FM: So you built them to adapt.
MS: For us research is one of the things that we thrive on. We constantly try and see what edge we can bring.
FM: Give us your outlook for fixed income and the yield curve.
MS: The yield curve currently is not in the normal market behavior [mode]. It has been manipulated by policy interventions and as a result they don’t reflect the level of debt that is out there, it is not reflecting the economic activity and it is dominated more by fear and flight to quality than by other economic factors. It is quite clear that the front end, Fed funds, are [set]. The Fed told us that they are going to keep it there. The real surprise is if they are forced to move earlier than they predicted. If the front end of the curve is going to be pegged, the real question is what is going to happen to the long end of the curve? The major factor that has been affecting [the long end of the curve] is on one hand QE or the Twist that kept buying the long end and the other part is the flight to quality that absent other safe investments, people are just putting their money there. As long as we will be in that state of mind of flight to quality, the yield curve could go into more threatening [territory] and lower rates. But is it sustainable for the long run? Probably not. How are you going to justify 10-year notes at 1% unless the world is really coming apart?
FM: Treasury markets are rallying sharply today (end of May); we are on all-time highs.
MS: That is flight to quality, the realization that the politics in Europe are not going well and the U.S. economy is not showing any signs of sustained growth.
FM: Many famous bond traders lost money last year because they didn’t gauge the power of central bank interventions. Is it a risk to the market that central banks have been so active?
MS: First, even last year there were opportunities in fixed income. Many of the quantitative strategies did make money last year. It was a difficult market for discretionary traders to try and identify or relate fixed income to fundamentals. But from a price pattern point of view, since the spring of 2011 until the fall, we were in a move toward lower rates globally and then we went into a period of uncertainty. That is why tactical participation is so important. Then over the last couple of months, we started a new round of flight to quality. When the government is that involved and creates basically artificial level of rates, the main trigger is, ‘What is the effect of the policies on the real economy, on the level of confidence, on the level of uncertainty?’ When they are unable to appropriately deal with those factors, we [see] what we are seeing now -- the markets are much more vulnerable. That is the major concern. We spent a lot of ammunition. We manipulated and intervened in many markets and put them at levels, especially in fixed income, that they wouldn’t have been at on their own. At the same time we have very little to show as a real achievement that we were able to get to with those kind of policies. So we spent all that ammunition and have little to show for it.
FM: We are in the midst of a 30-plus-year bull market in bonds. Is that just where we are until there is a recovery and there is going to be an unwind? When it happens is it going to be smooth?
MS: I doubt that it is going to be smooth. What fixed income did 10 to 15 years ago probably isn’t relevant to what it is going to do now. What is important is the kind of structures and the kind of positions that the most different environment of the last three years has supported. That will affect the exit strategy of the Fed. The level of unprecedented and accommodative policy will lead to significant unwinding consequences when they happen. When they happen, no one knows. When the environment will change the market will tell it loud and clear and we will have to respond to it.
FM: Will there be much global divergence? Will the European and Asian markets unwind similar to U.S. markets?
MS: It is uncertain. How the global markets are interconnected to one another is something that keeps being redefined almost every day. Globalization brought about a flow of capital from one country to another and we were not in that kind of an isolated scenario anymore. At the same time that globalization made the fact of one economy [tied to another] that more significant, and as a result when somebody has a disease very quickly it spreads to other areas. [Remember] in 2008, in the first half, we were still talking about decoupling, how the U.S. problem would not affect other countries and then everyone realized in the summer that the U.S. problems do affect other countries and suddenly it became a global problem. We don’t have that decoupling, the problems affect everyone. And [because] everyone benefitted from those global accommodative monetary policies, if they start to reverse the effect of it will also be global. How it affects different countries depends on their own economic situation at the time. Is there room for divergence? Yes. Will it happen? We will have to wait and see.
FM: So we are still in limbo?
MS: We are still in [these] unchartered waters in terms of policy; we are still in this transition period in terms of [the] economic, financial and political landscape. The world is full of uncertainty.
FM: Is managed futures the best investment for people to get into with all this uncertainty?
MS: More and more investors can look at quantitative strategies and managed futures are included, as being uncorrelated to their traditional portfolios and that relates [to managed futures being utilized] more and more as a diversifier. Many factors contribute to the rising interest. Many traditional portfolios — with 60% in equities and 40% fixed income — didn’t serve as a good investment in the long run and [investors] looked to be more in other strategies that tend to be uncorrelated. Managed futures with its ability to be on the long and short side of markets, ability to listen to the markets and, in the case of quantitative studies, ability to tactically [enter] the market, has proven to be a great diversifier. Investors are seeing it, acknowledging it and responding to it.