Episode #452: Jerry Parker & Salem Abraham – Lessons From A Lifetime of Trading – Meb Faber Research

Episode #452: Jerry Parker & Salem Abraham – Lessons From A Lifetime of Trading

Guests: Jerry Parker is the CEO of Chesapeake and a long-time trend follower since he was in the Turtle training program. Salem Abraham is the President of Abraham Trading Company and the Fortress Fund, which seeks to protect capital and achieve long-term capital appreciation.

Date Recorded: 10/5/2022     |     Run-Time: 1:16:31

Summary: In today’s episode, Jerry and Salem share some of the lessons they’ve learned from trading over the years. We spend some time talking about trend-following and the huge year most CTA’s are having. Plus, Salem even shares an area of the market he’s bullish on today.

To listen to Jerry’s first appearance on The Meb Faber Show, click here

To listen to Salem’s first appearance on The Meb Faber Show, click here

Sponsor: Composer is the premier platform for investing in and building quantitative investment strategies. What used to take Python,Excel and expensive trading software is available for free in an easy to use no-code solution. Learn more at www.composer.trade/meb.

Comments or suggestions? Interested in sponsoring an episode? Email us Feedback@TheMebFaberShow.com

Links from the Episode:

• 0:38 – Sponsor: Composer
• 2:16 – Intro
• 3:04 – Welcome Jerry and Salem to the show
• 4:21 – What the world looks like to them today
• 8:54 – Thoughts on the shifting narrative about bonds always protecting us
• 13:40 – How to think about incorporating trend following into your portfolio
• 22:25 – Why people who know better still ignore overwhelming data against them
• 27:36 – What trend followers haven’t done well over the past fifty years
• 29:26 – Episode #448: Annie Duke; Trend following could be defined by quitting and how letting your profits run is harder than walking away
• 31:49 – What it was like getting comfortable with losses in their early days
• 35:23 – It’s important to have criteria and rules to help you change your mind
• 38:00 – A trade that taught Jerry a valuable lesson when he thinks back on his forty year career
• 42:04 – Fond memories Salem & Jerry have shared
• 49:47 – Trading single stock futures to maximize diversification
• 51:38 – Rodrigo Gordillo and Corey Hoffstein – Return Stacking; Single stocks that are trending upwards
• 57:34 – Public sentiment on investing in China, sin stocks, and publicly frowned upon options
• 1:01:56 – Any markets they’d love to trade that aren’t available at the moment
• 1:07:56 – Is Buying The Stock Market at All Time Highs A Good Idea (link)
• 1:09:19 – Things Salem & Jerry are excited and worried about as they enter Q4 2022
  1:10:32 – Episode #438: Rob Arnott & Campbell Harvey

Transcript:

Welcome Message: Welcome to “The Meb Faber Show” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.

Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.

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Meb: What’s up, y’all? We got a great show today with not one but two returning guests, Jerry Parker and Salem Abraham. Jerry is the CEO of Chesapeake when a trend follower going back almost four decades to the turtle experiments. Salem is the president of Abraham Trading Company and the Fortress Fund, which seeks to protect capital but also achieve long-term capital appreciation. In today’s episode, my friends share some of the lessons they’ve learned from trading over the years. We spend some time talking about trend-following, of course, but also the huge year most CTAs are having. Salem even shares an area of the market he’s bullish on today. If you want to pause this and go back and listen to either Jerry or Salem’s first episode on the show, check the link in the show notes for each episode link. Please enjoy this episode with our good friends, Jerry Parker and Salem Abraham. Jerry and Salem, welcome back to the show.

Salem: Thanks for having us, Meb. Good to be with you.

Jerry: Yes, good to be here.

Meb: Jerry, we’re just talking before the show. Where do we find you guys today? You are post-hurricane, so made it through okay?

Jerry: We did. We’re in Tampa, Florida. I did leave Tampa for important things to do in New York City a few days early just in case. But I got back here, my dogs, my birds, and my chickens are all doing just fine. And my house.

Meb: And Salem, where do we find you?

Salem: I’m in Canadian, Texas today. And you think out in the country, I’d have chickens, but I don’t. But I do have an apple orchard and the hay is all build-up, but no chickens.

Meb: You guys have been on the podcast over the years. 2022 is shaping up to be a little bit different. I tweeted out the other day, “If we keep this up, it will be one of the top three worst years ever for 60/40 on a nominal basis.” And on a real basis, it’s already the worst ever, at least the last 100 years. 1917 is probably worse but we’re starting to get into some old times back then. What’s the world look like to you guys today? Salem, we can start with you. We talked about 60/40 I think the last time you were on. So, what’s 2022 shaping up to look like?

Salem: What I’m puzzled over is to what extent is everything baked into these markets. When it’s all baked in, that’s when you need to change course. And so, I don’t know but I kind of wonder maybe if it is. I also wonder about, you know, if you look at Argentina as a model, you see they had, over the last 12 years, 40% to 50% inflation and I’m measuring inflation by the depreciation of their currency versus the U.S. dollar because there’s a couple of years, they just didn’t even publish the data, which is fascinating where it’s just like, “Hey, nothing to see here.” When the government tells you nothing to see here, then you need to really look closely. But the other was their stocks went up 40% to 50% a year. So, inflation does help stocks at some point.

I think right now, a lot of businesses are behind. They have to raise prices and they’re chasing things. But eventually, that’s got to play in. Everyone is focused on these higher interest rates but I wonder at what point does inflation help stocks. You know, if you think of Walmart, if they raise all the prices, say, 20%, and all their costs go up 20%, at the end of the day, their profits will be 20% higher. So, it could absolutely show up in earnings. So, that’s interesting. And then for us, we run this mutual fund that we have stocks, bonds, and then we have alternatives. Alternatives have done great. If you sell tornado shelters, you kind of like to have a tornado every now and then, so we try to have a storm-proof portfolio and the alternatives has helped our fund. And so, any markets that are interesting and wild and crazy are always…I mean, these are fun markets in a way.

Meb: You guys both have come around to this discussion of the mixture of trend and stocks as well. Before we get to that, I wanted to point out I was thinking about inflation the other day because I keep cataloguing records for crazy things I see on a menu. So, we’re not talking about the fanciest places in the world but just like normal restaurants. So, I checked the box, I’ve seen a $40 hamburger, a $40 salad, a $10 Bud Light, and not at like a Cowboys game, just a restaurant. And then this week, I saw…this is very LA, a breakfast burrito, $25, a sign of the times of inflation. And the sad part, I really wanted to order it still.

So, on food prices, inflation is very much present. All right, Jerry, what’s the 2022 vibe you’re getting? Tough times for a lot of people. We did a poll, as I love to do on Twitter, the other day, and I said, “Are you up or down this year?” It’s something like 90% or 95% of ETFs are down and my expectation is that the same number of investors are down. And when I did the poll, it was like 85%. So, I think 5% to 10% others just click the wrong button or they just weren’t paying attention. But let’s call it 90%. What’s this year look like? How are you feeling? What’s going on? What do you know?

Jerry: It looks great. I mean, I was telling Salem earlier, I think the last three years are the best three years I’ve ever seen out of my 39 years. These risk-adjusted, leverage-adjusted, I used to trade larger and have bigger positive years and bigger drawdowns. But I don’t think since the fall of 2020, it has just been so amazing. Commodities started it. Of course, recently, the currency short all the currencies and short the interest rate markets. We’ve had a few stock winners too, you know, I trade the single stocks in my portfolio instead of the stock indices. But it reminds me of 2008 major lessons learned, diversification with the currencies, commodities, stocks and bonds, and shorting. Sometimes there’s no place to hide, there’s no place to go unless you short.

