This week's episode of Stansberry Investor Hour features John Netto, a cross-asset-class trader and author of investing book The Global Macro Edge. John is considered an expert by many in the industry when it comes to analyzing central banks and how their monetary policies impact the economy and markets.
Dan and Corey start the episode by examining the recent failure of First Republic Bank – the second-largest U.S. bank failure to date – and its acquisition by JPMorgan Chase. They raise concerns about the ongoing banking crisis and the role the government plays in backing "too big to fail" banks. With three of the four largest bank failures in U.S. history happening in the past two months, there's growing uncertainty heading into this week's Federal Reserve meetings.
Then, John joins the conversation and shares insights from his book, including the concept of how emotions act as the lubricant for decision making. He says that traders often make the mistake of analyzing their success based solely on the results rather than how well they executed their process. To combat this phenomenon, John created the "Netto number." He explains how it can help investors recognize when their strategy begins to decay and how they can use it to maximize returns.
The discussion then shifts to central banks and monetary policy, with John describing his four factors for analyzing Fed events. Based on his analysis, John argues that the Fed will not be cutting rates this year and will instead be keeping them near a 4.5% to 5.5% pace until the second quarter of 2024...
Because we have interest rates at 7%, it's going to take a long time for this housing inventory to roll over.
He asserts that if we go into a recession, it will be a very mild one. You can hear his full reasoning in today's Investor Hour.
Dan Ferris: Hello, and welcome to the Stansberry Investor Hour. I'm Dan Ferris. I'm the editor of Extreme Value and The Ferris Report, both published by Stansberry Research.
Corey McLaughlin: And I'm Corey McLaughlin, editor of the Stansberry Digest. Today we talk with John Netto, author of The Global Macro Edge.
Dan Ferris: And today we'll also talk about banks. We'll talk about JPMorgan's takeover of First Republic and some interesting comments from the Bank of England.
Corey McLaughlin: And remember, if you want to send us a note, send your feedback to [email protected] and tell us what's on your mind.
Dan Ferris: That and more right now on the Stansberry Investor Hour.
Well, it happened. We all knew it would happen. First Republic Bank was essentially taken over. It was seized and sold to JPMorgan. It is the second largest U.S. bank failure.
Of course, it came after a huge bank run, right? They had a bank run, the bank failed, the thing got seized by the government and essentially all the assets were sold to JPMorgan. My first thought about this is, boy, it's good to be JPMorgan, isn't it?
Corey McLaughlin: Yeah. They were the largest bank... Now they're bigger.
Dan Ferris: [Laughs] Yeah. And the stock, if they had had to really buy the company, I think the last quoted price was like $1.76, you know? And the 52-week high is like, what? It looks like $21-something. And it was much higher than that before.
So yeah, I'd say it's good to be JPMorgan, it's good to be a big bank with, you know – a big too-big-to-fail bank with the government behind you, you know, sort of backstopping you because you get to do things like this. I mean, Jesus, Corey, has anybody ever seized a bank and let you buy all the assets for dirt cheap? You know, this has never happened to me.
Corey McLaughlin: No. It hasn't happened to me. I mean this is – you know, like you said, it's kind of a bit expected when you were talking about the stuff, the run on Silicon Valley bank and the other back in March, that the bigger banks were going to kind of swoop – if there were more problems ahead, you know, the likely outcome would be these big banks like JPMorgan and the other too-big-to-fails swoop in and do exactly what happened today. What's interesting to me is first this happened officially over the weekend on Friday that First Republic Shares were down 43%, and then before the market today down another 35%, which to me, around this whole story, if you could know these things are coming maybe, but still if you think a stock can't go lower, it just keeps going lower.
Dan Ferris: I just want to say, Corey, before you continue, I misspoke a moment ago. I was looking at the preferred shares. So the last quoted price I have on First Republic is $3.51 per share, $3.51. the 52-week high is $171, and the last quoted market cap is $650 million. So you know JPMorgan didn't pay even that much for the asset probably. [Laughs]
Corey McLaughlin: Right. You know, they're not even taking on the corporate debt I saw or preferred shares, so they're just taking on all the loans – the stuff that would affect, you know, residential, commercial loans.
Dan Ferris: Probably a swap at a discount.
Corey McLaughlin: Yeah. I mean they're just picking up the pieces from this bank run and, you know, on we go to the Federal Reserve saying, all right, we don't have to worry about that anymore, and maybe they'll hike rates again this week.
Dan Ferris: Yeah. So three of the four largest bank failures in U.S. history happened in the last two months. I'm calling that, you know –
Corey McLaughlin: Everything's fine. Nothing to see here.
Dan Ferris: Yeah. It's a banking crisis, right? [Laughs] It doesn't mean it's 2008, but it's a banking crisis. I'm just, you know – let's call it what it is.
Corey McLaughlin: Yeah, and don't forget Credit Suisse too, you know, over in Switzerland.
Dan Ferris: Oh, sure. Yeah.
Corey McLaughlin: It being forced into being in a merger with UBS by the government.
Dan Ferris: Yep.
Corey McLaughlin: So just, you know, another day in global banking, I suppose.
Dan Ferris: Yeah. It's strange. I didn't read any of the terms of the deal, but I know Jamie Dimon is saying it'll be accretive to like $500 million in earnings. Like I said, they probably essentially – they probably just, you know, swapped some cash and treasuries for FRC's assets at a discount because they're kind of crappy at this point, and away they go. It'll be accretive to earnings probably in the first year. I guess if that's the way the bank exists, it has to work to keep everything from falling apart, but my skepticism is that I don't think they can keep it from falling apart.
Ultimately, I think, you know, the backstoppers run out of backstop. Or if you say, well, that can't happen because the government and the Federal Reserve can both print all the money they need to backstop anything, well, yeah, but eventually, you know, money printing equals debt issuance and eventually the world doesn't want your debt if they know you're just cranking it out to save your ass.
Corey McLaughlin: Yeah. Right. When do the band-aids – you know, how many band-aids do you need to get through this and is it too big of a – when does the wound get too big where the band-aid doesn't work anymore, if we get into a recession and the banks are not in a position to want to do this kind of thing, even the bigger ones, so could they come to their rescue?
