Brace yourself, “Winter is Coming” Posted on


This is our third newsletter of the year and as always developments in markets, politics and the economy are so many that it is difficult to follow everything.
When investors start initially to muddle through the markets they tend to read almost everything. It is imperative, they think, to be well informed so that investment decisions prove profitable. It takes some time to realize that trading and investing takes more than merely following the news. After all, you will find all kinds of views and ideas out there and most probably you will stick with the ones that fit your personal opinions (confirmation bias). You will be surprised to find out that usually the more informed you are the less profitable you become!

The difficulty lies in ones’ ability to separate what is signal and what is noise. In the markets the signal-to-ratio ratio is so low (for good reasons) that investing becomes more of a probabilistic game than anything else.

So what is the signal and what is the noise in today’s markets?

We will present to you our own take of the story and we will cast a spell so that we stay safe and secure!
Progressively since the crisis of 2008 investor behavior has become increasingly dependent on central bank policies worldwide. Such a behavior has been intensified since the introduction of quantitative easing along with the perception that central banks will “do whatever it takes” to attack any source of instability in the system. The dominance of central banks on markets has been accepted as certainty by most market participants. The side effect of the current state of affairs is that price action is no longer an expression of the economy but it rather reflects excessive confidence on central banks ability to intervene and “make things right”.
The confidence that markets put to central banks has changed the state of the game and has created a source of instability by itself. It is a risk that you don’t see, it hides in the realms of capitalism itself and it can prove disproportionately costly for everyone. Some people call it “shadow gamma” or “shadow convexity“, as it underlies a hidden risk that is highly non-linear in nature. To put it simply:
Most probably, we will be OK, but if things turn bad it will be really really really bad!

Imagine a scenario where investors lose confidence in their central banks: a crisis where the government or central bank is expected to step up and “do whatever it takes” to resolve things but proves unable or unwilling to do so (e.g. populist revolt). As improbable as this may sound this is a grave risk.

In markets (as in life) there are known-unknowns and unknown-unknowns. One cannot predict when (if ever) such events occur. Our advice is to seek ways to protect yourself from extreme events.

In our portfolios we actively buy protection for such extreme risks. The “tail-risk” strategy aims to cover exactly that so that we enjoy good returns in stress-free markets and protect ourselves when things turn really bad.

Currently, our portfolios posted new highs. We have the comfort to enjoy excellent performance but we are not complacent. Rest assured our minds and thoughts are tuned to protect our client’s portfolios from such extreme events.

So our friends, here is a warning, brace yourselves and be vigilant because “winter is coming“.

Enjoy a trouble free and tail-free summer!