. I suspect that he was referring to giving back some (presumably already very large) gains on this position (or something similar).
Crypto. Leitner was relatively early to the asset class and made a big bet on bitcoin in 2019 (@US$8,450). It is still a ‘fire and forget’ play him. “Either it goes to zero or it is going to be worth a lot”. He appears disappointed at “how few real businesses have been built on the technology so far”. 🐿️ note: Jim has the ability to ‘stay in the trade’ and tolerate drawdown pain that would put even the most committed trend followers to shame.
Jim’s book choices
The Socratic Method: A Practitioner’s Handbook (Farnsworth)
The Alignment Problem (Christian) - focus on Chapters 3 to 6 (about how we teach computers to learn).
The after show
I nearly missed this. Complete nugget at the end (not even sure it was supposed to make the final cut!) Jim often talks about the Monty Hall “Game Master” paradox and the fact that it is essential that you listen to the game masters. Listen to the Feb 2021 Huddle edition. This philosophy gave him his big EURCHF up trade in 2003/4 when he listened to the Swiss National Bank when nobody else was paying attention.
Given her background (Fed, Council of Economic Advisers and Treasury), the key game master to follow today is Janet Yellen! 🐿️ note: You may not like this message given her recent performance (messaging around bank policy etc), but I agree with Jim that you ignore what she has to say at your peril!
Also a big JL fan here. Thank you for this excellent summary!