(ZH) Meet The Man Rumored To Be Behind The Market's Relentless Ramp


Meet The Man Rumored To Be Behind The Market's Relentless Ramp


In an ironic twist of fate, it appears the catalyst for many of the biggest and most incomprehensible market ramps of the last few years is a fund called "Catalyst." With around $4 billion under management (before the latest collapse), the levered options fund is run by Edward Walczak who "uses options to create a better risk/return profile."
The Catalyst Hedged Futures Strategy Fund is an open-end fund incorporated in the USA. The objective is capital appreciation and capital preservation in all market conditions. The Fund invests primarily in long and short call and put options on S&P 500 Index futures contracts and in cash and cash equivalents, including high-quality short-term (3 months or less) fixed-income securities.
A 'great/lucky' year in 2008 and solid returns since...

Until recently...
  • 1 Week -14.07%
  • 1 Month -12.61%
  • 3 Months -16.96%
  • YTD -13.56%
  • 1 Year -10.11%
  • 3 Year -1.08%
Things have not gone well since the election...
As we noted previously, the melt-up in the S&P is the result of "a purported / murky melt-down over the past week in a large trade by a multi-billion Dollar (open-ended) futures fund which sells vol on S&P. Without going into specifics, there is market speculation that the entity is effectively short upwards of ~$17B of SPX (deltas to buy) through selling February expiry upside 1x5 (or 1x4) call spreads."
And here is the man that runs the show...
As FuturesMag.com detailed previously, Edward Walczak began his trading career after 25 years in business operations and supply chain management. It was Walczak’s experience running Chicago-based candy manufacturer Brach’s commodity hedging operation in the late 1990s that got him deeply involved in the markets.


At one point, Walczak’s boss asked him about position limits and he had no idea what he was talking about, Walczak says. “You only get embarrassed once and I spent a week with my trader [learning] the business and became intrigued by it.” Walczak is a math guy with degrees in Physics and Economics from Middlebury College and an MBA from Harvard, so naturally he was drawn to options. By 2005 he was making more money trading than in his day job, so he began trading proprietary money full-time and set up a commodity pool for friends and family. In 2006 his proprietary trading returned 52.68% and in 2007 he added customer accounts to the Madison, Wis. based Harbor Financial LLC.

Fortunate breaks come in all forms. For Walczak his biggest break may have been a painful February 2007 drawdown in his mainly option writing S&P 500 program. The drawdown was not fatal, 17.93% for the month, and the program was positive for the year, but it made Walczak rethink his overall approach. “Back in ’07, VIX was trading around 10 and all of a sudden the S&Ps dropped 50 handles in a day,” Walczak says. “A 50-point drop at the time was a big deal but historically was not that bizarre. It could have been a lot worse and I could have been wiped out, so I had to do something different.” He spent the next year researching. “How do I cover these other risks that are out there and how [do I] use options to have a better risk/return profile?” he asked himself.

He began a study of volatility and decided to move away from pure premium collection. “If you are strictly a premium collector, you have a couple of issues. If you collect $2, then $2 is the best you can make if everything goes right. Second, if that is the only way you can make money, then you often are tempted into doing a collection trade when the edge is not with you,” Walczak says.

What he discovered was a volatility trading strategy that could exploit rising volatility. “A simple example is you sell a front-month option and buy a back-month option. If you do that at a credit, you have the opportunity for the front-month option to decay in value or go away entirely and the back-month option still has value,” he says. “The secret sauce for us is in the placement. If you are correct with where you place these things, then you get the best of both worlds. You don’t just have residual value in that long option, the long option actually could explode in value while the short option goes away.”

The February 2007 wakeup call came enough in advance of 2008 for Walczak to complete his adjustments and earn 50% in 2008, a year that completely wiped out a number of option writers. “We found that rather than trying to trend-follow price to the downside, it is better with options to trend-follow volatility to the upside,” Walczak says. “Usually those are two conditions that go hand in hand.”

While the volatility trading strategy helped diversify the program and turn 2008 from a potential disaster to a home run, Walczak still was having problems in sharply uptrending markets. “Those really caused us a lot of problems with the techniques we were using, so I spent a lot of time [on that] and in 2010, we [began] to do some trend-following price wise.”
They still were using only options and found they could exploit trends more safely this way. The strategy uses a wide variety of ratio spreads, butterflies and offset butterflies. “It is basically 1 x 2s, 1 x 3s, 1 x 2 x 1s, where you are buying one, selling two, buying one,” he says. “That allows us to put trades on for little or no cost, so if the market tanks we are not long the market. We don’t lose money, the trade just goes away.” Walczak says, “It is not that we changed so much as we evolved: Premium collection, to premium collection plus volatility trading, to premium collection plus volatility trading plus upside trend-following price-wise.”
Walczak uses all three approaches but emphasizes the one appropriate to market conditions. “I can construct a spread that gives me the exposure I want. It is not a make-it-up-as-you-go-along [approach], we have established position templates for different types of market environments. If I want to go long volatility, I don’t scratch my head and say, ‘What do I do now?’ We go into our tool box and pull out the long volatility spread and do some analysis around where to put that on.” It is a combination of a discretionary and systematic approach that has produced solid returns in different market environments. Harbor has had no losing years and has produced a compound annual return of 22.07% with a 1.22 Sharpe ratio, and Walczak is still making improvements.
* * *
So major leverage on billions of AUM and a look at the unprecedented ramps in US equity markets over the last few years shows that perhaps Walczak and his fund did not fully figure out the "problems in sharply uptrending markets."
The Bullard Bounce?
The Brexit Bounce?

