Into the Mind of a Macro Manager – with Archbridge Capital

By Hakan Kocayusufpasaoglu, CIO of Archbridge Capital, with an introduction by Simon Kerr

Introduction

Some hedge fund strategies are more difficult to engage with than others. Most investors could understand what equity hedge funds do, but other strategies can be difficult (like volatility arbitrage) or just opaque (like most high end CTAs). Global macro investing, one of the original hedge fund strategies, has a whiff of mystery about it – how do those “Masters of the Universe” read global flows and politics and market dynamics inside one brain? Hedge Fund Insight asked Hakan Kocayusufpasaoglu, CIO of Archbridge Capital, to go through an example of a position from idea generation to implementation. Here is how he develops his trade ideas.

Reading the Global Economy

8.30 am, October 2012, A rainy day in the office. Like everyday it is time to make sense of the vast array of data that is released daily and informs us of the wellbeing of our global economy. Each country’s health matters and has a substantial effect on the financial markets. Like detectives traders evaluate each market in order to understand what discrepancies exist between their view of the world and what the financial markets are pricing; the markets’ view of the world.  Questions like: Will the eurozone exit its recession? Is China going to slowdown? Will US economic growth continue? and how will that affect the financial markets? require thorough and ongoing analysis of macroeconomic data. And the analysis starts with every morning.

Our proprietary forward indicators for the US are strong, showing a decent recovery for the US markets. Again budget talks in the news. About time that they agree finally, since we already know they will not let the USA go bankrupt simply because Congress does not agree an increase to the budget numbers.

Hakan Kocayusufpasaoglu

Best to fade that part of the newsreel. Bloomberg has plenty of other news stories of interest. Getting back to our daily analysis of the world. Our proprietary and faithful overnight system breaks down the economies of the world into indicators that we like following and also updates our proprietary indicators nightly so that we have our own forward looking guidance and a decent opinion about where we are for each defined economic region in the business cycle. Let us see what ‘Inspector Gadget’ (yes, our proprietary system has a nickname, which in this case was given because it can do so many things, from relative value analysis to macroeconomic story building) has to say about Euroland. Overall nothing positive to report except that there seems to be a small break-up risk compared to last year. But the overall economy – verdict: recession.

Turning to Japan, hmmm, a more interesting, but pessimistic outlook: disaster! Savings rates are diminished substantially, some months even worse than the USA (and the US consumer is not known for its propensity to save). Trade deficits are occurring frequently in Japan. (Isn’t the Japanese economy supposed to survive on exports?) Suzuki is going bankrupt in the USA (ie the US division of Suzuki) citing high Yen levels. With Japan’s debt levels at 200+ % – this country will hit a wall. And what happens then? The only viable thing is for the exchange rate to depreciate as it happens with all countries that hit a wall. This is getting interesting especially since the Yen has been made much stronger since the ‘08 crisis and has remained strong till today. This needs further investigation!

The Japanese Situation Commands Attention

Japanese GDP in 2011 was negative, while in 2012 only the first two quarters were strong (and clearly coming from a low base) and the third quarter was near zero growth. And all these real GDP numbers are bolstered up due the rampant deflation that has been plaguing Japan for more than a decade. Deflation nationwide was still around 1%, excluding food and energy.

What a country – with anaemic growth rates, an ageing population which has been propped up for years on government stimulus which has driven countries debt to GDP to above 230% (today more like 250%) – it is impressive if one thinks about it.

In contrast Greece is rolling over and having to be bailed out when their debt to GDP is exceeding 130% of GDP and here we have a country which for years has had deflation, anaemic growth but a strong credit and bond market with a AA- rating all the while having debt levels which would have caused any european country to default! How can this be?

Having analysed countries, including Japan, for over a decade and a half I know that this is due to a uniquely Japanese situation. 90% of all issued bonds are in the hands of domestic investors: it is their conservative nature and their ageing population of savers that is enabling such a large debt level to exist without causing the country to default on its debt. Deflation, however harmful to an economy’s growth rates, has meant that savers are rewarded and interest rates are kept low. In other words, debt servicing costs are tremendously low for years with the 10 year JGB rate at 0.25% for the last few years and savers getting rewarded in real terms for their savings. Imagine, then, that you are a saver. Why would you care that interest rates are very low if there is no inflation? In fact prices are falling every year, making the real purchasing power of your savings increase however low interest rates are (and nominal rates cannot go below zero).

So overall a very high savings rate has over the last decade or so financed the government’s debt levels, while exports have assured that economic growth, though anaemic has continued to grow and herewith has financed the governments injection programmes and debt levels. However, all of this should imply a relatively weak currency rate. Hmmm, but the yen has been bid up over the years since the 2008/9 crisis as it was considered a safe haven, while also conservative Japanese have repatriated their fortunes to the homeland and away from what they perceived as risky, foreign investments.

For a long while I was playing the thought of shorting the yen against pretty much all other currencies in the world, since at some stage the country had to simply give up. I never did, because for years there was no catalyst, exports were financing economic growth and savings were financing government expenditure and bond issuance. However now, for the first time since the 70’s when the Japanese ‘wunder’ started emerging we are seeing that trade deficits are cropping up consistently, not just one month of data. Exports are suddenly not financing gdp growth anymore. The engine is stalling. At the same time savings rates are diminishing – the other engine is stalling. Japan must be hitting a wall soon. Especially now that the crisis and fear levels are abiding we have to think that the yen will finally weaken…Inspector Gadget you again did your trick, pointing us to the right direction of analysis.

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