2024 Market Predictions with Co-Founder Piers Curran

Hello and welcome back to the first episode of the Market Maker podcast for 2024. So as per usual, I'm joined by our co-founder Piers Curran, and we're going to talk about two topics in this episode. The first one is hedge funds. They've been releasing their numbers for how they performed over 2023, and we're going to take a look at how they perform, but more importantly, a bit of a breakdown of some of the terminology I did read some FT, some Bloomberg articles this morning, and I would imagine there's quite a few people out there who are probably reading it going, what actually is that and how does it work? And how do they differ? Systematic, discretionary, hybrid, multi-strategy, fixed income, relative value, all these types of words, buzzwords with the hedge fund industry get thrown around, but we'll try to simplify it the best that we can, make it interesting. And so it's a bit more easier to interpret that type of thing going forward. So that's backward looking. And then the second half of the episode, we're going to look forward for the year ahead. And as highlighted by a couple of themes by the FT this week, going to talk about interest rates. We'll see the big one that defined really 2023. It's definitely going to be the headliner as well, most likely for '24. Long yields, the Magnificent Seven, bond equity correlations, and just global stocks.

Overall.

But before we begin, Piers, how are you? Happy New Year.

Happy New Year. Buzzing. I love the start of the year. I, uh, mainly because there's one big reason why I love the start of the year. Actually, tomorrow— well, we're recording this on Wednesday, right? So tomorrow's the 4th of January. That actually marks, uh, 19 years Uh, the 19th anniversary of what I'd probably say was my best ever trade. 4th of January, 2005.

It's been, it's been a long time. We do another one, aren't we?

Yeah, it's been a long time out in the wilderness. Um, I mean, best ever, like, best ever day Day trade. Yeah.

Okay.

Short-term trade.

So come on, you can't say that and not relive it for at least 15 seconds.

Well, all right, fine. Well, okay, you know, well, so when you're a trader, there's a bit of moral hazard issue sometimes if you're a macro trader or if you're an event-driven trader or you're a discretionary trader. And we're going to talk a bit about what some of these terms mean in a minute when we go through hedge fund performance in 2023. But Sometimes bad stuff happens and it could be terrorist attacks, it could be natural disasters. There was an earthquake in Japan over the holiday season, right? And that kind of reminded me of earthquakes. It's quite obviously an unstable region from a sort of earthquake point of view. And there's been plenty of earthquakes down the years in Japan. That have triggered huge devastation from a death toll and infrastructure damage and economic impact. And so when I say that last point, of course it has an economic impact, which of course means it moves markets. So then, right, if you're in the business of managing money, you're managing portfolios, your job is to trade and navigate through asset price, financial asset price volatility. Well, then of course, when prices are moving, you're right, this is my job. I need to get in amongst it and try and navigate through and make profit, right? But, you know, when you're making a profit off the back of, you know, if you are personally gaining or the company's gaining off the back of what is an incredibly negative scenario, then it's quite hard to manage and deal with that from a moral hazard point of view. The reason I bring this up is because the year before my best ever single day, the year before, 2004, over the sort of, well, end of 2003, I think it was Boxing Day 2003 and into the start of 2004 was a big earthquake in Asia, which triggered a big tsunami. And so, you know, countries like Sri Lanka, you know, got hugely devastated by this. And it was obviously a huge global, very negative scenario, natural disaster. Right. Fast forward 12 months. Okay. We're coming into the end of 2004 and into the start of 2005. And I think it was almost probably you actually that announced on my squawk that there was an earthquake off the coast of California. Right? Now, at that point, that was it. There was no other news. It wasn't like, well, how big's the earthquake? You know, how big is the— what's the likelihood of any kind of secondary sort of tsunami scenarios? Where along the coast of California? Where might a tsunami hit? What kind of, you know, impact might this have? There was none of that information. But of course, human beings are like, wow. And because we'd just been through the anniversary of the event 12 months before, it was fresh in everyone's minds and everyone panicked. Markets panicked and we had a big move. So stock markets dropped really, really sharply. I'm talking over the period of about an hour here whilst we were in that limbo where it had happened, but we had no granular information. So everyone panicked, assumed the worst, stocks dumped. I was trading bonds at the time. So bond markets spiked, safe haven bond markets. I was trading German government bonds. It happened to be the German 2-year government bond that I was trading. These markets went through the roof. So I bought heavily. And then about an hour later, the details started to come through, and the details were that actually it wasn't a very big earthquake. There was going to be no tsunami, and there is going to be no fallout, human or economic or otherwise. And so all these market moves came all the way back down. So I made money on the way up, and on the way back. And it's perfect because there's no moral hazard issue. Nothing bad happened in the world. It was just a short-term sort of piece of volatility in financial assets that I was able to take advantage of. So yeah, that was 19 years ago tomorrow.