So, that’s been one of the big benefits for CTAs is short almost every currency, short all the interest rates, but mostly long commodities as far as the money makers over the past few years. Oh, another big thing too, you know, is don’t shy away from markets that haven’t done very well. I think before 2020, the commodities had a really rough period for trend followers. And then likewise, shorting bonds was just a loser for 20 years. So, going with the trend and taking small losses, letting the profits run, but don’t pay too much attention to recent performance, good or bad, and it could always turn around very quickly.

Meb: I think a lot about trend following, and we’ll spend some time on this, of course, on its complement to a traditional portfolio and I think this year is such a good example. Almost everyone thinks about trend as, “Okay, this is going to be a complement to my portfolio.” But when they think portfolio, they think stocks because they know “bonds are safe.” I think particularly this generation’s investors on the bond side have been lulled into the assumption that bonds will always protect and capital gains during the bad times. And we were saying for a few years, I said the nightmare scenario for most of these big traditional allocators is stocks and bonds both down.

So, everyone who thinks to trend following, I feel like they get the stock’s big bear market part, but often the part about hedging/being able to short bonds is obviously evident this year but something that is a massive, giant benefit that I think almost no one in the decades I talked to people really even talked about because we’ve been in one environment where yields have gone down for 30 years. Any comments, gents?

Salem: Meb, I think what we’re seeing that’s unusual is there’s always different forces pushing on markets. But right now, the dominant force is higher interest rates and at the speed that rates are rising. And with that being the dominant force, you know, anytime you raise interest rates, the discount model on cash flows, whether it’s bonds or stocks, it hurts them. So, it’s hurting real estate, it hurts any investment. And then when you start from such low numbers too, if you double the rates, which we’ve done more than double, that even has a more dramatic effect. But it is unusual. I think, the early ’70s, you had some of it. You know, if you look in really extreme rising rate environments, this is unusual in the scale of it. It’d be interesting with some of the historical research, is this the fastest we’ve ever raised the rates? And particularly, percentage-wise too.

Meb: The analogy we always look back is people will hit on the ’70s. I think the ’40s are probably similar in some ways. The challenge, I think, that’s hard for a lot of people in this…so we’re recording this early October, I assume this will come out before the next…it might even be on CPI day. But with inflation last time at least above 1% and who knows where it’s going to be but it’s caught in the same vicinity, the historical Fed sort of approach and models is a mile-wide gap between where bonds are and where inflation is still. And I think that surprised…you know, potentially, that’s the beauty of trend is like, you know, the markets can always move more than even the historical analogues. I mean, we only have, what, 100, 200 years really that we can look back on? What do you say, Jerry?

Salem: Well, I agree, I think if we had 2,000 years, we’d still see some unusual things happen. And that’s how CTAs make their living is making money off things we’ve never seen before. Patterns that are reliable, well, all of a sudden, they are not so reliable. We’re in the business of pouncing on the unusual. We don’t know that they’re coming. We can’t see them coming. We’re as surprised as anyone else. Just sell the breakout, buy the breakout, and sit back and watch what happens, and then your downside is a small loss. Every now and then we really shine in trading all these markets and we got penalized for a decade of being diversified and not having enough long equities, so now we’re getting what we deserve. And the industry is making the most of it, so it’s really good to see.

Meb: Before we move on from 60/40 because it’s such just a traditional benchmark that has creamed so many professional masters for so long, the sort of money framework to think about in my mind is not just the calendar year. People tend to think in calendar years, but also the maximum losses and the maximum drawdown for traditional 60/40 was well over 50%. So, let’s call it we’re down 20, which feels painful, but think about what the world looks like in investor behavior and emotions, we’d like to say it’s like a Richter scale. Anywhere above 20, 20 is sort of, to me, the inflexion point. So, minus 30, minus 40, minus 50, that’s the really world of pain I think a lot of not just individuals, but institutions could potentially find themselves in if that actually were to play out. And who knows? I mean, usually, that’s a rare occurrence but at least it’s happened before. And if you look at every country in the world, I don’t think we’ve seen one that has a real 60/40 drawdown less than 50. Switzerland’s got to be close but I think the rest are at least half.

You guys both mentioned trend looks beautiful this year. We’re the belle of the ball now, finally, after a long time of being sort of Beauty and the Beast. People are coming around to this argument of, “Okay, I’m least interested in trend.” I’ve been banging this gong for a decade. Even then, I do my Twitter polls, I do use trend following and most people don’t. And that’s my audience too, so I’m really sad about that. So, talk to the audience, gentlemen, how much? So, somebody’s listening to this, they say, “Okay, I manage CalPERS, I manage my own portfolio. How should I think about trend following? Should I start 5%?” How much? What’s the way to think about it?

Salem: Well, you can run the numbers. You could plug it in and see. But, you know, trend following in a lot of ways is like a spare tire on your car. You don’t know when you’re going to need it but you want to have it there. But then a lot of people when they don’t need it for a while, they throw it out and they say, “Hey, I can have more stuff in my trunk without this clunky spare tire in there.” So, it is interesting what Jerry’s talked about was people have really maligned trend following but when you need it, it’s there. And that’s really important, particularly if you’re managing important buckets of money like the big endowments and foundations and pensions.

Meb: So, you got to give me a number, Salem. I’m going to hold you to it.

Salem: We have 35% of our mutual fund. I mean, as far as notional exposure, so 35. And the part that’s really dumb is, you know, the stocks, what I see that it’s just totally wrong is we talk 60/40, then at some point after ’08, we started going, “Oh, no, the benchmark is 70/30.” You look at most, you know, endowments, their benchmark is 70/30. But most of them are 80/20. Their 30, they have bond substitutes. So, you know, we had Harry Markowitz with modern portfolio theory in 1990, won the Nobel Prize, and he would talk about 100% stocks is wrong and 100% bonds is wrong and his world of diversification with stocks and bonds. But if you look at the math and what he did, the math would say, “Look, I need anything that’s not correlated.” And that’s what when you bring in managed futures, a lot of managed futures products and global macro, there’s a certain subset of the hedge fund space that brings non-correlation and they’re really helpful.

Meb: I think if you look at like even the Morningstar, a lot of the traditional categories like long-short equity are down this year, right? Like they’re not necessarily doing the job but what do you think? All right, Jerry, I think you have a different perspective on how much to include. I might not even be framing the question correctly. What do you think?

Jerry: It’s a couple of different ways of looking at it. One would be go back and do some number crunching. And my friend did that recently and he mentioned it on a podcast, and he said it was…over the past 22 years, he said it would be 36% long-only stocks, 64% SocGen trend index, but those numbers are going to fluctuate. And of course, you’ve got each individual investor or institutional investor that’s going to be unable to do the optimal allocation probably and probably a small allocation to trend following is probably what is going to be for most people due to capacity and from politics. But I think it’s important to remind everyone that it’s trend following, yes, but these days, you can underestimate the markets themselves.

The currencies, dollar move, the bonds, stocks as well, at least recently on the short side, and commodities would have been so fantastic in ’20 and ’21. Plus, the trend following piece, it’s a big, huge thing and it all goes together. Mine would be 100% because I don’t want to be stuck in a market or in any sector of my portfolio without a trailing stop and without a stop loss on the wrong side of a big trend. I think what’s happened recently over the past 10 years, stocks have been the best, that’s the one sector that’s been the best, and people felt like that’s the go-to and that’s what everyone else is doing.

