Alfonso Peccatiello: Unveiling the Macro Endgame: The Wealth Illusion Paradigm

And you can see that trend strategies tend to do pretty well during inflationary bouts exactly for this reason, because you need to restructure the way you think about interest rates and equity sectors and commodity prices. And so you have a lot of trends developing and you can benefit from an allocation to trend.

The fiat system and the end game, you released a video just today, actually, which I thought was a wonderful way to sort of set the table of what we've been going through over the last 50 years, you know, contextually, maybe in a broader sense of how fiat currencies have come about, how they've developed and you coined a phrase, the wealth illusion paradigm. Which I thought was a really, really interesting concept.

So why don't we start there, talk through that recent piece you had, and then we'll continue through the, through the rest of the show and we'll get to, the fund you're working on and how it's going to position itself within that framework and how asset prices might respond and all that stuff.

Because I think it feels a bit unsustainable for many looking at the ways we have structured our financial system. When you look at wealth inequality, when you look at asset prices, it often gives you that feeling that it's not really a very sustainable equilibrium. Right. It's a bit what Minsky would say, artificial stability breeds instability in the system. That's how many people feel about it.

That's why maybe they want to have some gold or for, you know, more, digital age oriented people, maybe Bitcoin. that's the feeling I think. Right. And I wanted to try and explain how did we get here? Why do you have this feeling and whether this system can actually be resistant or whether it actually breaks? And if it breaks, what's the macro end game? That was the idea behind the piece. And so it all starts, in 1971, when Nixon ends the, gold pack, right?

It basically, collapses the gold standard. And what he does back then is it basically ends the convertibility of gold into dollar at the fixed. exchange rate. And what happens back then is basically that all banks and governments in the world that were creating new money, and I will explain in a second what I mean with that.

They were also creating new money before 1971, but there was a clear limit, a hard peg to this because you would create dollars out of thin air like a government or a bank does. But then there will be a fixed price at which you could convert these dollars back into gold. And so you had to be careful with the amount of fiat money you would create, right? There was a balancing mechanism in other words. And after 1971, that's not the case anymore.

So in our system, it's not central banks that create inflationary money. And that comes as a news for many, but it's government via fiscal deficits and banks via lending that create the inflationary form of money. We can actually spend and how it works. It's pretty simple. The government is the issuer of the currency.

So the United States government issues dollars, they control issuance of the dollar and what they do when they do fiscal deficits is they decide to basically, let's say, blow a hole in their balance sheet. So reduce their net worth around deficits and inject this net worth into the private sector. So in 2020. You could open your mailbox and find a 5, 000 check from the United States that had become basically the issuer of this 5, 000 for you.

And you became richer because you could cash in 5 thousand dollars at J.P., Morgan and have this spendable money now all of a sudden to spend without having a liability attached to it. You didn't have any debt, any mortgage, any loan. Nothing. So your net worth went up because the United States government decided that its net worth had to go down.

So it's a simple balancing mechanism where the government decides to blow a hole in their balance sheet, issue new spendable dollars, and you as the private sector will be the beneficiary of it. And the second way is bank lending, where you want to buy a house of a million dollars. You don't have a million dollar cash in your bank account, but what you have is a job. Or a business. So you will produce cash flows over time.

And therefore a bank can look at your future purchasing power and give you credit against that now. So basically credit your bank account by a million dollar money you didn't have before. And now you can go and buy a house with the newly created million dollar from the bank, right? And the seller of the house will now have a new bank deposit of a million dollar who he didn't have before. So the creation of credit.

Basically allows the balance sheets to grow and it injects money into the system, although it comes with debt as well, because you have a million dollar, but you also have a mortgage of a million dollar now. So that's a bit the difference, but it still allows you to spend more all of a sudden to have more inflationary spending power than before. And after 1971, both the banks and the governments were more free to actually create new fiat money without having to convert.

Or check the convertibility of this new, of the quantity of the fiat money versus a dollar because the gold peg was basically. Gone. And when you look at this, you say, okay, cool. But the fact that they can, doesn't mean they will create a bunch of new fiat out of nowhere.

