Navigating Market Complexities: Insights from the Trading Desk | EP172

Can I ask you to provide a bit of a reminder as to as long term investors were buying businesses. But the way that we do that is by buying stock. And so what is the trading desk's role in our investment process. So once research makes an investment decision the traders job is to make that dream come true. So basically what we're doing is they've decided they want to buy or sell a stock but that doesn't happen the instant the decision is made. Someone needs to go and click that button and interact with the market to make sure that we can indeed buy or sell that stock. And just due to the nature of our holdings that can be more or less difficult. We hold some small cap names we hold a lot of large cap names and those trade in a very different- in a very different way. The trading team's job is to know how those different stocks behave what the best way is to execute them. Asia is just different. There's different regulators, there's different investors, there's different requirements and so that leads to many differences and nuances and it's tougher to trade. Got it. Rita you mentioned not only is the job to focus on the execution once the investment decision is made, but there's also this being in the market and reflecting information back to the team. We're recording this the week of the US election. I can imagine there's a lot out there to follow day to day and I'm just curious how you manage that and specifically how you decide what's relevant to pass back to the investment team. It's been a busy week for sure. We had the US election and then followed immediately after that there was the US Fed rate decision and US Fed rate decisions have had a very meaningful impact on market moves recently. Versus back in 2016, the Trump win was a surprise and there was an extreme move and extreme reaction to that and a lot of the time if it's an extreme move or an extreme reaction or it's a surprise, then you know it's not noise, it's signal. But like Rita said, our job is to execute around those small-term movements. So just to go back to what is a carry trade, I mean a carry trade is when you have a low-yield currency that people will short to go buy a high-yielding currency and make an incremental spread between the two currencies. And so what was talked about a lot was people shorting the Japanese yen and investing that money into the U.S. dollar, which had a higher interest rate at that time. That's correct, yeah. And so that was what a lot of people were actually using as the offset for the currency trade. Now that's the currency trade element, right? There's different perspectives or different angles on the currency trades. And what it boils down to is what kind of happens to the incremental buyer-seller. And so once those incremental buyers on that day start to get exhausted, then the price starts to really move. And that's when it kind of takes on a life of its own. And in the Nikkei terms, I think it closed down 12%. It was basically the largest one-day loss since the 80s or the 90s in Japan. And it has a life of its own. The conversation with the research team, and we certainly own a number of Japanese businesses, some more domestically oriented, others more global in nature. How does this risk or this awareness, how does that influence those conversations? I see. So if you're trying to buy a U.S. stock and you're trying to you're trying to fund that by selling European stock, you've got to plan ahead because effectively a day a day ahead of time. Yep. So there is a lot of planning going around on this, especially because and if you're holding different securities and different currencies as well, you have to keep the settlement cycle as well. Like currencies also have a separate settlement cycle. So there's a lot of different moving parts. And why was this done initially? Like, why did they compress the settlement cycle? So basically, they were looking to reduce margin requirements and to reduce settlement risk. On the margin side, can you dig into that one a little bit more? Well, if you go back to like the meme stock craze and Robinhood and they couldn't meet their margin requirements when, you know, at the height of the meme stock craze and they just didn't have enough money on hand. But if the if the settlement cycle had been shortened at that time, that might not have been an issue. You're getting your money sooner. You don't need to. It reduces the funding requirements and the margin requirements. OK, so are you suggesting that the move to T plus one might exacerbate excesses in the market? Good question, Rob. I think there is talk about the movement, the move to T plus one, perhaps sending more signals. So, for example, if you need to borrow a stock and that stock is hard to borrow, like in the US, you have to you have to be certain that you can borrow a stock before you short it. And it's all kind of public. People know what's hard to borrow and whatnot. But if you need it on a T plus one basis and you fail to deliver, it sends that signal earlier. So is there information leakage because they've compressed the timeline to a T plus one? I don't know if that answers your question, but I don't know that I know