Wow. And actually, this will tie in when we talk a little bit about one of the best performing hedge funds, one that you've probably never heard of, which we'll come around to, and how this one guy who heads it up adopts a fixed income, so same asset class, a relative value hedge fund strategy. And then, and the way he tackles it is not really using secret black box techniques to generate trade signals, but just common sense observations to kind of identify these potential investment opportunities, these mismatches in the marketplace. And that behavioral one is so interesting. Because the fact that it was on, I know having observed these events from the news dissemination point of view, it's the how news impacts markets is highly dependent on the sensitivity.

Right.

And that would've been heightened, as you rightly said. So yeah.

Wow.

Okay. 20 years ago. You're getting old, Piers.

Feeling young, feeling young.

Anthony Cheung: All right. So it was a pretty challenging year last year. I think we can all agree on that. And a lot of hedge funds got caught pretty badly actually by the ramp that came pretty late into the year. And throughout the last 12 months then, we've had interest rates of focus, namely the central banks cranking them up, but then this projection they're going to be cutting them heavily going forward. We'll discuss that more later. We had Silicon Valley Bank, that seems a lifetime ago now.

Yeah.

But that anniversary's coming up and given our conversation just now, I'd actually be quite keen to mark out what were the dates with that again? Because it was in Q1, wasn't it?

So yeah, I think it was end of March, wasn't it? Right.

So definitely that was a major point at the time, albeit It translated into probably something like you described, much smaller than many had feared, which was an all-out bank run at the time. Didn't quite materialize. Israel's war on Hamas in Gaza, the ongoing conflict, Russia and Ukraine, geopolitics certainly has stepped it up. And that's even without mentioning China. Yeah, I saw some of those shots of the newly formed BRICS, Saudi getting in some of the action with the Chinese and Russians. Now, which is likely to also cause, I'm sure, a few headwinds for 2023. But that was the scene. So how have hedge funds fared? And where this kind of conversation was coming from was that DE Shaw, one of the biggest hedge funds, returned just under 10% in 2023. So it's a pretty challenging year, as I just mentioned. But the quant firm performed relatively well. That being said, it is a quant firm and there's lots of terminology points that come along with this systematic against discretionary, but then there's also this hybrid format. So maybe we can start with those before we go down a little bit deeper.

Yeah, and DE Shaw, I mean, yeah, look, they had a relatively good year, I would say, but yeah, in what was a difficult backdrop. I mean, maybe I'll just say before we get into the de sure details, I mean, it was that at the start of 2023, if we just go back 12 months, the consensus outlook for the year of 2023 was really pessimistic. 2022 had been a bad year for stocks. Into 2023, most people predicting a recession. And actually, you had year-end forecasts for the S&P at 4,000. That was the average consensus year-end forecast for 2023 was 4,000. It ended the year at 4,800, 20% above what the average consensus had been. And you bring up the SVB thing because I think we went into 2023 pessimistic. SVB happened and it was like, we're right, this is perfect in so much as, right, this is going to— now our predictions will materialize. This is the straw that breaks the camel's back. And look, we're going to have this negative recessionary scenario. And of course it didn't happen. And you could point to, I don't know, was it the policymakers? Was it the government and the Fed and they did an amazing job to step in and make sure that a banking crisis didn't happen? Are banks more capitalized these days given all the regulation post-financial crisis? Whatever the reason is, it didn't materialize. And then, yeah, as we got towards the second half of the year and the US economic data story just stayed phenomenally strong. And actually it started to accelerate the growth in the US and it was like, wow, this is, this is crazy. And then we got worried about inflation again. And then all of a sudden at the end of the year you got the absolute perfect, perfect storm, or sorry, perfect scenario where you are starting to get a dovish Fed. We're going to cut rates, we're going to cut rates, but at the same time we've still got a strong economy. And so yeah, what an amazing end to the year. So those that performed well Um, are those that performed well, I would say in the main were probably wrong at the start of the year but were able to adapt and change in time, weren't stubborn, and in, and in time were able to benefit from that year-end rally. So they finished the year up. I mean, the S&P I think was up nearly 30%, to put that D.E. Shaw number into context. They were up 10%. Or the S&P was up 26%, I think, right? So they massively underperformed the S&P 500. And look, they're in the business of definitely delivering alpha. What we talk about alpha is, right, a return on investment over and above benchmarks like the stock index. Okay. So 10% might look good in amongst their peer group. It's not good when you look at the S&P 500, but look, they got it right at the end of the year and fine, we're able to generate a return. We'll talk about some funds who massively outperformed DE Shaw, and they're the ones, they're the outliers in some ways where they were the contrarians at the start of 2023 and they were saying, look, there's not going to be a recession, you're all wrong. And they were right. And of course they kind of benefit from that, from their strategy setup. But yeah, delving into DE Shaw, a lot of these big hedge funds these days they're multi-strategy. You know, they're in the business of, well, growing their fund, right? They're in the business and it's all about the end of the day. I mean, yes, returns on investment, but it's about assets under management. It's about attracting more money, building out your assets under management, and obviously your performance and track record helps with the sales and marketing initiative. And these big funds like DE Shaw, Millennium, Citadel, they've got global growth strategies, they're opening offices all over the world. They're trying to, you know, drive brand awareness and raise more capital, right? And along with all of this is multi-strategy. So they've got loads of different teams, and this is good from a top-level point of view, from a diversification perspective, right? If you're a smaller fund running one strategy, well, all right, to a degree, depends what the market conditions are like as to how well that strategy might perform. Okay. So, and what I'm saying is, I guess your performance is in some ways out of your control. Market forces will determine how much money you can make or not. But if you're a diverse strategy player, then of course got lots of different things going on. And whilst one team might underperform, you've got other teams that will outperform. And so yeah, for D.E., sure, they're systematic strategies. And their discretionary strategies, uh, teams, um, perform the best. Systematic, I guess it's going back to something we touched on, which is human behavior, um, where really they're trying to use quant models and algos to trade in a more robotic way where you're not being influenced by human emotion. A good example in 2023, why did systematic strategies work well? It's because if you went into 2023 with a negative bias and then you got your SVB news, which is confirmation. We talk about confirmation bias, right? Where you're seeking out information that supports your view. You almost like amplify the importance of that. You're right. I'm right. I'm right. I'm right. And then when you turn out to not be right, human beings get stubborn. You know, we don't want to admit we're wrong. We're like, oh, the market's wrong. I'm still right. I just got to wait. These human emotional driven things mean a human takes longer to come around and admit that our strategy is wrong. We need to change things up. And so a systematic machine will remove the emotion from it and will be more about the analysis of data, trend changes and so on. And so I think they'll be quicker to shift and adapt. To a market condition that they weren't originally expecting. So yeah, systematic strategies is about that quant and algo-driven setup.

