Odd Lots - How The Bond Market Changed During A Veteran Trader's Decades On Wall Street

Episode Date: July 31, 2017

Most people have some kind of hazy conception of how the stock market works. Stocks are simple to understand, and there are only so many of them out there to trade. But the bond market is a whole different beast, and in some ways it remains way behind stocks in terms of how technology has changed the industry. On this weeks' Odd Lots podcast, we talk to Bloomberg's Rob Elson, a former trader, who spent decades in the industry. During our conversation, he talks about how he got into the business, how his job changed from the early days to its end, and what he learned about what it takes to succeed in trading.See omnystudio.com/listener for privacy information.

Thanks for listening to Odd Lots. Follow the show on Amazon Music for more future episodes or just ask, Alexa, play the Odd Lots podcast on Amazon Music. Today's show is brought to you by Vanguard. To all the financial advisors listening, let's talk bonds for a minute. Capturing value and fixed income is not easy. Bond markets are massive, murky, and let's be real. Lots of firms throw a couple flashy funds your way and call it a day. But not Vanguard. At Vanguard, institutional quality isn't a tagline. It's a commitment to your clients. We're talking top-grade products across the board of over 80 bond funds, actively managed by a 200-person global squad of sector specialists, analysts, and traders. These folks live and breathe fixed income. So if you're looking to give your clients consistent results year in and year out, go see the record for yourself at vanguard.com slash audio. That's vanguard.com slash audio. All investing is subject to risk vanguard marketing corporation distributor.

Hello and welcome to another edition of the Odd Lots podcast. I'm Tracy Allaway. And I'm Joe Wisenthall. So Joe, what's the one topic that I enjoy talking about more than anything else? I was going to say, actually, I wish you hadn't to say more than anything else. I wish you would just left it. What's the one topic I enjoy talking about? Because I kind of feel like with a lot of our recent episodes, it's like, all right,

we're doing this topic that I really don't care about and force myself to learn about. They're all interesting topics, Joe. It's just I feel like I'm immediately on the back foot when we're doing poker or chess. Or anything like that. Or sports and games in general. But it is true that you have one topic that you regularly like coming back to and always really enjoy. I'll let you bring it out. Sure.

All right. So the topic is the bond market and specifically bond market structure. Right. The history of the bond market, how it actually worked. as we've explored in multiple posts, episodes on this podcast. It's very complicated and far more sort of far more many structural issues arise than, say, the stock market, which to some extent I think people get how the stock market works. Yeah.

So the analogy that people often use, at least when it comes to the corporate bond market, is to say that it's kind of like the stock market in, say, the 1990s, and that a lot of it still trades by appointment and over the phone. But on the other hand, you have the government bond market, the treasury market, and that has actually shifted to some electronic trading quite, well, I don't know if you'd say rapidly, but quite significantly. But then again, on the other hand, the credit market is still stubbornly old-fashioned. Pretty impressive in its own way. Yes, Joe. Okay. So we know we're going to talk about that today.

Yes. But what are we going to talk about specifically? All right. Well, I'm really excited because to talk about the bond market, we've tapped someone who's been in the bond market for decades and who works at Bloomberg. So probably, well, I was going to say probably somebody who's seen a lot of changes, but per your intro, maybe not that many changes. All right. Well, we'll have to ask him whether or not there have been any changes. So we're going to talk to Rob Elson. He is an analyst on Bloomberg First Word, and he covers the bond market day in and day out.

Let's do it. Thank you so much for joining us. Good morning. You know, I just introduced saying that you've been in the market for many decades now. But you had a kind of interesting career path into bonds. Is that the right way to put it? Yes. After college, I went to law school for about 20 minutes and was immediately drafted the nanosecond after I dropped out.