My friends do it, my competitors do it. If we all get crushed, well, we’re all getting crushed. Trend following CTAs are weird but you can get some good stock exposure, a diversified portfolio of a CTA. So, you get some stocks there, you’ll get some risk control capital preservation that you don’t get with long equities. A CTA that trades those four sectors with a medium to long-term trend following, it would be impossible for them to have as bad a performance historically as the stock market of around an 8% return and a 50% in drawdown. It’s just not possible because of diversification qualities and, you know, the benefits of and risk control of following the trends.

Meb: So, here’s a question, Jerry. You mentioned earlier, which I think is really important for Meb’s viewers to understand is with trend following, you don’t really bound the possibilities. You know, you kind of hit off into like a trend and then you say, “I don’t know how far it’s going to go.” So, there’s “The Art of War,” “Know yourself and know the enemy, you shall have 1,000 victories.” And most people, they focus on the enemy, they don’t focus on themselves. There’s things that we as humans do and one of it is we bound what we think the possibilities are and those boundaries are way too tight. And there’s a test…it was Bill Eckhardt who gave me this test.

So, in 1992, I went up to Commodities Corporation, I was trading for them. It was kind of a command performance, you got to go to Chicago, Richard Dennis and Bill Eckhardt were giving this five-day talk, and they had like the 25 traders that traded for Commodities Corporation and we all show up. And one of the things Bill Eckhardt did, which was fascinating, is this estimation test. It’s a 10-question test. The answers are all numbers, so like, “How many books are in the Bible?” And you’d say, “Okay,” you’re going to give an answer from low to high of what you think. How much does the Statue of Liberty weigh above the base? How many miles between New York and LA? How old was Martin Luther King when he was assassinated?

So, there are 10 questions I have and I’ve seen different 10 questions. All of them have numbers. And the answer is I’m 90% certain the answer lies between these two numbers, and you pick the two numbers. And so, everyone in this room, this is a bunch of good traders, 25 of us, and you got a perfect score if you’ve missed one of the 10. So, the perfect score is nine were correct on this one. So, invariably, the average that was missed in the room…I missed seven and the average was around six to seven people missed. So, what it showed us is it showed us how stupid we were. You know, zero to infinity were 100% but you narrowed it up, we narrowed it up too much.

And I think that’s where trend following, it sets that whole notion aside and just says, “I don’t know,” and it’s willing to go as far as the market will go. And that’s where I think most traders and I see…when you go 80% stocks, you can’t have looked at the history very hard. If you look back in the Great Depression when stocks are down 80%…between 79% and 89%, but let’s call it 80%. If you’ve got 80% in something that goes down 80% and you’re down 64%, it would be catastrophic to pensions and endowments. And these pensions and endowments are loaded up like that, and they don’t understand how dangerous that is. I don’t know, Jerry, did you ever do that when you were with Richard Dennis and Eckhardt? Did he do that test? Have you ever done it?

Jerry: Not the way that you guys did it, but it’s a great idea. These days, if we get a rally in the bond market, Twitter is just full of, “The lows are in,” or, “The highs for CTAs are in.” And it could be true, of course. I know Rich told us one story of something like this, that beings that never closed above $10 and anytime they got to $10, they would always go down. The one time they went above $10, I think they went to $16 or $18. It’s ironic coming from trend following traders who create their systems and their strategies based on backtesting to say, “We don’t pay any attention to history.”

We have a mechanical system that will yield 5,000 trades in a backtest, “Buy here, sell there, buy here, sell there,” and then that’s how we go forward. But history and that equity curve and what created all those trends is going to look much different in the future. We’re not immune to it. I have all sorts of political and economic opinions, but you got to divorce yourself and separate yourself from that in the day-to-day trading.

Meb: That comment you just made is I feel very simple on the surface, “If you trust the math, if you trust the historical evidence.” The challenge is no one does. I’d love to try to dig and figure out why. If you just look at historical summary bullet point stats, and there was one we did on Twitter where I said…and I’m going to paraphrase. It was something along the lines of, “Would you be willing to invest in an asset that historically outperformed bonds by a few percentage points per year but once generated zero outperformance for a stretch lasting 68 years?” And, of course, everyone is like, “No, that’s crazy,” and I’m like, “That’s literally S&P 500, that’s stocks.” And then another one was like similar and they’re always the same answers, which just gets depressing. I’m like, “Would you do this if it outperformed bonds by a few percentage points but could go decades with no outperformance?” Everyone is like, “No, that’s crazy.”

So, if you look at the Venn diagram, there’s the group that doesn’t know better, that doesn’t know history, that doesn’t understand the way markets have worked historically. And then there’s the very large group of people who do understand and continue to ignore or choose to act differently, which is 95% of all institutions in the world. Okay? The crazy part…and we’ve debated this over the years and I want to hear you guys’ kind of update thoughts because you probably talk to these allocators more than I do, but it’s still why at this point. So, we had 2000-2003, we had 2008, we have 2022, and trend following just delivers every single time. It’s not always going to be perfect. We had a long fallow period before that but you just blind it like the taste test trials. At this point, the evidence seems just too much to ignore. Why does everyone who should know better still ignore it? What do you think?

Jerry: Yeah, I don’t think they understand why it works. I think that’s the biggest hurdle. When I talk to allocators that don’t invest in the space and are just talking to me because they want to see a strange person and talk to a strange person back when we were marketing. Like looking at peacocks, I look at it but I don’t want one in my house. And so, they talk and they say, “Well, that’s interesting but I still don’t understand it.” And so, they require an explanation that makes sense to them and a lot of times, I couldn’t explain it. I said, “Look, if you had a coin that flipped 60% heads and, you know, you gave a statistician the coin and you said, “So tell me about the coin,” this person would flip it a million times and say, “It’s a 60% coin.”

It’s like, “Well, explain it.” You’re like, “I don’t know why, it’s just a 60% coin.” So, a physics guy comes and says, “There’s no reason for this to be a 60% coin, there’s no logical reason.” If you’re a good statistician, you’d say, “I don’t care, I can bet on the 60% coin, I’m betting on it.” So, there’s a lot of times you bet on it and you don’t even understand, “Well, I don’t know why this works,” but quite frankly, I don’t care why it works. But most people need to care and know and understand, and they don’t. Number one. Number two, the other thing with trend following you find out is what you’re really modeling is human emotion, I believe. If you had a curtain and someone is rolling two pair of six-sided dice, and they just put the number up there. So, you start writing it down. You don’t know what’s going on behind the curtain, but you analyze just the numbers.

Well, you would find out, “Okay, seven shows up more often than any other number, it’s from 2 to 12 is the limit,” you start understanding the numbers but you don’t know what’s going on behind the curtain. I think what you do when you research trend following is you’re really modeling human behavior. And humans, we have a lot of human tendencies that fight the movement of prices. And when you’re fighting the movement of prices, you’re going to eventually be wrong. Trend following just says, “I’m going to go with the movement.” And the people on the other side of the trade are emotional humans that you’re really taking advantage of their human emotions. But it’s hard to sell that.

Salem: I talked to a guy a long time ago, many years ago about our program and asked me to walk him through it, how does it all work? I told him and then I said, “We also trade single stocks.” And he goes, “Well, how do you trade the single stocks?” I said, “Trend following breakouts the same exact way.” He got so angry, “You know, dude, I went to business school, I have all these years analyzing balance sheets and value and growth, and you’re telling me that you’re going to look at some stupid breakout?” So, that went nowhere.

“Okay, you guys are weird, I don’t know how to really put commodities and currencies in my portfolio in a risk-safe way. You can do all the trend following stuff with that. But you start stepping over into my territory, the things that I hold dear, my MBA you’re telling me is a waste of time,” then they could get very upset with that. Some of that is possible but I think also, there’s too many assets in the world probably for everyone to be trend-following. I think that’s kind of a bummer. Especially CTA trend following, it’s better that it’s a niche product, but so much better…even some of the larger CTAs don’t practice 100% trend following.