So one of the things I heard about DE Shaw then is that they have a, a quantamental approach. So is that what the combination of having a fundamental view through more traditional techniques, but then utilizing quant data technology to support your decision-making process.

Yeah, I think so. The fundamental view is, it's kind of like the— almost like the macro view, right, where you're, you're thinking about the fundamentals, you're gathering. So it's not technical, it's fundamental. And the thing about that is there's so much data out there Right. There's so much economic data, and especially if you're a global remit where you're able to place bets and trades all over the world, well then, right, it's about harvesting vast swathes of economic data from all over the world and like inputting it into your models. And then your quant models that have been programmed to process and digest all of this stuff and spit out ultimately a strategy, right? We, we need to buy this now and it's gonna go up to there, or we need to sell this now 'cause it's topped out or whatever, right? So yeah, it's about harnessing way more volume of information and then systematically packaging it and spitting out a strategy that's based on all of that evidence. So it's something a human being couldn't do, hasn't been able to do in the past. And yeah, just way more sophisticated way of going about it.

So you mentioned then that these bigger companies, so like a DE Shaw, might have different funds that they're running. And the, the second biggest fund that they have is called the Oculus Fund. I love the names that they come up with for these. Just sounds intriguing.

That's sales and marketing.

The Oculus Fund.

Yeah. I want, I want to buy into that.

So that mostly makes macro wages in the market. And that was up about 7.8% last year. So the diff— a simple difference then, a macro compared to a multi-strategy. Yeah. But how would, what, what would be the marketing difference there then that you would pitch?

Well, a macro, yeah, macro I guess is when I said the fundamentals earlier, I, I kind of, I did focus only on the macro. There is micro fundamentals as well, which is like data about companies, right? But macro is very much top level. And it was a big year for macro in terms of the pivot I've already spoken about where we thought the macro environment was negative, but it turned out to be positive. I can't, I mean, honestly, I can't remember a year where the outcome at the end of the year was so different to what we thought was going to happen at the start from a macroeconomic point of view. And because of the Fed pivot from inflation is going to stay higher for longer, we're going to have to raise rates more, to right quick, we're going to cut, we're going to cut, we're going to cut. Such a big pivot that, that meant we got this big swing in markets. And these funds, look, 10% for— oh no, less, 7.8%, wasn't it, for their Oculus fund. I go back to the S&P, it's up 26. Whilst you look at the league tables for hedge funds and 7.8 gets you into like the top 10, it is not a good year. It's not a good year compared to the broader market.

