why are we seeing more, more random events, more spikes of, of asset classes than ever? And really, I think comes down to, The fact that prior to 2020, for many, many decades, we had been managing the situation both like with the way the Fed had to manage the situation and how advisors by virtue of that, had to manage the situation. It was a two-dimensional game. I think this concept of balancing on a barrel, right? You put a plank on top of the barrel and you're either going left or right.
It's a two-dimensional kind of balancing act that, you know, you practice it long enough, you kind of figure it out somewhat. It was, it's not as, difficult to game as when you introduce a third variable. So back then the variable was either a positive growth shock or a negative growth shock. The variable that was introduced in 2020 was inflation. And we equate that as having to balance yourself on the top of a ball now, right? That is a. Three-dimensional game. All right.
Hello everybody, and welcome to another episode of Resolve Riffs. This time it is truly a ReSolve Riffs episode. We haven't done one of these in a while, guys. we thought that it would be a good idea to revisit some of the discussions that we had last year with regards to the Global macrospace, how it affects the liquid alternative space, and, uh, and really just dig into what the setup is now, how our views have changed or if they have at all.
and I have here our CIO of Resolve Asset Management, global Adam Butler, our CEO, Michael Philbrick, and myself, president of Resolve Asset Management Global Rodrigo Gordillo. So let's get into it, guys. Um. You know, one of the key topics that we talked about over and over again that I get a lot of flak on, is the idea of inflation. Uh, more specifically. I think the way we frame it is different and people get confused, but the concept of inflation volatility,
You know what, actually, before you even go there, I think it, it's even worth talking about the idea of inflation. And I don't mean like what the macro definitions are and stuff. I just mean like rate of change versus a change in the price level, which I think, which, which really gets people confused, right? So most people, or many people anyways, sort of think that inflation means that. Prices have gone up. Well, and which is fair, right? I mean, that's what you feel.
It's what you feel in your pocketbook, and it's what gives you anxiety. You go to the, the grocery store and the prices are higher than they were a year ago. Maybe your income hasn't kept up. but for economists, they only really worry about rate of change, right? So you can have a major, you know, prices over the last year could have gone up 20%. But if they're no longer rising, then economists say there's no more inflation, right?
So when we talk about inflation, we're referring to the, current rate of change, not, you know, has the price, level risen over the past x number of months or years or whatever, right? So, you know, at the moment we had a major price shock for a bunch of reasons. We had huge, supply chain, shocks because we had, uh. Shipping shutdown and manufacturing shutdown during the epidemic.
And then we had, a major, uh, demand shock because governments around the world were handing out money as a substitute for income because so many people couldn't work. But they had all this, now they got all this money to spend, they got all this money to spend, but there's a, slowdown in manufacturing and shipping, so there's not enough goods and services to consume. So we had this, this price shock. There's a bunch of other dimensions of that. We don't need to get into all of it, but.
I think that's what we sort of saw in early 2022, right? So as everyone was now paying attention and there was emotional salience in early, in early 2022, because there had been this major price shock. And what we've seen over the ensuing sort of 18 months is that, the rate of change of the price level kind of peaked in mid 2022. The rate of inflation has stayed high, but the, it has come down, right? So the year over year price change is, going up at a much more moderate rate now.
And so now the markets are not so fearful about an acceleration, a continued acceleration in the rate of change of inflation. And the Fed has become more comfortable about that as well. And they're beginning to change their position on monetary policy. Right? So that's kind of, that's what's a very TLDR over the, you
but it is super important to talk about that because even the president of the United States, or at least his Twitter account, isn't getting it right. Right. This idea that people are expecting a reduction in prices. They want prices to go back to what they were prior to 2020, but that's kind of not how inflation works. Prices just go up. The question is whether they're going up
Well, they can go down. I mean, I
but, but the price level,
see prices go down pretty
But let's,
in the short term.
But in, in developed markets, I mean, I think people look at. Gas prices going up and down to previous levels, right. And so they see a single line item that goes down and they're thinking, when's, when's my fruit, price gonna go down? What is, where is how, how is it that my household is spending 20% more than they did two years ago? And why isn't that going down? Well, it it, it's never gonna go down.
What's happening is you're gonna ask for higher, you're gonna ask for a raise, you're gonna ask for higher Wages. so that your discretionary spending can remain at pace with that new price appreciation as, uh, the basket of expenses. And so, This, the people who, who are clamoring for lower prices just simply are having a hard time understanding what reduction in inflation. And that's partly the industry's, fault in terms of language. And when they say inflation has reduced, they're not talking.
They, they, the average person thinks they're saying prices are going down, when what we actually mean is that the price appreciation has tapered somehow, somewhat.
It's the, it's the variance around that steady rate, and it's been in the narrative that the Fed has had to dance around. To me, it's been plainly obvious that, you know, Adam's foresight on inflation, volatility being the thing to focus on, was bang on the inflation is transitory. How transitory is it?
Well, it's so transitory that we had to raise rates faster than any time in history because we kind of shit our pants a little bit because it didn't look transitory, even though we were talking it up as transitory. That is the inflation volatility that Adam brought to the forefront for us to chat about a couple of years ago, was the fact that. The rate can be 2%, but how wide is the bell curve around the 2%? Sometimes it's zero and sometimes it's six versus just being two.
And from 19 eighty-two, the falling of the Berlin wall, the opening up of China, the the D, the globalization of the world, providing so many disinflationary types of, opportunities for markets to take advantage, lower, lower interest rates.
That paper by HL Fire and Ice just showed how little inflation volatility that we had over such a long timeframe where the participants of the market didn't have any real experience with it, and now we're conversely in another environment and inflation can run at the same rate it had prior to 20 twenty-two with a much larger variance around it. And that changes. Everything. It changes the volatility of asset classes, it changes the correlation relationships with those asset classes.
And that has occurred. I mean, that has happened. We have rates that were zero and then we're five, you know, maybe four in the US but you know, around around jigs and rails, if you wanted to take a little bit of credit risk and whatnot, you could get more than four. But let's, let's call it the, the tenure you came to four or the two year rather. That's a pretty significant increase. And we're in for more of that. We don't have de-globalization. The Berlin wall is not falling.
U Ukraine has been invaded. Taiwan is saber, rattling. we've got all the things in the Middle East that are adding to the opportunity for simply more variance around the average.
And I think, one of the, one of the analogies that we used back then that I think is important to bring back to the forefront is, you know, I was in a podcast, interview yesterday and I was asked like, why are we seeing more, more random events, more spikes of, of asset classes than ever?
And really, I think comes down to, The fact that prior to 2020, for many, many decades, we had been managing the situation both like with the way the Fed had to manage the situation and how advisors by virtue of that, had to manage the situation. It was a two-dimensional game. I think this concept of balancing on a barrel, right? You put a plank on top of the barrel and you're either going left or right.
It's a two-dimensional kind of balancing act that, you know, you practice it long enough, you kind of figure it out somewhat. It was, it's not as, difficult to game as when you introduce a third variable. So back then the variable was either a positive growth shock or a negative growth shock. The variable that was introduced in 2020 was inflation. And we equate that as having to balance yourself on the top of a ball now, right? That is a. Three-dimensional game.