So this would have been in the. 60s, 70s? Right. It would have been 68 in law school and then 6970 in the Army, the last year of which was an interesting year in Vietnam. And when I came back to the States after that, my college roommate, who had legitimately, I might add, been 4F legitimately, had been working in New York and then quit that, was traveling in Europe, got back to New York about the same time I did, and he said, hey, I've tried this work stuff. It's not such a big deal. I'm going across country, want to come. And I figured, well, better to do it before I start working. So we spent 6,000 miles going across country somehow and wound up on a little island called Vashon in Puget Sound off the coast of

Seattle. And that was a very interesting year. And after that, I came back to New York and looked for a job. One of the women I had went to college with had a connection at what was then First National City Bank. And I went in for an interview, and the guy who was going to interview me wasn't available and basically sat me down with a guy who it turned out was a treasury bond salesman. I'm sitting at his desk for about 30 seconds or a minute or so. His phone rings. He goes, yep, yep, and looks across the trading room and yells to buddy or whatever the guy's name was at the time, bid 56 is for American Road, which was their code for Ford Motor Company back in those days. And the guy yelled a number back at him, and he repeated it into the phone and then sort of flicked his finger

at the guy on the other side of the room and said, yep, thanks very much, and hung up the phone. And I said, what just happened? And he said, I sold 50 million six-month treasury bills to Ford Motor Company. And I said to myself, oh, I could do that. As it turned out, I could, but you don't really get to be very good at until a year or two goes by. But you got the job, right? I got the job. So real quickly, what strikes me already about this story is, you know, and I think of people trying to get into Wall Street these days. I think of people who for years have had the ambition of getting into Wall Street. Maybe they studied some business and some math and technical stuff and college, did an internship, took all kinds of sort of licensing.

Like, it seems like there's this model person who really tries to get into finance and checks all the boxes. And I get the impression from your story and other stories that we've heard at the time, that it was definitely a bit more informal, that people with more sort of unusual, diverse backgrounds. And I'm saying that from a sort of experience and education standpoint could find their way in. Is that fair to characterize it that way? It's absolutely correct. There was literally, I think, one master's amongst the people that I worked with. And I think he had a master's in something like geology or something. There was no such thing as an MBA that anybody in the bond market knew anything about

internships. The only introduction to this that I had was sitting at this guy's desk. I had no idea what the bond market was other than it was sort of like the stock market. And that was it. one of the fellows I worked with, and by the way, who was times, I am working with again here at Bloomberg, actually came out of a seminary, dropped out of a seminary, and became a bond salesman. So very, very different times. It was sort of, you know, if you knew somebody who knew somebody to get you in the door,

you had a shot at an interview, and then whatever happened, happened. So what was trading actually like when you started and how did you find it? Was it hard or was it easy for you? I don't really remember except to say that I think instinctively I knew that I didn't know anything. And so what I did when I started covering people who were real clients and had really. real experience and managed money and knew what they were doing, I wouldn't pretend that I knew what I was doing, but if the first guy I spoke to in the morning said something smart or what I took to be smart, I would rearrange it and repeat it to the second guy. And then the second guy would either agree or sometimes say, no, that's not right because of X, Y, Z. So I could go back to the first guy and say, well, what about XYZ? And slowly, slowly, you begin to figure out

what's important. And, you know, when the Fed does something, what does that mean? And it was just a different world. At that time, what were the characteristics of a good bond trader or a good bond salesman. What did the people who are really good at it versus the people who are sort of mediocre at it versus the people who were let go? What did those really top ones possess? Good question. And I have an interesting response. When I started as a trainee, it was unknown as to whether I would wind up in sales or trading. And one day the head trader called me up on the trading desk and sat me down next to him, and, you know, I picked up the phone and listened to his phone calls. And at one point, he picked up a phone to one of the brokers and got a run of, let's say, two-year notes. And so

the guy was saying 15, 16, 1820 on the November's, 2025 on the November's. And the trader just said, I'll buy the octobers, sell the Novemores, and then he picked up a handful of tickets and tossed them to be and said, write the tickets. And while, yes, I had been listening into the phone call, I really didn't pick up quickly enough to know what I was supposed to be buying and selling. And I think that was my holding my feet to the fire, and that was my test. And then I was in sales. The guys who were traders, the good guys, they had some instinct about it. They just knew in their fiber that something was getting overbought or oversold.

it was getting ahead of itself, or they could read that when a big portfolio came in and bought or sold something, they knew what was going to happen next. I don't think it was a skill that you could learn very easily. These guys really just did it from the gut and off the top of their heads, and in some cases were amazing money makers. Today's show is brought to you by Vanguard. To all the financial advisors listening, let's talk bonds for a minute. Capturing value and fixed income is not easy. Bond markets are massive, murky, and let's be real.