Dan Ferris: Yeah, it's an odd situation. Actually, it's not odd. It's rather typical, right? It's the way – this is how everything is designed. We know under certain circumstances there absolutely will be bank failures and even major bank failures, and it's set up so that we have this lender of last resort, backstopper of really only resort, and too-big-to-fail banks to sort of supply the reserve that we tap into.
And then if they can't supply it then the lender of last resort supplies it, the Federal Reserve. I don't know. It all seems too easy and too neat, and I think we tend to lean on the top-down, I'll take care of you aspect of our society too much. I think that's just the way of big countries, right? It's the way of all big countries. You develop these safety nets, and over time everybody knows the net is there.
So in finance, they take more and more and more risk with really less and less skin in the game, and the cost gets passed on to everybody else through the safety net, and the incentives to really create things, you know, they're not what they used to be even if there are still plenty of them. I feel like there has to be a better way. But throughout history, financially things always tend to kind of go this way. They always tend to go to the way of too much leverage, too much belief in the safety net, too much reliance on it. I don't know. I'm just philosophizing. This is just –
Corey McLaughlin: Well, and then in the end, you know, the consequences of that kind of situation and belief get passed onto everyday people on the ground, which kind of flows with our next story about the Bank of England economist who told people in Britain that they need to accept that they're poor because of inflation and that they need to – basically it sounded like this guy, Huw Pill, the chief economist of the Bank of England – this isn't just like some, you know, random person who works there talking about it. This is the chief economist saying that workers and firms should stop trying to pass on higher prices, inflation, by rising prices or asking for pay raises to keep up with inflation.
Basically it's your fault, people. Peasants. Get out of here. None of these problems are because of just the way the system is or the decisions made within it. It's your problem. I mean it was kind of shocking to see that article.
I haven't seen something like that in a while as far as the quiet part being said out loud, and this was on a podcast too. The guy was being recorded, you know, just like us.
Dan Ferris: [Laughs] Yeah. This is so insane. This is sort of – I don't know. Maybe this is like the U.K. example of the stuff that usually Liz Warren or Robert Reich or Bernie Sanders, they always talk about inflation is basically caused by the greed of corporations. Then why isn't there inflation all the time, every single day, every single year? Because that's always there.
So it's a ridiculous argument that you're the problem, you know? Stop asking for higher wages because you're causing inflation. That's ridiculous. It's like –
Corey McLaughlin: Do your part. You know, it's "do your part," but we'll just come up with any wild stimulus plans or whatever we want and not believe that inflation is coming in the first place. I keep remember Christine Lagarde from the ECB. It's different from the Bank of England. This was like two years ago. She had a speech.
She was like, "Inflation is like a hump. You know, it'll come up and then it'll come down," and then the hump kept getting bigger for a year and a half and inflation over there is at 10% still and it's just now kind of starting to turn over, the pace of it. And so for people, if anybody was listening to this guy in the first place, I'm sure they're not very pleased with any government official telling them don't ask for more pay for the job that you've been doing when everything else has been getting more expensive.
Dan Ferris: Yep. They're still at double-digit inflation rates, and the Bank of England – there's no way inflation is caused by anything but the government or some interaction with the government and the central bank, right?
Corey McLaughlin: Right.
Dan Ferris: There's no way it's caused by anything else. There's no way it's caused by people asking for a raise. And this guy is saying the exact opposite of that. It's your fault, don't ask for a raise... accept that you're poorer. Good God. I mean, accept that you're poorer? It's disheartening.
It's like demoralizing actually to tell a whole country just accept that you're poorer and stop asking for more. You know, should we fill in the blanks there? Because you're not going to get it, you know? We're going to make sure you don't get it. This is another thing.
I don't know. For some reason I'm thinking in just big, broad, historical terms, there's always a group of people in control, in power, who are trying to keep everybody else down to some extent, you know? [Laughs]
Corey McLaughlin: Right.
Dan Ferris: And here we are. Like you say, the quiet part out loud, you know? We're in power and we're telling you to cut it out.
Corey McLaughlin: And, you know, it is the quiet part. It's tough to hear, but it is also – I think people should know that it is the truth, right? You are getting poorer, which by the way, reminds me of all the crypto and bitcoin people say have fun staying poor to everybody else. This is like that, the central bank saying that to other people. But anyway.
Dan Ferris: That's right, yeah. [Laughs]
Corey McLaughlin: But it's true, right? This is what inflation does. It does make you poorer relative to – for no other reason than what happened with money supply and prices and policy decisions trying to control the existing world that's going to be there anyway, you know? All the different forces that you always say.
Dan Ferris: Exactly. And that hump nonsense from Christine Lagarde, it's not a hump. You never get the purchasing power back, you know? The prices rise and your purchasing power sinks, and you never get it back. They never say, well, you know, we're going to have a 5% deflation next year so that we can get everything back to where it was. [Laughs]
No. No, that doesn't happen. That happens, you know, in TVs and computers and things. That doesn't happen in your food and your utilities and things, you know?
Corey McLaughlin: Right.
Dan Ferris: Those prices just keep going up.
Corey McLaughlin: Yep. And to what end? Like to your point, there has to be a better way for this, but I don't know what it is personally at the moment, but this goes on and on and on and on and on, much longer than I've been around, so I don't know. But to live through this cycle of inflation and just what you've seen happen with it, yes, the pandemic was a thing that had to be addressed one way or another.
But the decisions made after it and in it, I think as time goes on, will realize a lot of them were pretty bad and it hurt a lot of people for a longer period than most people will ever think. I just don't know the solution. I wish I had a solution to offer up right now, but I don't. I hope, and it's a hope, that our government leaders and whoever comes into politics next remembers this period and inflation and actually gets an education on how monetary policy affects everyday people's lives.
It's too much influence that the people don't fully understand, and it's hard to fix anything if you don't even know what the problem is in the first place.
Dan Ferris: Yeah. So that's where you get all the – like throughout American history especially, you get all these quotes about banks, about politicians who hate banks and say banks are the scourge of society and all this stuff. You know, they take over things and they basically become like a second government. You can see that happening before our very eyes.
When the government seizes a bank and then gives it to another bank I'll bet or free or negative – I don't know what was paid or what, but for some discounted price or something, you and I are never getting that deal from the government. Nobody's seizing anything and giving it to us, you know?