The Trump Bounce?
Of course, Walczak's strategy is not alone and if not the catalyst it is these levered options strategies that are the reflexive forced buyer that appears to be driving such self-reinforcing and seemingly incredible moves in stock markets as volatility has collapsed and the cost if funding massively levered strategies is de minimus. In a different world of considerably lower leverage, LTCM nearly blew up the world; in the new normal of as-much-leverage-as-you-can-eat, even a mid-sized fund's positions can be the butterfly that flaps its wings and become the forced 'ax' in world equity markets... even if it doesn't know it.
Just how much of the last 150 S&P points are due to the liquidation of 'Catalyst' (and strategies like it)?
As RBC's Charlie McElligott warned:


This equities upside short-gamma grab has taken out a ton of ‘bid on the downside’ in equities index, in the case that we were to see any sell-off post a Trump speech disappointment. This lack of cover-demand on a vacuum-move could see sloppiness develop, as it seems that the data and Fed itself are no longer dictating the market story at this stage - whether stocks, fixed-income or vol. “Policy” is now firmly “in the driver’s seat,” and that is where I see the least degree of confidence in the market.

I’m worried that this stock ‘melt-up’ move is extraordinarily mechanical right now - almost entirely the aforementioned forced-covering, not high conviction induced-buying - and may be sending a “false signal” which is potentially dragging-in new buying on the breakout to new highs.
As he concludes: "This could lead to a scenario where a market can “collapse under their own weight."
Indeed, because if one removes the forced buying from the "blowing up fund", there is certainly a long way down.

WSJ : Time for Nestlé to Make Major Cosmetic Changes

Time for Nestlé to Make Major Cosmetic Changes
Selling out of cosmetics giant L’Oréal looks like an easy win for Europe’s most valuable company

It is a bad time to buy a consumer-goods company, said Ulf Mark Schneider in his first public appearance as chief executive of Nestlé. The other side of that M&A coin is that it is a good time to sell. Mr. Schneider has an obvious place to start: Nestlé’s €23.9 billion ($25.34 billion) stake in cosmetics giant L’Oréal.
Nestlé bought into L’Oréal in 1974 at the request of family shareholder Liliane Bettencourt, who wanted to avoid French state involvement. In 2014 the Swiss giant sold part of its holding in exchange for cash and its partner’s stake in a dermatology joint venture, but insisted its remaining interest was “strategic.” Reassuring words for the now 94-year old Ms. Bettencourt, but in practice Nestlé’s portfolio of mainly food and nutrition products has almost no overlap with L’Oréal’s beauty and cosmetics empire.


The potential sale of its L’Oréal shares—the price of which fell 2% on Thursday morning but is still close to an all-time high—slightly peps up an otherwise dreary investment case for Nestlé. Europe’s most valuable company posted its weakest organic growth rate in years in the fourth quarter, at 2.9%. Pricing remains weak, which is partly a cyclical effect of low commodity prices but also the result of unprecedented competition from small, local brands. Some of these are proving more agile than multinationals like Nestlé and its U.S. peer Procter & Gamble in responding to consumer demand for products with wholesome ingredients and authentic-sounding back stories.

Mr. Schneider has his work cut out convincing investors he can restore organic growth to a “mid-single-digit” rate—a new, slightly lower target—by 2020. Selling shares in L’Oréal and returning the cash to investors could at least establish his credentials for sound capital management. In a tough world for consumer groups, this looks like an easy win.

FT : China’s January credit frenzy masks growing debt pressure Premium

China’s January credit frenzy masks growing debt pressure Premium
Beijing may want stability but record lending signals rising risk

* Record credit activity in January signals growing credit risk as much as it does increasing confidence in the recovery.
* The People’s Bank of China has begun raising rates in the financial system but is constrained by the risks of putting up borrowing costs too much and pushing companies into default.
* We do not expect this volume of borrowing to continue. Once local government bond sales are up and running for the year, reliance on bank loans will fall.

Another January, another credit blowout. But the month’s record lending activity signals mounting pressure on corporate China to roll over its debt as much as it does confidence in the economy.

The People’s Bank of China is now tightening monetary policy at the margins but is constrained in how far it can go because of the mounting pressures to service outstanding, and growing, debt obligations.

