“People always forget that 50% of a stock’s move is the overall market, 30% is the industry group, and then maybe 20% is the extra alpha from stock picking.” – Scott Bessent
Q1 2022 hedge fund letters, conferences and more
This week we’re unpacking a critical (yet often misunderstood) aspect of investing: Nobody and Everybody is a Macro Trader.
But before we do that, I want to quickly remind you that we’re opening up our Collective for new members this week.
The Macro Ops Collective is where the world’s best traders and investors sharpen their iron, improve their game, and have a great time doing it.
The Collective shines in today’s market environment, and here’s why. We have a go-anywhere approach that allows us to profit in any market under any condition.
That’s what we do in the Macro Ops Collective. And it’s one of the many reasons we’re up 25% YTD while the S&P is down 5%+.
Join below! We can’t wait to see you there.
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Alright, onto this week’s piece.
Scott Bessent said it best when he claimed (emphasis mine), “When an equity guy is playing airlines, he’s making an embedded macro call on oil. I honestly think that people forget what a macro trend is.”
Every investment decision we make is in some way a macro bet.
Of course, it’s easy to draw the connection between “betting on airlines” and a “macro call on oil” as anything related to oil is automatically “macro.”
But most FinTwit investors aren’t buying oil. They’re buying consumer tech, B2B SaaS, and other internet names. However, those investors are also making macro bets.
How exactly?
We can see these hidden macro bets by combining Bessent’s analogy above with Aswath Damodaran’s famous Google Talk, Narratives and Numbers.
Here’s the big idea: Investors that benefited from the insane run in tech/high-growth stocks wrongfully thought they were generating alpha from picking individual stocks.
Instead, they rode one of the most significant factor bets in recent memory.
They bet on Narratives when that’s what mattered most.
Why is this important? Because the market isn’t buying Narratives anymore. They’re buying Numbers.
We’ll unpack essential questions like:
- How did we get here?
- What happens when Occam’s Razor has no clothes?
- How can we adjust to this new macro bet?
How Did We Get Here?
Humans love stories, which makes sense. We’ve had language far longer than we’ve put pen to paper.
Stories are a potent tool in investing, as Damodaran explains (emphasis mine):
“We relate to and remember stories better than we do numbers, but storytelling can lead us into fantasyland quickly,”
Combining stories with financial markets is like giving Tom Brady a world-class receiving corps. It’s deadly.
Deadly because stories, if taken beyond rationality, have severe financial and psychological consequences. And we can thank reflexivity for that.
You can feel the power of storytelling (read: Narratives) woven through George Soros’ example of reflexivity below (emphasis mine):
“Financial markets, far from accurately reflecting all the available knowledge, always provide a distorted view of reality. This is the principle of fallibility. The degree of distortion may vary from time to time. Sometimes it’s quite insignificant, at other times it is quite pronounced.
Every bubble has two components: an underlying trend that prevails in reality and a misconception relating to that trend. When a positive feedback develops between the trend and the misconception, a boom-bust process is set in motion. The process is liable to be tested by negative feedback along the way, and if it is strong enough to survive these tests, both the trend and the misconception will be reinforced.”
Reread this part… “When a positive feedback develops between the trend and the misconception, a boom-bust process is set in motion.”
Reflexivity is how we go from “EVs are the future!!” to “Let’s roll our truck down a hill because it doesn’t work, but we want those sweet ESG funds.”
Tech/high growth investors didn’t make a straight macro bet like oil. Instead, they made an implicit macro bet on the strength of their stock’s narrative feedback loop relative to all other stocks.
Such narrative viciously fed off macro policies like “stimmy” checks, record low negative real interest rates (which incentivizes burning capital), and a Federal Reserve leaning into Reflation.
Rivian, Virgin Galactic, Peloton, take your pick. Each was a macro bet on positive feedback loops and which stock had the most viral narrative.
Maybe Alex was right after all.
Occam’s Razor Has No Clothes
There’s nothing wrong with placing macro bets on narratives. That’s how anyone with a pulse made money the last few years.
But like any market strategy, eventually, it stops working.
It’s tough to spot when a macro bet like Narratives loses its luster. Remember, it’s not like crude oil where you can draw a fancy log chart to spot the reversal.
One way to think about the changing of the guard is through an Occam’s Razor mental model.
Occam’s Razor states that when faced with two competing hypotheses, one should choose the hypothesis with the fewest embedded assumptions (i.e., choose the simpler hypothesis).
