Years ago, when working at an unnamed European bank, I was attending a corporate retreat. During lunch one of my European colleagues jokingly but rather pointedly asked me, “why do you Americans think you are the center of the universe in finance?”
Never known for my tact, I responded, “because we have the deepest, most liquid financial markets in the world. The US comprises about 40% of global debt and equity, which is 2 to 3 times the size of all European markets combined. Moreover, (yes, I really do speak like this and it’s as obnoxious as it sounds) about 25% of global trading volume across financial products is executed in NYC. So it’s not that we think we’re the center of the financial universe, it’s that we actually are.”
Yeah I know, but they were French and traded equities. Two things I find baffling. I don’t inquire why France thinks it has the best wine or Paris believes it’s the cultural capital of the universe. It does, it is, and you’ll get no arguments from me.
Size matters
The global fixed income market had $140 trillion of securities outstanding as of 2023, with US fixed income accounting for roughly 40%, or $55 trillion. That’s nearly twice the size of the EU and UK combined, which account for 23%.
The global equity market is smaller at $115 trillion, but even more heavily weighted towards the US. The US equity markets represents 43%, or $49 trillion, while the EU comprises 11%; making US equities nearly 4 times the size of the next largest market. The third largest region is China, whose equity market cap is just under 10% of the global total.
Bonds vs equities
A favorite quote of everyone in fixed income is from James Carville, a political strategist who rose to prominence during the Clinton years.
“I used to think that if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.”
If you work on the equity side of financial markets in virtually any capacity people tend to have at least a vague notion of what that is, and will politely suffer through a three minute response to the inevitable cold open of “what do you do for a living”? Those of us in fixed income have learned that responding at any length to such casual inquiries can result in a stampede to the bar as everyone within earshot suddenly needs to refresh their drink.
The funny thing is that even within finance the two groups don’t tend to cross over much. It’s not just that they are functionally distinct markets, but the personalities of people who cover them are nearly diametrically opposed.
The cheerleaders gravitate to equities
Equity markets are famously emotional. Yes, there are valuation models. Stock prices are supposedly tethered to reality via discounted cash flow models, price earnings ratios or other multiples, or some asset based method for estimating intrinsic value. Three different models will produce three wildly different theoretical valuations and none of them will be close to the actual stock price. The best laid battle plan rarely survives first contact with the enemy and the best stock price model can become irrelevant given a new company press release or government regulation.
On the upside, every publicly traded share of stock of a company (of the same class) looks and is valued identically. Price, liquidity and trading volume data is mostly transparent and publicly available relatively quickly. There are nuances and dark pools and I’m sure loads of intricacies that I don’t know about or track because I’m not in equities. But overall I would say equity markets are easier to understand, particularly for non-experts, but can be more volatile and much harder to forecast.
People who end up covering, trading, investing or underwriting equities tend to be optimistic, salesy, enthusiastic cheerleader types for their sector and the equity market in general. They tell good stories and they’re great fun at parties.
The nerds are in fixed income
The bedrock of the fixed income universe is valuation models. These models project principal and interest cashflows, prepayments, delinquency and default rates, volatility and just about every nuance you can incorporate when valuing fixed income securities and derivatives. Practitioners spend an enormous amount of time and energy learning about, refining and evaluating them.
The bond universe is also much more complex. Bonds from a single issuer will typically have a variety of coupons and maturities, and can occupy different places in the capital structure. Structured products, such as mortgage backed securities, asset backed securities and collateralized loan obligations, bundle loans into pools and structure the cash flows within an issue to create bonds with different interest rate and credit characteristics.
The economic cycle, political shifts, global macro events and changes in investor sentiment impact trading and valuation in bonds as they do in stocks, but overall the impact tends to be more predictable and quantifiable. Disclosure of a CEO’s pending retirement or announcement of a new product launch, for example, might reverberate to the stock price but the company’s bonds are unlikely to register the event.
Recognizing nerds in the wild
Many careers with a variety of specialties tend to sort based on personality type. Fixed income is no different. The following guide is based entirely on my subjective experience across sell side fixed income desks and my utterly biased opinions. Comments or additional color highly encouraged.
Rates
May as well start with the adrenaline junkies. Treasuries, swaps and repo work closely together. They possibly have the broadest knowledge of markets and the Fed, deep appetites for risk, and if they execute basis trades for clients a pair of big brass ones. They don’t know a damn thing about credit but they don’t need to because everything they trade is either government guaranteed or fully collateralized on a mark to market basis. Not as sexy or complex as e.g. structured products, but the incredible pace, amount of risk taken and the size of their books can dwarf every other desk in fixed income. The biggest trades I’ve ever seen have been in treasuries and swaps, and they act like moving a few yards late on a Thursday is nothing. Intense, focused and surprisingly personable at work. Complete nutjobs off the clock. Someone is doing naked handstands at the rooftop bar? They work on the rates desk.
Agency mortgage-backed securities (MBS)
More cerebral than rates but less dangerous than vol. Agency MBS is the second largest, most widely traded fixed income product after treasuries. It’s a flow product with functionally zero credit risk and is popular with investors worldwide. Broad based expertise similar to rates but with specialized focus on residential housing trends, prepayment risk, structured securities and mortgage derivatives. It’s a tricky combination of a deep, fast paced market in TBAs with the sophisticated knowledge and approach required to trade CMOs. MBS desks can be insular and clubby, as befits their reputation for reliably producing superstars. Intellectual, cool under pressure and quietly competitive AF.
Volatility
Arguably the smartest desk in fixed income. Not always the most profitable. Heavily staffed by quants, these groups can produce wild P&L swings. As a vol trader once explained to me, “most traders are dating their risk. Vol traders are married to theirs, because they can’t usually get out of it.” Introverted and keenly sharp, they are appropriately wary of cowboy clients. Often at work the latest because their daily P&L isn’t calculated until all the vol and derivatives models have finished running. The MBS desk will be on their third Stoli O and soda before the vol desk badges out. Nerves of steel, an unassailable work ethic and a warped sense of humor are par for the course, because its not unheard of to walk into work to find that a trading book blew up overnight.
That’s enough for today. Next episode will dissect the two sides of corporate credit, because investment grade and high yield have virtually nothing in common. And maybe I’ll profile the CMBS desk. Freaking hell.