the answer to your question. Well, that's part of the fun of the job, I suppose, is just watching to see how some of these impacts might play out over time. We've sort of danced around one of these already just in the discussion about leverage and I suppose my question on stability. Can you talk a little bit about that? I mean, it seems like markets have become quite a bit more volatile. I don't know if I think I read somewhere that fixed income markets are expected to be more volatile with the recent election results. I don't know if the same is true for equities, but just in general over the last several years, are there aspects of market structure that have either increased or decreased volatility? Are there structural reasons for this or is it just uncertainty? Are there aspects of market structure that are contributing to that? I think there are several things. You have these zero-day options that will increase volatility. You will have HFT that will try and pick up signals from long-term investors and actively buy it ahead of them. So that increases volatility. HFT being the high-frequency trading? High-frequency trading. Zero-day options trading. I think those are probably the two biggest ones in terms of moving stocks in the short term. And zero-day options, Peter, I mean, for those who are less familiar with this, is this effectively a coin flip on what will happen to a stock over the course of a single day? Yes. Okay. Yes, it's 100%. And then sometimes I think there's even some regulation issues on these zero-days, like in terms of the brokers that are offering them. And so there's issues around that. Like even just the ETFs, there's the two-time or the three-time leverage ETFs, and they're very structured in how they operate. So they square up over the course of the day, and that changes how a stock will trade during that day. It has to. And so that – we know that there's a day trading element in some of these markets, and we know that sometimes they will trade on things that we don't necessarily care as much about from an institutional investing point of view. And then Taiwan is largely – it can be retail, not as much local institutional, and a lot of foreign investors. And so those all come together a little bit differently in why stocks react. Oh, wow. Okay. So if your goal is to front-run an institutional investor and take advantage of those momentum swings, the higher that number is, the more likely it is you have a long-term investor that's buying a stock versus day trading. So I agree, the momentum shifts can be quite different and they can be long-lasting. Like in India, when you had demonetization with gold wanting to be tracked, what that causes is a lot of investors to invest into local mutual funds. Sometimes it sells offshore, but for the most part, the big picture is you've had a strong momentum. So they've come in with like a minimum tick size and so they're going to reduce that. So basically stocks that were quoted at a penny will move to half a penny and they're thinking that that's going to benefit the retail investor. And it leads back to this idea of accessible versus inaccessible liquidity. So what happens in the US, like a lot of much of the retail flow gets bundled and it's actually inaccessible. And it just really highlights the importance of the retail investor and how valuable people consider that flow. So in terms of volume throughout your day, I can imagine that there's a spike at the beginning of the day as markets open. But are you saying there's increasingly more liquidity and volume at the very end of the day now than previously? And are we talking like the last five minutes, the last half hour? Like what are we talking here? It's a separate auction in the US and in Canada. Okay. What does that mean? Is it better to trade midday or end of day? Or like, what does this mean? So for our purposes, I would say it's more looking for liquidity at a price. Okay. They're impactful. I didn't say anything, but Japan is 20%. So if you don't miss, if we don't participate in the closing auction, our participation numbers drop substantially. Okay. So it's a really big deal. Presumably that influences you knowing that there are, I don't know if this is the right word, but predators out there. You kind of want to go big on day one to, am I thinking about that right? Okay. Back on overcrowding, pod shops. I've heard a little bit about these recently, effectively these multi-strategy head funds. What's been their influence on markets? And so people were pre-positioning ahead of this, and that might be, for example, something that a pawn shop might do as well. And again, they're very secretive, so I can't say for sure. Yeah, that's the mystique of trading, that's for sure. I mean, we're talking about secret models and kind of what these guys are doing and who's blowing up and what country are they in. And the reality is, when you look at some of the strategies that are employed, like the long shorts or the market neutral events, the reality is that most of these guys are employing leverage and they're piling on risk. So it creates more risk in the market. And I would assume that there's probably a bit of a cycle with the risk. So when the market gets