Now imagine the entire investing universe rests on a sliding “Occam’s Razor” scale. Over the past two years, investors have plowed trillions of dollars into “High Occam’s Razor” ideas.
These are your Peloton’s, Rivian’s, and (take-your-pick) ARK funds.
High Occam’s Razor ideas make wildly audacious assumptions about the world. They imbibe complex 10-year DCF models with aggressive margin expansions. They then slap altruistic sales multiples at the end to justify ownership.
The “problem” with Narrative macro bets is that investors focus on inherently good things about business, like customer satisfaction, addressable markets, secular tailwinds, etc.
I say “problem” because though investors focus on the above attributes, there’s no financial incentive to weigh these factors against reality.
There’s no incentive to pay a cheap price for the above characteristics because that’s not how one makes money in a Narrative macro bet.
You can’t pay expenses in TrustPilot ratings, but that doesn’t matter!
That’s how you play the Narrative Macro Bet game.
Then there are the Low Occam’s Razor ideas on the far left of the spectrum. These are your boring, cash-flowing generating companies that boomers own.
Narratives don’t matter (as much) here because these businesses already generate cash. They have proven business models. In other words, they don’t need to convince anyone about the story they’re creating.
Nobody cared about Low Occam’s Razor ideas because big money was made in High Occam’s Razor bets. Narrative macro bets.
However, this year, the tide has gone out on High Occam’s Razor bets. And we realize that one side of the Occam’s Razor scale has no clothes.
We’re seeing a shifting macro bet, from Narratives to Numbers, and the consequences for Narrative-only macro investors have been severe.
How To Adjust To The New Macro Bet
If Narrative is The Land of Narnia, Numbers is the closet portal back to reality.
We’ve stepped back into reality from Narnia so far in 2022. But most investors still invest like we’re in that magical land behind the mothballs.
There are a few simple heuristics to adjust to this new Macro Bet environment:
- Focus on Reality
- Pick Low Occam’s Razor Bets
- Discount Narratives
Let’s unpack each of these heuristics.
Focus On Reality
Numbers-driven macro bets rely on tangible results like cash flows, durable margins, and existing competitive advantages.
This means investors should focus more on current reality and less on potential futures.
It pays to look backward in a Numbers-driven macro environment. To seek businesses with a history of generating real cash for shareholders over multiple market cycles.
Pick Low Occam’s Razor Bets
Investors will naturally find themselves drawn towards Low Occam’s Razor bets by placing greater weight on reality. Companies that require the fewest assumptions to reach an attractive investment case.
Low Occam’s Razor bets aren’t sector/industry-specific, either. It could be as simple as, “Demand for x will increase because of a, b, c. If that happens, Company Y will be the best positioned to capture that increased demand.”
My old boss (who crushed the market for decades) would routinely say, “we invest in wipe ass/wipe face companies.”
In other words, buy things people need, regardless of economic cycles.
Discount Narrative Macro Bets
We know Narrative macro bets don’t work in Numbers regimes. But that doesn’t mean we stop searching for them!
Numbers-driven macro environments are a great time to collect a watchlist of Narrative bets (for when the tide eventually turns).
That’s what we’re doing at Macro Ops. Nearly every Narrative stock we find has a few things in common:
- Strong top-line growth
- Differentiated product/service
- Exciting future and large addressable market
But this fourth one is the most important …
- A bombed-out stock chart
Instead of stubbornly investing in what we know isn’t working, we keep these ideas on a watchlist for further study.
One of the best parts about Numbers-driven Regimes is that it gives investors plenty of time to deeply study more Narrative macro bets. So that when the time comes for Narrative to drive returns, investors are prepared with myriad options to deploy capital.
Don’t force what isn’t there. Don’t force Narratives when Numbers will do just fine.
Nobody And Everybody Is A Macro Trader
Bessent was right. Nobody and Everybody is a macro trader, whether they know it or not.
Macro bets come in all shapes and sizes. By combining Soros’s reflexivity with Aswath Damodaran’s Narrative & Numbers, we better understand which macro bets most investors make daily.
More importantly, we learned how to identify which Macro Bet environment we’re in (Numbers or Narrative) and how to adjust fire to maximize our time and profits.
One last thing!
Remember to sign up for the Macro Ops Collective if you haven’t already. And why wouldn’t you? We’re killing it this year doing what we explained above. We’ve shifted out of Narrative bets and focused on reality, on Numbers.
We’ve crushed the indices and generated 25%+ returns YTD in the process.
So what are you waiting for? We’ll see you inside the Collective.
Article by Brandon Beylo, Macro Ops.