Lots of firms throw a couple flashy funds your way and call it a day. But not Vanguard. At Vanguard, institutional quality isn't a tagline. It's a commitment to your clients. We're talking top-grade products across the board of over 80 bond funds, actively managed by a 200-person global squad of sector special. specialists, analysts, and traders. These folks live and breathe fixed income.

So if you're looking to give your clients consistent results year in and year out, go see the record for yourself at vanguard.com slash audio. That's vanguard.com slash audio. All investing is subject to risk vanguard marketing corporation distributor. So, Rob, I want to move on to the evolution of the bond market over the last few decades. But before we do, what's the most... interesting or remarkable thing that happened to you during your career? Is there one sort of incident that stands out? I think it was 1974. I had started in October of 71. I think it was

1974. Interest rates were high, although not as high as they would go. And the Treasury would auction coupons where they had already set what the coupon was going to be. And so there were what came to be called the front nine and the back nine. Of course, everybody played golf in those days. In any event, I think it was the nines of 77 and the nines of 81. And we're at the morning meeting and I literally pounded on the conference room table and I said, nobody's going to buy these. Everybody thinks they're going to wait and you're going to get 10%. If we take a position in these, we're making a big mistake. Don't do it.

I'm telling you, don't do it. And the boss looked at the senior salesman and said, the end. of the world speech. And that's what it was. And I gave them the information that things were so bleak that nobody knew what was going to happen. And they went and bought as many as they could at the time of both auctions. And the market went straight up and yields dropped something like 100 basis points. And it wound up being a big home run for them. And I always try. try and remember that, particularly when I'm looking at charts about where we are now. Interest rates have been going down for a very, very long time.

And yes, we're higher than we were from the all-time lows. But still, when you look at a long-term chart, we have barely budged off the bottom. I think, I don't know whether they'll live to see it or not, but I think that one of these days, somewhere down the road, the Fed will tighten in a way that will take the breath away of market participants, and we will have a bare market that will just amaze people. I don't think there are very many people left who really have ever seen a real bare market. Right. I was just going to point out for listeners who aren't aware that essentially bonds have been in a

bull market now, you know, over 35 years. I mean, there have been some ups and downs during that time. But for over three decades, bonds have been in a bull market. So what does that mean? I mean, if we do get, you know, as you say, maybe it's a Fed-induced move that it creates a real bear market, not like this little like sell-off that we've had since last summer. What will be the ramifications from the fact that so many, so few people in the space these days have ever seen a bear market? Well, it's not just that they've never seen a bear market. It's also that the whole structure of the dealer community has changed.

People have serious risk limits and serious position limits. The banks obviously have capital requirements that were not in play over the years. So the question is, do the big dealers have the ability to stand there and buy securities when they're going down by not one or two basis points, by perhaps five or ten basis points at a time. And I think that's a big question. Ultimately, in theory, the Fed will have to be there as the buyer of last resort,

or at least that was how it used to be. I suppose we could ask the question, and how many people are left at the Fed on the open market desk who really have had, you know, that experience. So is the issue with the market right now, on the one hand, you have the shrinking of the dealer balance sheets, their ability, their appetite to take risk, supposedly. A lot of people argue with that point, by the way. But at the same time, the way that bonds are traded hasn't really changed.

You know, you still need to pick up the phone to some. someone, you still need to put an order in. It's not like the stock market that's highly liquid where you can just enter orders electronically. Is that the issue, the dichotomy? Well, I think that the conversations between clients and dealers has diminished. Not for the big guys. The Black Rocks and the Goldman's presumably still talk daily to each other. But for the vast majority of clients, it's all electronic. Electronic communication, you mean? And electronic trading.