And while it is possible to do, if you have the right portfolio, the right balance, the right preparation, the right prediction, it is going to lead to a lot more jittery balancing acts, and you're gonna be caught off side more often than you have in your previous investment career. And introducing this inflation variable, will require allocators and investors to really throw away their intuition as to how they think the markets work, based on their personal experience.
And they're gonna have to start digging into, wait, how does the market actually work during period of inflation volatility, like the seventies, like the forties, like the 1920s. And when you examine that, you realize that hey, it's just more volatility everywhere asset volatility goes up, whether it's on currencies, equities, commodities, bonds, and as asset's volatilities go up, there's opportunity sets, but there's also risks if you are still playing that, that, balancing on a barrel game.
You're not gonna ha you're not gonna find the same success. So I think, the question that that we started with is, has our thesis about inflation changed? No. Thesis was not that. It was gonna be an inflationary period. The thesis, what was that? There's gonna be a lot of inflation volatility. so yeah, we're kind of sticking to.
the current, waning of the rate of inflation for, the Fed or the authorities or, you know, easing of economic situations that were exerting artificial. All these variables are sort of conspiring to tame inflation permanently. And I think at this point, what's more likely is that we are just, you know, as we said, inflation is gonna have a wider range of outcomes than we're used to over the last two or three decades, in the next decade or so.
And we're just happened to be sort of near the trough of one of those waves, right? for whatever reason the Fed and probably a variety of other, dynamics, we've had a slowing of the rate of inflation and people are becoming a little bit more sanguine right at the point when it looks like growth is beginning to re-accelerate, and inflation is beginning to re-accelerate, especially on the wage front and in important service, sectors of the economy.
So, you know, we could easily go back to, Some of the dynamics that we experienced over the last few decades. I mean, look, if you wanted to buy a TV 10 years ago or 20 years ago, you can buy a TV now that is vastly superior than what you bought 10 years or 20 years ago for either the same price or a lot less, right? So, manufactured goods, especially, you know, technology-driven manufactured goods have continued to go through deflation, right?
They're in, especially when you adjust for the utility you get from them. But we don't really make a lot of new humans, and so the humans are involved in the service sector, and oftentimes you can't really scale what a human does from day to day, Um, now new technology might be able to, Implement some pretty substantial changes to that over the next five or six years.
We could get into what is happening in ai, but at the moment you can't really replace humans further in terms of the service economy. And that is where we continue to see, a re-acceleration of growth and a re-acceleration potentially of, of some inflation dynamics. So we shouldn't get sanguine just because we've seen inflation tame over the last little while. We're probably just at the off of a wave and, and about to, see it re-emerge.
And, and I was just kind of reviewing the, some of the notes I had on that IMF paper that went back a hundred years to review a hundred inflationary shocks across all the major countries. And one of the things that they found is that, uh, number one, you don't, we don't nail the inflation problem on the first try. It just doesn't happen. there's both structural reasons why not, and, and there's political reasons why it's really unpalatable and difficult to do.
And so it doesn't matter who you are, you're probably gonna have a few tries before you put that genie back in the bottle. The other interesting thing is that those countries that actually did a good job of aggressively dealing with inflation ended up having a negative growth shock that was more pronounced initially, but a significantly higher growth rate five years, five years later, versus countries that did not have that.
And I don't think, as you look at the landscape, especially, I think it's more pronounced in Europe where they have their, their economies have been much weaker in the US where they've. Actually stopped raising rates even when the inflation rate was still higher. And we're starting to see the impacts of that.
And by the way, that speaks to that, diversity in policy speaks to that, what we're chatting before, how it's likely to be higher volatility across assets than we've seen in the previous 10 years. Right. It's just, it's not as uniform as it used to be. And so, yeah, I think we need to get used to the fact that right now we have strong economic growth. Still in the US we have a, low unemployment. We have continued stable wage growth.
Yet we have a hundred seventy-five basis points, 200 basis points priced in, in terms of cuts in the next 12 months. Right? There's, this is the type of confusing signals that one gets. Is it, is it over? Are we now we hit our inflation marker? Is the Fed gonna reduce rates when inflation still going up? Are they actually gonna ease? Right? So it really is structurally difficult.
And then we're going to an election year where people like Yellen, have actually pulled levers to stimulate the economy when, Powell is actually trying to put the brakes on. So I. We can see how, how it's becoming more and more difficult on the inflation side to navigate this easily. And so it really comes down to what can, what can investors do when we don't know when the accelerator is gonna be pushed and when the brakes are gonna be pushed and when they're both gonna happen at the same time.
so any thoughts on, on that, on how, what it looks like for investors and what investors can do, to deal with that environment?
Well, I mean, the first and foremost is to think through, diversity in the portfolio, which is always very difficult to times like this. Assets that have treated you so well for so long, and now you're going to de-emphasize them. And why now potentially is the challenge. So are, you know, return stacked and return stacking is about not having to sacrifice that.
But again, when you think about the, discussions lately you've seen around valuations and valuations of what obviously is a very important consideration there. So U.S markets, they're at high valuations. They're not the highest valuations, they're at high valuations. What do high valuations mean? Well, they mean that future returns are probably lower cause you pull those future returns into the present. And that's why valuations are a concern at the moment.
So if you are going to ride that momentum wave of A.I tech, U.S equities, you should be quite diligent about managing the risk associated with those positions because when a strong trend upwardly with high valuations becomes a strong downward trend. That's where you get periods like 1929, 2000, Japan circa 1990. This is where you get wealth altering events that are wealth altering and not the way you like.
And so if you're going to take the chance of saying, well, the trend is still so strong, okay, that's great, well then you better have some other risk management techniques going into the portfolio. Something that's gonna counterbalance that. Now you could take the view of, well, let me look further afield. Lemme look into the small caps. I look into value, lemme look into four and lemme look into emerging markets. And there you see valuations that aren't stretched.
Actually, you might even see downright discounts, but it's again, we come back to the Turkey story. You know, how does the Turkey know when Thanksgiving's coming? The farmer treats 'em real well and it gets better and better until It's Thanksgiving. And so this is not an easy challenge and it's, it's a, it's a behavioral trap of recency bias. And overconfidence happens every time. You know, investors today are expecting 15% return over the last five years. Why?
Because they've got 15% return with last five years. What's the long term? The long term's? 10. These aren't real, obviously these are nominal, but if you did 10, you have to do something else in order to get the, if you've done 15, rather to get back to 10, you've gotta spend some time below the average. And that those corrections have one of two
but that's 10 real, right? Like 10 real versus the the long term equity risk premium real is more like four. We.
of course. And all of that is valuation, that all of that excess return is increased valuation. Now those correct through either time or price. So either you get a very long period of not very good performance while valuation catches up. Or you get a significant decline in the markets and those types of things. We saw it in 2000. We saw the equal weight or small cap stocks actually have positive performance.
While the S&P 500 was down 50% wasn't great positive performance, but it was positive simply because the valuation was way too high in those S&P 500 stocks, and it was reasonable on the rest of the marketplace, which is not too far from here. So an investor has a choice.
