The Economist - USA (2019-11-30)

66 Finance & economics The EconomistNovember 30th 2019

2

Buttonwood A league of their own

I

f you watchmuch too much televised

football (soccer, if you must), you will

often hear a particular lament. Whatever

happened to the playmakers, the socks-

rolled-down mavericks whose individ-

ualism could alter the course of a match?

The question is invariably posed by

grizzled ex-pros. They are saddened but

also puzzled by the systematising of the

modern game. Players go through a

series of prescribed moves (“automa-

tisms”) when they get the ball. Passages

of play are minutely choreographed.

This leads us smoothly to Louis Ba-

con, a game-changer in the world of

“macro” hedge funds, which make bold

bets ahead of predicted shifts in the

macroeconomic climate. Mr Bacon is to

close Moore Capital, the hedge fund he

founded in 1989, to outside investors

following poor returns. Many of his

peers have already quit the game. Hedge

funds are bleeding institutional capital.

Cue much sad shaking of heads by

grizzled ex-pros. The markets game has

changed, they grumble. It is now a play-

ing field for well-drilled algorithmic

traders or for index funds which passive-

ly hold a basket of leading stocks. The

minutely choreographed policies of

central banks act to suppress the market

volatility that hedge funds thrive on.

There is no place for the individualist

who makes a variety of bets at his own

discretion. A lot of this is true. But the

prognosis is too bleak. Many of the great-

est hedge-fund trades have been bets that

official efforts to suppress volatility,

such as exchange-rate pegs, would ulti-

mately fail. Playmakers of Mr Bacon’s

stamp will surely make a comeback.

To understand why, go back to the

1970s when a first wave of macro traders,

including George Soros and Michael

Marcus, made their names and a lot of

their money. The end of the Bretton Woods

system of fixed exchange rates created

opportunities. There were newly volatile

currencies to wager on. Inflation also

surged. This, along with advances in the

pricing of commodity futures and options,

spurred interest in the trading of grains,

beans and metals. A new school of macro

traders, which later included Mr Bacon,

emerged from the Commodities Corpo-

ration, a trading company founded in 1970.

Commodity markets provided a great

training for trading currencies and bonds.

Supply veered from shortage to glut. Offi-

cial price controls added to the fun. The

shifting forces of global economics and

politics amplified the volatility.

Betting that a currency peg would break

became a signature hedge-fund trade. An

early example was a bet made by Michael

Marcus in 1975 that a surge of oil revenue

would force Saudi Arabia to revalue its

currency. The exchange-rate crisis that

brought hedge-fund managers blinking

into the limelight was their bet made in

September 1992 that Britain would aban-

don the pound’s peg against the Deutsch-

mark. The Bank of England was obliged

to sell its foreign-exchange reserves to

buy pounds at a fixed rate for as long as

the London market was open. Mr Soros

sold as many pounds as he could. By the

time the peg broke, he had made £1bn

($1.8bn at the time).

Mr Bacon was on that trade, too.

Earlier, he profited from the stockmarket

crash of 1987 by piling into the safety of

bonds, which rallied in the aftermath. He

also made a tidy sum by predicting the

impact on oil prices and the stockmarket

of Iraq’s invasion of Kuwait in 1990.

Crunch situations like these are when

the truly gifted macro traders come into

their own. They have many of the qual-

ities of great playmakers. They are able to

see things that less gifted players cannot.

They are unhurried under pressure. They

know when to bide their time and when

to go for the jugular. And they can imag-

ine a world that might soon be arranged

differently and work out the implica-

tions. “Don’t try to play the game better;

try to figure out when the game has

changed,” Mr Soros would tell col-

leagues. The most profitable trades

would often come after periods of calm,

when volatility had been suppressed

either by complacency or official fiat.

Macro traders are not comfortable

during those placid periods. They have

struggled for much of the past decade,

which has seen a steady upward grind in

asset prices. Inflation has been absent, so

central banks have been free to respond

to any signs of trouble in markets with

easier monetary policy. But stability

breeds instability. Over-coached foot-

ballers do not respond well when a game

takes an unexpected turn. Investors

schooled in calmer markets may similar-

ly struggle with renewed volatility. One

day, the playmakers will be back.

Do not write off the macro hedge-fund manager just yet

broader trend masks a chasm between

state-owned and private companies. Of the

firms that have missed payments on bonds

this year, 89% have come from the private

sector, according to Fitch. s&pGlobal cal-

culates that 12% of private issuers since

2014 have defaulted, compared with just

0.2% of state firms. Over the past two years,

private Chinese companies have been

more likely than global issuers of junk-rat-

ed bonds to default.

This has only reinforced investors’ ten-

dency to prefer state firms, in the belief

that the government will usually act as a

backstop. State firms have issued the vast

majority of bonds in China this year; priv-

ate firms have been all but shut out. In oth-

er words, it is not necessarily the most de-

serving firms that are attracting capital, as

the central bank would like, but rather the

best-connected firms.

The simplest way for China to change

this is to allow more state-owned compa-

nies to default. The few that have missed

bond payments in recent years have not

been enough to persuade investors that

government is cutting them loose.

So it was notable on November 22nd

when Tewoo Group, a commodities trader

owned by the city of Tianjin, asked credi-

tors to take haircuts of up to 64% on their

principal. Although its bonds were sold

offshore, the impact will be felt domesti-

cally, because many creditors were Chi-

nese. An eventual default would be the big-

gest on overseas bonds issued by a Chinese

state firm since the late 1990s. But it is also

only one step. Propaganda will serve as a

good test: when the state broadcaster starts

loudly reporting on the woes of state-

owned firms, it will be clear that China has

truly turned a corner. 7