Our outspoken CEO Keith McCullough just hosted an investing conversation with the equally outspoken hedge fund legend John Taylor.
If you don’t know John, you should.
In 1981, he launched what eventually became the world’s biggest currency hedge fund, FX Concepts. He oversaw the fund for over three decades, as assets climbed to a peak of about $14 billion in 2008.
No surprise, John and Keith had a lot to talk about risk managing today’s manic market moves. Both discussed lessons learned (losses and successes) from nearly 60 years of combined trading experience between them both.
Below we’ve transcribed key excerpts from the conversation between John and Keith. Watch the entire hour-long interview below.
Keith McCullough: I know you study cycles. That’s what I really wanted to talk to you about today. Benoit Mandelbrot would say, ‘What matters is the particular, not the average.’
The important thing is getting the cycle right over time. There are people that I have a tremendous amount of respect for – Stan Druckenmiller and Ray Dalio – who are great at this. Timing the market.
What I saw in January into February was the complacency building in the equity market. You could see it in implied volatility discounts and, on the story stock side, the move in Tesla (TSLA). I couldn’t believe hedge fund exposure to the equity market was in the 95th percentile of all 1-year readings.
John Taylor: I’ve made an awful lot of unbelievable forecasts, but four days before that I couldn’t tell you I’d make that forecast. I sold the dollar at the peak in 1985. I wrote in my letter that there was ‘Only a 1 in 100 chance that the dollar would go up tomorrow. It’s going down.’ Those numbers were unbelievable.
That was one of those moments and I feel like we’re in one of those moments now.
You made the comment earlier this week that ‘The Fed is shooting its bullet. There could be a crash coming out of it.’ That was a ballsy call. On the other hand, it was a really good call.
McCullough: In 2008, you were up 11.5%, when most hedge funds were down. In 2001, you were up 26%. A lot of people got body bagged in 2001. That’s when stocks went down fast, not unlike where we’re at today. Can you go back to 2001? How did you nail that?
Taylor: 2001 was hard. It wasn’t really clear in that year what was going on until the World Trade Center. That event happened just as the economy was getting to the point where it was going to be a complete disaster. Just like the virus now, an outside action made it a disaster. The timing was such that it made a really big different.
McCullough: A lot of people on Wall Street go back to the past and then suggest the average return from those points. Again, it’s about the particular, not the average. That’s why this is a good example.
When the economy is already slowing, the shock just speeds up the slowdown.
So again, in mid-2000, you were coming off the all-time high in profit growth. That was your comparison in 2001. Profits went negative in 2001. So you’re in a profit recession then you get 9/11.
It’s a particular thing that causes the trend to accelerate.
Taylor: Here’s another example. In 1998, the Yen went down -25% against the Dollar in a day. That changed the amount of volatility that the market accepted at that point. We’re talking about the currencies of the largest economies in the world. Was that a rational drop? No. But most people don’t think these things can happen until they do.
So what does that mean today?
In one of my letters this week, I suggested what we saw in the selloff last week was totally polite. It was a little extra volatility. It wasn’t enough to shake anyone up. There are a lot of investors who are still bullish. We haven’t even seen the crisis yet.
McCullough: We’ll see if Morgan Stanley’s prime brokerage data is right, but hedge funds still “bought the damn dip.” What I said when the Fed was cutting was that this wasn’t a dip. It was a correction from the all-time high a week ago.
Taylor: The Fed blew it. They were too early.
McCullough: I’ve got one of John’s notes right here. John doesn’t mince words. He actually wrote that, ‘The Fed blew it.’ Can you go through that?
Taylor: The idea is that you’ve only got so many bullets. You’ve got to have the market shaking in their boots rather than saying, ‘We can’t wait for the Fed. They’re going to come in and we’re going to make a lot of money.’ No. That’s not what you want because now the psychology is such that it’s time to trade against the central bank. When the market goes way up, my cycle research says to sell.
McCullough: That’s absolutely what happened in 2008. If the Fed can’t break the back of volatility, you are the volatility. That’s really what happened. Volatility got as high as it’s been. That’s post the Fed cut, post the OPEC cut, post the ‘Biden bounce.’
Remember that in 2008? Bernanke couldn’t do anything that was enough. That’s a really scary thing.
So when the Fed comes out and cuts rates what they’re really trying to do is devalue the dollar. I know you’re very bullish on the dollar here.
Taylor: It’s one of these boxes that you can’t figure out how to get out of. I’m talking about the U.S. economy here, of course. I hate to focus on situations like this because we usually get out of these situations.
This one is a tough one.
I’ve been aggressively long the bond market for years. Now you’re down towards zero and where do you go from here? So you only have to play one move at a time. Every day you look to see if things have changed. If things have changed you change your strips too.
McCullough: I thought that the Fed would have to cut rates in Q2 but I didn’t think they’d come out of this as quickly as they did. It was a surprise but the dollar didn’t break the long-term trend.
I know you’re working on China. Can you talk about that?
Taylor: My forecast for China is that it actually crumbles and goes away economically. Look at Russia. The Soviet Union started in 1917. It died in 1991. It’s 70 years plus. China is dealing with a cycle that’s a little longer. Russia had it’s Olympics in 1980. China had it’s Olympics in 2008. Ten years after that Russia was gone. And a little over 10 years after that China is on the rocks. We’re talking about cycle. We’re talking about age.
McCullough: I love this conversation because there are all these numbers in my head and as you’re speaking you’re putting down signposts along the way. If you go back to the Japanese demographic peak, literally China in the past two years is right there. The Chinese core spending population, 35-54 year olds, the rate of change on that number is negative for a long time because of their one child policy.
Taylor: Yes. And a lot of people challenge me on China. A lot of people say this dumb thing that, ‘You’ll go broke before the government goes broke.’ Alright. So you’ve got to bend your knee to the government. But which way? How are they going to make you do this?
McCullough: Well, taking this back to the Fed, a lot of people say, ‘You can’t fight the Fed, Keith.’ I started this firm fighting the Fed in 2008. We fought the Fed this year saying they were going to cut interest rates. You can fight the Fed a lot from both sides. They get it wrong a lot. Fighting the Fed was a great idea in 2008.
Taylor: Why do you think I made so much money in 2008? It was the fact that I was cantankerous and said, ‘You guys are fu@$ing wrong. You cannot do this.’