So I just had a quick look. I mean, the Oculus Fund, it's never had a negative year. It's been annualizing at almost 13% since its inception, 2004.

Right.

Over the same period, the S&P is just under 10. But I don't think it probably takes into account actually last year's, which will bring it closer.

But, but that, that proves my point exactly, right? That's alpha where you, you've basically got a 3% alpha year on year on year on year on year compounding. Great. That's value, right? But that's on average across 20 years. But last year they were massively underperformed. It wasn't a small underperformance. No, it's half of their 20-year average, and it's like a quarter of what the S&P— or not quite a quarter, but like 3.5 times less than what the S&P returned.

So, okay, so there was one hedge fund. Yeah, you've probably never heard of the S&P, beat the S&P by a comfortable margin, and it was the only one because there's, there's a second one I'll mention which came close. And the rest were quite far behind, all centered around that 10% kind of level. It's called Discovery Capital Management. They're a macro hedge fund. And what I like about this guy, uh, he's a Tiger Cub. His, his name's Rob Citrone, uh, and his fund saw a 48% return. So just to be clear here, you've kind of alluded to the fact that last year was super hard for macro managers. To catch the pivot. This guy smashed it. Now, why is he— first of all, two things. What's a Tiger Cub? Why has he got this cool nickname? So he's a protégé of the legendary investor Julian Robertson, who ran the hedge fund Tiger Management back in the '80s, and it became one of the most successful hedge funds in history. And basically, protégés of Robertson are all known as his cubs, basically. They go out into the wilderness, fend for themselves, and generally do very well. And this guy, Rob Citrone, his angle here for 2023, his funds' gains were driven by long bets on equities. So I'm sure he got hold of that pivot and rally into year-end. Sovereign bonds in Latin America, US credit. As well as long and short wages on financial stocks. The one thing I did like though about this, now to talk the book the other way.

Yeah.

So, this fund had a spectacular 2023. So how did they perform in 2022? They were down 29%. 2021, up 18%. 2020, up 55%. 2019, down 23%. So this guy definitely swings it about. It's a wild bat out and goes, right, I'm definitely looking forward to '24. Sat with this, this fund because, uh, it's either boom or bust, it would seem. So does go some way to show though that to outperform just a passive investment you've literally gotta be at the fringe probably of your view and where you're putting your cash. And that can go one of two ways essentially. The second person is probably the polar opposite individual. I would hazard a guess is a guy called Bob True. And actually in preparation for this episode, I watched a YouTube video of him. You would think that he's probably like, if he lived in a small town in in England and you went to go to like a local accountant's office where it has two members of staff. There's the guy that, who's the accountant, and then there's the lady who brings around the cups of tea and biscuits at lunchtime. And it's kind of like, this guy's so unassuming and he's so quiet. You would never have guessed it, but his hedge fund was the second leading one on the list. And it's called Bernegat. The fund came, came second, had a return of 22%. So didn't quite match the S&P, but was double the performance of some of the giants in that respect. Now, let's be straight, it's much smaller. I've had a look through recent years. I think his assets under management have gone up to about $2.5 billion. They're currently tracking sub-1 at the moment. There's some fluctuation. But what I thought was interesting here is going back to your example of your your biggest trade or your most memorable one is a fixed income relative value hedge fund. So, or perhaps you could explain, because this was probably cuts to the strategy of probably what you were trading in many ways.

