December 7, 2021

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A $1.7 Billion Quant Fears Monetary ‘End Game,’ Bond Crisis

(Bloomberg) — A golden rule of investing is falling apart in this market meltdown, and to Nigol Koulajian that’s stirring some of his darkest fears.

As stocks stage historic plunges, bonds are offering no refuge — whipsawing the trillions of dollars lavished on diversification strategies from mom-and-pop to systematic traders. A typical allocation style which puts 60% in shares and 40% in fixed income is set for the worst month in its 16-year history.

Koulajian, hedge fund founder at Quest Partners, reckons it’s a signal that monetary policy might be close to losing its stimulative power as ultra-low yields coming into the 2020 crisis now turn some investors away from government debt.

A market crash sparked by the black swan of a novel virus is one that central bankers can’t fix — and the credibility of fiat currencies is at risk, warns the $1.7 billion quant.

“It’s liquidation but the end game is effectively when people say I don’t want to hold fixed income at around minus 70 basis points and I’d rather buy a real asset,” he said by phone on Wednesday from New York. “That’s how the Fed every time loses control in the end.”

The MSCI All-Country World Index of stocks is down more than 10% since Monday, and at the same time U.S. Treasuries are headed for a second straight week of declines. Koulajian says his trend-following models are riding out the equity bear market and that his flagship fund is up about 19% this year.

As U.S. stocks dropped another 5% Wednesday, a $17 billion exchange-traded fund that tracks long-dated Treasuries known as TLT posted its second-worst day ever, just a day after its sharpest plunge in its history.

Koulajian’s funds are run by computers that detect short-term trends across global assets, rather than forged by his macroeconomic views. Since he looks for patterns across days rather than months, his momentum program has already turned bearish on both equities and bonds.

As a commodity trading adviser — the regulatory term for futures speculators — observing cross-asset correlations and volatility is Koulajian’s bread and butter. In this regard, the past two weeks have departed from textbook thinking. Even as a sell-off in equities flagged a degree of risk aversion reminiscent of the last crisis, gold plunged along with both credit and government bonds.

That spells trouble for most standard portfolios that rely on the negative bond-stock relationship. A risk-parity index — a diversified systematic strategy that allocates money based on volatility levels — is set for its worst month on record.

Disorderly Gyrations

For now, this week’s disorderly bond-market moves have lot to do with investors liquidating across the board including interest-rate positions. And Koulajian concedes the Federal Reserve still has a degree of stimulative leeway even after its emergency measures of the last two weeks.

Hours after he spoke, the European Central Bank also sought to defy fears that it had run out of ammo with an emergency bond-buying program worth 750 billion euros ($810 billion), igniting a rally in periphery bonds.

But Koulajian has a warning for those still plowing money into government debt: Gold may be a better option in the long term if policy makers keep launching massive stimulus programs in the wake of the coronavirus outbreak.

The White House is mulling new ultra-long bonds to help fund a $1.3 trillion plan to cushion the disease’s fallout, according to people familiar with the matter, while Germany is also considering permitting an unlimited increase in borrowing.

“The closer the yield to fixed income gets to zero the more negatively skewed they become, which means they start losing money fast as opposed to making money fast,” he said. “You’re starting to have crises in fixed income because you’re effectively cornered.”

(Adds news on U.S. and Germany borrowing in second-to-last paragraph)

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