And this is true because if you think about why would government run a lot of deficits or the private sector demand a lot of credit from banks, you would do this if the organic growth in the private sector, if the structural growth of the private sector. So if you see your structural ability to generate growth going down, what you will be doing is look for an offset. And that offset is credit, deficits, more money being created to offset your inability to create strong structural growth.

And that inability started to surface in the 80s. Because the inability, and I can share the screen here to show what are the drivers of long term economic growth, And they're pretty intuitive. One of the re the ways that you can create organic growth in an economy is through demographics. Pretty simple. If you have more people working productively, then your structural GDP growth will be higher. So one of the ways to create strong organic GDP growth is through demographics. So pretty simple.

If the amount of working age population as a percentage of total increases, so you have more people actually contributing to your working, to your labor force, then you can have more. Structural growth. Vice versa, if your working age population shrinks, then you will have less people contributing to active economic growth, and your organic growth will also shrink.

And as you can see from this chart, whether you take the United States or even Japan or Germany or Italy, up until the 80s, the amount of working age population was increasing. So you add basically a demographics boom in the post second world war era that led 20 years later, because to make a new worker, you actually need 20 years, right? They need to be eligible to work. in the eighties, you had the peak of this working age population growth as percentage of total. So you had. happen.

So All countries basically ranging between 65 and 70 percent of working age population as percentage of total. But in the eighties, we peaked, basically demographics peaked. They remained healthy between the eighties and 2000, but the marginal growth, the marginal benefit from better demographics had exhausted. And if you look at the next 10 to 20 years, of course, this projection, these projections look blicker and blicker. So in the eighties, you had demographics peaking, and you also had.

The second factor that stands behind, structural growth, you had productivity also peaking because at the end of the day, you can have better demographics, but if those workers aren't productive and if the use of capital isn't productive in the economy, you're still going to struggle.

Now, the good news is, as you can see from this chart, that if you look at the decades, like the fifties, the sixties and the seventies, and all the ways until the eighties, Productivity growth on a 10 year rolling basis was increasing. So you were becoming. more productive year after year, and the marginal rate of productivity was also increasing. But once you reach the eighties and the nineties, this productivity growth was still there, but it started to decline on a second derivative basis.

So you were still more productive, but the productivity growth benefits were mostly exhausted. And so what happened basically is that by the eighties and the nineties, you were in a situation where the gold peg was gone. You could create new money. without having a hard pack to gold and your structural growth forces. Driven by demographics and productivity were declining.

And so politicians had to basically find an offset, a way to offset this dwindling structural growth to make GDP growth socially acceptable again. And how would, how were they going to eat their 3 percent real GDP target each year? Well, with the use of leverage. And therefore they said, you know what, we are going to start doing it and we're going to lever up the system because we don't have a hard peg anymore and we can create as much fiat money as we want.

And so you go into a situation, as you can see here, where whatever country you actually put, you can use the US or Europe or Japan or China, as you can see in this chart, as long as you look. At the total leverage in the system. So you look at the private sector, as we said, bank lending, private credit, and the public sector combined.

If you look at the use of leverage you can make throughout the economy, all biggest economies in the world went through the same process between the eighties and 2020. They all levered up their economies from about a hundred, 150% of GDP, all the way to 300, or in Japan case, even 400% of GDP. Yeah.

So somewhere around 2005, 2010, they actually had to lever up and they did. So very,

Now, one issue with leverage is that it makes a system, of course, a bit more fragile and also to be used as a recurring system, more leverage and more leverage and more leverage, you need to make sure that the next guy who's levering, the next generation who's levering is able to do so at a marginally cheaper interest rate. So if you lever up the system more, more and more. And your salaries aren't increasing in real terms and your structural growth is not that strong.

The only way to sustain, to basically have a servicing, ability for this high level of leverage is to make servicing costs pretty low, is to make interest rates as low as possible. And so you went into a situation where the system got more leverage, often unproductive to be frank. So this leverage went into real estate and asset prices. It wasn't really used to. generate innovation and structural growth.