So yeah, relative value then, that's, it's just another kind of key strategy type and it's designed to be lower risk. You might sometimes hear it being called market neutral It's basically pair trading where basically you're— well, I guess, look, there's systematic and there's unsystematic risk. Okay. Systematic risk is, it's like kind of the macro stuff which has an impact on everything. All right. So if the Fed in their meeting in January comes out and hikes interest rates, Right, which would be wildly against expectation. Let's just say that happened. That would be a systematic risk where it's just going to affect everything. I mean, all asset classes and pretty much every financial asset within all of these classes, right? It's a big top-level event that impacts everything. That's systematic risk. You can't do anything about that as a trader or an investor, or even a, to a degree, a, a company CEO, you, you can't alter or influence how the Fed's going to behave, but how they behave will ultimately potentially heavily influence how you perform. Okay, so if you're betting on stocks, if you're buying Tesla, right, well then fine, you're taking risk, you're taking unsystematic— sorry, you're taking systematic risk because Tesla will be influenced by interest rates, but you're also taking what's called unsystematic risk. So unsystematic risk is then, right, with the Tesla example, is right, what is the micro? You know, what are Tesla's, I don't know, unit sales or deliveries? What's their profit? What's their revenue growth? All the rest of it, right? And all of that stuff is controllable by Tesla. It, to a degree, it's controllable by investors as well if you're big enough. And you've got a big enough shareholding and you manage to get yourself a seat on the board, then actually you can control this kind of stuff, right? So you've got systematic, you can't control that, and unsystematic. If all you're doing is going long Tesla, you're taking both risks. Okay, now what some hedge funds like to do is to say, well, look, that's too much risk. We don't want to be like your Discovery Capital who are wildly up in 2023, but massive car crash in 2022, wildly up in '21, massive downside in 2020. They don't want that because it's not attractive when you're trying to sell your fund to potential new investors, right? Investors don't like wild seesaw swings. They want to see consistent outperformance year on year, right? The D.E. Shores 13%. On average, bang, bang, bang, bang. That's what, that's what attracts funds, okay? So they want to trade in a less risky manner. So what you'll find is rather than just going long Tesla, they might pair that trade up by going short something else that's kind of corre— you might go short, I don't know, Chevron, okay? Oh, sorry, not Chevron, um, Chrysler was what I was going to say, right? So you might go long Tesla, short Chrysler, two automotive companies and you're really taking the bet that the EV space is going to build and the old school, you know, the, the kind of the legacy players aren't going to be able to catch up, right? So you're long one and you're short the other. The thing is here is you're removing systematic risk, because what happens if the Fed hikes? Both companies' share prices drop sharply, right? Well, fine, you're long Tesla, you're going to lose money, but you're short Chrysler, you're going to make money. Net-net, you're neutral. So you're remove— you've removed your systematic risk. So all you're then trading is the unsystematic risk, and there you're betting on Tesla to be able to win market share versus a Chrysler of this world. Okay, so that's like a relative value trade, uh, using a simple kind of equity example.

Yeah, what I like about what Bob had to say about his strategy was that he said, I'm not trying to anticipate unexpected events or catalysts that other relative value managers look for. He says they've already happened in creating such pricing divergence. I'm simply betting that rationality will ultimately prevail.

Right. So it's almost like a reversion to the— it's a reversion relative value trade in a way, but he's using fixed income, which is kind of what I used to do where in many ways you're looking to try and— I don't want to get too technical, but like trading, trading the shift in the shape of the yield curve. So you might be long 2 years and short 10 years because, you know, you're, you're looking for that shift with regards to the price and yield of one duration bond versus the price and yield of the other. Um, yeah.

And just to make this like a clear differentiation between— I know some of our listeners might retail trade But Bob, like you, it would only take a 20, 40, 80 basis point move, and that's massive.

Yeah.

Which a retail trader would be absolutely unhappy about from a size of a trade. So how does this like kind of leverage come into it?

Well, yeah, and that's actually a really good point because you can, you can justify much, much, much bigger positions because your overall risk is lower because you've got this relative value play on. So you, you can justify in throwing, you know, multiple size, multiple larger size positions, right? So as you say, all you need is a little bit of a tweak, a little bit of a tick, um, a small, relatively small move in your overall strategy can translate into a large return. Um, you can leverage it up. I don't know what this guy's trading, but we used to trade Government bond futures. So that's a derivative product on top of the underlying fixed income asset, which then, you know, using derivatives also enables you to leverage up your ultimate position size as well. So, but yeah, bigger positions because you're taking overall less risk. So you only need small moves to make actually a decent return.

So we've kind of got these polar opposites then between Rob and Bob, as it were. One's a super alpha. He's out there batting, hitting for the home run. The other guy's playing a bit more safe, conservative. One thing that Bernegat doesn't do any marketing. In fact, I read they actually turn away funds.

I like this guy.

So who would you be then in this scenario if you were going to be a hedge fund manager? Would you want to be out there marketing it, beating the drum, and have like a big massive AUM figure by your name? Or this guy apparently has got an office in Hoboken in New Jersey, not even in the main space in Manhattan where all the others are, or in Connecticut. He's just doing his thing so he could be close to his kids apparently and take them to school.