They can start to think about, you know, those quality factors start to think about diversity in portfolio, in the stuff that their friends don't have, that they're, they don't know, that they don't love, that they don't trust, or they can start layering on diversifying strategies like we talk about in the Return stacked portfolio solutions, website and suite, where you take those betas that you know, love and trust and stack upon them diversifying strategies so that when there's blood in the
streets. You actually have something to go buying with.
Yeah I, You know what's crazy is as we came into 2022 and saw the biggest rip your face off drawdown in bonds, I mean it's, was it officially like the largest drawdown for the long, for the 30 year treasury in history? I think I heard that. I'm not sure, but it certainly was one of the most aggressive and largest drawdowns.
I think you gave back half of the returns.
at that point, I'm like, that's the lesson. That's where people are like, oh, okay. Things have changed that you got, and we dropped equities and bonds, number one correlated, which wasn't supposed to happen. You know, you, we had a lot of discussions last year. People were like, when is the market gonna get back to normal? And I'm like, that. That is normal in a, in a rising rate, shock environment that is ex, that is normal. You just, haven't seen it in 40 years.
and I thought it was gonna change, you know, the chip was gonna be changed. We gotta figure it out in different way. I'm scared of just going, you know, 60 40. But what's happened is, I think all of those accumulated lessons from the previous 10 years, which is okay, be recovery from here. And they have been, uh, it, it worked out for them. They have been rewarded once again, right. Been rewarded again. They're like, I don't, I don't know what you're talking about, Gordillo.
Like that was just a blip. Right? That was just a blip. Don't worry about that. That's a thing of the past. And I think, The benefit, the, the problem there of trying to show things like, hey, commodities actually were the best performing asset class in the last couple years. Um, hey, by the way, uh, managed Futures is still the one of the best performing asset class over the last two years, right? It was up the index, uh, the Soc-Gen trend.
Index and CTA Index we're up double digits in 2022 and then gave back half of that maybe a bit more in last year. Well, the lesson is that was momentary. I'm out, no need, you know, that's what I think we're still dealing with today. And if inflation volatility, the, the inflation volatility thesis plays out, that's not the only time it's gonna happen. Right? It is exactly within the thesis. And now how do we get people to diversify, right?
To just move away from that equity bond exclusive portfolio.
let's maybe not. Let's not let them make them, make them move away. Let's stack some things on top. And I think
I think that, is the solution, right? It's like you gotta, how do you, how do you get people to move on this so you don't get 'em to move you, you just get 'em to put it on top. You don't get 'em to sell and get out. You get 'em to put it on top. It's, you know, I'm just still bitching because.
well, the reality is too, that things can always get more expensive. So if there's one thing that I think all of us have learned, like if you think the Nasdaq was expensive, go look at what Japan was. It was 60 times or 90 times, whatever the ratio you wanted to use, I think it was Cape, Shiller or whatever it was, but it was, it was a full 60% higher than what happened in the Nasdaq and the S&P and p. And it's interesting.
So when you look at, you know, sort of a statistical background and say, well, if you have high valuations, does that in fact in the short term lead to anything? And it's like, no, it doesn't mean anything really. A lot of the times it means it's gonna get more expensive in a, you know, in the one to five year timeframe in the 10 to 15 year timeframe. It's kind of like gravity. Um, but there's that meaty middle.
And, and if you look at a scatter graph of that, of that chart, you'll see all of these high valuation, high returns, which came in, in the late nineties where it just got more and more highly valued. So we could be in the same situation here if we get into a world where we just start printing money as we kind of have. Where things could go, at, to a place where you think people are in a, in a zombie like trance.
Now following these, uh, these AI stocks, this can, we've seen it, this can get way, way more
What does Cliff say? It can get to a hundred 10th, decile valuation, right? Uh, way more than a hundred percent. Um, but you know, the value is an interesting thing in terms of sequence of return of value returns. I think, Adam, you've done a lot of work on this, on valuation CAPE ratio and trying to like assess the, forward returns of our five year, 10 year, 20 year.
can you like, I kind of feel like value is one of those things that you get all of the returns in like a few months, once every 10 years, and you look at Warren, Buffett's out performance, it feels like, it's not like you're gonna get a little bit of that sugar every, every year. It's almost like you get it all of it in once every 10 years and then you can suffer again for another 10. But maybe that's just my
Well, there's a couple of different things going on, right? One is sort of, I think what you're referring to is the, character of the value premium, right? And absolutely, uh, value is one of these things where you suffer sort of 80% of the months underperforming the market, and then you've got kind of like a six to eight month period that if you miss it, it delivered all of the excess returns that you're gonna see for that decade, right? so you really have to hold your nose and stick with it.
A lot of strategies are like that. In fact, I would argue that a, a big chunk of why you might expect to receive an excess return on these strategies because they're hard to hold and most people don't wanna hold 'em, right? So they're under-owned. And, and when something's under-owned, it means that you require a higher return in order to entice people to own it, right? And so, you know, I think that's just the nature of it. You know, trend following can be kind of the same.
Momentum is kind of the same, right? Like people, it just hurts to be different from your peer group. And it especially hurts the longer that you are accumulating that difference, especially if that difference is negative. So, you know, I, I think that's, um, a quality that you need to endure in order to be able to expect to generate higher than, market returns.
And then, you know, in terms of the profile of markets when they are expensive relative to their sort of historical CAPE ratio or what-have-you. I think Mike nailed it. You know, for the next year or so. The, the likelihood is the trend's gonna continue. You know, it's gonna, you know, you're gonna get more expensive, not less expensive and, but, it's, um, oh. Buffett's mentor now that I can't remember his name of, it's
Charlie
bill Yeah. Graham who said
Billy Graham.
term. Yeah, right. The market is, uh, weighing machine, right? So you have to wait for it to, um, to start weighing instead of, running on on emotions, you know, what makes the current environment so, especially. Challenging for those of us with a sense of history is just how concentrated like it. It's not only just that you're, the only returns are, coming from US cap weighted equities. it's that it's coming from like 10 stocks.
You know, those 10 stocks represent more of the index than any 10 stocks have ever represented. So, you know, they, they, they actually end up representing approximately the, an average amount of the index's earnings over, like over the very long term. The top 10 stocks do historically generate a disproportionate percentage of all of publicly generated earnings. But, the market cap of these companies is just so wildly out of whack.
And it's not like you've got a diversified, you know, at least in the, back when the nifty 50 was in vogue. You had conglomerates with very high valuations, but those conglomerates owned divisions across a wide variety of different segments of the economy. Whereas you've, you know, you're very narrowly exposed to a group of, of tech stocks that are in turn, very narrowly exposed to the future of ai.
I mean, I happen to have a strong view on, on how well AI is gonna play out, but whether that translates directly to the bottom line of a few tech conglomerates, I have a great deal of, of suspicion about. So, you know, it's just, it's a very concentrated bet and it's concentrated and then, then it's concentrated and then it's more concentrated. And so, you know, I just find it particularly scary at this point.
