Taking a Look at “Macro” Trading

Having spent decades in the markets, I have seen almost every strategy out there...

The most well-known is picking stocks based on analysis. This is what the legendary Warren Buffett has primarily done with Berkshire Hathaway Inc. (NYSE: BRK-B), what made Peter Lynch famous with Fidelity Investments' Magellan Fund (where he posted an average annual return of 29.2% for 13 years), and what enriched countless hedge fund managers—including myself!

There are many other strategies, though. The largest one after picking stocks is called "macro," which in this case stands for "macroeconomic"—the study of the greater global economy.

While this strategy can include individual stocks, it's mostly focused on trading large asset classes like bonds, interest rates, commodities, and anything you can take a view on.

A simple way to understand it is that if you have a positive view of copper, you buy copper futures or the metal itself instead of trying to buy the best copper stock.

When executed correctly, this can be an incredible strategy for making money in any market environment.

Some of the most famous traders employ macro strategies, including George Soros, Paul Tudor Jones, Ken Griffin, and dozens of other big-name money managers.

During my Wall Street days, my funds took many macro views (e.g., a view on copper) but tended to express these views through individual stocks. Over the years, though, I have begun to have a greater appreciation of macro trading and have employed it both personally and professionally.

One of the great things about macro trading is that you are betting on big underlying asset classes.

This matters because, over time, "mean reversion"—or returning to some sort of long-term average—is much more likely.

For instance, let's go back to our copper example. Maybe, at some point, we'll be in a world where either we no longer need to use copper or find so much copper supply that it changes the market for the metal.

Here's a historical chart of "real" copper prices going back to the 1860s—" real" means that it's adjusted for inflation, so the numbers are comparable. As you can see, copper has traded for roughly $1 per pound to $8 per pound for nearly 175 years.

And do you know what copper has never done? Gone bankrupt! How many stocks have been around since 1850?

Another traded asset class is government bonds and interest rates... But how do you trade interest rates?

Remember that when interest rates go up, bond prices go down. This is because the newer bond issuances at the higher interest rates are more attractive and devalue the previous lower interest rate bonds.

Someday, the U.S. could go bankrupt... but it's not happening anytime soon!

We haven't seen any major economy go bankrupt in the past 100 years, and even the emerging market economies that have gone bankrupt haven't paid zero on their bonds.

For macro investors, one of the benefits of having these large asset classes, which are some of the most liquid in the world and will never go away, is that they can employ a lot of leverage.

While it's rare for a stock fund to have more than 2 times or 3 times its assets in stocks, it wouldn't be unusual for macro funds to have five times, ten times, or even 30 times.

This can create some incredible returns but can also result in disaster.

I have written numerous times about the collapse of Long-Term Capital Management in 1998. That fund's destruction almost brought down the entire financial system and economy!

I don't recommend individual investors use this kind of leverage for the most part, but some leverage can be smart on occasion.

For example, here at HX Research, in our HX Trader publication, we have repeatedly recommended triple-levered exchange-traded funds ("ETFs") on different stock indexes. We would be unlikely to do this with any given stock, but with these assets, you are sure they aren't going to zero.

For instance, please look at this chart of the 10-year U.S. Treasury we came across last year around this time…

At the time, we noted that it was becoming an interesting area to monitor and could present a great opportunity. Whenever you see something happen for the first time in two-and-a-half centuries, you should be interested!

If this were a stock, we know it could go to zero. But that is not happening with U.S. government bonds – not now and not anytime soon.

Do you know what ended up happening?

Since then, the 10-year US government bond has had one of its better twelve-month periods! It is up almost double digits…

“Macro” is a different type of investing but one that can be very powerful!