Yeah. No, I think it's probably a mindset thing. It's probably a work-life balance thing. You know, you're either, dare I say, like super alpha, you know, I'm going to take over the world, you know, your ambition is almost infinite where, right, yeah, you aren't happy just sat, you know, with a team of 3 people in your living room, essentially, you know, doing small relatively small stuff. You're not content with that because you want to take over the planet. So you are out there, you know, it's about brand, it's about, you know, and a lot of hedge funds and a lot of asset management, a lot of the job which people don't appreciate because all you think about is, well, I've gotta make investments and I've gotta manage a portfolio. I've gotta try and make money. Huge part of it is about sales and marketing. Uh, and it's a huge effort globally for them to get out there, sing and shout, you know, call your fund something snazzy like Oculus, because it's great brand, it's a great branding, and, and just get out there and raise more capital. So, but some people out there, there's an interesting thing, um, where when it comes to trading, right, if you're trading your own money versus trading other people's money, people behave differently. So if it's your own money, some people feel like, okay, it's mine to lose, right? I'm not going to hurt anybody else by losing my own money. So they feel a little bit, they feel less inhibited and they feel freer and they feel more confident to get out there and take the decisions and not hesitate, right? And those types of people, if they take on external funds and they start having clients and they got to answer to the clients, They're like, well, A, some people don't like that, that they feel a more heavy burden on every decision they take because it's not just themselves that might get hurt now. That's number one. Number two, it is a pain in the ass to deal with clients versus not dealing with them, right? Because clients you've got to be, you know, sending reports to, you've got to be, Answering for your underperformance when it happens and dealing with outflows and inflows and all the rest of it. It's a whole different ballgame. So yeah, this guy, look, I think he's less ambitious. He's content. He obviously wants a better work-life balance. He's happy to work with what he's got. And look, good for him. And I love the fact that he turns down money. I like that a lot because basically what he's saying is, I don't know what I would invest that money in at the moment. I've got some trades on. I don't really want to add to them because I don't feel more risk here is appropriate. I don't have any other great ideas at this point. So you know what? I'm not taking your money. I respect that a lot. Most people go, yeah, bring it on in, right? We'll just lump it into what we've already got. We'll just take more risk, or we'll just get forced into trading something that maybe we wouldn't have done if we didn't have that money. So yeah, there's lots of things going on there.

Yeah. The, the final point on, on this before we look ahead to, to 2024 was that, yeah, you reminded me of a conversation I had with a, a PM probably about 2 years ago, and he's let, since left that role. But he was saying that he, as you rightly said, what he underestimated the most was the amount of time that had to be put into talking to your investors.

Yeah.

And he was like, he, he actually said that at the time, the other people around him, he had to be spoken to about the way he was talking to the investors, right? Wasn't palatable because he was just talking about the strategy and it's making money. Like, what are these questions?

Yeah.

But actually, your job is to be a client kind of manager in that sense, as well as invest. So Yeah, really important point. All right. Well, look, I'm going to set you a bit of a challenge then for the second half of this episode. We're going to look ahead for the year. There are 5 different areas. I want to see whether you can summarize then the outlook in these 5 distinct areas with just 2 or 3 minutes on each one. So we'll kick things off and talk about interest rates first.

Yep. And that's, that's king still. I mean, it was last year. I mean, it was the year before. Well, I guess it's inflation. Okay, maybe it's different this year. Sorry. So last year was inflation, right? Is it coming down? And right, when will the rate hiking cycle end? This year it's going to be, right, well, inflation, certainly in the US particularly, inflation is back down. So does it continue to go down and become too low? Does it go back up? You know, so it's still about inflation, but ultimately it's about, right, well, what does the Fed do about it? And here we are at the start of the year, consensus forecast, 6 rate cuts in 2024, 25 basis points each time. Okay, so that's a 1.5% locked off the headline interest rate by the end of this year. That's, that's huge, right? So obviously I think the big risk is, well, is that going to happen or not? And we shall see. I mean, there's a kind of slight sort of subplot in some ways because what happens to inflation is a function of how the economy performs. And the kind of slight subplot is the political situation. So fiscal policy where you got most, to be honest, a huge amount of democratic economies have elections this year. you know, the US and the UK included. And so, right, in an election year, do the current incumbent pump the electorate with loads of tax cuts? And, all right, that could stimulate the economy, could be inflationary as well, by the way. Or do they not do that? So there's a whole kind of subplot this year, which wasn't there last year, which is this political situation. But ultimately, 25— sorry, 6 interest rate cuts Feels like a lot to me. And just a further point, there's two reasons why they would cut. There's two types of interest rate cut, you might want to say. Number one is a disinflation cut. That's what we're hoping for. That's what we're pricing in. That means inflation continues to fall, so the central bank cuts interest rates to keep the real interest rate level. All right, so that's interest rate cuts with no recession. That's your sweet spot for things like equities. So that's a disinflation interest rate cut. The other type of interest rate cut is, well, hang on a minute, the economy's in trouble, and so you're cutting rates to stimulate growth. That's a bad interest rate cut, and, and stocks in that scenario would go down. Right? So it's not as easy to say, well, hang on, interest rates are going to go down, so stocks go up, full stop, no matter what. It's not like that. It could be that stocks go up, but they could go down depending on why the interest rate cut is happening. That's the Wuhan.