So you had this system, these lowered economic activity as the entire economy was basically burdened by that. And so central banks decided to stimulate economic growth and make the system more sustainable by lowering interest rates. This was the trick to continue levering up the system. Without having effectively the leveraging episode like we had, for example, in Japan, a system which was highly leveraged to the real estate market in the eighties.

And when the bank of Japan, Japan raised rates, you then had a deleveraging episode who lost it for decades. So the West didn't want that. And they said, well, you know what? We're going to cut rates and accommodate this process as we speak. And that's what we did.

So with the US running 180% of private and public sector data, percentage of GDP, we could run in the US with about three and a half to 4% real interest rates. Okay, let now, as the US became more and more leveraged and more and more leveraged, let's say all the way until today with the US running 250%. of private and public sector, that as percentage of GDP, real yields have been for the last decade, somewhere around 1%, roughly 50 basis points to 1%.

Now the Federal Reserve has hiked interest rates much further in this specific economic cycle, which makes the system Arguably a bit fragile, right? Because what you're having is a decent level of leverage in the system with real interest rates that are higher than what the equilibrium of the last 30 years between these two variables would suggest. But real, really, the other effect of doing this is boosting house prices or asset prices in general.

So I'm now sharing part of the article I wrote just to make people visualize as well the figures that I'm using. If you bought a house in the US, let's say in the early nineties, right? let's assume for a second that the bank would have lent you a hundred percent of the purchase value. That's not standard, but please bear with me just for the sake of the assumption. Okay. So let's say, In the nineties, you wanted to spend 1, 000 a month in mortgage installments.

Okay. And let's say that in the nineties, the actual third year mortgage rate back then was about 10%. Okay. So you had to pay a 10 percent nominal mortgage rate for 30 years. And with a 1, 000 mortgage installment budget per month, that meant at these interest rates that you could buy a house worth about 120, 000 a month. dollars back in the nineties. Okay. Now let's bring this back 30 years for, forward. Okay. And let's go specifically to 2021.

I just want to show you the peak euphoria of this, wealth illusion paradigm, as I call it. Let's say that you are in 2021 and you still want to spend a thousand dollars a month in mortgage installments. That's your budget. But your 30 year mortgage is now 3%. So you do your cocks and all of a sudden you can afford a house worth 240, 000. This is double the price in the nineties.

So effectively by lowering nominal interest rates over time, you have allowed another generation to lever up more and more and more. Specifically to double the amount of the 90s and be able to afford the same price.

And so what you have achieved is a continuous use of leverage and injection of leverage into the economy, which makes not only the new buyer feel like he can afford new credit simply because interest rates have gone down, specifically the old buyer, particularly happy because his house price is now doubling price. and still can find a buyer because interest rates are much lower than they were in the 90s.

So the combination of lower interest rates and injection of credit into the economy makes this offsetting effect basically, or what I call the wealth illusion paradigm, actually go further and further. And the reason why I call it the wealth illusion paradigm is that where you're forced to rapidly reverse this interest rate story and move back from 3 percent to 7 or 8 10 percent and stay there for a while.

So find a new equilibrium borrowing rates, a bit like it happened in Japan in the nineties, you're facing the risk. Yeah. That you have to reverse this wealth effect and basically deleverage the entire system.

So you have this sort of perfect storm of opportunity to create the wealth illusion effect. What happens going forward from here? When we're at 5 percent interest rates, do we need a massive productivity growth? are we going to see, you know, some sort of, the classic, there's three ways out of it, you know, debt, you can be austere. Nobody likes to do that. Nobody gets elected. You can default, or you can sort of debase the debt and inflate it away.

So those are kind of the three paradigms that people talk a lot about. How do you see us resolving this in the past forward, given the current set of circumstances?

They're being much more friendly on the fiscal side, hoping to basically balance out this tightening from The Federal Reserve and other central banks and come in support in the private sector on the other hand of it. Now, can this work? Again, yes, it's a fragile equilibrium as long as bond vigilantes and markets don't start questioning this gigantic use of fiscal stimulus in a pro cyclical way and start wondering, you know, let's put a premium on long bonds.