over-complacent, prime brokers are lending out more money, these guys are getting more capital to do more trades. And their investors want them to make more money, so they're using more leverage and taking on more risk. And then it's a house of cards, and when it hits, it falls apart really quickly. Because they've got to manage that risk just through, if something turns, pretty tight stop-loss. And what ends up happening, this has happened so many times in history, is that people haven't managed their risk properly. And then that's when we read about it, right? And this is something that keeps coming up in the market, so it's probably going to happen again in the future. And I think it leads more to human behavior, so complacency or humility. Those are some of the things that I think about. Yeah, momentum. Even going back to Japan and the carry trade, I think some of that was just over-leverage. People just were borrowing money. And so when the tide turned against them, they have to sell. There's margin calls that are happening, right? So it's when things surprise people, that's when the market kind of seems to turn and go quickly. Now, as long-term investors, sometimes these are opportunities for us. So volatility can lead to opportunities. The toughest part about trading or buying something when everything else is down is, is this the time? Is this the day you should be doing it? It's hard for a lot of investors to do that. But that's the opportunity it creates. If we didn't have volatility, we probably wouldn't need traders. The computers could just do this for us. We haven't spoken about algos and stuff, but there is a lot of computer trading today in the marketplace. And they're sophisticated and good. Yeah, I was going to bring that in because you mentioned humans. And I could also imagine, as a long-term disciplined investor, sure, this might create opportunities at some point. But could it probably be pretty painful for a while, too, if these really crowded trades that are perhaps artificially bolstered through leverage, momentum, success, flows, markets dominated by retail that really chase some of these trades, it could be really painful not to be on that side of it. And then you brought in algos, which effectively are regression models based on what's happened in the past. And if these models have been very successful in the past, they'll extrapolate going forwards. Do you have that sense, too, that it's also actually really hard in that type of market? Yeah, I mean, I think for sure, right? I think if you look at who has been successful long-term with quant models, like Renaissance or Rentech, what strategies they have employed and how have they been able to have strong returns over a long period of time. Well, some of them are systematically and have done very well for long periods of time. But then we don't talk about all the ones that haven't worked out and have left the marketplace because they failed and they weren't good at what they were doing systematically. So, yeah, I mean, the market is very smart. It's tough. It's a tough game. It's a tough job out there to get these things right all the time. It just is. And I think anybody, any investor out there should use the tools that they can to help them, whatever their approach is. And even though we don't necessarily trade on quant models or using like stats to trade, we are open to learning about that to try and do that for clients. I think just going back to like an example where, yeah, sometimes the NVIDIA, if you're not involved in that, it's painful to be. It's painful to be not involved while the ETF, all the fund flows in the ETF start to carry some of those names. We've also seen it on the reverse where it's been a benefit. So we have securities that get added to the index. And for fundamental reasons, we think they're good, good companies. And then we get incremental investors that come in and push the price up. So we've seen it on both sides, right? It's not, I mean, NVIDIA is when you get one stock that might be outperforming the market. There are other examples out there that have benefited our clients over time. And so it's a bit of, you know, it's just kind of how the investing side of things work out sometimes. Okay. Greta, I want to give you the last word, if I might. Markets are basically at all-time highs. Yet what I'm detecting from our conversation is that there are structural, perhaps, fragilities that might be higher than they were in the past. How do you reconcile the two and what's your advice to clients? What do they do about that? Well, I think one of the great things about our funds is that we are looking at individual companies and there's always an opportunity to find that trade or to find that name that hasn't just been piled into because it's popular. We're looking at unpopular or unknown companies and just to be aware that, you know, sometimes you're just following the herd and maybe that's not the best strategy. Very good. Short and sweet. Peter, Rita, thank you so much for coming on the podcast today. Peter, I'm sure it's close to time for bed for you. Enjoy your Friday evening. Enjoy the weekend. And Rita, time for you to get back on the desk for the Friday here in North America. Thank you.