Corey McLaughlin: They're just going to say pay more taxes, please.
Dan Ferris: Yeah. And I think in the end – you know, I've been worried about just our society in general almost more than the stock market or something lately, and I think this stuff will come to a head. I keep thinking of that chart of percent of net worth by the top 1%, and it just goes up and up and up, and right after every crisis. It goes down during the crisis, like in 2008, late 2018 maybe or today, 2022, and then after it soars. It just goes up sharply, and over time it just goes up and up and up because of that.
Eventually people who aren't benefitting like this, they're going to get upset. It's going to spill over. There will be violence in the streets. I hate to leave our listeners with that, but every now and then maybe I should scare you a little bit. [Laughs]
Corey McLaughlin: Yeah. No, it's what we're staring down. This wealth gap is wild. Yeah, you're right, throughout history there's these cycles where you get to the extremes of the differences, like you were just saying, and things change one way or another.
Anyway, yeah, I think the takeaway for any investing point that we can make here is just kind of – I can make, is be prepared for that sort of – this climate to continue for a while until it's obvious that it's not going to continue anymore. That's how I'm looking at it.
Dan Ferris: All right. Maybe we should move on and talk with our guest John Netto. I've been really looking forward to getting John on the show because I have his book, which is this massive book called The Global Macro Edge, and it's all about trading. He's kind of like the trader's trader. I kept hearing about him from other people over the years and then I got this book and I was like, whoa, this thing's amazing.
Rather than tell you why it's amazing, let's just talk to him and we'll talk about some of what's in there because it's really important. So let's do that right now. Let's talk with John Netto, let's do it right now.
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All right. It's time for our interview. I'm really looking forward to this one because our guest today is John Netto. John Netto is the author of The Global Macro Edge: Maximizing Return Per Unit of Risk. He is considered an expert by many in the industry in analyzing central banks and monetary policy's impact on economy and markets.
He has appeared on CNBC's Fast Money, Closing Bell, and Squawk on the Street as well as Bloomberg, CNN, Fox Business channel, PBS, probably others. Mr. Netto speaks, reads, and writes Japanese, Chinese, Portuguese and Spanish to help him articulate his vision of the markets to an international audience. Netto has served in the United States Marine Corps for over eight years and is passionate about veteran's causes. John, welcome to the show and thank you for being here.
John Netto: Dan, thanks for having me. It's great to be here. So much to get to. Let's play pepper.
Dan Ferris: Yeah, let's do it. So for our listeners' sake, I just want to say I'm starting with a topic that I have been dying to get to, and for those of you who are long-time listeners, you've heard us mention John Netto in regard to this topic when we talked with Jack Schwager, and the topic is covered very well in chapter 19 of John's book The Global Macro Edge, and John does the exact opposite or says the exact opposite of what Schwager and all the other traders tell us they say. They all say the same thing, you know, we've got to get our emotions out of this process, I don't want my emotions involved, keep your emotions in check, keep your emotions, keep your emotions away, basically. So they all develop a process that they try to work in a very mechanical way, but John, you say something different, don't you? I mean, chapter 19 of your book is called "Emotions are Our Greatest Ally, Not Our Biggest Enemy." It's the opposite.
John Netto: I would say opposite is – OK, so let's take a step back and talk about what the global macro edge is and what we built the book around and then how it plays into the subject of chapter 19, all right? So when it comes to teaching – because ultimately when you write a book or you do a podcast, you want to create a place where people can come and learn new information, and learn ways that they can improve their process. In the book writing world, if you can bust a myth or a common perception that people believed to hold true, and you can demonstrate through evidence that this is actually a viable way doing it, contrary to what you may have thought, you're going to really resonate with them with the thought.
So the global macro edge, for starters, actually busts six of the biggest myths out there on Wall Street. So one of those six myths is that emotions are your biggest enemy. I just want to from a top-down perspective walk you through kind of how we got to this chapter. Now it's important that when we draw this distinction and clarification about the role that emotions play in our investments that I don't – I'm not trying to refute Jack Schwager or others who want to build an automated process or want to build a system around what they do, because they do understand – and I talk about this in chapter 19 – that if you allow emotional impulse to dictate your investment process, it is a perilous endeavor.
It is deleterious to your investment process to allow impulsive emotions that are not based on process – so I think I use a line in there that says investment based on process leads to success and investment based on impulse leads to regret. So it's that impulse versus intuition dynamic, and that's the first place I would start with. In fact, if you ask even a lot of traders out there who've been at it for a while, there's a certain intuitive knack that exists. So chapter 19 is as much about taking our collective intuition, which now there's evidence that shows that our human subconscious can actually analyze data at 20 million or 25 million bits for every minute in an order of magnitude greater than what our cautious mind can process information at.
So if we are in an emotionally calm place, if we're effectively operating – and a lot of neurological people discuss, you know, when you're analytical and you're relaxed and you're able to look at things in a calm, pragmatic manner, you're using the prefrontal cortex part of your brain, OK? Whereas if you get to a place of fear and you go more primal, the amygdala region of your brain is what takes over. So for a lot of traders, speaking for myself, if you get caught in a situation where you start chasing losses or you become I just want to get in, you're no longer using the prefrontal cortex and you're sliding to the amygdala part of your brain.
That's where what Jack Schwager and others say is actually spot on. You do not want the amygdala running and making your trading choices, OK? And that's a lot of the core of what chapter 19 gets to. However, if you can synthesize and harness, which is what we show in chapter 19, if you can synthesize years of experience, OK – because automation works to a point, but ultimately the markets are adaptive, and so this intuitive mechanism that we have that processes this information at 20, 25 million bits, you know, in a short period of time at a unconscious level, that's what we want to tap into in chapter 19, and that experience of years of experience that comes from a calm place, analytical place, has a lot of value. So from a broad perspective, that's what we're addressing in chapter 19.
Dan Ferris: OK. I have to say though, even then – and I totally appreciate the point about this being you're not following your gut, it's a very well-developed sense of intuition based on years of experience. I totally get that. But I have to say though still, even like the old traders that we have on this show, they'll say something like, well, you know, you'd think you'd develop some intuition after 25 years of making money at this game but, you know, every time I go outside the system or something like that I screw up.