Let's see what happens there, for example. So this could be a release valve for how the system becomes all of a sudden very, very fragile. But going forward, let's even assume. that we go back to a situation where you have a perfect soft landing, it's disinflationary, so the Federal Reserve can cut rates all the way to 2%, right? So we go back on this treadmill basically of let's try to put new leverage at cheaper interest rates, okay? Even if we go towards that, okay?

There are limitations because as you said, the private sector is much more leveraged than before in general, not specifically in the United States, but if you look around the world, that is the case. you are in a situation where you then slowly, but surely move back towards low interest rates. So your ability to lower interest rates further. Right. So there are obvious limitations and this is why I think people feel uncomfortable with the system. Right. They feel it needs to crack.

So then my, my, the piece was there to try and answer the question, what is the macro end game? What are the solutions to this? Right. So I see three. The first one is. Politicians would show up and say, sorry, guys, we're going to clean up the mess. So we're going to go with a gentle deleveraging. They would like to be gentle, but with a deleveraging process, I think that's pretty much politically unviable because.

You would have to deleverage a wealth illusion effect system and a levered up system that has benefited two generations. That will be a disaster. And even if it's true that let's say after 2028 in the US, the majority of voters isn't going to be The boomers or the people who benefited most from this still, they would account for like 40 percent of the voters. So I'm not sure that any politician would volunteer to actually deleverage the system. Would you agree with me?

Like, what, what's the motivation for them to eat this particular shit sandwich so that, that older generation, which is clinging to power in a political sense and driving the bus still, and still votes predominantly much more than the millennials vote. it's a very unlikely scenario where we get the, you know, austerity deleveraging without some sort of, War, some sort of call to action that, you know, sort of solidifies the population across the generations. So I agree.

And China, which is a centrally planned economy, still got a lot of backlash from this, you know, attempt at deleveraging. So it's very hard in general to deleverage a very leveraged system. And on top of it, it wouldn't really benefit the status quo, I would argue so. Politically unviable, low, low likelihood. What's the second solution? The one we were suggesting, hinting at before, which is wealth redistribution.

So what you do there is you don't try to necessarily deleverage the system, but you simply try to shuffle around basically the wealth distribution. So you do targeted fiscal policies to make sure that some of the wealth that has been allocated to a certain cohort of the population gets moved around basically to another cohort of the population. So wealth redistribution. That's it.

In my opinion, this is more politically viable simply because the majority of voters will be very happy with wealth redistribution, let's be frank, but it is also a very volatile outcome because when you redistribute wealth, you're also changing basically the consumption patterns in the economy. So you're moving money towards the right direction. the higher core, the cohorts of the population that are the more, they have the highest propensity to consume basically.

So what you're doing there is you're really applying tectonic shifts at our economic resources are allocated. That's a very volatile outcome, which I think is still politically viable and likely. And what this does is it brings more vol, more inflation risks, more stagflation risks to the economy. So I think this is an outcome where this could be. The macro endgame or a step towards the macro endgame.

And I think that investors aren't necessarily prepared in their portfolio for more periods of inflation vol, more periods of stagflation. I think this could be one of the most likely solutions. What do you say?

So, you know, you had a couple of world wars, you had a great depression, you didn't have quite the coordinated central bank efforts, and you didn't have this wonderful starting place where you'd ratcheted rates up to 18 percent to purge the system of debt, and then set the stage for a wonderful, levering of the economy. So, you know, yeah, I think that's, that is, that's An interesting scenario.

What always triggers my thoughts in this is the really rich seem to figure out ways in which to work around a lot of these, these situations. So, you know, as much as you have smart people in government trying to think through ways in which to, make the tax system more fair and redistribute wealth, at the same time, you have very wealthy individuals who have, you know, legions of lawyers and tax structures set up.

To simply counter, counteract those policies and programs, but it's not to say that it's not possible. It's just, you know, you kind of have to have buy in from everybody that we're going to do this. and then you've got, you know, the geopolitical side of things where, nations are competing with one another. You have the Japanese scenario where you've got the yen falling through the floor, making that particular economy pretty competitive.