Total social financing, the central bank’s broadest regular measure of system-wide credit activity, rose 7.6 per cent year-on-year to a record Rmb3.74tn ($544bn), equivalent to 5 per cent of 2016 GDP (see chart). This included Rmb2.03tn in net new bank loans, representing a slower pace of growth year-on-year and lower than market rumours in the lead-up to the release, but still the second-biggest monthly haul on record after last January’s Rmb2.5tn.


Even by the standards of the China debt debate, these are big numbers and we certainly do not expect lending to continue like this through the first quarter of 2017, never mind the year. We see a number of factors driving January’s activity:

Companies may have noted that the central bank has begun raising interest rates in the interbank market and rushed to borrow before these feed into corporate lending rates. After nearly five years of producer price deflation ended in September, companies are regaining confidence and willing to take the government’s lead on infrastructure investment.
January also reflects increased bank borrowing by local governments, which are waiting for the central government to hand down the year’s bond issuance quota. A substitution effect has been seen between local government bond issuance and medium- and long-term corporate loans since 2015, when Beijing began a programme for local authorities to issue bonds and retire their bank loans (see chart). As with the same month last year, local government bond issuance in January was zero.


The end of the bond market rally has also driven up demand for bank loans. The record Rmb1.52tn in net new medium to long-term corporate loans — which are thought to be put to economically productive use — represented a 43.4 per cent increase over the same month last year. In contrast, net new corporate bond issuance was net negative for a second straight month, at -Rmb53.9bn against Rmb508.3bn in January 2016.
Another key driver of medium- and long-term bank loan growth was household borrowing, which rose from Rmb421.7bn in December 2016 (and Rmb478.3bn in January 2016) to Rmb629.3bn in January, also a record high (see chart). Although mortgage lending unexpectedly surged in January, we do not expect this to last. Much of this lending was probably carried over from late 2016 as annual quotas were reset, but the screws are being tightened on the housing market, and this will continue. Housing sales have fallen sharply already, and local governments are continuing to restrict purchases.


Into the shadows

But these data also reveal weakness in the economy. The surge in shadow finance activity at the end of last year has carried on into January, reflecting a crackdown on traditional financing channels for property developers and the end of a bond bull market. Combined net new funding via entrusted loans, which are made between companies, bankers’ acceptances, which are issued between banks on behalf of borrowers, and trust loans hit a record Rmb1.24tn versus Rmb405.4bn last January.

Increased reliance on shadow finance confirms our view that Chinese companies are facing mounting pressure to roll over their existing debt and are resorting to shorter maturities at higher interest rates to do so. Ahead of a key Communist party meeting in late 2017, the authorities may want to keep a close eye on the shadow finance system as they try to maintain stability. However, these latest data suggest default risks are increasing.

A balancing act

The central bank is continuing to tighten monetary policy at the margins in order to bring credit activity under control. Since January, the PBoC has increased the cost of the funds it regularly lends to institutions in the interbank market, covering loans of between seven days and a year (see chart). The intention is to guide up interest rates in the financial system make it more expensive to engage in the kind of speculation that drove bond yields to multiyear lows last year. Higher onshore rates may also help deter capital outflows.

The central bank’s trick will be to discourage investors from taking undue risk with cheap money — “curbing asset bubbles”, in official parlance — while keeping economic growth on an even keel. That is why the rate increases so far have been low-key and moderate; the price of borrowing from the bank’s medium-term lending facility rose just 10 basis points. These moves are unlikely to discourage indebted companies from continuing to borrow, banks from continuing to lend — and local governments from encouraging these relationships — if the alternative is default.

The PBoC still publishes the deposit and lending rates that acted as market benchmarks before deregulation in 2015. Although the banking system is no longer bound to follow them, adjustments to these rates would send powerful signals to the market because they are still used as a guide for pricing deposits and loans.

We never rule out surprises in Chinese monetary policy decision-making, but also believe there is no need to resort to this policy tool immediately. January’s higher inflation readings than expected may have given a scare, but we expect price pressures to cool in the months after the lunar new year holiday and as the property cycle continues to turn down.

FT : US mid-Atlantic factory growth rockets to highest since 1984



Growth in the US mid-Atlantic factory sector surged to the highest rate in more than three decades, underscoring the brightening outlook for the world’s biggest developed economy.

The Philadelphia Federal Reserve’s manufacturing index soared to 43.3 this month from 23.6 in in January — marking the highest reading since 1984, according to Bloomberg data. Wall Street expected a fall to 18, which would still have been above the 0-line that separates expansion from contraction.

The gauge tends to be a volatile indicator so economists typically suggest not reading too deeply into a single report. But looking at the broader trend shows that the sector expanded for the seventh-straight month in February, rebounding from a rocky start to last year.

New orders and shipments both increased markedly, the data showed. Inventories did, however, slip into contraction territory — potentially an indicator about worries over the future outlook.