So they don't seem to have the process that you have developed for developing this sense of intuition that you're calling your greatest ally, your emotions are your greatest ally. They never get there it seems like.
John Netto: Yeah. There's a few things I'd push back on that, which makes a good podcast. [Laughs] My first thing is that change inherently – and I'm going to go a little metaphysical on you here, all right? – I believe that the markets and the universe is as abundant place, but I believe the universe tests us, OK? If we want to make a change to ourselves or we want to begin to grow as people, oftentimes the universe is going to put obstacles in our way and really see if we are serious about that.
I also know that there's a lot of human biases, that when we go back and reflect upon things we tend to either remember them at a greater extent than what they actually were or we dismiss them completely, but our ability actually to correctly and precisely recollect exactly how an experience was is more tied to an emotional feeling we had, and that emotionality retrofits with the logic around that, and there's ample evidence that many choices we make in society – not many – all of the choices. Without emotion, decision-making is impossible, OK? So if you're trying to extract out the emotional side – and people may have a negative connotation or pejorative connotation for what emotionality encompasses, but emotions are the lubricant for decision-making.
So putting that aside, so for the traders that say that they may be right. The strategy as a standalone of what they did in that in instant may not have been the right call to make or it may have been the right call to make, OK? But I know from a personal level that just about every aspect of growth in my life or every amazing thing I was about to do, whether it was going to law school, whether it was a great relationship, whether it was buying a new house – who here thinks that buying a new house is an easy process?
Think about moving to that home or the discomfort that it brings, right? But the universe has a way of testing us, but then once you move in and get settled and you went through the paperwork and you did all these things – like I joined the Marine Corps. I spent nine years in the Marine Corps, Daniel. Do you think it was easy going through the medical process and all the paperwork and those cumbersome aspects?
So many things that are part of us evolving as people will bring some type of resistance, which is completely natural. So it doesn't surprise me when I hear that traders who've done something for 20 or 25 or 30 years are now attempting something new, the first thing they should do is celebrate that. Celebrate that you are trying to evolve and become a better version of yourself, OK? And then whether in that instance it works out or not, you know, that's why you set a predefined gameplan, which again, the goal of macro edge, we talk about maximizing return per unit of risk, it's about having an ability to analyze everything ex-ante, or before the fact.
You know, a lot of people analyze it ex-post and then don't have a fair assessment of what actually just happened and they let the results guide them and not how well they executed the process. So that's some of my pushback on where I would say, well, did they try that new system or did they try to use intuition over 100 instances or was it over three or two and they decided to go back in to where they were comfortable again? Because the comfort zone is a tough thing, man. We all love our comfort zone, but that's not where greatness happens. Greatness happens... growing and evolving.
Dan Ferris: Right. I mean the pull-quote that you start out the chapter that we're talking about, the book, is when I start to get too comfortable in a position that makes me nervous.
John Netto: Yes. Absolutely. And maybe you know that feeling. When you feel like, oh, it's going to be easy to get to that next level, that's a freaking warning flag, man. That's a red siren.
Dan Ferris: Yep, yep. Or even just, oh, this is a gimme. There's no way this thing goes wrong.
John Netto: Yeah. Ruh-roh. That's a big ruh-roh.
Dan Ferris: Yeah. [Laughs] Ruh-roh. Yep. About to get run over. OK. So let's talk a little bit about you make some comments in this that just – there's this one sentence in bold in the book: "The next wave of alpha will be generated by tapping directly into the emotionality or animal spirits of the markets, harnessing our own intuitions as signal sources."
And you've got at various points in the book like all the ways or some of the ways that you have figured out how to do this. I wonder if we can give the listener sort of the outlined version of that, like how do you get from the idea that your emotions are absolutely indispensable to decision-making but problematic for trading to, yes, now it's a tool for trading? How do you get from there to there?
John Netto: So some of what supplements chapter 19 is in chapter 18 because it talks about market positioning, OK? So I created ways to measure what I call market position premium because that market position premium does reflect some of – it can be a manifestation of what people are feeling about certain positions. As we know – and I delve into this more in the book – a lot of us – you don't want to be in a – it's tougher. It's not impossible but it's tougher to make money if you're in a crowded trade, OK?
So a lot of people are already in a trade in that position or looking for that move. You're going to really have to get something to go in your favor in order for that position to work out. So the first thing we talk about, harnessing the animal spirits, is at a very general level being aware of just how the market's positioned and what the current market narrative is around whatever trades you have on, OK? If you're going to trade for five minutes, that's less consequential. If you're going to trade for five weeks or five months, that's much more consequential, OK?
So I want to just start with that to answer your question, just that general what's the market positioning. Now let's get more down to specifically what you asked about harnessing the animal spirits, OK? So the first thing I tell people is not to use just your memory as a means of assessing or building what I would call an emotional trade result correlation, OK? In other words, if you go back and somebody says, oh, I remember a year ago I felt this way about the market and it did either the same or the opposite, that's not good enough, OK?
The commitment to this begins with a trade journal, and I'm absolutely not unique in saying this. Everyone from Paul Tudor Jones to Ray Dalio talk about keeping a trading journal, an investment journal, outlining what you've done. And that investment journal, in chapter 19 I give some specific metrics to measure what I would call your trade results and your analysis to your emotionality correlation, OK? So when I'm in this position, what's my fear level? What's my comfort level?
How do I feel about the risk around this trade? Where do I feel this is going? So establishing those metrics to say, OK – and now you've built a blueprint on that and that becomes part of your recordkeeping over a week, over two weeks, over a month, over three months, over six months, over 12 months, all right? And the more process driven you become, those feelings – and the more you execute actually, a lot of that emotionality can – you don't actually begin to live on the extremes.
So you're not going to be getting into positions where you're extremely fearful or you're extremely greedy because you've been keeping this journal. You become much more self-aware of your state of mind, of your feelings, and you'll adjust accordingly because of that. So again, let's continue to drill down on this because this was a great question. So that's at the individual level. When I talk about at the collective level, what I mean is that if you can take a group of, let's say, 50 traders and you would, say, have access to – if I'm a prop firm, all right? And I know that there's a trader who has – so there's two metrics I use called the maximum favorable excursion and maximum adverse excursion.