You know, I want to diversify more than ever, but, it's more painful than ever to be diversified.
And it,
it's the railroads, it's the internet, it's the, it's the, you know, as I know you've pointed this out to, in the past, Adam, same 500 stocks. You equate 'em over the last year. You get 6%. You market cap weight. 'em, you had 22 and a half. It's the same five stocks, so obviously market cap is dominating. So what's that? That's, that's the valuation of those stocks increasing based on the potential for their earnings to increase down the track. Boy, oh boy.
Starting to sound like Cisco Sun, Micro, uh, Nortel. I mean, this dance is getting very familiar.
It is, and it, and it's that, It's
good
discussion of like, this time it's different. It's this time it's different. You don't, we're not valuing things the same way we used to. Right. We got ai. Now it's different. We got Bitcoin.
like we had the internet, right?
Exactly.
was a major thing accruing. Profound value for all of humanity and generating massive productivity gains. But it just didn't accrue to nearly the extent that investors were betting to that small number of companies that were getting all of the benefit of the doubt back in 19 88, 89.
What do you mean? Look at Netscape? Wait, wait,
but, but this is an important discussion that kind of ties into that misunderstanding of, of how inflation works. It's, and we had this discussion with, uh, in our last podcast, you, me, and, uh, were, uh, yeah, Bianco, right? Which is, look, you should be careful with investing right now, but the economy's fantastic. Like there's a big difference between an economy doing well and what your portfolio is likely to do, or what level of danger is it in, right?
I think Mike, you used to use an analogy, not a historical analog here, which is from something like 19 sixty-six to 19 ninety-seven, the Dow Jones annualized at, sorry, let me get this straight sixty-six to eighty-two Dow Jones annualized at zero, eighty-two to ninety-seven. It annualized at 16 growth rates for the first portion of that was about five growth rates. For the second portion of that were around five. Like the economy isn't
GDP growth. Real, real. GDP. Yeah.
right? Isn't necessarily tied to what's gonna happen in your portfolio. I think that it's what's priced in, and it's something that Bob Elliott keeps on, harping on that I love where he is like, well, what do you think? What's the setup and what do you think is happening right now? It's like, what's more important? Is what the market is not pricing in right now. What it's getting wrong. And that's how you make money in the market, right?
And I think what this, you could LLMs and uh, and machine learning and the tech stocks could be huge for humanity and still be way overvalued and make you zero money over the next 10 years. It could happen. It's, and it has historically happened over and over again, but momentum's a bitch, right? So it could last a bit longer than what we think.
it was argued that the part of what happened in the Great Depression was a function of the industrial revolution and a function of the fact that you did not need all that labor on the farm. The family farm became, obsolete, but there was no place for those workers to go. The farm, you had a tractor, you didn't need a horse, you didn't need a family, you had a tractor, and you had the amalgamation of all of these family farms, which left quite a number of people displaced.
It's not the only reason, but boy oh boy, if you start displacing three or four or 7% of your employment, force because you can make the remaining ninety-five percent more efficient through the use of ai, and then you start to interplay robotics into that, there's, there's a dislocation there that is not, this is not talked about very often, and it's not unusual happened with the telephone. It happened every time there has been a major leap in some sort of, technology.
Oftentimes it comes with a displaced workforce that needs to be retrained. I. And how big that workforce is and what the infrastructure is within the country to retrain it or what the policies are around re-education and retraining are incredibly important, points to mitigate those factors. And it's, it's not being talked about, but if ai is this, this boon and productivity, okay, well, does that mean we're all gonna make more and produce more and everyone's gonna consume more and it takes less?
Or will some, some portion of the labor force be displaced for a period of time?
Yeah, the, the addition of all that could be lack of a reduction in productivity for a short period of time until we get an outstripping of productivity that'll help reduce, you know, government debt and all these wonderful things that productivity tends to do. But there, this is the thing about preparation and prediction, right?
And I think we've been talking about all of these, these continued gaps in understanding of inflation and how valuations work and what it can, it's really tough to then know how to position your portfolio to benefit from these understandings, and, and it's really, really difficult to do. So the first thing that we always advocate for is make sure, like, I mean, if you, this is, if you guys are listening to this for the first time, the key thing to take away is.
You gotta put most of your effort in, preparing your portfolio for those shocks. And so you gotta have something for bull markets, which generally tends to be, you know, equity, indices, globally diversified, hopefully. Right? So that's another thing. Is it gonna continue to be U.S domination? Probably not. If it, if history is any indication, you have to have something for bear markets. And this goes back down to, not credit, but government bonds, right? When there's.
When there's a non-inflationary bear market and panic ensues, people give money to the government and they start bidding up bonds, government bonds across the G-seven especially, right? So you have that opportunity set to protect your portfolio in bear markets. And then the third one is commodities in periods of high inflation shocks. And we saw the benefit of that in the last couple of years. Right? that's preparation.
I think, you know, we used to talk about prediction, in the context of our alpha sleeves, but I, I think we can talk a bit more about preparation. With the introduction of, trend replication strategies, So this, I think that's more now become a bit of an, an alternative beta that has a set of characteristics that we can count on to be there in, periods, especially of pronounced, trends.
A prolonged and sustained trend like we saw in the first quarter of 2022, we saw in oh eight, you know, in periods of duress, trend following managed future strategies tend to be. Really, really good in bear markets. Multi-month, multi-year bear markets, as well as inflationary shocks because 50% of what they trade is in the commodity space.
So I would say in terms of preparation, we have to consider as investors a solid diversified equity portfolio, a solid diversified government bond portfolio, a solid diversified inflation portfolio that should include that trend following. Portion, and that's a hybrid one because it also tends to help bonds, right? So it's kind of like, it straddles commodities and bonds in terms of its, benefit as a a, as a preventative measure, as a, preparation portfolio.
And then just make sure you're not letting the maniacs take over the asylum, as we've always talked about, don't overweight, one allocation from a risk perspective. So those that are highly volatile, should get less. And those that are lowly volatile should get more right. And that's the beginning. I think for me, you know, I'm, I'm kind of that set. If I had to like tell my wife, listen, I got one day to live. What are you gonna do for the, this is what you're gonna do.
You're gonna, you know, allocate to something like this. Talk to your advisors. This is non-investment advice and all that. But, uh, my wife would get a very simple portfolio
So is it your wife that has one day to live or you I, I,
that's. see how I feel about that. So I think the message here is it's gonna be complicated, right? And it's, you gotta start with that. I think that's how you minimize the shocks that you're gonna get. and then we can, you know, try to add more innovative ways to diversify. and, you know, we can talk a little bit about the replication world that's coming out. Uh, Mike, you had some thoughts there that make it even more valuable these days to, to really think about that space.
So why don't you tell us a little bit about that.
Well, I, I think that, you know, when you think about, harnessing the, the trend factor via managed futures managers, commodity trading advisors like we are. You're thinking about harnessing both long and short exposures across bonds and stocks, currencies and commodities. Like you already mentioned in the past, these have been harder markets to, take advantage of and they've had higher fees associated with them.