Meb: I was actually thinking about it on the intro when we were chatting about some of the flows into trend this year, which had been great. People always love to buy what they wish they had bought a year ago, so hopefully, it continues. But certainly, trend is having a moment. But I was thinking about and I said, “I wonder what we haven’t done well necessarily as a trend group for the past 50 years,” is it’s a little easier to have an investable benchmark in traditional assets. So, stocks, S&P 500, Wilshire 5000, bonds, Barclays AG, corporate bonds, the Merrill, for REITs, the Nareit. I go on a list, EFA, EEM, boom, boom, boom, and you have an investable benchmark.

We know there’s a few, I can name three off the top of my head, maybe you guys know a better one, but the SocGen, the Mount Lucas, Barclays. But traditionally, they’re often an index of underlying funds. I feel like it’s just a little more step up on a challenge of tracking those versus something like the S&P 500. I wonder if that’s part of it, I wonder if it’s just the familiarity of investable benchmarks being the default in equity and bond land.

Jerry: Yeah, you sit there in an investment committee on endowments and have some smart financial consultant and we’re talking about an index for literally 45 minutes. And I’m like, “I really don’t care,” and I agree, it’s hard to come up with an index and why are we even trying because it’s pretty much impossible? I mean, it’s like having an index if you did it on poker players or something. There’s no one, you know, that’s really tracking…there’s no good index, but I agree with you. That’s a problem. There are a lot of problems. Mostly, people don’t understand it. They don’t like what they don’t understand. They think they understand stocks.

Meb: You guys are going to like it, this is a great reference because we published a podcast today with poker player, Annie Duke. She’s written three books and all of them speak very directly to the trend following world. The first one, “Thinking in Bets.” I mean, if you were to come up with a tagline for trend following, “Thinking in bets,” that’s like a perfect one. The second one, I’m blanking on it, something about decision-making. But the new one she has out, you guys are going to love this, it’s called, “Quit,” and it’s about how quitting has kind of a bad rap and we need to like rebrand quitting. And if there’s anything more than trend following, like, as defined by other than thinking in bets, it’s literally quitting. You have a position, you get out, you say, “That’s enough,” and move on. And what a good descriptor for kind of what we all do.

Salem: Well, that’s the hardest thing too. Once you sell a loser, selling a small loser, you’re a loser. The concrete is poured, there’s no hope. You know, you have this hope, “Well, it’s gingivitis, if I stay with it a little longer and…” But to have no emotion and walk away and just say, “I’m fine being a loser, see you.” “Quitting, I’ve lost money.” What do you think, Jerry?

Jerry: Not anymore. I think it’s so easy now to take those losses. It’s much easier than the hardest thing in life, which is to let those profits run. Letting profits run is 10 times harder than taking a small loss. If you don’t practice taking small losses and it’s not part of your strategy, yeah, I get it. But more money is left on the table, that is the real problem with human nature. “That’s my money, I want it.” When we started Salem, a 50-basis point loss was a loss. Now, they say losses are the drawdown. So, if you’re up 50 and you draw down 5, that’s a 5% loss.

Well, you know, you never would have gotten to 50 if you hadn’t accepted some volatility along the way. And I learned that in 1983, that, you know, holding on to those profits was going to be…holding on to the trades that are really profitable, we just get freaked out and afraid. And every trader I’ve ever spoken to, myself included, that’s been their biggest problem, the amount of money that you didn’t make because you didn’t want to have a drawdown.

Meb: I’m trying to think back to my own history. And like many, I started out sort of in a discretionary trading world but at this point, I have had thousands of losses. I also do a lot of angel investing, which is like, you know, makes trend following look like a high batting average. I mean, I think angel investing, it’s probably north of 50%, 70%, don’t really contribute or losses. And I can honestly say with the most part, like the little losses, it affects me not at all anymore. And I wonder, is that just like getting anaesthetized to it for many years? What was it like for you guys? Because I remember it being very painful in the beginning.

Salem: I think you’re right, you get calloused up to it and you just say, “This is a part of it, you get used to it.” I was really lucky back in…I think it was ’87 that Jerry Parker let me come visit him at his house in Virginia. And he was very kind to me, that he put me on this path and it was as a math geek finance guy, and then to have this idea of systematic trading with the odds in your favor was very appealing to me, and Jerry was very kind and I always appreciated that. But Jerry, you know, would say these things and to him, it was second nature. I was listening to Jerry back then and it’s very counterintuitive, and I think it’s very hard, but it gets easier as you go.

Jerry: I think taking the actual loss, you know, it’s never been too much of a problem. I think what happened with me and a lot of people is you don’t take the trade, you’ve had a lot of losses in a row, and you say, “Well, I don’t want that to happen again.” When I was learning in 1983, filters were a bad thing because filters will keep you out of trades, which keep you out of trends. And that was the huge no-no, you must always get in the trend eventually. You can have a little filter if it’s not a perfect setup but eventually, you have to say, “Okay, enough is enough, we got to get in this thing.” And I didn’t always do that.

The first big turtle trade was Feb heating oil, 1984. January didn’t do anything. March didn’t do anything. It was February heating oil and like one or two people in the entire room got the trend. And not putting that trade on, in my opinion, makes entries just as important as the exits. You’re not going to have a quandary over, “When should I get out of this big trend?” if you don’t put the thing on. And what’s the downside? I remember Rich said, “What’s the downside?” 50 basis points, 20 basis point loss. The reward/risk is way out of whack. You do that trade every single time and don’t even look back. And if it’s the third or fourth time buying it, who cares? It’s the big trends that are going to make all this money and going to cause you some pain if you miss them.

There was another funny thing back in the ’90s when I was living in Richmond. We all rode up to UVA and heard Paul Tudor Jones speak at Darden. It was right after he had shorted the Japanese stock market and he said, “Yeah, people always ask me about this Japanese stock market trade, but what they don’t know is that was my fifth time going short and that’s what makes a good trader.” That’s what I noticed with Salem over the years. He never missed a good trade, and the recent drawdown and choppiness and losing period had no impact on doing the next trade. And that’s how you really separate the good ones from the pretenders, is when all hell breaks loose and you should have low confidence, are you going to do that next trade?

Meb: A relevant takeaway I think for a lot of the people who may not be full boat trend crew but that also think about markets, in particular stocks a lot. Even if you got the timing right, even if you saw the writing on the wall in 2007, and you said, “You know what? The stock market is going to take a bath.” In the Twitter polls, we say, “Do you have a written investing plan? Do you establish sell criteria when you make a purchase?” You know, again, it’s 90% don’t. And the problem with that is let’s say you miss the bear market…I mean, how many people have you guys talked to? Because for me, it’s dozens, if not over 100 over the years, that said, “Meb, I got out.” Most of them got out in like ’08, ’09, they didn’t get out in ’07 but they say they got out in ’07, and they said, “I just never got back in.”

That’s part of the same problem. You know, it’s like whether you have a bunch of little cut losses or you just even have a great trade where you miss a bunch of losses, you still have to have some criteria. And this is why I always say to these discretionary folks, it’s such a nightmare because you spent all day and all night gnashing your teeth, questioning yourself, wondering. And the problem was a lot of the permabears, I think, is…it’s not that they’re bearish, it’s just that they have no criteria at which to change their mind, which I think is hugely destructive.

Salem: Yeah, I think that’s where technicals can help you sometimes too. Because there’s times where you’ve got to say, “Okay, I had a strong opinion but I don’t have it anymore,” and sometimes you get some information from technical that ought to guide you. So, even if you’re mixing, sometimes the technicals tell you something you don’t want to hear and you got to be willing to at least listen to it.