You don't call up Bob Elson anymore and say bid 50 million two-year notes. You know, you just do it on the screen and you hit enter and you hit a bid. It's right there in front of you and you see a trade. Yeah, I was just going to ask about that. So obviously, we talked about the sort of, you know, the changing rates market and some of how different it is these days. From a technical standpoint, when did you start to see a change in the way bonds themselves were dealt? What kind of, when did you start to notice this shift? And what hasn't changed or what would you have expected to have changed by now that the industry is

really holding out on? Tellerate, I think, was the first screen. And I guess that was in the late mid to late 70s, maybe later than that. This is all pre-computer and pre-Bloomberg. There was just nothing like that out there. There was a world pre-Bloomberg? Hard to believe. Yes, I know, I know. Truly on message, Joe. And I will tell you that when I first started using Bloomberg and realized how much was there and how much could be there, I would send the message to Mr. Bloomberg, with the subject line being idea of the day. And he always picked up his own messages back then.

And I'd say, you know, the money supply figures come out on Thursday, but by the way, dealer positions also come out, and you really should pick up dealer positions. And lo and behold, one of his elves called and said, what are dealer positions? And how do I find him? And I drew him a little diagram and he figured it out. And there it is. There's a function in Bloomberg that I can take responsibility for.

Everything had been on a personal level. Everything. You spoke to good clients multiple times a day. and everything was done on the phone. And your word was your bond. Everything or a big percentage of things is now all done electronically with less and less human contact, as near as I can tell. When we get to the bare market, will the dealers just turn off the machine and not show price? and not be able to be hit and nobody knows.

So what's the one piece of advice you have for Treasury investors right now? Well, the one piece of advice for everybody always is take the high road and know what you know and know what you don't know and don't confuse the two. And I've always felt because of the way I was treated by senior people who had no business spending time with me because I didn't know what I was talking about. I always felt like that I owed it to the next group coming up. And so I've always tried to spend time mentoring, if you will, or at least helping out younger people, which is basically every. Everybody now. All right. Rob Elson, BFW analyst.

Thank you so much for joining us today. My pleasure. So, Joe, was that as interesting as poker or chess for you? I thought it was very interesting. And probably we should do, you know, tilt this back towards a series of these. I really do like this topic. And I'm particularly fascinated by the cultural change aspect. And the idea that the industry wasn't once is sort of.

of, I don't know, it strikes me a sort of conformist and everyone sort of goes the same path. And so hearing about Rob driving across country and then living on an island off of Puget Sound for a year and then being able to move from that into the bond world, it sounds very cool and very much more positive vision than people going straight from prep school to their Ivy League MBA. Yeah, you can't really imagine someone kind of wandering and off the street and going to Goldman and asking. to be a bond salesman. No, and it's also interesting, you know, this idea of, you know, we talk in the stock market, there's so much focus on passive management. Everyone wants to, you know, robo advisors and just set it and forget it. But that whole period hasn't really seen a bare market yet.

So who knows if people are really going to stick with passive the next time there's like a true crash? And so very similar to what Rob was talking about, slightly different. But we really don't know how people are going to behave when there's a true bond market. We just have no sell-off. Yeah, that's absolutely right. And, of course, the bond market, U.S. Treasury yields in particular, underpin pretty much everything else in financial markets.

So you could see this massive repricing. Of course, people have been predicting it for a long time. So we might be. We're still waiting. It could be in 10 years from now when we're doing this. We could still be this podcast, which I'm sure we will be in 10 years. Of course. We might still be talking about this topic of when it comes.

All right. Well, let's revisit it in what, 27? Sounds good. Looking forward to it. All right, I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway. And I'm Joe Wisenthal. You can follow me on Twitter at the store. Thanks for listening. The news doesn't stop on the weekends. Context changes constantly. And now Bloomberg is the place to stay on top of it all.

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