Gripping markets are uncertainties with respect to the path of the economy and markets. In the news are pundits expressing their perspectives about recession odds and the like. Notwithstanding, all too often, many of these same individuals do not have capital at risk.
It’s easy for one to make a call. It’s hard to stand by it.
Let’s get into Constan’s background, perspectives, and tips for success in markets.
From Pre-Med To IB: A University of Pennsylvania alumnus, Constan was actually a biomedical engineering student in pursuit of medical studies.
He then joined a fraternity and was encouraged by peers to also explore finance.
“I was thinking about being a doctor and was quantitative, taking all the math courses you need to be an engineer,” he said. “My friends encouraged me to take finance and economics classes, and I found them extraordinarily easy.”
Pursuant to the ease with which finance came to Constan, he gave it a go in real life and joined Salomon Brothers as an entry-level corporate finance analyst in the mid-1980s.
Early Days of Quant: “The initiation of spreadsheets was happening at the time,” Constan said on the early “demand for quants,” which lent in him pivoting to finance with ease.
He excelled quickly in his investment banking (IB) cohort and was the go-to for questions.
That’s what played into Salomon’s late vice chairman Jay Higgins tapping Constan for help with an investigation on the Oct. 19, 1987 market crash.
It was called Brady Commission, named after its head Nicholas Brady, and was an assignment by then U.S. President Ronald Reagan.
Through that experience, Constan learned more about the interplay between participants and how their demand or supply of liquidity can play into self-reinforcing market strains.
“The highest level thing was the idea that a dynamic hedging process could operate in all market environments, at an unlimited size,” he put forth.
“Portfolio insurance assumed a continuous market in which, no matter the size of the total portfolio insurance being done, all those players could sell on the way down and find ample buyers to be able to execute their dynamic hedging strategy without thinking about how the flow would essentially be too large to fit through the available liquidity at the time.”
The lesson, according to Constan, was having regard for the liquidity that is available and how participants’ interactions, in trying to tap into or provide it, may manifest market volatility.
Accelerated Career: From thereon, Constan took on more responsibilities and quickly moved into leadership roles.
Given the immense research and modeling he engaged in, in 1991 Constan became a trader in the convertible bonds department, one of Salomon’s best businesses in light of early mispricings and other opportunities that helped in practices such as arbitrage.
By 1995, Constan was managing Salomon’s U.S. and global derivatives trading and structured products businesses, as well as the sale of those services. He assisted in Salomon’s mergers and integration with other firms, the evaluation of Long-Term Capital Management’s (LTCM) collapse, and sell-side model building.
“I tried to make everything I can systematic,” he said about how, broadly speaking, those roles helped in his progression as an analyst, trader and leader.
“In everything, I can’t make systematic, I operate with a framework that is built on my understanding of how markets work, and those are the assets that I use to invest.”
No, Not That Asset: Constan’s use of the term asset varies from that of the consensus.
This is in part to his experiences at Ray Dalio’s Bridgewater Associates, where he was key in boosting the firm’s Pure Alpha Fund via the volatility research pillar, Brevan Howard and others.
At Bridgewater, in particular, at the back of the May 6, 2010 flash crash, Constan found a trade he liked more than any other. It involved the use of options space and that is in part a reason Dalio, as well as co-CIOs Greg Jensen and Bob Prince, brought Constan on.
“They were trying to understand an asset class — volatility — and they hired me to explain,” he said on observing the trade before ultimately researching it in an in-depth way and pitching it.
“I made a very convincing argument and Bob agreed but did not see how that trade would make them money, long-term. Once the trade reverts, we’re left with nothing for our effort.”
The lesson here is that Bridgewater wanted to invest in things they could do every day, in every asset class, through time. The objective is to find a systematic trade that happens regularly and the alpha stream, from the capture of that edge, is the asset.
Constan explains that this is what many great traders — systematic and discretionary — do. They parameterize and act or program and execute. Otherwise, there is style drift.
“They don’t spend their time finding big trades. They spend time finding the persistent trade.”
Avoiding Employment At LTCM: At one point, Constan had the opportunity to join Long-Term Capital Management. He didn’t, thankfully, before the highly-leveraged hedge fund suffered immense losses that required a bailout brokered by the Federal Reserve.