Jerry: Yeah, I mean, we’ve just had some horrendous performance this year from famous hedge funds or ETF people and I just sit back and watch all this destruction and I’m like, “Where is your trailing stop? Where is your rules?” You’re going to get in trouble one of these days if you don’t have a trend rule or a stop loss. You’re going to be found out, they’re going to come to get you after years and years of success. No one is immune to situations where there’s no way you can predict what’s going to occur. And without rules…you know, the S&P hit a 200-day low in January 2008. January. And so, all the problems that people have, at least back then, could have all been avoided with just a simple trend rule like Salem said, if you’re going to combine it with something, and then use that same rule to get back in. But without a rule, without an objective trend-base rule, you’re going to be in trouble.

Meb: Let’s mix up a fun part. The last time we had a three-person show, we let the guests ask each other some questions. So, you guys get to ask each other, ask the crew, ask the whole panel, something that’s on your mind or something you want to chat about. Salem, I’m going to kick you first. Anything on your mind you want to chat about or ask Jerry?

Salem: I think it’s fun to hear about maybe a trade which really taught you a lesson or something. Is it a really good trade or a really bad trade or something? I mean, Jerry, does anything stick out with you as you think back? And I’ve always seen you in this way as a veteran trader. But I think all of us when we were first starting out, we learn things that I think are interesting to newer traders. Is there anything that sticks out with you when you think back on your trading career?

Meb: Jerry is hitting his 40-year anniversary? What is that, rubies?

Salem: Yeah, I think so.

Meb: We need to come up with different criteria for…that’s for marriages. For trend followers, it’s like Year 1, you get a barrel of oil, Year 10, you get a certain amount of Yen, Year 20, you get a Bitcoin hard drive, USB drive.

Jerry: I didn’t hear a wine in there. I’ll take a bottle of red wine from California or Texas.

Meb: They do. Right, they have Bordeaux futures. They probably do Napa futures too.

Jerry: I think that’s a good question, Salem, and I think that’s the way you want to look at yourself and evaluate your career in obviously a period shorter than an entire career is that is by looking at those trades or the opportunities that you had, how did you maximize those opportunities? And I think it’s one thing I’ve learned is that there is just comfort in losing money doing the right things and there’s no comfort in not doing the right things. It’s hard to follow the systematic rules-based approach. But I’ve been fortunate in that I’ve never had much success with discretion or gotten lucky with violating my rules. It’s always been punishment. So, I have no incentive to not follow the rules.

But I do remember one trade, I think it was the British election in the ’90s, the John Major one, and we were short gilt and short Sterling and FTSE and I think they all rallied, and I had to go into the office at 2:00 in the morning and liquidate those positions and I think we ended up losing 7% that day, which was a lot for me. And I remember going back to my house and pulling in the driveway and just saying to myself, “You know, don’t be so wimpy, deal with it, this is life, this is what happens.” And I think we ended up making money that month. So, I think that the payoff of doing the right thing and following your system is so, so high. And I’m sure I got some of that by watching your trading too and sometimes you would do a lot better than me, so I was very jealous. But I took the right lesson. You were sort of a natural in that regard.

Salem: You’re the man. You always were the man. You know, one thing funny that you said…because we’ve talked over the years as we, you know, would have good years and bad years. I remember there was a year, I had made a little more money than you but you had had such a smooth year and I said, “Yeah, but your Sharpe ratio was so good, you know, I was up like 15 and you’re up 12, but you have this great Sharpe ratio.” And you said, “Well, yeah, you know, you can’t spend the Sharpe ratio, try to buy a new Cadillac with the Sharpe ratio.” I mean, yeah, there’s a lot of wisdom you’ve taught me over the years.

Meb: I mean, with practice, I feel like it gets easier. And certainly, with winning, it gets easier and trend following, back to the thinking in bets and expected value, doing it long enough…I mean, I think that post-GFC, pre-COVID period, you know, if you’re a trend follower and you’d survive that, you’re golden, you don’t need any more practice. And, you know, a lot of these equity curves that are hitting all-time highs, which is great to see, but just that sustenance and sustaining. And that’s not just trend following, it’s really anyone in our world of asset management, getting taken to the woodshed and not giving up is a biggie. All right, Jerry, what do you want to talk about? Do you want to ask Salem something or just anything on your mind you think deserves some attention?

Jerry: Yeah, well, definitely the latter. I don’t know if I have any questions for Salem but I did want to bring up that, you know, we have hung out a lot. He did invite me to his ranch a few times and the branding. Do you still do the branding, Salem?

Salem: We have not done it in a while but those are fun times. We did that for about 10 years and had a lot of fun.

Jerry: Yes, Salem would invite all these city slickers out to Texas and show them about cattle and riding horses. And he took me hunting one time and he tried to let me shoot, but he just couldn’t stop himself. He needed to shoot all the birds himself.

Salem: Jerry was too slow.

Jerry: Yeah, I was slow. I was a client at the time too, so Salem would let the clients win.

Salem: Yeah, that didn’t matter.

Jerry: Salem has done a lot over the years. He’s got a great history. He’s a great businessman. I think one of my issues is that I just was head down trend-following all the time, not really interested in anything else. And Salem was able to chew gum and walk at the same time, so he had a great business career with all of his things out in Texas that he was involved with, water, land, all of that stuff. So, I always admired him for that. But I do remember that one time that was really fun at the Robin Hood dinner. It hadn’t been that long ago. And Salem came in with, I think, seven of his eight kids or six of the eight or something like that.

Salem: It’s all of them.

Jerry: All of the kids.

Salem: Ten of us, yeah.

Jerry: Yeah. It was such a great thing to see all these very well-mannered children from Texas shaking my hand and saying, “Hello,” and sitting there at the Robin Hood dinner. So, we have a lot of good memories like that, a lot of fun things to think about.

Salem: The camaraderie. I think a lot of times as a trader, it’s a lonely kind of business and the camaraderie amongst traders is a lot of fun over the years. That’s been fun with Jerry and I.

Meb: Well, the wacky trend following family can stick together. In a year of trend…I wanted to circle back to this because I think it’s something that people overlook. They always think about having rules and a process when things go bad. But let’s celebrate a little bit, trend is having a great year, a great run. Let’s talk about when things go great and kind of letting these winners run. I think it’s a struggle for a lot of people. Maybe talk about either any positions that have done particularly well this year for you guys or that you have on currently. And obviously, it’s codified for you all now, but maybe just try to illustrate to listeners why that is such a significant input into being a successful investor and trend follower being able to have the big winners too. So, what’s working for you guys this year?

Jerry: Well, definitely the short bonds.

Meb: And is that short bonds across the whole complex? Is that just kind of short everything?

Jerry: Yeah, country bond futures, short-term interest rates, 5 years, 10 years, 30 years. ETFs, TIPS, mini-bonds, mortgage backs, high yield. I ventured out into ETFs a while back, Italy, Europe, U.S., Canada, Japan. So, my strategy is fairly long-term, it’s hard to shake me out of these trends. I like to use breakouts because they are even worse than moving averages, they just don’t move up very fast. You have to really not be too afraid of a lot of pain and give back, and I was pretty happy that we were able to stay in the shorts when it had that big rally a few months ago. So, I think that that’s a really good chart to look at. I like to look at charts and I like to see what has worked historically in the big trends.

