OAP 161: Interview w/ Kevin Smith & Tavi Costa of Crescat Capital

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As many of our long-time listeners know, over the years I've become increasingly protective and selective with the guests that I invite to come on the show. Truth be told, we get pitched weekly for people looking to expand their reach. Somethings it's just so off the wall and disconnected to trading that I have to laugh. But this isn't the case with today's guests which I'm super excited to bring on for an interview.

Kevin Smith and Tavi Costa both generously gave their time to join me for an incredible look inside their philosophy and macro models at Crescat Capital, a hedge fund based in Denver Colorado. This is an episode you won't want to miss. In fact, I encourage you to listen to it at least twice to make sure you pick up on all the little details you might have skipped the first time around.

Key Points from Today's Show:

  • In today's episode, we hear from Kevin Smith and Tavi Costa from Crescat Capital.
  • Kevin is the founder and CIO of Crescat Capital and has 26 years of investment industry experience. 
  • Tavi has been an analyst on Crescat's investment team for more than five years with a focus on global cross-asset research.
  • Last year, Crescat was the number one performing hedge fund by BarclayHedge.

Crescat's Macro Model

  • The 16-factor macro model that includes macro indicators, fundamental factors, key valuation factors, and a few other technicals.
  • Quantifies several factors that have worked in the past and have a really high correlation with the changes in the business cycle.

Flawed Narratives:

  1. The Central Bank
  2. US Stock valuations
  3. China

Yield Curve Inversions

  • 55% of the yield curve in the US is inverted.
  • Yield curve inversions in the US may take 1-2 years to play out.
  • A lot of times the market peaks have coincided with inversions.

Corporate Debt

  • We currently have record-high levels of corporate debt.
  • Companies have been taking on debt to buy back stock in this cycle. 
  • But many companies don't even have the free cash flow to fund their ongoing business operations.
  • Many of these "disrupter" companies have gone through IPO's without generating positive free cash flow.

Market Sentiment

  • When sentiment is at either end of the extreme, you get the biggest inflection points that become tradeable events.
  • If future expectation starts to fall versus the present situation, it tends to be a very negative sign.
  • When the spread turns negative and consumer confidence falls, it leads to a recession.
  • Whereas consumer confidence tends to be high every time at the peak of a cycle.

The Goldilocks Scenario

  • At this time, everything in the market is as good as it gets.
  • Consumer confidence is high, low rates, low inflation, low unemployment, and corporate earnings are high.
  • This type of perfect setup happened right before the 1929 crash. 
  • So ultimately, it is not the best time to invest in US equities.

Potential Market Issues

  • The Fed could drop interest rates
  • Precious metals have been in a 7-year bear market and would take off if the Fed changes the rates. 
  • When yield curve inversions happen, it tends to be very positive for gold relative to the S&P 500 ratio.
  • All the signs that are present give tremendous value on precious metals in general.

Using Options Trades

  • Because of the low volatility environment that they are in for equities and for corporate credit, they are using long put options to express their bearish views on those things. 
  • When building a position, they are looking for their views to play out over the next 3 to 6 months, so will select something within that range for duration.

Staying Consistent with Investment Views

  • It is important to provide good research and quality content that proves your thesis and validates if it is right or wrong. 
  • Pricing can go in different directions for the wrong reasons.
  • Make sure that the models you look at are still supporting your thesis and that your overall ideas are still correct. 
  • Research and validation of your thesis is a continuous, on-going process. 
  • Sticking with your plan (if you have a good plan) is better than panicking and trying to move in the direction of the markets in general. 
  • Stay committed to your fundamental and macro models to keep you positioned.
  • Use the risk model to contain your exposure and ride through pullbacks.

Conclusion

  • You can never be right on all your views and should recognize when you are wrong. 
  • It's not about the short-term losses, it's about the long-term view that you take.
  • The long-term value of the portfolio will play out, but it may take some time.

Option Trader Q&A

Trader Q&A is our favorite segment of the show because we get to hear from one of our community members and help answer their questions live on the air.

Remember, if you’d like to get your question answered here on the podcast or LIVE on Facebook & Periscope, head over to OptionAlpha.com/ASK and click the big red record button in the middle of the screen and leave me a private voicemail. There’s no software to download or install and it’s incredibly easy.

Thank You for Listening!

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About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. In 2018, Option Alpha hit the Inc. 500 list at #215 as one of the fastest growing private companies in the US. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and three children.