So the maximum favorable excursion is how much a trade goes in your favor before you close it out versus at the maximum adverse excursion, how much it goes against you. So you can use those as ratios to measure, oh wow, I was up, you know, 10 points on this S&P trade while I was only down three points. And over time, those should level out. Conversely, Daniel, if you find that you're a trader and you look back at the last 100 trades you made and the average trade you were in, you were down 10 points but you only averaged up three points but somehow you still break even, that's an ominous sign.
You're probably about to go on a losing – your system isn't that effective because you find yourself taking a lot of heat only to make a little bit in the end. So these are ways that you can use analytics to then begin to harness the animal spirits of the market or at least follow traders who exhibit really bad behavior signs. So if you sent a question like this – if I said, all right, Daniel, if I let you know – in other words, do this. If you can do the opposite of the worst traders you knew or the same as the best traders you knew, which trades would you take? I would do the opposite of the worst traders I knew. Absolutely.
Dan Ferris: Yeah.
John Netto: Let me see what the worst trader I've ever seen is and let me do the opposite of what he does, assuming that the commission aspect doesn't grind me out. I mean if they take a trade a week, I would much rather have the opposite trades of the worst trader than to follow the best trades of the best trader, because the worst traders implode in a spectacular manner. They blow up in a spectacular manner. So when you talk to me and you ask me the question, how is it that you – in the next wave of alpha, I believe the next wave of alpha is already happening now.
Yes, AI is a part of it but it's actually tapping into those impulsive intuitions that traders have. You build a mock trading room and you actually establish who the worst traders are and what the impulse trade is and that impulse trade becomes your fade mechanism or what you do the opposite of, and I think that's the next wave of alpha that could be manifested.
Dan Ferris: Oh, yeah. That's cool. You know, there's a hint of Chris Camillo in this. Chris Camillo is the "neither" guy, neither fundamental nor technical, and he's looking on social media and trying to figure out kind of what everybody's excited about and what they're wanting to buy that he thinks maybe has some legs under it. That idea is similar to you, it's like you're wanting to know what the crowd thinks –
John Netto: But going one level deeper than that – and not deeper but just maybe a subset of that is that it's one thing to look at social media to gather that, and that can be effective. I haven't found a way to use the social media yet per se to where I put legitimize size behind a trade. However, the idea of watching people actually do it with their money – you know what I mean? Aggregating that information. So what I think is the large hedge funds actually are creating outposts or trading firms, and that trading data of the worst traders of what the impulse trade is actually very valuable and effective because if you can have four bad traders lose you $50,000 a month but those 10 bad traders collectively generate five signals a month that generate major market turns, i.e. whether you should be buying the bottom or selling the top, the $50,000 a month they take in losses can generate you $5 million a month in revenue because you can scale those trades and go the other way.
And there's an infrastructure aspect to that. So it's one thing to look at social media, Daniel. It's nothing to actually see real positions that people who based on emotions are actually applying and putting in place.
Dan Ferris: Yeah. I mean I don't want to oversimplify what Camillo was doing.
John Netto: Sure.
Dan Ferris: There was just a similarity that I sort of recognized there.
John Netto: That's absolutely spot on, totally spot on. Yep.
Dan Ferris: Right. Yes. So maybe we'll talk about the Netto Number now. Do you want to do that?
John Netto: Yeah. That'd be great, Daniel.
Dan Ferris: That's an interesting figure because at the bottom of it is the idea of incentive.
John Netto: Yes, yes.
Dan Ferris: Which is important, is it not, in rewarding traders?
John Netto: Absolutely. So one of the things we – I want to go back to the six myths that we talk about that we bust in The Global Macro Edge, and a couple of them kind of tie in or don't kind of directly tie into the Netto Number. So let's just start with what the Netto Number is from a conceptual framework and then go from there. The Netto Number teaches people how to maximize or at least measure the return per unit of risk for an investment, OK?
So most of us know what returns are at a first dimensional level, Daniel. You might ask a colleague or a colleague might ask you, "Hey, Daniel, how much did you make or lose in the market last year." That's a fair question. That's the first question we all kind of want to know or want to ask, all right? And you might say I made 15% or they may tell you I made 15%, and that gives you a context, right? They made 15%, but there's a challenge in that, right?
We don't know a whole lot more than that they made 15%. We don't know how much capital they had at risk, we don't know the volatility around that portfolio, we don't know if it was down 40% at one point in time, was it up 60% and then they gave back and then they only ended up 15%? We don't know – like I talked about was the whole portfolio at risk? In other words, if I told you, Daniel, that I made 15% but at no point in time was more than 2% of my portfolio at risk, that's a much different figure to make 15 when only 2% of it was at risk versus you made 15% when half of your portfolio was at risk, right?
So what the Netto Number does, the Netto Number quantifies – so that's the first dimension. The second dimension – and there's already metrics out there. There's like the Sharpe ratio, the Sortino ratio, the Calmar. That's like the second dimension of performance analysis, all right? So what they do is they say, OK, you made 15%. However, the volatility in the portfolio was X, and so as a result of that we're going to apply this ratio to it, which is an important distinction and context, right?
Because now you know that, all right, I made 15%, but the portfolio had this kind of volatility around it. OK, so that's like the second dimension. But there's a challenge with those ratios, is that while they tell you the volatility that was realized to get those returns, they still don't tell you what was actually at risk to get those returns. So if you have an options selling strategy that generates premium, it may not show a lot of volatility, and so it can give some deceptive numbers, and so people say, "Oh, wow, this strategy made 15% and had a Sharpe ratio of 1.7, wow, that's a really good Sharpe ratio because there wasn't a whole lot of risk in that."
Well, that's true. At least it wasn't a whole lot of realized risk. There may have been a lot of implied risk in that trade, they may have been taking a lot of risk, but the realized risk wasn't so high. And so that's in essence what the Sharpe ratio and Sortino ratio can help address and cover, which is better than just the returns, but it's missing one point. What the Netto Number does is the Netto Number, in a very simple way, lets people see what the return per unit of risk was, meaning how much money was made relative to both the realized volatility and how much risk you were taking beforehand.
So in that example I mentioned to you, if you're only risking 2% of the portfolio or 3% of the portfolio and you make 15% for the year, the Netto Number will show you a better Netto Number, a higher Netto Number than the portfolio that was risking 30% of the portfolio and made the same return. And that helps when it comes to assessing leverage, and they'll vet you on an apples-to-apples basis, compare strategies and managers.