So in our trend replication paper, we go through a process of thinking through how you might replicate those return streams. And there's a bottom-up method and there's a top-down method, and you get very high correlation to, uh, the trend factor in the CTA space.
But the nice thing is you're picking up a massive fee alpha, because in the, the replication, if it were a product would, let's say the product is done at 1%, but if you're trying to replicate the B top 50 or the SOCT and trend Index, those indexes actually include real managers. But the real manager's fee is two and 20. So let's say next year, this year is li like 2022. We have a really difficult year for stocks and bonds and the trend factor does really great.
Well, if you're in those higher price managers, let's say the return is 20%, and I'll play a little fast and loose with the numbers. Well, you got a 20% performance fee minus the 2% management fee. You end up with 14%. That's great. In a year like 2022, boy up 14, especially when the world, you know, fell apart and down 25, if you do it through a trend replication process and save the fee, let's call it 1% fee, you're now up 19% versus 14. That's 5% in fee alpha.
And we have to remember that you pay the fee when you make the money, and when you make the money in these types of strategies is when the rest of the portfolio is really suffering. So where do you want the 5% You want it in your portfolio. Not the managers, because that gives you the opportunity to rebalance. It gives you that extra money to buy when there's blood in the streets.
It also prevents you from making the error of buying one of the managers in the dispersion where, you know, if the average is 21, got zero, one got 40. If you have this diversifier that put up a zero in a difficult time, that is going to be a, a really challenging conversation for the asset owner if you're the advisor. Now, larger, larger asset owners can buy many of these, managers and diversify across that.
But RIAs register investment advisors, smaller Diy investors may not have the capital to be able to allocate to these very large managers, you know, $5 million at a time. And so the process of replication gets rid of the dispersion, and it allows for a higher capture of the upside when you would pay the fees and when you want that upside in your portfolio.
that's an interesting point that I hadn't actually zeroed in on until we did the analysis, right? Like, where is the fee Alpha? Obviously you just needed to look at it, but it was like, oh, right, When the sock gen trend index, whatever index you're following is going sideways or down, there's not a lot of difference. Right? It's what I thought. I thought there was some value in doing some replication. What's, what's going on now?
The value accrues most, most of the value does really accrue when it's these massive upward swings and, and, and it's, you know, Cliff's, saying it hurts when it hurts to get hurt, right? That's generally what value I think investing is in this case. It pays when it hurts to get hurt and you wanna get paid the most when it hurts to get hurt. And I think that's, that's the fee alpha there is, is a crucial thing to contemplate if you're thinking about allocating to those type of strategies.
I wanna move on to other things. So we talked about, I think the basis of a do-no-harm portfolio. A Hippocratic Oath portfolio that you can count on. there are things that we can do that we've liked over the years that we've implemented internally. And, uh, and Adam, you did a great summary of this a couple years ago for us, but I want you to kind of talk about it again because if you think about diversifiers, what, what is it that you wanna continue to add on?
Once you have your prediction portfolio down, you wanna add on things that have a positive expected return that have been true, tried and tested in history. You're not kind of creating it outta thin air and hope that it works. and you want something that is lowly correlated to your existing sleeves. And one of the things that keeps on coming up in our radar is that carry strategy or what we, uh, managed futures yield or alternative yield.
But can, can you walk us through again, you know, what is carry, why we think it works, why we think it exists? And maybe we can talk a bit, uh, some of the, the benefits of including it into a portfolio.
Yeah, I mean there's a number of frames to explore the concept of carry a good, a good place to start is from the do no harm portfolio that you described earlier, where you kind of have an equal amount of your risk in assets that do well in inflation, shocks an equal amount that do well in positive growth shocks and another that do well in negative growth shocks. So you've got the sort of equities, commodities, bonds.
The idea there is you just sort of assume that over the long term there's a duration premium. In other words, you know, investors require a higher return to lock up their money for longer. So longer duration bonds on average, typically have a higher return than shorter duration bonds, required even, even higher return to put your money in equities 'cause you're taking on this growth risk.
You know, you, five years could go by and the value of the portfolio is lower today than it was when you invested in it. 'cause you don't know what the trajectory of that price evolution is gonna be. and that over time, because of the steady drum of inflation, commodity prices are gonna rise. But there actually are, A double handful of extended periods over the last a hundred or so years where those basic assumptions don't, actually, they're not true. Right? And we just went through one in 2022.
So, like I said, typically longer duration bonds have a higher return or higher yield than lower duration bonds. Well, at the moment, and you know, for the last couple of years or so, that has been reversed. And so investing in longer duration bonds and locking up your money for longer has actually earned you lower returns than just keeping your money in T-bills or two year bonds. Right? So why are you taking more risk for less return? That equation is inverted in commodities over the long term.
You do end up earning a roll yield because the, the near term commodity is at a higher price than the, the commodities, sorry, than the contracts that are further out on the curve. And that as those further out in the curve contracts roll up, they, they approach the, being the most recent contract or the nearest term contract, they approach the same price as the near term contract. So they roll up in value, right?
So you earn this kind of roll, commodity yield, but a lot of the times commodities are, that is inverted. And so you actually, if the price of the commodity, if the spot commodity doesn't change, you actually wanna be short the commodity because the far away contracts are higher than the spot and they're gonna roll down and you're expect, you're gonna expect that price to come down.
So, you know, the idea of carry in this context is, well, yeah, you want to have equal allocation to equal risk allocation to all of these different, areas of the economy and different financial markets for. These diverse reasons, but you don't always want to be long them, sometimes you want to be short them, right? And so carry is just the return that you expect to get on a market. If the price doesn't change in equities, it's the dividend yield and bonds. It's the coupon.
And in commodities it's this roll yield that we discussed, right? Well, most of the time this, you know, duration, premium and bonds is positive. Most of the time the equity, risk premium is positive. Um, you know, dividends, the dividend plus shareholder yield is, is higher than the risk-free return, Etc, you just wanna be Allocated to all these different asset classes, but in the direction of the expected premium, right?
Yes. Most of the time that premium is positive, but carry, because it allows you to go short. I. It gives you a chance to earn that premium when the sign flips on it. Right. And I mean there's a good question on why this premium exists, especially in commodities. And I really like the idea that carry in commodities is a win-win. It's a win for producers and it's a win for speculators.
It's a win for producers because they want to sell their production forward to lock in a price and have visibility on what their earnings are gonna be.
And the equity and credit holders that supply those producers with the capital to run their business really like having that earnings visibility because their earnings Volatility is a lot lower and they've got a much higher probability of being able to deliver those dividends and pay those coupons to the money that loan those firms the money to operate. and so those companies are willing to pay speculators. A premium in order to take on that price risk.
They lock it in, the speculators take on the price risk. And so the speculators get paid basically for selling insurance on the earnings of the producers. The producers make out and the speculators make out 'cause they're selling insurance and earning that premium. Right? So, you know, it's great to think about carry as just a really great way to get access to a diversified basket of asset classes in the direction that they are currently paying that, um, that premium, right?
Rather than always assuming that that premium is positive.
