Finding Leviathan: Big, Fat Carry

Feels like perhaps we're approaching the turn now, but people say that sort of thing a lot so I’m going to try once again to paint a little Jackson Pollack collage to illustrate the invisible.

So hard for a fish to grok the water.
1/
Note that when I say “approaching the turn…” well, this stuff moves slow so:

- There is always plenty of time to think
- There is nearly always plenty of opportunity to trade long and short tactically even if markets trend in a particular direction.

Don’t get all hotheaded.
2/
Last March was a carry trade unwind. In fact, the point of this book is that most things are a carry trade unwind.

What is a carry trade?

It’s a trade that makes money when nothing happens.

Selling volatility is a carry trade.
3/
And right now all the volatility guys (who are the smartest) are like, “yeah that shit unwound though and we don’t have the same risk profile now.”

And they’re right.

Well, about ravenous vol selling, probably. Still some of that but it's less.
4/
But as this book I’ve been harping on lately “The Rise of Carry” (buy it; read it) notes —

“…as liquidity in the economy starts to evaporate, rather than all carry trades crashing at once, certain carry trades may crash while other carry bubbles become even larger.”
5/
What is a carry trade?

It’s a trade that makes money when nothing happens.

Back in the day, the mortgage bubble was a carry trade - and on a number of levels. Property owners make money when nothing happens, as did those yield farming mortgages.
6/
2008 was a series of layered carry trades that set off a daisy chain of carry trade unwinds.

All that yield farming which was going so well suddenly started to get painful - things that “weren’t supposed to happen” started happening and invalidated everyone’s models.
7/
Carry trades have gravity - as they stabilize, they exhibit Sorosian reflexivity. The trade becomes “obvious” and attracts more and more capital, and the profits from the carry get reinvested too.

The most dangerous forms of carry trade are the ones that seem bulletproof.
8/
Back in the mortgage crisis, this was homes. Home prices never went down - at least not that much!

This was a bedrock assumption that everyone based their models on

Carry trades need and thrive on bedrock assumptions, because…. well…

What is a carry trade?
9/
It’s a trade that makes money when nothing happens.

But then things so start to happen, and the bedrock gets invalidated all the other derivative carry trades sharing that same assumption start to unwind too.

The bedrock assumption is the assumption appears unassailable.
10/
So what’s the big carry trade right now?

Well we need to know what the ‘bedrock assumption’ is. And again, we turn to our friends who wrote Rise of Carry (buy it; read it).

The bedrock assumption is that the Fed has our backs. So what do you buy if the Fed has your back?
11/
You buy American Exceptionalism. You buy target date funds. Buy your 401(k). Buy your kid’s 529 plan. Buy the FIRE movement. Buy sector ETFs. Buy the reflation trade. There's foreign liquidity inflows.

There's baked-in diversification.

You buy the S&P 500.
12/
You buy the bedrock belief that, for the faithful, equities go up.

You buy the calm assurance that an investor who doesn't lose their cool will weather the storm. The 60/40 portfolio but... I mean... why bother with the 40 amirite?
13/
Because of course… the Fed won't let equities drop. They can't - it'd be unthinkable. National security. Retirees. Society.

Just like Americans would never mass default on their homes - they never have, and why would they? Too proud.

Of course they wouldn't.
14/
Because of course, this inflationary pulse will translate into higher profits for these corporations.

Of course the government will continue to fund consumption to fuel this, even after the meat of the pandemic is over.

Of course it will.
15/
Because of course, bundling and indexation is a sufficient form of diversification when it comes to risk assets.

Of course it is. It's the state of the art in de-risking, in safety.

What is a carry trade?
/16

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More from @coloradotravis

15 Sep
I don’t own any crypto, and I don’t own any gold.

But I respect the Keepers of the Rock here.

If you don’t like crypto skepticism, I recommend you skip this one.
1/
Where did you first hear about Bitcoin — who told you about it?

Where were you sitting? What did you do next to learn more about it?

I’m serious pull up the lineage of your understanding in your mind’s eye.

I’ll wait.
2/
Do you have it now — your epistemological timeline?

That is your trust chain.

It’s yours, and it’s personal, and like a fingerprint no two are alike. Some chains are complex and some are a bit more off the cuff.

This is how we learn.
3/
Read 16 tweets
14 Sep
The chart looked ready for a bounce
And so the capital deployed

But then that knife just kept falling
Down, down into the void
I feel like everyone who says I don’t appreciate the arts when observing that NFTs are nonsense needs to experience more of my original slam poetry.
Gap down on these sick lyrics.
Read 4 tweets
7 Sep
Game Theory & Bubbles

This whole game theory thing gets talked about a lot on here, but a lot of it is just hand waving or 101 bush league stuff.

So let’s talk Game Theory 201 for a hot second.
1/
So most people are familiar with the Prisoner’s Dilemma.

This is the simplest setup — both prisoners have a personal incentive to defect, yet cooperation leads to the best net outcome.

This thread assumes you’re already familiar with the simple form here.
2/ Image
But this simple form is damn near irrelevant when it comes to most practical applications.

Why? Because the construct assumes that only a single version of the game is played.

The interesting bits of game theory don’t even get started until we start repeating this game.
3/
Read 15 tweets
5 Sep
So I occasionally run into people who have like 1 or 2 seed stage investments that they ‘feel good about’ and I instantly know they’re doing it wrong.

Let’s talk about some basics of venture investing.
1/
The first thing to understand is that *most startups fail.* I mean it’s the overwhelming majority.

So even if you’re a savant at picking them, most of the capital you’re allocating is going to zero.

What does that imply?
2/
Well it’s a bit like the long vol gang, really.

Since most of your bets are going to zero just statistically, you want to make sure each opportunity shows our source has a chance of a huge payout if it goes your way.
3/
Read 8 tweets
5 Sep
One of the things a good VC will ask you toward the end of a pitch that’s going decently well is, “Why now?”

Like - sure, perhaps there’s a business here, but why hasn’t someone already built it? What’s changed?
1/
It’s a great question: a lot of the most successful startups are formed on the back of some subtle shift that would previously have prevented that business model from thriving.
2/
Sometimes these are regulatory sometimes it’s consumer behavior.

For us it was market convergence around a version control system (Git) that we built analytics on top of.

Without that convergence, the market would have been too fragmented to go after.
3/
Read 7 tweets
3 Sep
I don’t think this liquidity is from the Fed.

Now - people talk about liquidity a lot and wave their hands about it, but few bother to define it because… well, that bit is hard and it’s better to just smirk wisely than actually put forth a disciplined view.
1/
And while that’s snarky, the truth is that defining it is hard - especially in today’s world where memes are a constant assault on the senses.

Liquidity is bout big, meaty capital flows.

And it’s about the geopolitics of trade.
2/
To better understand this, let’s think about simpler times — times when currencies were, in some sense, a representation of how much gold a country had.

Overly simple, but imagine a currency’s value working like stocks: split the shares, the total company is still worth X.
3/
Read 18 tweets

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