- Where The Hell Do You Get This Stuff?!

A commenter on a previous post asked me a perfectly reasonable question which when I thought about it, I was a little surprised I hadn’t seen before. It’s right here (in the comments section), but to paraphrase, he basically said “Where the hell do you get all this stuff anyway?” That’s a fair question I think. I consider myself somewhat less apocalyptic than many others in my circle, but some of the speculation I offer is still pretty far out there. And I think if I were on the receiving end of it I’d probably be asking the same thing. So for his edification as well as others, let me explain a little about my own information gathering process.

First to speak to you directly James, yes I’m a quant, which in the strictest terms means that the trading strategy I run lets the computer make the actual trading decisions rather than the decisions being made based on my moment by moment discretionary judgment. But when you’re designing a trading strategy, if all you know is math then you are only half way there. In order to make money you have to understand virtually everything that ‘discretionary’ traders do, and all the math as well. Every sword maker wants to be a Samurai, but the career graveyard is full of skilled mathematicians who believed that their math knowledge was enough to turn a profit in the markets.

A better way to think about it is that a ‘quant strategy’ is really the same as a discretionary strategy with a single difference. The tweeks and tunes that we make to our strategies are still done based on our discretion and our judgment, but we make them more infrequently and more methodically than your average discretionary trader. We still need to be tuned in to the markets and still need to be prepared to revisit our base assumptions. But we’ve designed the computer system to worry about the minute by minute issues, so we can focus on the big themes.

And even intra-quant the lines aren’t very clearly defined. Some quant strategies rely very deeply on higher math while others rely more on an understanding of the markets. I can’t discuss it too much in this format, but the strategy I run is more markets focused than many others in the quant space. My own area of expertise has to do with the way that markets discount new information. I’ve spent most of my career studying it. And when you layer that over the top of my career (spent mostly in Macro focused hedge funds), in most circumstances I tend to sound more like a Macro/Commodity guy and less like a pure quant.

So, to the nuts and bolts of ‘where I get this stuff’ the answer is ‘in lots of places’. But as generally informal as the structure of it all is, there is a methodical process around it. Let me give you a partial example.

This evening I’m meeting a few friends at a Christmas party. Among our little circle there will be two “C level” executives at a well known hedge funds, two senior staffers in Research and Trading at others, a department head from the NYSE and an FX Trader from a major bank with 20 years experience. (Virtually all of whom are also regular readers of this blog and whose comments can be found all over the place.) Since I try to stack up my Manhattan socializing, I’m also getting together before that with one of my oldest friends in the business who was the head of Commodity Trading at DB, but now just runs a Billion dollar trading book at a Hedge Fund.

Apart from being first rate at their jobs, all of them also have areas of particular expertise that I like to tap when I have the chance, and this evening will be no different. My FX trader buddy not only knows all the ins and outs of the currency markets but he’s also an expert on the effects of inflation and sovereign credit risk. He knows as much about what happens in those moments of civil crisis as anyone I’ve ever met (and is also the only civilian I know who’s ever actually shot someone). One of the research guys has a deep understanding of what’s happening in European markets, which is particularly tough to do for those of us on the outside because if you aren’t focused on it, it’s such a developed market that it can be hard to see the forest for the trees.

All the other guys have areas of focus which they bring to the group too, as do I. They’ll all ask me about the state of affairs in relative value trading, HF and the quant space. The FI guys might ask me about commodities, and commodity guys might ask me about FI (since I know more on both those topics than they do respectively). And because they know it’s a particular area of focus for me, they all might ask about the current state of ‘bubbles’ across the globe.

No one asks anything too specific about what we’re doing, nor would they be willing to discuss it if someone did. We’re not trying to pick each other’s pockets. But we’ll talk about all the big issues. And when it’s all been said, we’ll take the data from those conversations back to our own firms and toss the most compelling ideas around among our peers. They will discuss them with their friends at other firms with everyone adding their two cents, and everyone sounding it all out. And from all of those conversations, a medium term ‘general consensus’ will form which eventually becomes the ‘conventional wisdom’ of at least my Macro Hedge Fund part of Wall Street.

Keep in mind, this isn’t like a journalist talking to a politician. The journalist usually has no expertise in anything except in repeating what people say. They don’t have any practical judgment or experience to act as a filter – they just repeat what they think sounds good. And the politician they speak to probably just buys votes for a living and doesn’t know much about anything at all.

Instead, these are conversations between people who have skin in the game. They have, over the years, been taught ‘how to think’ by the hardest experience. Because if they’re wrong more than they’re right, then they will end up unemployed. They are in the business of forming these judgments, and over they years I’ve come to trust their individual thoughts on particular topics as they have come to trust (or distrust) mine.