And that’s how I sort of do my research. I flipped through all the biggest trends ever, what sort of parameter has kept me in that trend without getting shaken out too quickly but, you know, hopefully, you don’t get back too much at the very end? Then I’ll take those parameters and research them, first is trying to optimize and cherry-pick. It’s just a very hard game to play. I was listening to a podcast the other day, and one of my friends said something like, “Well, obviously, everyone is short wheat,” and I was going, “Oh, darn, I’m still long wheat.” So, it’s embarrassing sometimes. You can’t even bring it up because you’re like, “Man, what idiot is still a long wheat?” So, you have that tendency every now and then to really not only lose money, that’s bad enough, but relatively speaking, you know, how is so and so doing? And that it’s just something you need to try to not do so much. I’m better at it now but I wasn’t always that good.

Meb: Salem, same thing, I wonder what the overlap on the Venn diagram for you guys right now is on the position sheet. Do you think it’s like 80% on the trend stuff? Are you still short on these bonds?

Salem: So, our hedge fund, we quit doing the hedge fund. You know, back in 2019, we quit that, and we started…it’s kind of like a baseball player and instead of staying up all night, we traded 90 different futures markets 24 hours a day, 5 days a week. And so, in 2019, we just focused on…it’s like being a baseball player returning to be a manager and hiring baseball players, other players. So, what we do now is a mutual fund. We have stocks and bonds and then we have seven different hedge funds that we’ve hired that mix in with the stocks and bonds. And what I saw that was interesting as part of that decision was, you know, you try to tell people how to construct a portfolio, and I saw this as a member of investment committees that I’ve been on over the years, and no one follows the math on portfolio construction.

And I think they pick alternatives that are…like, they’ll say, “I’ll pick long-short hedge funds, long-short hedge funds are correlated with equities.” So, they think they’re doing something different when they say, “We’re allocating to all these alternatives.” Well, if they quack and act like a duck, they’re a duck. And so, even though long-short equity is great, instead of adding it to equities, you want to substitute it in. What we have now is just one mutual fund, I’ve got a bunch of my money in it, and this mutual fund has stocks, it has 50% stocks. Today, it’s 50% stocks, 15% interest rates, and 35% notional exposure to hedge funds. And we’ve got a lot of trend followers in there and people in there, and they’ve done really well, so that’s helped.

What we’ve done is just allocate to non-correlated hedge funds and they’ve helped us this year. So, the mutual fund, even though it’s got stocks and bonds, it’s only down about 5.5% on the year, so it’s…you know, you get punched in the face but you get some good offsetting positive performance for the alternatives. I finally got tired of trying to explain it to people and I just said, “Look, I’m going to do it, let me do it for you.” It was like we were selling cocoa and trying to tell people how to make the best chocolate cake ever and they never listened, so you said, “Let me just show you, let me do all of it.” So, we do that now and like Jerry said, I do think when I look back on the trades I’ve always made, once you’re in a good trade, then to sit with it is hard.

But sometimes…and Jerry told me this before I even started trading, he’s like, “If the trade is really hard to put on, psychologically, you’re like, “This is the dumbest trade.” I remember in 1989, I went long crude oil at $19. It was right at $20, we hadn’t seen $20 ever. And here, Iraq was next to Kuwait and, you know, this unthinkable, “Well, they’re not going to do anything.” Six weeks later, you had a $30 oil, and to put that trade on to me was really hard. And the more you know about a market, the harder it is to trade it because you think you know it and you’re like, “This is a dumb price.” We’re having a great year, we just have an alternatives in our mutual fund, and I don’t have to stay up this late at night anymore.

Meb: I think it’s important to think about it. I mean, it’s never fun to be down but losing less in a year…I mean, a lot of these risk parity funds that are not levered, they’re down 25%, 30% right now. And so, being down single digits, thinking back to compounding long-term wealth, you just got to avoid these big haymaker giant portfolio losses. Jerry, I was thinking about this as Salem was talking about stocks. A new input for you in the past decade has been the addition of single stocks. Talk to us about that. Is it long-flat, or is it long-short? And if so, are you just short everything now or what’s it look like?

Jerry: In order to maximize the diversification, I started trading single stock futures a long time ago. When they went away, I started trading single-stock cash stocks. So, yeah, I think in order to maximize that sector of the portfolio, you want to be able to get away from the indices and choose the stocks that you want to trade based upon diversification, not rely upon indexes or pre-designed indexes. And the single names are going to have bigger outliers and be better using the trend-following strategy than an index of a bunch of…you know, an average, and within that average, you know, you may actually want to be long some of those stocks, short some of those stocks, and flat.

This allows us to treat the stock part of our portfolio in the same way we treat the currencies, commodities, and bonds. It’s a great thing and we like trading those stocks and it’s something that I think that all the CTAs should do and it’s a huge mistake for the traders not to trade equities. In my portfolio, people can liquidate some of their traditional stocks and bonds and put it in our fund and they’ll get some of those stocks back in a slightly different way, but it’s not like they’re given up the upside in the stock market at all.

Meb: Yeah, it’s like the old PIMCO … our buddies, Corey and the ReSolve crew was talking about return stacking, but this concept of when you have overlays or derivatives or whatever it may be exposures, that you can kind of optimize how it works. So, I was going to say you can say your short Tesla, what would be going up? I’m trying to think if there’s any charts of any stocks that are industries performing.

Salem: There are a lot of stocks going up. This is a really interesting period where there’s virtually no diversification in the dollar trade, zero diversification from a long-term trend point of view in the interest rates, maybe something going on in commodities but for a long time, there’s been shipping stocks, oil stocks, steel stocks, all sorts of stocks going up, and then a lot of the portfolio has been in a downtrend for a long time. It’s the only sector where we’re getting any meaningful diversification. Thankfully, it doesn’t look anything like the S&P. There’s a lot of stuff going on in these companies worldwide that is not reflected in the S&P 500.

Meb: I was going to give Salem some credit. We talked about energy quite a bit in our podcast, it was the beginning of January 2021, I think, and energy is a good example of something that has had an absolute monster run/rebound from just decimation over the years. And I imagine there’s probably some energy names in there, Jerry, if not, maybe some, I don’t know, utilities. There’s always something going up, but probably more going down currently than up.

Jerry: Yeah, energy is a fascinating one. You know, we have wind turbine, solar, and oil and gas out in the northern part of Texas. And what’s interesting is I’ve got 19 square miles, 12,000 acres of some of the very best wind in the United States. Nobody calls me because you can’t lease, they don’t want to put turbines there because there’s no transmission lines, there’s no takeaway. So, I think there’s that piece of it that’s fascinating, just how hard it is…I think people underestimate how difficult it is to do any type of energy, whether it’s green energy or carbon fuels. And then the other thing that’s interesting that we’ve got a front-row seat out here at is with the oil and gas side, oil and gas drilling I think is up somewhere around 70% in the last 10 months and the fact that we have less rigs operating worldwide today than we had in December of 2019 with $60 oil and $2 natural gas.

So, we’ve got higher oil prices, higher gas prices, we have less rigs running, the supply disruption hurts it but then to some extent, you just say, “This isn’t profitable to drill at $85 oil anymore.” And so, in my mind, I think oil stocks, if you can get it beyond, “Hey, I want to invest in carbon fuels,” you can say, “I think they go up a lot.” And then the ESG money constraints? Out here, it’s fascinating. The peer pressure of if you inves3t in oil, you hate your grandkids, you hate the planet, you’re a bad person, you’re not welcome at the country club, and you’re like, “Okay.”

Coming from the part of the world where you see food happen, you see energy happen, and you see people in the city sometimes not cluing into how it works, you’re like, “Okay, most of the electricity in the country is natural gas and if we stopped doing that, I hope everybody’s okay in the dark riding their bike.” So, it’s fascinating. That opinion doesn’t guide my mutual fund trading. We have the mutual fund, we do it in a way that’s more indexing and things like that. But my personal trading, I’m like, “No, I think oil and gas could go $150, $200.” I think oil and gas energy stocks are an interesting place to be because $100 isn’t what $100 used to be in oil.