And then what are the, What's the game theoretic of all the economy economies of the world trying to redistribute wealth at the same time, but also trying to compete with one another.

So as you said, there are like three, ways to face this going forward. And I think number three, preserving the status quo is what politicians want. but it's going to be a bit more, you know, interval by, step number two, which is wealth redistribution policies to try and gain more voters and try to make the system a bit more balanced. So what I'm looking at is situations where if you think about how to. Positioning a portfolio for something like that.

There's a chart in the article that shows the, LCTM, NAV, the net asset value of a dollar invested there. and, you know, if you would understand straight in 1994 and what LTCM was doing was basically, levering up on, on illiquidity and relative value, that really was more illiquidity, illiquidity premium than anything else. You would say, look, if these guys keep doing this, At some point, they're going to blow up, right? There's going to be a situation where they're going to blow up and.

You had to wait four years until that payoff came, right? There is a chart that says you can basically mirror it if you're trying to bet against them and you will lose money, lose money, lose money, lose money, lose money for four years, and then you would make a ton of money, right? And then I say, look, if you want to Time or trade the micro end game as a binary outcome. Basically what you're looking at is potentially a few decades of under performance on the performance on the performance.

And none of us are in the business of underperforming for more than actually a few quarters, unfortunately, how the financial industry is set up nowadays. So, so we have to find ways to incorporate, I think, these probabilities into a framework, into a portfolio so that. You can build something that is relatively well balanced that doesn't necessarily underperform while you preserve some convexity towards a scenario where one of the, of this macro end game solution actually pops up. Right.

And I think that's the aim. And it's important to pass it through as a message. Don't binary trade something, which is potentially decades to go because it's going to cost you a fortune to do that. And maybe the payoff comes way too late for you to actually be able to benefit from it.

And then you have a technology bubble that is to some degree what the U. S. may be facing yet again, in that if we have something that causes a global breaking of something, and then the U. S. has to decide whether prioritizes the global stability over. The U. S. inflationary stability. So how much will the U. S., if it had to loosen rates because something breaks globally, what are the implications for an inflationary situation for the U. S. population?

And for those, that large swath of voters that isn't rich, you know, if you're living paycheck to paycheck, 25 percent increase in the cost of living is, is extremely difficult and is heartfelt. And you have a vote in that.

So there's lots of, Unintended consequences that come from the central bank's interventions and these three levers that they're trying to work through, kick the can, slightly de lever, redistribute wealth in a world where inflation volatility goes up dramatically, which then of course, I think as you're alluding to, and I will, second is that now you need a framework that considers all of those issues, that considers the implications to asset prices. How are you going to balance those exposures?

How are you going to? Add a global macro framework to your asset allocation system because we are not today starting at 18 percent interest rates going to zero. We're not sitting at a very lowly levered economy. We're sitting at, you know, high rates at a high levered economy. Sure. We've got some ability to cut, but that is what makes global macro so popular or so potentially profitable in thinking through how you might balance your exposures.

And as you say, you don't want to bet on these things in a binary fashion. You want to think through the probabilities of them and probability weights, some of your thinking, and you probably need a base portfolio to think through, to think about bets against a base portfolio as well.

So let's say that, for example, let's not even talk about the macro end game, but the simple situation where inflation picks up and in 2022, it was the result of 2020 and 2021, not wealth redistribution, but simply fiscal interventions to make sure that, you know, that the system could continue to exist during the pandemic. And so the result was inflation because the U. S. ended up doing too much and there were supply bottlenecks and so on and so forth. So what happened back then?

Well, as my friend Dan Rasmussen from Verdat Capital, he has a very good chart where he goes back, I think, 150 years and looks at the three year rolling correlation between bonds and stocks. Right. And then he looks at, that level of correlation pending. or conditional of the level of core inflation that is prevailing, right? And then it's a very simple chart where you see this negative correlation existing, mostly in periods where inflation is between one and two and a half percent.