Dan Ferris: All right. And actually, what you're talking about there, that's like the essence of the whole book, I feel like.
John Netto: It is. Yeah.
Dan Ferris: It is the core notion behind the whole thing. I mean it's in the subtitle.
John Netto: The subtitle.
Dan Ferris: Maximizing Return Per Unit of Risk. All right. Well, you just told us everything. We're good. Yeah, right.
John Netto: You're done. Just go make – you can all retire, OK?
Dan Ferris: But I feel like the other thing – I mean if you have more to say on these topics, like lay it on me, but I feel like the other thing we should talk about with you is like one of your things is knowing about central banks and monetary policy, and I feel like we're at a time when that's kind of an important topic right now. It's on everyone's mind right now.
John Netto: Yep. So yeah. So one thing that I do and I talk about, and chapter 20 of the book is called "The Impact of Automation," is I trade very actively through my Impact trading software, central bank FX. And I have a way of building out the qualitative scores behind them, and I'll share at least broadly how I do that so your listeners today can at least for themselves at a very general level know how I handicap these events and how I build algorithms around them.
Ultimately, you know, every event is different and I customize the weights behind this and pluck out what are the idiosyncratic aspects, but nonetheless, I'll maybe talk about the four things that I look at when I trade these events, and then I can speak more broadly to the current environment about how that might apply today so your listeners can take this and move forward and apply it in the markets. So there are four factors that I look at when it comes to handicapping or building a model to a Fed event, OK? The first is what the statement – so think about the FOMC statement. You're talking there's four to five paragraphs in each one, maybe six at times, but really four or five.
The first paragraph makes a general assessment of the economy and sort of how that assessment – and maybe some even some inflation language will fit in there more generally and more past-looking, OK? The second paragraph, you know, is where they drop lines about what rate changes may be made, and they'll throw in some other stuff. You know, we've seen recently – not recently, but the last year the whole situation in Ukraine. They'll throw some geopolitics in there. The third paragraph, you know, can vary.
The fourth paragraph then may through some future guidance as well, but this stuff can mix and match over time. So here's the bottom line. Given those four paragraphs, I give a score for what the Fed's economic outlook is, in other words how they assess the economy and how they look at it going forward. So both how they characterize past economic events or recent economic events will give you some color about what they think about future economic events. So if they, you know, comment about how strong the job market has become, well then I guess that recent jobs data, you know, did impress them.
If they talk about maybe how strong the job market has improved but still shows signs of weakness, well then maybe that recent job data wasn't so influential to them as we might've thought. And again, that's a general example right there. So the first part I look at is what the economic perspective is, OK? The second part I measure is what their outlook on inflation is, OK? Is inflation contained? Does the 2% mandate look good?
Do they think it's going to come back? For a long time, in 2021, talking about supply chain issues. You know, so that was sort of the qualifier for high inflation, OK? That's the second part. So the first one is economic, second one is inflation. Now let's go to the third, all right? And the third is what I define as what their outlook for interest rates is, OK?
Any evidence they give in there for interest rates, all right? And again, these are things that while I program them quantitatively and algorithmically, anyone can take the statement, use this metric, and sort of check the box. So this is something that can help all of your listeners to at least do a quick sort of top-down assessment. And then the fourth thing is the idiosyncratic aspect. So, you know, if the Fed does an Operation TWIST or a TWERP or whatever it is, you know, or a TWEAK – in other words, are there any programs they're introducing that would on balance impact the hawkishness or dovishness of that statement, OK?
And these are things that I programmed into Impact. I come up with a score, and depending on what aspects of those or how they're impacted, I set up and trade parts of the yield curve or fixed income or currencies or the equity markets based on these Fed statements. And of course, I follow other central banks as well because these guys kind of mirror each other or follow the lead of the Fed, etc. So that addresses sort of how I grade these events in terms of what we're seeing today and how I might grade this upcoming event coming early May.
In fact, I'm giving a presentation next week at the money show here in Las Vegas on this exact topic, so if anyone hears this podcast, you can check that out for a more specific component to that. So anyhoo, let's talk about this next Fed event coming up and really for the June events as well, all right? We're at a point in time where a lot of people are effectively pricing in for the Fed to have actually rate cuts in place by the end of this year . It's a point of a lot of controversy.
I think, you know, given the language that Powell has put in place, after his complete about face in November of 2021, which was pretty disgusting and lost the Fed a ton of institutional credibility, when for a year it's supply chain, supply chain, supply chain, and then one week later it's inflation's not transitory, it's a major problem and we've got to deal with it, and that coincided with his reappointment as Fed chief. Powell and the Fed just lost a ton of institutional credibility in my opinion as a result of that. But that being what it is, let's deal with the here and now and what's going to make us money.
I'm not here to make a political comment or whatever, but that's contextually – let's happily monetize what the current state of play is, OK? And that is that this Fed chief, this Fed head, he's not the same guy as 2021. He's not the same guy as 2020 or 2018. He's bee firm. And while the markets are pricing lower – cuts coming the back half of this year and interest rates coming the first part of 2024, I think that's being a little too optimistic right now. You know, I think that this is going to be a lot of backend filling.
I ironically think that you need to be looking for, by and large, range trading, and when I look at what's taking place with the dollar, you know, I think that the Fed is not going to be cutting rates this year. I think inflation is sticky. I think they're going to keep rates at this 4.5 to 5% pace probably to the middle of 2024. Maybe Q2 2024 is when we get, you know, possibly some easing, if then. The market is very strong, wage inflation is there, which is not a bad thing, and it's sticky.
Service sector is doing well. By and large, people are calling for recession. It may happen, but the data coming in that I'm looking at and seeing is I think we're doing a good job sort of holding the ground. And if we get a recession, it's a very, very mild one and there's a couple of reasons for that. You know, I think that the home wealth that's been created – like we're now looking at a housing crash in the same way that we saw in '07, '08 because there's a lot of people like myself and maybe like yourself, Daniel, we're locked in on our homes at 2.25% and 3%.