Actually, as you're describing that, I mean, I would have that 6th rate cut. It's almost like And we feel like a lot, doesn't it? Many times over the last year we've discussed this a lot where there's an unexpected event, so a news-driven event that happens, whether it's a CPI above or below expectations, whether it's a geopolitical event or something happens, and the market has this knee-jerk reaction where it seems to overextend. So I'd love to see some back-tested data over this kind of inefficiency of mispricing over that mean reversion where Every time there's a news-driven event of X magnitude, the market, it feels like, tends to always overstretch and then come back. I'd like to know by how much does it overstretch, what's the time frame of how far it comes back. Um, would be an interesting study to look at. So any, any, uh, quant-oriented students out there who want to do some research for me to set up the, uh, I don't know, I'll have to come up with some sort of AlphaGen name type fund to, uh, run the strategy in. But, um, all right, so that, that was interest rates. So the next then is, is long yields. And maybe first off, what is long yields? And then what are we talking about?

Yeah, all right, so long yields, this is talking about bonds. And let's just talk about the king of all bonds, which is the US government 10-year bond. Okay, we call that the Treasury. US Treasuries and the yield on that, which is a hugely important sort of benchmark rate that borrowing, you know, particularly for like corporate borrowing through corporate bond markets— how much does it cost for a company to borrow money through the bond market? Is really— it's as much a function of the US Treasury yield as it is the Fed interest rate. So whilst you might have the Fed cutting rates, fine, that means borrowing cost is going to get lower, certainly for the consumers out there, right? But what about corporates? Well, actually, if you want to borrow over 10 years, it could be that the Fed cut rates and the short end of the yield curve drops. So 2-year yields drop, definitely, right? It doesn't mean the 10-year is going to come down with it. So we could have a scenario where even with rate cuts, the 10-year yield stays, I don't know, 3.5%, 4%, which is double what we've been used to for the last 15 years. So post-financial crisis, the 10-year yield's been 2%, but now it's 4%. So does it stay 4%, in which case, even with rate cuts, doesn't mean borrowing costs are going to go lower for everyone in the system. So that's one thing to kind of look out for, that 10-year yield and where does that go.

All right. Now the big one for a lot of investors out there is the Magnificent Seven. And actually, let me just remind myself, because I did clock at the end of the year, roughly the end of the year, the Magnificent Seven stocks had risen 75%. So you talk about these hedge funds and their 10%, and then you talk about the S&P at near 30, Yeah. Magnificent Seven, 75% and now make up about 30% of the entire S&P 500 index. Here's some numbers for you. NVIDIA, 235%.

Boom.

Meta.

Yeah, that's 200%.

There's a, from the grave. Yeah. Meta, 194%. Tesla, 106%. Amazon.

That's gotta help.

Amazon, Amazon don't have AI. No one, no one's interested in Amazon. Amazon up 83%. Alphabet, 60%. Oh, everyone's really gangbusters. Microsoft, OpenAI, they were actually came 6th out of the 7th.

Is that right?

Wow.

I wouldn't have predicted that.

They were up 50% only. And then Apple were up, sorry, Microsoft were up 56%. Apple were up 50%.

Right. I mean, yeah, I mean, look, 50s, absolutely incredible, phenomenal. But unfortunately, when you're competing with two— what was it, 280?

235.

I mean, it's just literally insane. Right. So the key question then, looking forwards, we know what's happened. Amazing year last year. They carried the team. But what happens in 2024? And here there's a real— oh, it's incredibly difficult to predict, I would say. Do we have a good year economically and rate cuts, that Goldilocks thing, right? Everything goes up. Do we have— actually, there's a recession and we're wrong about being positive and these rate cuts come in, but they come in for bad economic reasons. Well, what happens then? Do these stocks come down or actually do they not? Because basically we're not quite sure what these stocks are in terms of how do they behave. So are they growth tech stocks? You know, well, yes they are, but are they going to behave like that? If they were, they'd drop sharply in a recession. Okay, but I thought they were defensive stocks. Wasn't that proven by at least the first half of last year? Because interest rates were going up sharply and they're, you know, they're not interest rate sensitive. So that was the place to go. But hang on, if interest rates are going to come down, isn't the opposite argument true then? The interest rate sensitive stocks should outperform, therefore bad news for the Magnificent Seven. So are they defensive? Are they cyclical? Are they a duration play? Are they, I mean, what are they? So actually no one knows the answer to that question. There's a potential argument you could say it doesn't matter what happens. Whatever scenario you paint, you could spin a positive argument for these, for certainly some of these stocks. But so that's a real outlier, a real— that's, that's a real unknown, I think. Um, and you've got most of the investment community fully wedged in, into these 7 stocks. You could say there's still a lot of cash sat on the sidelines though that could come in, but Yeah, everyone's got a bit of action on these 7. It's just, are they willing to add to those positions or are they going to be, ooh, best take a bit of profit? I think that's a really hard one to predict.