So that's, that's a great summary. It's a great summary. And I think, you know, the example for, the average investor of a, the, the carry of a stock being the dividend is appropriate, right? You, you look at a stock that pays a 5% dividend, you don't necessarily expect to make 5% total return on that stock, right? You could make a 5% dividend and at the end of the year that stock have gone down 5%. You made zero. Right?
So it, the, the crucial point here is the definition of carry being what you expect to make if the price doesn't change. But of course, price does change, which make, which makes it. it's not a, a, a no brainer, right? It is, again, you're taking risk. You could have years where that bet is not paying out off for you.
You know, in Canada it's everybody's enamored with a big five banks and their big dividends and their consistent dividends that, you know, in 2008 you had negative 55 to negative 75% drawdowns in those banks. it is just another risk premium that you're taking. The importance here being how closely correlated I. Is that risk that you're taking to achieve that long-term return by choosing futures contracts, whether they're in contango or backwardation, right?
Whether you're getting a high carry or a low carry, what is a correlation to everything else? And it turns out it's extremely low when you're, when you're using a diversified set across commodities, currencies, equities, bonds, and the decision making is different than the decisions you're taking for everything else, right? You're getting an equity risk premium based on, economic growth.
You're getting, uh, term premium based on the fact that the longer term, term bond is paying more than the shorter term bond over time, not all the time. And on trend, you're making your choices as to whether to be long or short a futures contract on. Anchoring and adjusting, and you know, uh, hurting effects. Uh, these are cascade effects that tend to explain human nature and people wanting to pile into something for a short period of time.
Well, it turns out that the decision to choose something to go longer, a short based on carry is very different than trend. And therefore, even the correlation between carry and trend is quite low. I think our internal numbers show something around 0.25%, right? So very, very creative. And, and you see that the, combination of those two is, is kind of killer. It's not surprising that a lot of trend managers starting started adding, carry more and more to their trend following strategies.
Not, not a lot because you know, it does have a different character. but uh, it is useful. So anyway, I just
got a bad name too, because, you know, it was for, for the longest time it was associated with currency carriers. So you've got, managers who are effectively long, you know, developed market currencies in short, emerging market currencies. And the emerging market currencies pay a higher yield than the developed market currencies because they've got more currency volatility. They typically have higher inflation dynamics for a variety of reasons.
And so you could, you know, you could, own these emerging market currencies with high yields and borrow in, in develop market currencies and are in that spread. Right. Well, the thing is that, that the profile of that return stream. to Rodrigo's point earlier is such that it hurts when it hurts to hurt. And so you wanna have a more diversified basket of markets that you're using to be in the direction of this carry. Right?
You know, there's, in a diversified carry strategy, you do have currencies. Adding emerging market currencies does change the character of a, a carry strategy. We don't actually, invest in, real emerging market, uh, currencies in our carry strategy for that reason.
There's just so many different bets you can take around all of the different global bonds, global equity and global commodity markets that when you're, when you have all of them in the portfolio, you don't have at all the same character you had when it was just that kind of currency carry, right? So, you know, carry gets this bad rap because it was a very different strategy than what we described when we talk about kind of global carry. Right. And I think
It, it is interesting. why people who don't know it, don't understand it. you know, you kind of explain it to 'em on the different side. They get people who have heard carry, they immediately say, oh yeah, but that'll blow up in your face. 'cause it, well actually, I, I don't even think they think about it as like, emerging market and, and domestic currency. I actually think about it's a yen us cross, right? That is kind of steady, steady, steady, and then you're gone.
And so every time I bring up carry, they're like, oh, that's dangerous. And you know, the bring the quote that I always use is, it, it ain't what you don't know that gets you into trouble. It's what you know for sure. That just ain't so. And I think that Carry falls into that category. because there's also an, one other thing that adds to that story is that allocators didn't love, for example, when Winton started adding a lot of carry to their strategy.
'cause they wanted that, that crisis alpha. So the, I think the takeaway from that, that line in the newspaper was, oh, it carry must lose all of the money that trend gives you. And I think when, when we look at, I've just kind of gone through all of the major years of paying for equity markets and it's just, it's not that it loses it's that it makes less, it is, the trend tends to be more trendy. It tends to like, oh, that's exploding upward or downward.
I'm gonna go long and short that aggressively. Whereas carry's taken a whole different approach. It's still trying to be an absolute return type of product. And most years where we've seen bear markets in equity markets and when we've seen negative growth shocks, carry's strategy, muddles along quite nicely. not always, but most of the time. Yes. So I think you need to, it, just ain't so that carry always loses money when there is a negative growth shock.
Oh, it's, yeah, most of the time it doesn't, you know, it, it really is very uncorrelated with, with stocks and bonds and, and a, a a very effective complement most of the time, you know, it's not, it's not the only premium, right. I mean, I love, I love a, a variety of premiums. You know, I think eventually we'll probably add something like a merger arbitrage, or a convertible arbitrage, or, you know, there's the fallen angels premium.
Like there's a number of really great risk premium out there, and I, you know, people should be seeking all of them, right? but in that basket. I would put trend at the top and I would put carry right next to it. And, um, so I, I'm excited to be on the verge of offering both of those to, um, to investors just for, for stacking purposes.
And I, you know, as you were talking, earlier about the optimal or do no harm portfolio, and I know we've been talking in harping for 10 years about this, gold River's parity portfolio and it's, you know, it's what we all prefer.
And, I don't think any, it's still in our hearts is it, it takes center stage, but I do like the fact that, you know, you, we've got solutions for people who just aren't ready to go, to move far enough away from that sort of more traditional 60 40 orientation and that trend, that the return stacked concept. Allows them to, to preserve that sixty-forty that they've come to love. So, you know, they just wanna hold onto it because it's been so good to them for so long. Right? I get that.
But you don't need to let go. You can, you can put something on top, you know, you can already stack the trend on top. You can, very soon you'll be able to stack carry on top. And, you know, there's lots more common on the pipe. And I think people should really start to, if you're not ready to go right to that global risk parity portfolio that we, we all three know and love and, you know, lots of devotees among the sovereign wealth managers and largest hedge funds in the, in the world.
But if, if you can't quite get there, return stacking is a really good place to start.
So that's actually a point I wanted to hit today. Uh, so you nailed it, right? We are all terrain lovers. We want everybody to invest in this very weird high tracking error portfolio that, you know, it doesn't matter which all terrain, whether it's a permanent portfolio, adaptive asset allocation, cockroach or otherwise, in the last two years has avoided most of the pain, but it's kind of flat lined, you know, single digits, maybe flat returns in the last two years, avoided most of the pain.
And people are like, well, what if that, you know, that was all terrain. That's a type of pain that you get when you invest in something that weird. But the other thing that is really interesting about this concept of stacking is for those who don't want the all-terrain, who have been, who have spent their careers or their investment, careers as individual retail investors trying to beat a benchmark. Let's say you're trying to beat the S&P-Five hundred for the longest time forever.
The way to do that is what stock selection. You're trying, there's 500 stocks. Here's what I'm gonna do. I'm going to choose a style growth investing. I'm gonna have a subset of those 500 or 2,500 if you're looking at the full market, 2,700, whatever it is. And you're gonna choose a subset that is going that because of whatever characteristics you like is gonna outperform that benchmark. And there's been endless research done on this.