You know, when inflation is between one and two and a half, bonds and stocks are negatively correlated. It makes all the sense in the world because if something goes Poor, let's say in earnings or in the real economy, the central bank will cut rates. You know, they have inflation at their target level with actually even maybe lower, so they can and will cut the interest rates and this will benefit bonds.

And therefore this negative correlation exists very, very well, very well documented through decades when core inflation is between one and two and a half percent. But the chart also shows how, the correlation turns positive. when core inflation is above 3 percent and particularly when it's very volatile, you know, and ranging between two and four and three and five, and then the correlation becomes positive. And that's exactly what we saw in 2022, right?

So stress testing your portfolio mentally would basically bring you to a situation where if you're running only bonds and stocks, I'm sorry, but you have two items. They're both going to go down at the same time. And I'm going to, I'm going to also say that the 60 40 portfolio is 85 percent equity ball in the first instance. And so, you know, your job is also somehow correlated to the business cycle and to equity and to earnings.

And so if everything is falling down and your job is more at risk and your portfolio is facing a 20 percent drawdown, I'm going to argue that is not necessarily a robust framework to invest, especially if you think these vol events. So let's say wealth redistribution, fiscal deficits, high inflation, low inflation, more volatility is going to pop up, right? You need something else. You need to mental stress your portfolio before we even talk about.

Sources of uncorrelated returns, so alphas like carry or trend or global macro, we first need to fix the beta. Like do you have exposure to, different beta elements that will contribute to stabilize your returns if the macro environment is not what you have seen for the last, 10, 15 years.

So this inflationary growth driven by the U S if you have any other outcome, which is maybe inflationary growth or deflation or growth outside the U S is your portfolio from a beta perspective, prepare to really benefit from this environment, different lenses.

And, you know, it's said that an AI search now takes 17 times more energy than a Google search once did. So we have a very energy intense economy. Yet, if you look at the S& P 500 at the moment, 4 percent of the S& P 500 is energy. 2 percent is materials. So what is your hedge in the situation where we get into a stagflationary environment where the cost of inputs to production energy and so on are rising rapidly? That takes profits out of the rest of the 96 percent of the S& P 500.

And you've got nothing in your portfolio that is adding positive returns if you're in a stagflation environment where growth is threatened by maybe the cost of inputs or debt or other things. So you have a totally imbalanced portfolio. You're basically letting the maniacs run the asylum here, right? But it feels okay right now. 2022 was just like a little appetizer in that scenario. So, I mean, people have this recency bias.

What has been the, you know, sort of Pavlovian or habit based response that they've had over the last 20 years, they've been trained very well to buy the dips. I think, you know, you probably get a Pavlovian response in a growth, threatened environment where bonds do rally. In some way, but I don't think that rally is going to be what it has been in the past because if you're injecting that stimulus, then on the other side of the equation is, okay, well, who's going to pay off the bonds?

Like how do we pay off all this debt that's accumulated? And what's the credit rating on those bonds? So how do you fill out the portfolio? Like we have this, you know, largely sort of, maybe we've reached peak passive, peak market cap, which has been dominated by a disinflationary growth environment, which means largely US equities are the largest piece of any sort of market cap portfolio. How do we protect ourselves going forward? What do we need to incorporate?

And what do we do in a global macro framework from your perspective in order to round this out?

And then you can, you know, just look at, for example, on equities, you can do a internationally diversified to protect you against the outcome that growth comes from outside the U S. you can do, equal weight rather than market cap weighted to make sure that, you know, you have a broader exposure to the equity market. And on bonds, you know, you can do. different points of the curve.

So especially through futures, you can use very little cash to get your bond exposure and get, a certain amount of volatility out of the bonds because often, you know, in the 60, 40, you will target intermediate bonds. They have very low duration, very low sensitivity to move to interest rates. And therefore you will need a ton of them to make sure that they contribute actively as a defender in this inflationary environment.

