The Origin of Global Macro

Global macro is possibly the most academic and profound area of investment, beginning with John Maynard Keynes and thriving under legends like George Soros and Julian Robertson. Even the world's largest asset manager, Bridgewater Associates, led by Ray Dalio, belongs to this category. Despite such legendary status, for most people, global macro remains a realm of myth.

Global macro doesn't have a universally accepted definition, but it generally possesses five characteristics:

1. Global scope of investment

2. Multi-asset class

3. "Top-down" approach

4. Emphasis on liquidity

5. Creating trades with asymmetric risk and return

Typically, global macro is divided into two main categories: discretionary global macro and systematic global macro. The former relies on discretionary judgments about macroeconomic trends, using medium to long-term judgments on macro assets like interest rates, exchange rates, bonds, and stock indices as the basis for investment. Traditional systematic global macro, on the other hand, relies on computer algorithms to make trend judgments, with managed futures remaining the dominant strategy. However, since the 2000s, rapid technological advancements have brought some changes to systematic global macro, incorporating more cutting-edge technologies like machine learning and artificial intelligence.

Keynes and Global Macro

John Maynard Keynes is often considered the father of global macro.

Besides being a top-tier macroeconomist, Keynes was also an outstanding investment manager, achieving a 15% annual return over his 22-year investment career (1924-1946), which included the Great Depression of 1929 and World War II. During the same period, the British stock index had an annual return of only 8%.

Keynes initially expressed his views through foreign exchange. He went long on the dollar and short on the French franc, Italian lira, and German mark, betting that the latter would plummet due to post-war hyperinflation. He frequently used high leverage, nearly facing a margin call due to a brief optimistic market sentiment that caused the latter currencies to rise temporarily. This experience led to his famous quote:

"The market can remain irrational longer than you can remain solvent."

Eventually, Keynes raised more funds and increased his positions, and the market validated his judgment, leading to significant profits. He called himself a "scientific gambler." Keynes then ventured into scientific speculation on commodities, bonds, and stocks, developing various macro investment strategies, including interest rate prediction for bond duration switching, credit cycle investment strategies, and various timing strategies.

Transition to Value Investing

A few years later, during the commodity boom of 1928 and the Great Depression of 1929, Keynes once again came close to a margin call (in his personal account). This time, the impact seemed greater, prompting him to abandon his previous macro investment path and focus on value investing and contrarian investing in stocks. This transition transformed Keynes from a Soros-like figure into a Buffett-like one. Ironically, Keynes' outstanding investment returns came not from his global macro judgments but from value investing, a poignant fact for such a remarkable economist.

There are alternative explanations for this shift. After 1929, the world moved towards protectionism and nationalism, whereas global macro heavily relies on an open economic system. It is possible that Keynes recognized the upcoming challenges for global macro and decided to change his approach. However, the true reasons remain known only to Keynes himself.

In Keynes' later years, he profoundly influenced the trajectory of global macro for decades. The Bretton Woods Conference, which established fixed exchange rates and closed capital accounts, effectively made global macro investing disappear. It wasn't until decades later that it re-emerged.

Rise from the Ashes

In August 1971, US President Nixon removed the gold standard, marking the end of the Bretton Woods system of fixed exchange rates. Subsequently, in 1973, the OPEC oil embargo led to soaring oil prices, high inflation, and volatility, resulting in numerous high-liquidity commodity futures contracts in the financial market. This changing global landscape provided many opportunities for professional commodity traders.

Thus, after its rebirth, global macro first took root in the commodity sector, dominating for about fifteen years. One legendary commodity trading firm was Commodities Corporation, whose reputation rivals that of Long-Term Capital Management (LTCM).

Commodities Corporation was the world's first quantitative investment company, co-founded by Nobel laureate and legendary economist Paul Samuelson

and Paul Cootner, the proponent of the random walk theory and the father of efficient market theory.

This company pioneered the modern systematic global macro approach, creating the first computer trend trading system, thus founding the managed futures (CTA) field. It also pioneered multi-asset macro investing based on technical and fundamental analysis. Many of Commodities Corporation's multi-asset macro traders later became legendary traders themselves (Michael Marcus, Bruce Kovner, Paul Tudor Jones, Louis Bacon, Jack D. Schwager, Ed Seykota).