We talk about how markets are micro efficient, but macro inefficient. And that just means that the efficiency in, in the stock selection market, the micro market is such that it's really difficult to outperform. Right? We've seen all those SPIVA reports that come out every year, how many active managers are able to outperform. It's really,
pictured these value managers, you know, back in the back of in their office hanging their heads and the growth managers walk by and they're. Hiding behind their shelves and they don't wanna look at 'em. And all the growth managers are all huddling around the water cooler, High-fiving each other, you know, and then, you know, a year goes by and then all the growth managers are hiding behind the, under their desk.
You know, while the value managers are walking by with, with the head held high and strutting and high-fiving each other at the water cooler. But it just ends up being this, you know, from growth, the value of growth, the value, and over time, because the stock picking orientation is so much more efficient, there's just, there's not much to eke out of that. Right.
But the, the fact is that there are just very few players in the global investment landscape that have the mandate flexibility and the agility because they've got a small enough portfolio to, to be agile in moving around your, the, capital in their portfolios to be able to take advantage of those. Macro anomalies, macro inefficiencies, like trend following global carry, etc. So I think it, this is just a way more inefficient area to operate with more sustainable, larger premia over time,
But let's just, can I just,
that as an alternative.
I want to, yes. And this, Adam, I wanna say, look, if you're, if you can, if you have the wherewithal and if you're willing to invest in some of the more concentrated, for example, value ETFs that Alphar Architects puts in, right? 40 stocks, you, you may be able to outperform you, you will likely, if history is any indication in intuition and how valuations work, you should eke out a positive rate of return. That'll be painful, but useful. But what does that pain do? Like, you can do it.
Okay. Let, let, let's give the benefit of that and people who want to follow that should, and if you wanna beat a benchmark, that's a, a, a way of doing it that you should pursue. If, if that's your passion, and then you can stick to it. but. Let's take the value concentration. For example.
When you measure the beta of a value ETF like that, you find that the, a lot of the variance is not explained by, or a portion of the variance is explained by the beta of the market, and another portion of the variance is explained by the value factor, right? What that means, in essence is you're taking, you're not taking the 15 ball risk of the market. You're taking 20 twenty-five percent volatility in order to achieve that excess return, right? Taking more risk to get more return.
And so it, for you to achieve higher returns against a benchmark, oftentimes it means that you have to take higher risks. So if you're into that more power to you go do that, but let's diversify
into higher risk, go for it.
But let's, let's think about another way of trying to do that, right? And, and this is where I come in now with this concept of stacking, what if you're not about stock selection? Right? You want the S&P 500 and beat it. Okay. Well, what if you were to find stacks that had a positive expectancy most years, but also had the benefit of being lowly correlated to the S&P 500?
Okay. Well what does that mean in actuality, if that indeed comes to fruition is that you will over time stack a return that is above the S&P 500, but because of that low correlation, you may not actually be taking higher risk to achieve that excess return. You may in fact be reducing drawdowns. You may be in fact Maintaining or even maybe you're slightly increasing your volatility 'cause you are stacking, depending on how big your stack is.
But it's just, if you're not into the game of all-terrain and all-weather, but you're into the game of outperforming the S&P or the global market, then this is just another way to try to do that. And I'm super excited by just that. And you don't have to take that. It's tracking errors low. You're just, you're just saying, Hey, we're gonna try to be the benchmark and one way it's gonna be value.
Another portion of our portfolio is gonna be growth, and the other portion is gonna be return stacking. Right. I just, I love that.
been, you know, people like meat and potatoes, right? And we've been like, yeah, man, but you gotta try Thai food and you gotta try this Indian curry dish and you gotta do this and that. And, you know, instead it's like, dude, just add a little gravy, right? Yes. Have your, have your meat and potatoes, right? But you need to try this jus with your meat, right? Or this gravy. And, um, man, is it spectacular?
But, uh, yeah, I mean it's just a really good gateway to, um, to learning more about what else is out there when you sort of take the peelers off and use your peripheral vision. There's, turns out there's a lot of different ways to earn a living off of capital markets. Um. And it's great if you can find diversification against those meat potatoes that you've, grown to know and love so well.
Okay. Now guys, what do we think about the setup? Let's go back to macro for a second and leave people with, you know, I don't, I don't even know if you guys have any opinions about the current setup and what to expect in 2024.
Well, I, I will say one thing we haven't touched on is the, just the, we've, we've got a lot of elections this year. I think more countries are going to the polls this year than any other year in modern history. And
that.
there's a lot of, polarity, right? There's a lot of people with very strong views on both sides of the island where we seem to be having more trouble than usual coming together and, and having a consensus. And so there could be a lot more surprises in store. This year politically then, we're used to, and that also could be a source of volatility in both, interest rates and, and in currencies and, and potentially growth expectations.
And we've also, at the same time, we've got massive fiscal stimulus. You know, you've got the US Treasury running six to 8% annual deficits over the next, right out to 2032 according to the, um, to the budget office.
And when, you know, the deficit of the government is a surplus for the private sector, that is extra money that the, that the government puts into the private sector year in, year out for it to spend and generate wealth And, over time inflation really is too much money chasing too few goods. And um, so if we continue to put this amount of extra spending power in people's pockets, it's not just the U.S., The Canadian government, the Australian government Europeans, the uk.
There's just a lot of fiscal largesse out there. And it's not just a supply issue, it's also a excess demand issue and that that's going on as far as the eye can see. And some people have pointed out that maybe, you know, if, if Trump comes in, he might trim some of the spending side of the income statement, but he's also likely to preserve more tax cuts. Right. And you get deficits both from.
Direct spending and also from lower taxes, which means that there's less money coming out of people's pockets and and flowing back to the government. Right. So, you know, there's a lot of reasons and you know, we're, we're starting to see in several key areas that both growth and inflation are picking up.
We haven't even seen, you know, labor is still way behind the eight ball we've had that we had this big price shock and labor is still catching up, you know, so there's every reason to believe based on what we're seeing, that over time we're gonna see the power of labor begin to re-emerge more unionization, and, um, eventually labor is gonna insist on having a larger share of the pie. So, um, all of these things are, are potentially inflationary.
Wage inflation.
Well, That's his
the seventies.
Wage inflation. The problem is sticky is what you do that year, what you ask for that year, you're gonna ask for the following year, right? So it really is as, as a Latin American, I can tell you that it's. the ex inflation expectations is a tough thing to kill That really is a behavioral thing. And, and this, this is why Powell wants to signal as much as possible that they're going after inflation aggressively. but it's, the story tells it itself.
This is again, back to what the belief has been for the average person is that inflation has not gone down. And it, the more they believe that and they don't understand that indeed we have tempered inflation cha uh, the rate of a rate, the rate of change of inflation, then the more entrenched they're gonna get and the more they're gonna ask for that, wage growth to get higher. And, and that's why the Genie is going to be put back in the bottle.