We all refi-ed, OK? And we all got equity, or many of us have equity. Many of us have this crazy low interest rate that we don't want to give up, OK? So you're seeing this housing market, and correspondingly, because now we have rates at 7%, it's going to take a very long time, like through deaths of people, for this housing inventory to kind of roll over. So I think the housing market is kind of in a nice equilibrium place, actually.
It's not crazy like it was, but also it's not going to crash because I'm not being forced by the bank to sell because I've got X amount of dollars in equity and I've got a great interest rate, and I could always rent the house out because the rental market is on fire right now, OK? So there's that in place. And there's some other factors as well, but please, ping me with a question, sir.
Dan Ferris: Well, actually, the degree to which we're kind of on the same page here, I've been thinking the same thing. I've been thinking, you know, the narrative around pivot has always bothered me. It's always bothered me. And I tell this story on the podcast and in my newsletter that, you know, Jay Powell is a high school quarterback walking down the hallway looking at the picture of the champion from years past 40 years ago, Paul Volcker, and he said, "I'm going to be just like Paul. I swear I'm going to be just like Paul."
The other thing that impresses me is that in the same way that Ben Bernanke said don't worry, we're not going to do the Great Depression again, we made that mistake once, I think JP is very much in the opposite mindset. We're not going to do the '70s again. Don't worry, I got this. And I've said inflation is sticky 500 times. I think the view among the sophisticated sort of economically kind of macro aware folks is that sticky just means lagging, and they can handle that.
"Sticky" just means lagging and just wait and it really is transitory. I read another piece like that over the weekend. You know, it really looks transitory because you see this – the year-over-year, it looks like this curve that has rolled over, right? But, you know, now what's in the news the past 48 hours, well, services are kind of – I wouldn't say on fire, but not declining, right? Nothing like that.
Housing too is the one that has – yeah, I don't like the action in it. I have to say I don't like some of it. But that structural shortage is in the back of my mind and it's irritating the hell out of me because it doesn't go with the drops in sales and the drops in prices in various places. And at some point, real supply and demand has got to mean something, right? So yeah, I don't even know if I haven't another question. I'm just kind of delighted that somebody who has a whole process for scoring the Fed – you know, I mean I read the statements too but I don't have your process for scoring it, but we're seeing the same thing.
John Netto: Well, intuitively you probably do, though. Maybe you don't write it down or put it on a spreadsheet, but as I'm talking about all those points, those are the things that over decades of reading Fed statements, Daniel, you just do intuitively. So the global macro edge and my process, well let's quantify this and create something that's repeatable and scalable so that we learn from experience, we adapt, we evolve, we get better. And hence, that's what protean means.
Protean is a Greek word from the Greek god Proteus, who his son – he was the son of Poseidon, the god of water, the god of the ocean, the god of the sea, and so Proteus was able to take on many shapes and forms, and so you see the term the protean act or the protean composer, the protean chef, OK? So I want to be the protean – I aspire to be the protean trader who's adaptable, versatile, and able to take on many shapes and forms and use many different strategies.
Dan Ferris: You know what I love about the character of Proteus is that in the Odyssey, our hero, Odysseus, if he can hang onto Proteus, Proteus assumes these many forms trying to scare the hell out of him, but if he just hangs onto him he'll see his true form. I think that's metaphorically brilliant, right?
John Netto: Wow.
Dan Ferris: Just you have to hang on through all the changes to see the true essence of Proteus, and it's sort of – I must've interviewed 200 guys who call themselves traders in various ways over the past few years here, and they're all hanging onto that process. They're hanging on to what they know works, and through changes, you know, in the market and eventually if they're successful, if they've got the process right, if they're really doing a process and not just assessing recent results the way so many mistakenly do, you know, the market reveals how to make money, the market reveals a good process over a long period of time. If that's not too labored –
John Netto: No, it's brilliant. I've been recently prominently influenced by Greek culture and Parisian culture, and it's so appropriate that you would bring up the Odyssey and Proteus and the idea that we'd be talking about it now sort of talks about how – it speaks to sort of how the universe and things can kind of tie into together things energetically. You know what I mean? Intellectually, spiritually, conceptually. So it was really refreshing to hear you go to obviously one of the most prominent and bedrock stories of all Western civilization, you know, and reference to the protean concept because that's – what I'm doing now – so the principles of what I'm doing now are there and will be there – they will be there when the little macros came out six years ago and are viable today.
But how they are applied and how the markets have evolved – in other words, maximize return punitive risk is an evergreen concept, OK? But how we maximize return punitive risk is adaptable. It changes. And that's why the Netto Number is so important because it gives you a means to recognize when strategy decay is taking over, OK? When, oh, this strategy is having to take more risk to make the same amount of money.
Interesting. So six years ago, the strategy had a Netto Number of 1.8, which is great. Two years ago, it had a Netto Number of 1.5. Even though it still made 15% both years, it had to take more risk to make that 15%, OK? And that's why that ties into manager compensation based on the Netto Number because now once you have the Netto Number, I want to build a system that would reward managers who can make a lot while only risking a little, but would not necessarily punish managers but wouldn't incentivize them to make a lot while risking a lot or to make a little while risking a lot.
Because we don't want people risking a lot to make a little with our money. They can do that with their money, Daniel, but not with our money, OK? All right?
Dan Ferris: Right. That's right.
John Netto: So the way the Netto Number works is that if a manager has a Netto Number of three or higher, they can earn an incentive fee of 50%. Fifty. Five, oh. Which is great. So some people hear that and say, wow, well I don't want to pay 50%. Yes, you do. Yes, you do.
Because a manager gets a Netto Number of three, he delivered a spectacular return punitive risk for you, and your net return after fees is higher than if you had a Netto Number of only one, OK? And what that does is that then allows someone to make – so a lot of managers play the AUM game, which is fine. There are strategies that allow for that, OK? But if you're out there and you say, listen, I run $100 million and, yeah, I can manage $300 million with no impact to my strategy, yes, I can run $1 billion with no impact to my strategy, well, if there is strategy decay as a result of you hitting your capacity constraints, the Netto Number is going to lower your incentive fee.
So the Netto Number conservatively is the natural self-regulating component of you not to take on too much capital because you can denigrate your returns, at least from a return punitive risk basis, and then that's going to impact your overall performance.
Dan Ferris: Right. And this is something, I suppose for our listener's sake, you know, it's something that they would keep in mind to evaluate a manager rather than doing it themselves. We assume they're not going to run up against any capacity constraints.