Commodities Corporation was also a pioneer in risk management. Many risk control measures in hedge funds today are modeled after Commodities Corporation. Unfortunately, like LTCM, the company no longer exists, having been acquired by Goldman Sachs in 1997.

Soros vs. Tiger

The second peak of global macro occurred from 1987 to 2000, a period dominated by two legendary figures: George Soros, the "man who broke the Bank of England," and Julian Robertson of Tiger Management.

However, it was actually Stanley Druckenmiller, Soros' right-hand man, who masterminded the famous attack on the British pound, not Soros himself. Yet, for various reasons, Druckenmiller's name is less remembered by the public.

Druckenmiller left in 2000, and Tiger Management closed the same year, plunging global macro back into obscurity.

If hedge fund as a concept strikes people as legendary, it is often due to these two figures. My earliest impression of hedge funds was Robertson's Tiger Management.

Soros and Robertson initially operated their hedge funds by mimicking A. W. Jones, the founder of the world's first hedge fund, in long-short equity hedging. Later, each developed their own styles. Soros' 1987 book "The Alchemy of Finance" was a public introduction to the mysterious world of global macro. His theory of reflexivity is still not widely accepted by mainstream economics, but we see more and more reflexivity-based explanations today, including studies on real estate cycles and bubbles. Soros acknowledges market noise but attempts to trade with it, famously saying:

"Invest first, investigate later."

For Soros, the real signal of an event might be unobservable, and price movements may already contain valid information. Waiting to find out what the information is might be too late. Sometimes, even if price movements don't contain valid information, they might generate reflexivity and create trends. This approach is also reflected in his risk management strategy; he often cuts losses when his positions suffer instead of validating his theory. Sometimes, he doesn't even have a theory.

Robertson's method is entirely different. He wouldn't invest until he thoroughly investigated the story behind the opportunity. If his positions suffered, he would reassess his investment thesis and, if still convinced, would increase his positions instead of cutting losses. In 1994-1995, we saw the risks behind Robertson's approach. He believed copper prices were significantly overvalued and should only move downward. He took a massive short position. However, copper prices inexplicably rose during this period, leading to the death of many hedge funds shorting copper. Tiger Management, however, held firm and eventually profited greatly when a Japanese trader was found manipulating copper prices in the spring of 1996.

This might be a good investment story. However, the market does not always behave as expected, and noise does not automatically dissipate. Sometimes, when noise contradicts information, rational traders may face margin calls. As Keynes said:

"The market can remain irrational longer than you can remain solvent."

Financial trading doesn't depend on asset pricing models from Ph.D. mathematicians; the existence of noise creates opportunities while also posing risks to arbitragers attempting to exploit these opportunities. It's easy to say that prices will revert to value in the long term, but most people cannot see the long term and lack the patience to wait for it.

The fate of Tiger Management was nearly sealed during this event. Its subsequent closure and the restructuring of the Quantum Fund dimmed the light of global macro once more.

However, after 2007, global macro saw new opportunities and vitality. We will look at the current landscape of global macro in future discussions.

Global macro is a fascinating field - I hope you like it as much as I do.

References

• Asness, C. and Berger, A., 2008. We're Not Dead Yet. Institutional Investor.

• Black, F., 1986. Noise. The journal of finance, 41(3), pp.528-543.

• Chambers, D., Dimson, E. and Foo, J., 2015. Keynes the Stock Market Investor: A Quantitative Analysis. Journal of Financial and Quantitative Analysis, 50(04), pp.843-868.

• Novy‐Marx, R., 2009. Hot and cold markets. Real Estate Economics, 37(1), pp.1-22.

• Peterson, R.L., 2016. Trading on Sentiment: The Power of Minds Over Markets. John Wiley & Sons.

• Rozanov, A., 2012. Global Macro: Theory and Practice. Risk Books.

• Shiller, R.J., 2015. Irrational exuberance. Princeton university press.

• Skidelsky, R., 2003. John Maynard Keynes 1883-1946: economist, philosopher, statesman. Macmillan.

• Soros, G., Wien, B. and Koenen, K., 1995. Soros on Soros: Staying ahead of the

Disclaimer: The data and information mentioned are from third-party sources, and accuracy is not guaranteed. This article shares information and views, not professional investment advice. Consult professional advice before making investment decisions.

This article was originally written in Chinese and posted on my WeChat platform in 2017. The Chinese link can be found here