Why did he not join?
It really comes down to pitfalls of relative value (RV) strategies he spotted, and even more so, the arrogance and self-sufficiency of some of the firm’s members.
Constan’s career was all about RV, he said, and “trying to capture inefficiencies generated from some form of concentrated positioning that pushes assets out of whack.”
That’s precisely what LTCM was doing, just with a bigger size.
His experiences, such as Fed Chair Alan Greenspan’s surprise rate hike, helped him realize that many RV drawdowns were often on the back of macro circumstances.
“That’s why I evolved out of RV toward macro,” he said. In early conversations, the LTCM members, many of who were Ph.D.s, expressed their beliefs that they could trade better.
It was a group of smarts with little regard for the delicate balance between quant and trader.
Ultimately, Constan recognized “they had the same liquidity problem that the portfolio insurers had in 1987.”
“I learned this from Dalio later. He doesn’t start with lofty principles built on many bricks of understanding. He starts with the base bricks, the understanding of how things really work.”
Gauging The Market’s De-Rate: Over four decades or so, monetary policy was the instrument for stimulating the economy. This money stoked a technological revolution, bolstered the supply of goods and by that token, promoted deflation, which was kept at bay by rising asset prices.
With recent trends in the geopolitical climate, the focus on fiscal stimulation, as well as supply chokepoints, a lot of the money that was sent to spenders stoked goods and services inflation.
The newfound commitment to addressing inequality, as well as misallocations of capital — via the tightening of liquidity and credit — has consequences on the real economy and asset prices, which are highly connected given the aforementioned multi-decade trends.
The move to stem inflation, via supply-side economics alone, is folly.
“You have to look forward before looking back,” Constan said in a talk on the de-globalization pulse on popular sovereignty, part of which is a product of the monetary policies of the past.
“The most destructive things to future prosperity are the tendencies that have developed over the last five years, like Brexit, the border wall and the war in Ukraine. Comparative advantages, which globalization is essential for, generates uninsured supply chains and now we’re spending money on insurance.”
At its core, prices are set by the equilibrium between the supply and demand for goods. Both are not in line, and the stimulative monetary policies that helped keep the supply-side in check are now off the table, all the while supply chain replication is not adding to production.
Wealth being spent, instead of being created, is inflationary. Thankfully a gridlocked political situation over the coming years is set to keep a lid on this trend.
Constan adds: “We’re in a recession — a period of modestly to significantly below-trend growth — and the fiscal side would have to not force the Fed to do more by having a large spending bill which would hurt markets in a meaningful way.”
He predicts that 2022 may be a 1% total GDP year with a 4% inflation rate. Asset prices have adjusted, and recovery in equities is not off the table. He adds that over the long-time horizon, interest rates will have difficulty rising on factors such as declining in population growth.
“It’s unclear what the obvious trade for the balance of the year would be,” he noted.
Expressing Your Views: “Having been trained at Bridgewater, I saw that there are silos you can’t have” between traders and economists, he said.
Accordingly, Brevan Howard co-founder Alan Howard, “asked me to start and fund the start-up of Damped Spring Advisors to develop syntheses of what’s priced into markets and how those connect with the flow and positioning, and then give my outlook on how changes in the economic drivers of growth, inflation and risk premium will [impact] assets.”
For accountability, Constan manages a small fund that provides people with an idea of how to express those views financially. Trades are constructed around Constan’s two- to four-month time horizons and are structured long and short using defined-risk options trades like debit or credit spreads, depending on whether volatility is cheap or expensive.
“I want deltas and leverage. My macro indicators give me an edge on price and in the worst case, the loss is limited to 10%, if everything has to go against me all at once. I can be 100% invested and only risk 10%.”
Nearly a year ago, Constan began posting to 300 or so Twitter Inc TWTR followers on his volatility and macroeconomic frameworks. Since garnering a following of more than 43,000, Constan founded new ways for those more interested in learning to connect with him. Through Damped Spring, he allows users to subscribe to and receive the same reports he sends to institutions, as well as a private Twitter where he offers real-time commentary and high-touch interaction. Check it out.
Photo: yuan2003 via Flicker Creative Commons