But that’s only a small part of what I relate. Some of the other stuff you asked about has been common knowledge on Wall Street for so long that I don’t honestly know where I first heard it. Something like the expectation you mentioned that ‘rioting happens at about 25% unemployment’ I probably heard for the first time while I was in school years ago. In that particular case, it’s like the idea of Mastodons roaming the earth. No one has actually seen one, but everything we have seen since points to it as logical so no one gives it much thought. Keep in mind, no one can tell when a specific riot is going to break out or particularly cares when that first rock is thrown. There’s no money to be made in knowing that level of detail so it’s irrelevant as far as we’re concerned. And we probably couldn’t guess anyway. But a general sense that unemployment in the low 20% range causes civil unrest does matter. And that broad statement is usually enough for Wall Street’s decision makers to frame their thinking.

And that raises another issue – documentation. A larger source of what I write here is either taken from formalized research or from informal discussions with people who generate formalized research for a living. Since it’s their job that also means that they’re charging for the service. Many of them you would know if you watch things like Squawk Box or follow the business news closely. But in many cases it’s often because of a personal relationship that they are speaking to me off the cuff. The long and short of that is that I’m probably not going to be able to provide you documentation or attributable sources for any of it. No one is authorizing me to give away what they are selling, and I wouldn’t ask.

I can however give you my impressions of what they say or tell you the ways it changes my broader view of the world. I can’t for instance, reproduce the research that I was given about the state of China’s banking sector. But so long as I don’t name him, I can repeat that my buddy who produced the report thinks that a large part of the assets held by the Chinese central bank are just IOU’s from the PLA. I can also tell you what I think the consequences of an insight like that are. His conclusions come from distilling the facts through his years of experience in the area, and his distilled results are then mixed by me with my own. What you’re getting is my judgment after all of that. That’s what I’m writing here – in legal terms I think it can be described as well informed hearsay. In other terms, it’s all ‘off the record’ talk.

So why should you pay any attention to it? Well to be perfectly fair, if you think you shouldn’t that’s fine with me. But since I’m not trying to get money out of you, and I have no axe to grind other than those I state up front, I don’t see any reason to suspect my motives. (I don’t think you did James – I’m just sayin.) While I may be ‘wrong’ I think it’s apparent that I’m not trying to slip anything past anyone. I have my specific areas of expertise, and my friends have others which I think are interesting and entertaining to talk about. And I think it serves the broader interests of the country to get information from such skilled and experienced thinkers into public consumption where it can influence the broader political dialog.

The things I know as hard and fast ‘facts’ are usually things I’m trying to make money off of so I can’t talk about those. I won’t ever talk about specifics from my strategy, or medium term issues related from friends because those are our value added items. Knowing those things better or sooner than others is how we all make our living. It’s all independently derived stuff about Macro Economics – no insider trading. I can’t remember the last time someone mentioned a specific company. But the longer term speculation (which by definition is less precise and is therefore offered in less precise terms) I will discuss. I respect the opinions of the people offering the info – both formally and informally, or I wouldn’t relate them. But if you decide not to… it’s no sweat.

And the reason I don’t’ get worked up about it is because disagreement is part of the process. Although my friends, coworkers and I engage in this sort of speculation for a living, and most have demonstrated a level of success over the years, on any particular issue there are plenty of people out there who think we’re full of it. In fact, we often disagree with each other about all sorts of things all the time. That disagreement is the way our individual opinions are tuned and tweaked to match what we expect the world to do.

And that’s the heart of the thing. If there is some ‘truth’ offered here it’s a consensus truth. I don’t generally offer views I disagree with, at least not without saying so. But it’s equally unusual for me to offer an opinion of my own that hasn’t been passed through the filter of my circle of friends and coworkers. This may not seem like much, but you should remember that my friends are all experts in related subjects and each has their own area of deep expertise. When I ask them what they think of X they know there may be money on the line. So although we’re friends, they tend to guard their credibility carefully. Since in this business, in the end, credibility is all you’ve got.

They (really) are the reason I think this is interesting enough to write about. It’s because I respect what they say so much that I think it’s worthy to repeat in some form to all of you. It may just be chatter – but it’s the chatter of guys who are some of the best thinkers in the world in their particular space. And because I value it, I assume others probably should too.

I hope this answers your question James, but if it doesn’t or if you’d like to know about something specific please - always ask, and I’ll tell you what I can within the constraints I mentioned. Thanks.