John Netto: Right.
Dan Ferris: You know, the average sort of small trader. But good to know. This is your first myth in the list of myths that you bust in the book, is about risk and reward, thinking the two are – you know, you need to take more risk to get better returns and you don't. And this cuts – this isn't just a trader's thing. This is like Warren Buffett, Ben Graham, like all the long-term sort of bottom-up fundamental analysis guys, are all aware of it. They're all aware of trying to sort of squeeze all the risk that they can out of the investment position before they take it and then achieve a better return over time by doing that rather than sort of trying to shoot the lights out and using leverage and all these other crazy things that people do.
John Netto: I mean leverage is OK as long as it's risk defiant.
Dan Ferris: Sure.
John Netto: So one of the titles on my website is, you know, the better the brakes, the faster you can drive your car, right? If your brakes can't stop, well you can't drive very fast, OK? But if you have a solid risk management process in place that comes through targeting multiple noncorrelated strategies that are executed in a risk-defined way, where risk is not only quantified but controlled, well I can tell you have – you know, I only risk 3% per trade. Well, how do you control that risk?
So, you know, if you can build systems around a number of noncorrelated strategies and you can leverage those strategies, and the risk is controlled behind that, that's like a utopia, OK? Because you build up across a bunch of noncorrelated aspects. But if you go in and you just leverage, there's no control and you can't ring fence that one strategy, well your 5% allocation to that one strategy – if that was a risk allocation – can become a 15% loss if it's not ring fenced correctly. And so just like you said, you know, you've got to have these risk parameters in place.
Dan Ferris: Yeah. We always wind up here with risk as the core concept of talking with all these guys from Schwager and Peter Brandt and all these other guys. We always wind up here. It doesn't surprise me at all. But I think it's time for me to ask you my final question, which it's the identical question for every guest, no matter what the topic.
Even if I have somebody – every now and then we'll have a nonfinancial topic. Same final question for everybody, OK? And no, folks, I didn't tell our guest what the question is. He's hearing it for the first time right now.
John Netto: My anxiety level is building right now. I'm getting super hot. Yeah.
Dan Ferris: That's OK. It's kind of the point, it's kind of the point. But we pick good guests, and you're a good guest, so I'm sure you'll handle it OK. The question is simple. Very simple. If you could leave our listener with one thought today, what would it be?
John Netto: The thought I would leave with them today is what are you doing to be a better version of yourself? And insofar as that incrementalism is the pathway to greatness, all right? So being a better version of yourself can simply mean today I made this one small change and tomorrow maybe you simply do that one small change again to build a habit for it. The power of incrementalism, the power of small, subtle changes done in a methodical, consistent, committed manner, have a profound impact one month, three months, one year, three years, five years down the road.
And the habit of making a promise to yourself you're going to do this one small thing, and then keeping the promise to yourself, is really big, not just in the trading world but in your personal life. So I would leave the people with – I would say – and I aspire to this myself. I need to be better at this myself, but it's what I aim for, is to constantly making small, incremental improvements and keep the promises I make to myself.
Dan Ferris: Excellent. That's a great answer. I love that, especially coming from somebody who's done all the things that you've done. You know, you obviously – you're practicing what you're preaching. But listen, John, thanks so much for being here. I really enjoyed this conversation. I feel like we could do it for a lot longer.
John Netto: We could, Daniel. Please, let me know. I love being on here. It was great to have a chance to interact with you and your audience. Super thrilled. Keep up the great work and keep up doing the great service to our investment community, Daniel. A real pleasure to be on here and very, very thankful. Thank you, sir.
Dan Ferris: Oh, you bet. Thanks very much. I'm going to be hard to get rid of.
John Netto: Excellent.
Dan Ferris: Many mainstream analysts are predicting that stocks will recover soon, but I say we'll instead witness a cash frenzy unlike we've experienced in 21 years before stocks recover, and I'm urging Americans not to buy a single stock until they see it. I predicted the Lehman Brothers crash in 2008 and I called the top of the Nasdaq in 2021, but this, this is the No. 1 most important thing to pay attention to for 2023. And I'm not talking about another market crash or politics or inflation or any of these other things. As all this unfolds, the financial consequences of what I'm talking about could last for several decades if you don't understand what's happening.
There will be winners and losers, and now is the time to decide which one you'll be. This is why I strongly encourage you to read about my warning totally free today. It's all spelled out in a free report we've put together. Get the facts yourself. Go to www.StockDeadzone.com to get your free copy of this report. You can learn how to get my four steps to prepare for what's coming. Again, that's www.StockDeadzone for a free copy of this new report.
Wow, it was really great to speak with John Netto. That was the first time I've ever spoken with him. I really enjoyed the book, The Global Macro Edge. It's a huge book. It's like a little telephone book or something. [Laughs] It's really huge. And it's got all kinds of other folks contributing to it, some of whom have been guests on the program.
I know Raoul Pal has a chapter in the book. If you are a trader of any kind, I think you'd benefit from it. And if you are a macro trader, well, you know, it's kind of must read material for that. You know, a great trader like John, they're so deeply process oriented. You heard he used a lot of terms for things. You can tell he's just got his own way of looking at everything.
He's got his own way, for example, of reading each paragraph and scoring each paragraph of the FOMC statements at every Fed meeting, and that strikes me as a very Netto thing to do and a very, you know, just expert trader kind of a thing to do. And if you're a trader, I hope you're doing these things. I hope you're keeping a trade journal. John said everybody does this. He does it, Paul Tudor Jones does it, everybody does it.
So I really think you should be doing it too. If you're a trader, you've got to keep a trading journal. It's just like one of the fundamental things that you do, and you have to be very process oriented like that and develop your own tools and your own ways of thinking about your process and stick to it. I think you should read that chapter, chapter 19 of Global Macro Edge. The idea of using your emotions in that way and having a systematic way of doing that is very different. It sets John apart. It's an idea worth entertaining if not adapting and using. So I really enjoyed that.
That's another interview, and that's another episode of the Stansberry Investor Hour. I hope you enjoyed it as much as we did. We do provide a transcript for every episode. Just go to www.investorhour.com. Click on the episode you want, scroll all the way down, click on the word "transcript," and enjoy.
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