Meb: Spoken like a true Texan.

Jerry: Yeah.

Salem: You know, it’s okay to have those sort of views. You just don’t want it to unduly influence you to take that small loss. So, I think it’s good. I do think I’ve benefited over the years, mostly from not knowing anything about anything I trade. That’s another way of doing it as well.

Meb: I talked to a lot of startup investors too. And for me, I think it’s over 350 now and I’ve been trying to chronicle that on the podcasts over the years. But it’s a pretty similar sort of outcome in my mind, where often trend followers, you place a lot of trades and you have your emotional bias or hunch as to what may really do well. But often you look back and you’re like, “Wow, it really maybe was obvious that bonds were going to be this huge return driver when they went from negative and zero rates to 4% but, wow, I’m not sure I would have predicted that necessarily at the time I put the trade on.”

But it’s the same thing with the startups. I look at some of the best-performing startups and I’m just like, “It fit the criteria for the buy signal but as far as the actual outcome, I don’t know if there’s any correlation between my initial enthusiasm and actual outcome.” Which goes to a takeaway for me on the startup side but I think it’s true on the trend side too, is that you need enough bets to capture that, to capture that working. You know, if you just trade a few, the breath is harder. I don’t know if there’s a perfect curve number there but I tend to default to more is better if they’re truly independent, which is the big question.

Jerry: That is where sometimes in the future space, you can tell that, “Okay, orange juice and copper are truly independent.” If you’ve got 100 startups, they all still rely on the economy. And that’s where the diversification that we all need, you know, that’s where you find it in managed futures. You can really find it in some interesting ways.

Meb: I had a funny Twitter poll when we think about ESG and energy and everything else. But mine was regarding investing and I said…and I’ve done a few of these over the years, I did it with tobacco, I did it with China, and then I did it with Russia at one point because the sentiment on what leads the ladder too is all over the place. Tobacco is universally hated but I said, “Would you invest in tobacco stocks?” And everyone says, “No.” I said, “Would you invest in…” And then I follow up a couple of hours later, I said, “Would you invest in tobacco stocks if you knew they were going to outperform the S&P for the next decade?” And then everyone said, “Yes,” and I was like, “Okay.”

So, when you say ESG, you really just mean ESG as long as it doesn’t cost you any money. And so, if it’s a money-making question, then it’s not really ESG, it’s just a question of all things equal. And I said, the two best-performing industries in history, if you go all the way back to the French-Fama inception, I think, in the ’20s, were tobacco and beer. So, I don’t think those are ESG-friendly but humorous either way.

Jerry: I just thought of another big move, which was coal. Coal stocks have just had a monster move recently. And another thing that I noticed that…you get some diversification by trading the futures of oil and maybe trading some oil companies and it can help or hurt but it’ll give you some extra diversification. So, I think adding these stocks in there is always just going to be a good thing. I trade 250 markets. What’s good about that is there’s no reason to care about any of the trades because they’re all too small. That really has helped me become more disciplined.

You know, so often, I would not be able to stick with my strategy and it was just usually a function of trading too large for my own personality. And now, I trade sort of a reasonable size, leverage, and then every trade is just so inconsequential unless it just has a really large move. So, that’s another reason I wanted to go to stocks was there’s no place to go if you want to trade 300 or 400 markets, you’ve got to add equities in there.

Meb: As you’re talking about coal, I just remember my buddy Jan van Eck had a coal ETF which they shut down, and now there’s no way to trade, there’s no tradable for coal now in equities. And one of the things about ETFs that people often miss is whether you have an opinion on the ESG of coal or not, it gives you the ability if you hate it to short it. And if you have a regular portfolio and you’re anti-coal, you can go short it and take it out.

Salem: Well, you know, Jerry has…you’ve really been in the managed futures space, I think that pioneer into the single stock futures and then single stocks too. I mean, you’ve been doing that from the beginning.

Jerry: I mean, we were just hammered on, you know, in the turtles to trade, diversification was very important, trade as many markets as possible. So, naturally, when I got going with Chesapeake, that’s the logical place to go. There are so many stocks to trade and you could create this portfolio and try to get as much diversification as you possibly can. But it was not encouraged in the managed futures industry, it was, “You know, let’s trade futures, that’s what we do.” So, when stock futures came out, single stock futures, some class let me trade them because now they’re futures, it was all pretty silly.

I think it’s a huge missed opportunity for CTAs in general to only trade these indices…well, especially in their trend-following programs, it makes literally no sense because I’m not going to stand by and be subject to another 10 years of tremendous underperformance because stocks were the best trending markets and everyone loves stocks and we’re stuck with currencies and commodities and are not going anywhere. I’m going to put up a huge fight and make my portfolio more of a perfect portfolio rather than a perfect hedge. I’m not interested in hedging. And for any dysfunctional portfolio of long stocks, long bonds, you’ve got to add in a lot of good trend following, a lot of these commodity markets like you’re doing with your outsourced traders. Because people are going to wake up one day and say, “Hey, I only love stocks because they made me a lot of money, now I love you,” and I’m going to be ready for that.

Meb: Some markets enter the portfolio, some leave over the years. Are there any that you think about or you look and you’re like, “Man, I would love to trade X if that was a tradable and liquid and deep market?” Is there anything that’s on, like, your wish list or that you think about as being particularly interesting that just doesn’t fit?

Jerry: There are some markets out there that I can’t get my hands on. I can’t get there. I don’t know if it’s my broker or if it’s being an American, but the European power markets, you know, they had some amazing trends this year. That’s definitely one. Oh, yeah, another one is shipping futures. There is an ETF that contains shipping futures, it has a 3% load on it, and then I trade some shipping stocks that have had better runs than the shipping futures. They’re still running. So, I’m always on the lookout, that’s 90% of my research these days is researching stocks.

Salem: Way back, Jerry, when I got out of college and was just starting to trade and was understanding the value of trend following, but I didn’t fully appreciate how trend following can work across…really, anything with a price that’s traded by humans I think is subject to trend following because, again, I think it’s people with our emotions and just our human tendencies, we’re going to fight the trend. One market that moved with a trend that could have made a lot of money on trend following is emu futures, breeding emu pairs. If you look it up, it was more of a Texas phenomenon. But these emus, just as birds like ostriches, they would breed and they said, “Oh, they’re the best thing.” I mean, they got up to $30,000 per pair and I even actually participated in this in the FOMO, my first case of fear of missing out, everybody is making money, I bought these three pairs.

And so, yeah, the trend is your friend till the end when it bins, you know? Well, the bin came and I’m like, “Oh, boy.” You know, as a trend follower, I’m like, “I got to get out of this trade because they’re dropping,” and so I started selling. I sold two pairs, I remember I sold them for about half what I had in them. And then the last one, I actually had to…I was selling them for about 25 cents on the dollar to me. And he had some cash but he said, “But I don’t have all the money,” I’m like, “What do you got? I’ll take anything.” He had some collector shotguns and I said, “That’ll do, I’ll take the shotguns.” And six months later, they were zero. So, I think the lesson I would say, Meb, for your viewers is trend following works on I think everything. As long as it’s freely traded with emotional people, it tends to work.

Jerry: Oh, I thought you were going to say liquidity.

Salem: Yeah, no, liquidity was a problem for me but I…you know, I traded milk futures and everything, and I traded a lot of really illiquid stuff.