So again, through futures, you can structure that in a more interesting way than just targeting your five or seven year bonds. And then you have commodities. And then we go towards the more defensive side of things. Okay. What if there is inflation, for example, so how do we work around that? If there is inflation, you can think of commodities, but you can even think of strategies that actually benefit from inflationary environments.

So in 2022, we saw, the rise, I think, or the comeback, I should say of trend strategies. So these are strategies that, you know, basically make money when there is a clear breakout in prices. And when does that happen? Well, when there is a lot of macro volatility, you would expect, right, that there are more convex reactions in prices and therefore trend strategies can actually benefit from this a bit.

And you can see that trend strategies tend to do pretty well during Inflationary bouts exactly for this reason, because you need to restructure the way you think about interest rates and equity sectors and commodity prices. And so you have a lot of trends developing and you can benefit from an allocation to trend.

So we are now moving from the structuring the beta in a smart way, sizing it correctly through futures, looking at international diversification into more Let's say the alpha side of things or the uncorrelated stream of returns or the defenders. And so when you look at defenders, I think trend does a great job at being a potential defender. And then there are strategies that are a mix of defenders and, uncorrelated stream of returns.

And I think global macro is in that category because a good global macro strategy, what it does is it looks at. idiosyncratic opportunities popping up around the world because of macro volatility. So it doesn't necessarily need a trend to develop somewhere, but it needs a set of idiosyncratic opportunities available. These might be in the shape of the yield curve. You know, interest rates are priced between countries, maybe Europe versus the US, maybe in equities versus each other.

So Chinese equities versus US equities. It just needs a set of idiosyncratic opportunities that are popping up. because of more global macro volatility, right? And so it's a strategy that can do well, let's say in normal times, but it's expected to do particularly well when there are clusters of volatility, right? And that's, it's a mix between a relative value, neutral type of strategy and a defensive payoff, which tends to do well, particularly when macro volatility is picking up.

So you think of all this potential stream of returns and you guys with the return stacking concept are popularizing. That worked very well, I think, because you basically are very optimal in how you spend your cash to obtain your beta, your SMP, your bonds, your standard beta, right? You obtain that with little cash, and then you all of a sudden freed up some of your notional to invest in the strategies, which you, as you correctly say, you can stack on top of your betas.

And then you have your standard balance portfolios betas, plus your SMP. Your new attackers, your new uncorrelated strategies, your new defenders in an alpha format because you have freed up the cash to allocate to those.

And I think that's another thing that benefits as well as the position sizing you talked about, right? So it's, you know, it's not a, capital allocation of 40%. You do it on a risk allocation. So you can size your bonds to have an impact on your portfolio. That's beneficial during those dark times. One other string I want to pull back into this to make it very clear for people out is we were talking about inflation volatility previously.

When you have very low inflation volatility and you have a stable environment from the late 80s until 2022, you don't have a lot of these dislocations. They just occur less often, and it makes those types of managed futures and trend following strategies, they just have less opportunity.

But if you look outside of those periods, pre 1990, and now post 2022, what you get are these dislocations created by fiscal policy, central bank policy, the realities of debt and leverage in the system, where these types of strategies that Alf was talking about Actually have more of an opportunity to import that important value to the portfolio.

So not only do you need to structure your beta thoughtfully to think through all of the allocations and the different regimes that may occur, but then your hedge or your explore portion of your portfolio that that attackers and defenders actually has more opportunity to provide greater value. In this current paradigm.

It's just all over the place. And this increases the chance that there's going to be more macro ball down the road. And if you look at changing demographics and you look at, you know, the green transition, there are so many moving parts out there for which I think. Macro vol is going to increase.

And so you look, if you have this view that macro vol is going to increase, then as you said, you not only have to look at your betas very carefully, but also consider an allocation to other strategies, more on the alpha side, let's say that are able to diversify your return. So global macro, for example, did particularly well in 2022. a year, which was very, very volatile for macro in general. And then it saw your betas do particularly poorly. So that's bonds and equities.

They did particularly poorly and global macro did very well. If you expect more years ahead that are as volatile potentially, then you need stabilizers in your portfolio. I personally expect a lot of macro vol, and that's the reason why my macro hedge fund launches in Q4.