I'd say that they will outperform the index again, but nowhere near to the magnitude of what we've had this year. But I think that they will benefit in both scenarios. To see that outperformance. This is not investment advice.

I'd probably agree.

All right. So 2 more to wrap up.

Yeah, 2 more.

Bond equity correlations. Yeah.

Sorry. Yeah, go on. So stock and bond correlation. So like, if you go back through the years, the kind of general default idea is that bonds and equities have an inverse correlation. So when equity prices go up, bond prices go down. And I'm talking bonds here, I'm talking about the safe stuff. Let's just say government bond. Let's just say US, let's take the US Treasury and the S&P 500. Okay. Normally long-term they move in opposite directions. Normally, right? One's a safe haven, one's a risk asset and so on. What happened in the back end of 2023 was very unusual because both went up, both The prices of stocks ripped through the roof. S&P finishes 26% up on the year, most of that in the last quarter. The 10— oh, sorry, bond prices went through the roof as well at the end of last year. The 10-year yield dropped from 5% down to below 4%. When yields go down, prices go up. Again, that was about the Fed pivot, right? Pricing in now rate cuts. Okay, both went up a lot over a sustained period of a few months. And this is the interesting thing. So when you're looking at a 2-year correlation between these 2 assets, the last time we had a positive correlation for such a long period— so on average over the last 2 years, there's been a positive correlation. The last time that happened was in the year 2001, meaning it's incredibly unusual. Now there's two schools of thought here. One is, well, if it's that unusual, it can't continue. So we're going to revert back to the inverse correlation. Now that doesn't tell you, well, hang on, do stocks go down and bonds continue to go up? Or do stocks carry on going up and bonds come down? It's a, it's a, even though the correlation might return to being inverse, doesn't necessarily help you. You've got to decide which way it's going to go. Um, the other thing is to say, well, maybe we're back into a, a different era because we've had a bond market rally for 40 years. And there's lots of people out there who think the 40-year rally's over. Um, and so it could be that this bond rally that we've seen into the end of the year is short-term, and you might get stocks and bonds going down this year, meaning the positive correlation remains. Remember, they're going in the same direction, up or down. That means the correlation is positive. So there's a few— obviously, like with everything, there's a few moving parts here, but it's something to think about. The end, the back end of last year was really unusual. We had such a powerful positive correlation between these assets as they both went through the roof. So maybe can't last.

All right. And last but not last, last, last, last.

Let's step out of the US and think about the rest of the planet, because what happened at the end of last year was everything went up. Stocks across the world, uh, Japanese stocks had a phenomenal Q4. European stocks went up. I remember on the podcast a few weeks ago, we were talking about the DAX. That's the German index hitting record ever highs when Germany are like the sick man of Europe, right? Where they're in recession and things aren't looking great, and yet Stock market new highs. So everything went up, basically fueled by the US and the Fed's pivot. And because the US is such a big engine for the world, if you're gonna have a boom in the US, great, everyone's going to benefit. Now, so the thing is, the US stocks went up and the rest of the world's stocks went up, but the rest of the world's stocks went up without strong economic conditions like the US saw. U.S. stocks went up with strong economic conditions. The rest of the world went up without strong economic conditions. So globally, are these elevated global stock index positions sustainable if there's no kind of economic recovery in some of these places that have seen weakness. And you'd probably put China, you know, right at the top of that list as to, well, economic concerns going forwards. Yeah. And being such a big economy, of course, then, you know, what happens in China economically this year, and then from a monetary policy and a fiscal policy point of view, is, is as always really important.

Any, any black swans for '24? I can't say I've actually read Anyone talking too much about that this year?

Yeah, I think, I think everyone got burnt. You know what happens at the start of the year, right? Let's all have our posi— let's all make our predictions. What's going to be the S&P at the end of the year? Basically everyone had a shocker 12 months ago predicting XYZ. None of it came true. So you've definitely had a massive reduction, it feels like at least, in people stepping out and making predictions. Including your black swans and stuff. So yeah, I, I don't know. I mean, you know, in the end, like we saw last year, the big powerful force is the Fed. Do they cut 6 times? Do they not? Ultimately, that'll be the biggest influence from what we can see. There's always your unknown unknowns, and obviously you can't predict those.

Trump or Biden?

If it, if it's Trump versus Biden, then Trump will win.

All right, on that bombshell, thank you very much, Piers. And yeah, feel free to, uh, drop us a comment if there's anything else you'd like to hear, uh, in any forthcoming episodes. But hopefully that was a, a good breakdown of some of the terminologies around the hedge fund community, and then also a bit of an overview top-level-wise on the macro front for the year ahead. All right, thanks, Piers. Thanks, everyone, and see you next week.

Yep, have a good week.