Jerry: I do that now. I mean, you bring up a really good point because you’re always reading and listening to people about diversification in the portfolio and it just goes without them saying that it’s buy and hold. Gold can fit into your portfolio because we’ll do the buy-and-hold-back test, and okay, now gold’s in. And once Bitcoin had a nice run, now Bitcoin can be in. There’s just so few things that can be in but everything comes in with trend following. Everything makes money. Trend following, it’s like raising Lazarus that all of a sudden, comes from the dead. Any market, corn, cocoa, every market can get in there. And Eric Crittenden is a friend of ours, all of ours, that wrote a paper on stocks and he was talking a lot one day about survivorship bias of equities and I’m like, “Eric, that’s not a thing for trend followers.” And I said, “Have you ever tested stocks that no longer exist with the trend following?”

And his response was, “Yes, I have, and they made about the same amount of money as the stocks that continue to exist.” So, really, if you want to get your portfolio safe, there’s really no way to do it. You can’t throw things in there unless you wrap trend following around it and anything, everything becomes a meaningful part, not just for diversification purposes, but providing some income to your portfolio, as long as you use the trend following. But it has to be a market and it has to be liquid and exchange-traded, or something like that. I think as the world progresses over time, we’re going to see more markets like that and portfolios of 1,000 markets in 50 years will probably not be unusual.

Meb: The software can definitely handle it. The custom indexers out there, you’re often owning a ton of stocks, hundreds even. And it’s just an algorithm, it’s not that much more complicated on other things and to trade it a little more actively for trend exposure as well.

Salem: You know, I think for your viewers…because some are going to be saying, “There’s more to it than trend,” and I would say the fundamentals matter, absolutely, and the people that pound the table, the fundamentals matter. But oftentimes, there’s fundamentals that are either not known by everybody and someone’s out there trading and buying and you don’t know who or why. And then there’s the human emotion factor. So, there are a lot of things at work. But I think for people to say, “Well, you got to pay attention to fundamentals,” the flip side is fundamentals need to pay attention to the emotional side because if anyone’s ever traded, you know you get emotional.

And then if you say, “If everyone’s thinking like me and is wired like me,” basically, you’re gaming people’s human emotions because as a trend follower, you have to fight your own emotions. You find that buying something that’s high and expecting it to go higher is very counterintuitive. The first time Jerry told me that’s what he did, you’re like, “That’s the craziest sounding thing ever, why would you wait till it’s high? Why wouldn’t you just buy it low?” The emotions of it matter, the fundamentals matter, and the fundamentals get baked into the price and if you’re looking at the price, you’re looking at the fundamentals too.

Meb: We tried to publish a paper that was, like, trend following and drag targeted at the buy and hold community a couple of years ago, and it was called something along the lines of like, “Is buying stock market at all-time high a good idea? No, it’s a great idea.” And I remember talking to Jerry about this because it was looking at markets…a very basic system of owning the stock market as long as it was within like 5% or 10% of all-time highs or something. And then we showed it across every market, and then obviously, variants of like instead of all-time highs, like a 12-month breakout. So, sneakily, the paper is a trend following paper but we tried to target the equity crowd. Now, I think it got repurposed as, “You should just buy markets at all-time highs,” but what they missed was the exit criteria, the stop loss.

They got to just own at any price, it’s going to the moon, doesn’t matter, but they missed the part where you had to get out. And so, I think they got half the message they wanted to hear and the other half they didn’t want to hear, they just ignored it. So, that paper I don’t think many people read it, but the ones that did get the wrong conclusion of what they were supposed to get. All right. So, gents, we have you on the record. CalPERS is listening. Salem says put a third in trend following, Meb says half, Jerry says put it all and then some. So, hit them up when you got some ideas. Gents, any last thoughts before we get going? It’s been a blast, we should do this, like, quarterly. I love talking to you guys. Anything else on your mind that you’re excited, worried about, confused about as we enter Q4 here in 2022?

Salem: Getting back to what you guys were talking about in the very beginning, as a child of the ’70s, I’m an expert on inflation but nobody is listening to me. So, I just really do wonder, though, this is the big question I have, do interest rates need to get close to the inflation rate? That was a given at one point in time. Now, is it a given? I mean, I just don’t understand the action of the markets. We know where we’re going, it’s not going to be pleasant, and it’s going to take a while. And yet, valid rallies and bonds and stocks are frequent and dip buying and getting these bargains, and you can kind of see how trends work. Over the years, people have said, “How could that trend that you participated in keep going? Everyone knew what was going to happen.” Well, case in point, right now…of course, you know, I could be wrong and flip my position around but it does seem that the fundamentals are fairly obvious.

Meb: You know, I was saying for a few years, I said, “The nightmare scenario for the big institutions is stocks and bonds is down.” And if you look at…one of my favorite podcasts of the year was the one we did about a month or two ago with Rob Arnott and Cam Harvey, which is why we’re trying to do more of these multiple guests because it’s fun to let the guests interact. But they basically spent, like, half an hour, an hour laying out the case why the September CPI was going to be elevated when everyone expected it to be going down a lot. And sure enough, they printed eight-something and the market fell 4% or 5% the next day.

But within their logic was that not just it was going to be elevated one month, it’d be elevated for, you know, a few months because of the way they smooth the real estate exposure. And so, this is probably, again, going to drop on CPI day but you see a scenario that if inflation…and again, this is three rules-based trend followers BS-ing here at this point, so this is like happy hour coffee talk. Our algos will get us back in if these things go up but in my mind, the market, and I’ve done some polls here, firmly expects the inflation to come down. So, not bonds meeting inflation, it’s inflation coming down to meet bonds.

But I think if you see the sticky, even if it’s 8.7, stickier for longer, the two-year historically, Fed funds is pretty close/above inflation and it’s nowhere close now. And so, if you think about this scenario where it’s just been a world of pain with bonds getting to 3.4, imagine what the world looks like if bonds go to 4.6. You talked about Argentina at the beginning, you have to at least consider the possibility, however small or improbable, of the test on how much the Statue of Liberty weighs.

Jerry: You look at the amount of money we printed, the expansion in the money supply versus Argentina, we were about half of what a normal Argentina year is. And if they have 40% to 50% inflation, then 20% to 25%…but we stopped printing, so that’s good. This is the worry I’ve got. You’ve got the whole Fed board. Now, who’s their hero? Their hero, the biggest stud, the Michael Jordan of Fed is Paul Volcker. He slayed inflation. Their six foot seven, Paul Volcker. So, you’ve got a lot of the nerd economists, I mean, you want to be Paul Volcker.

So, if they all have kind of the Paul Volcker, “I can slay inflation,” and they’re just going to raise inflation no matter what, full steam ahead…because I’m surprised at how fast they’ve raised rates and how diligent. I didn’t think they had the backbone, I think a lot of people in the market didn’t think they have the backbone. As a trend trader, you’ve got to say, “Okay, if they’ve got enough backbone to take us to where we are, why wouldn’t they take us to 8%, 10%, 15%? Whatever it took?” And then they say, “Yeah, we’ll be right there next to Paul Volcker in the Hall of Fame.”

Meb: They don’t want to be known as the one that let it get away.

Jerry: No, no. So, it’s interesting. You wonder what they do but I think a lot of it’s baked in, I really think a lot of it maybe has been baked in. But as a trend follower, you’d never let those kinds of emotions rule you.

Meb: Gentlemen, it’s been a blessing to catch up with you guys again, would love to see you in the real world. Thanks for joining us today.

Salem: You bet, Meb.

Jerry: Yeah, thanks for having us, Meb. It’s been a pleasure.

Meb: Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us feedback at feedback@themebfabershow.com. We’d love to read the reviews. Please review us on iTunes and subscribe to the show anywhere good podcasts are found. Thanks for listening, friends, and good investing.