And I think if you can, you know, enlighten everyone on that and then Obviously, if you do see this and you are interested in, in what MacroAlf is talking about for later this year, make sure you get in and send them a DM or, you know, get on Substack and get on the macro compass and let them know. and, yeah, make sure you're in line for when, when the launch occurs. But yeah, take us through the structure.

They try to have a filter for S& P 500, treasury beta, the standard beta, to have as little beta exposure as possible in the fund, and to instead deliver a stream of return, which is positively skewed as we would define it. And it benefits the most during clusters of macro volatility. So this is a strategy that Basically looks at idiosyncratic opportunities.

It looks at interest rates, at equity markets, at currency markets, at commodity markets from a global perspective, and it tries to identify this location. We think in probabilities. So we always look at different scenarios. We have various models that look at. Scenarios and how markets are pricing them in probability terms where consensus is. And we try to look at potential catalysts for these locations.

We say, look, if the market, for example, from let's take a look at the Fed funds today, right? And what the market is thinking about the distribution of these returns of these outcomes for the Fed. I think it's a good example for how we think about it. So if you take a look at this chart right here, it shows the distribution of probabilities, the top chart here for Fed funds future in 12 months from today. So we're looking at what the market thinks Fed funds will be in 12 months from now.

But instead of looking at one number, we're looking at the probability distribution. Okay. So I derive this by looking at options that are underlying the future contracts. And what it's telling me now, if you look at the summary table here, is that the recession in the U S or cuts that are in line historically with the recession in the U S are priced by the market at a 5 percent probability. 5%. So what do I think about that probability?

Well, historically you have a recession in any given year with about a 10 percent chance. You have a recession every 10 years in the US. Okay. So now you're getting this tail price at the 5 percent probability. That's relatively cheap, I would say.

And also you, you start thinking like, I don't think the U. S. will be in a recession necessarily in one year, but if you think in probabilities, you just need this distribution to shift a bit over time your way and you can structure option payoffs that will pay very handsomely if that transition happens. And then you look at this and you say, Hey, the modal outcome of this distribution, the most observed outcome is actually zero cuts.

So the market is fully gone in now on the idea that the Federal Reserve will not cut interest rates at all over the next 12 months. Actually, there is even a tail right here for hikes. So now the market is starting to price in a relevant probability that the Federal Reserve might hike rate, a modal outcome of no cuts at all, and an only 5 percent probability of a recession going forward. So now how do you think about this? It's like, okay, if I need to take a position here.

Then I can think of an, of a structure that might bet on the idea. The economy may be weakens a little bit going forward. It doesn't need to end in a recession, but as long as this distribution shifts to the left over time, shifts towards more cuts, you can benefit from it, even if ultimately you don't have a recession, just by understanding our consensus position, how the tail surprised and thinking in probabilities.

That's what we do a lot in the macro fund and in the framework we have created.

So if there is macro ball, if there are these classes of volatility, you have positions on that might. Allow you to benefit from it and actually You serve the role in the client portfolio and the role is, and when your betas are not working because of that cluster of volatility, you are there to offer them diversification benefits and actually upside returns.

So the idea is you size them all in a way that they contribute equally to the risk of the portfolio because As a macro manager, you are right 50 to 55 percent of the times, unless you're selling volatility, which is not what we do. You are right. 50 to 55 percent of the times. So what you want is that when you are right, actually, the specifically, sorry, when you're wrong, each of these uncorrelated trades can contribute Only to a maximum capped amount of loss in your fund, right?

But when you are right, you have strategies in place, either through an option payoff or a trailing, profit strategy to be able to extend the right side of your returns. And so by doing this, even being right, only 50 percent of the times, as long as the portfolio construction and the risk sizing process is accurate, you actually can get positive, positively skewed returns at a fund level.

Part of the diversification, I would say of this fund is that. I will be the opposite of your standard macro manager who you only hear during tax season, maybe, and through some investment letters. I'm very open to discuss the ways I can help potential investors. So just send me a message and I'll pick it up.