Not today, not tomorrow, but probably in a few years. And in terms of, you know, pricing, I. Right now it's, again, it's crazy to me to think that there's over 30% probability that there's gonna be 200, points of rate, rate cuts this year. Does anybody have any thoughts on how, which is it, right? Are we, do we have continued wage growth, strong economy,
We had constant down here in the summer of, it was early summer, I think Mike Kay. And
July, I think.
and he had. We were talking about soft landings, no landings higher for longer. And I think we ran around the table and, eight outta 10 people thought we were gonna be in recession by
Yeah.
as of last summer. And I remember saying not with the amount of fiscal largesse that we've got coming down the pipe, there's just way too much money flowing into public purses for us to have a recession. We are continue to be sub-four percent unemployment rate. the employment rate number of people out in the economy working is, is higher than it's been in 15 years. And we've got the government even while the economy is running this hot, the government is continuing to put six to 8%.
Of GDP back into the economy for extra spending. So, you know, I just don't see a recession on the horizon. And as long as equity prices keep going up, then companies have no reason. Even if their productivity growth is above expectations and they have excess staff, there's no reason to cut because, you know, they would just went through this period where it was hard to get workers.
It was like a couple years ago, it was hard to get the workers you need, so they're likely to hold onto them unless the market forces them to cut to preserve earnings. So all of the things seem to be conspiring for a hotter than expected economy over the next year. Not a, not a loose,
And it's Andy Andy's roadmap is bang on. I mean, the way it has to go, right? The timing of it is always what makes it difficult to invest. But the way things have to go in order to have sustainable low inflation is first you have to have from here, rates need to go up on the long end, right? That's either, it's unlikely given the growth that we have that the feds gonna be cutting 200 basis points. So I think that's the mispricing that, that he's talking about consistently.
So, if rates go up, that puts pressure on assets, right? Bonds are gonna go down obviously at the same time, but then that's gonna put pressure on equities. Equities should get hurt from there. You have a lower demand from consumers that's going to hurt earnings. That's gonna allow for the wage, the employment market to soften, which is gonna allow for reduction in wage growth, which is then going to lead to a, permanent or more consistent, hopefully reduction of inflation.
But that's the order of operations that we need to see historically in terms of a macro cycle for us to finally say, okay, listen, soft landing, we, we killed it. But those things need to happen. There's not, we're not gonna get from here to there in, in 12 months, right? It's
Especially not in with, with the current structure we
no. And, and, and macro cycles.
and,
Macro cycles aren't months, they're years, right? I think Bob Elliott talked about the fact that, 2008 was not a macro cycle. It was a credit crunch. 2020 was not a macro cycle, it was a negative growth shock. Macro cycles move insanely slowly and take a long time to move. If we look at what, how people have perceived the outcome of the economy over the last 18 months, like you said, Adam, you know, was it a soft landing? Was it gonna be a recession?
Now we're talking about soft landing again, like the variation around the actual macro numbers. The macro numbers have been fairly consistent. They have not, with the exception of inflation changes, you know, the employment, the, the wage growth, the the amount of fiscal spending and it's all maintained relatively the same rate. And the only thing that's changed wildly is the narrative around that. Right. So I think we're, people need to get prepared for the long haul here.
And again, you know, the reason you wanna be prepared is because while Andy was right about the order of operations, you know, one felt when you spoke with him that, oh, this is eminent. Like this rates up assets down. That's it. And it happens for two months, and then we recovered very quickly. Right? So it's not, it's one thing to know what the order of operations is, and it's another thing to be able to get it right in time and, and win.
again, more emphasis on why you need to prepare, first and foremost. All right. Any other thoughts, gentlemen?
Yeah, the NASDAQ went from like 2,500 to 5,000 in the last six months of its run. That's a bubble. And uh, we'll see. We'll see.
Well, it was crazy. Remember, remember the one we did, the pandemic, the pandemic portfolio that we, that we had in March of Twenty-Twenty, where we kind of like, okay, what's gonna happen here? And it's, uh, we said a everything can happen. Again, it's just a testament, like, we don't know. It could be this, it could be that. What happened was not, I think, high in our, guesstimations, right? We knew that. We didn't know.
But if you were to poll us, really at that point, we're like, oh, it's probably gonna get worse from here. And it got so good. Um.
still falling short. You know, the, the, the Russian debacle, the tie bought, I mean the, the NASDAQ went from 1400 to five grand. We got another
1994, August, 1994, the U.S Equity market, hit the most expensive it had ever been on a P.E basis in August of 19 ninety-four, and then went on to double again by 19 ninety-nine. Right? So, absolutely anything can happen. We're not, this is not a prescriptive exercise, but it, it is helpful, I think to, explore. All of the other things that might happen that may not be quite as favorable to everybody's favorite portfolio
Oh, I, I don't think that would be a favorable outcome. Market's going up with that kind of intensity. I'm not sure. We have a lot of people who are like, Ooh, hoo. Did I ever do good? And, and, and, and then investing from 2000 to 2014 was like two 50% drawdowns with a return of zero,
Mm-Hmm
Well, look, it's how many
In US equities. That's exactly the S&P
that you know in 2023 that actually participated in this run up? It happened in the last quarter, right?
in
the favorite portfolio was cash. Cash was king, 5%. Why would I do anything else? Why would I take the risk? Boom, two months, 20% return? I mean, I don't know anybody that was fully invested for their
Well, this is the other thing that we need to re-emphasize. I know you mentioned this earlier, Rodrigo, but the, you know, we could easily see a situation where the Fed holds or even raises. In six or nine months 'cause inflation's re-accelerated and what we're coming into an election. And in all likelihood, Janet is gonna allow the amount of bills issued to get way outside any historical, precedent in an effort to avoid having to issue long duration coupons to fund the deficits.
And therefore equity markets could continue to do well. You know, so, you know, it it, it takes both the treasury deciding that they're gonna allow equities to, to drain out and the Fed saying that we need the economy to run a little less hot in order for the market to capitulate here and coming into an election cycle with what a lot of people feel to be existential things at stake. It'll, you know, I think we need to acknowledge the, the potential for very extreme things to happen.
Amen. Yeah. All right. Well, gentlemen, thank you so much for the 2023 recap. Uh, we, I think we gotta do this more often. I really enjoyed this one. Maybe once a quarter, get back in there, bring a special guest in. right.
You guys are special enough.
I guess. All right guys. Thank you so much for, uh, doing this with me today. I know that I pushed for this last minute, but, uh, I think it worked out.
That was
Any other, any final thoughts? Where can everybody find you guys? Everybody knows where,
There it
Gestalt, you got at GestaltU for Adam Butler and Twitter. I got, uh, Rod Gordillo P, the worst Twitter handle on the planet.
Rumor has that your LinkedIn profile's on fire. Lately though, you gotta find Rodrigo on LinkedIn
Rodrigo Rodrigo Gordillo Forward slash Rodrigo Gordillo. And then Mike, you're MikeNinetyNine.
At? At Mike Philbrick 99
MikePhilbrickNinetyNine. All right.
on Twitter. That is. But
And for our content, you can always find us on investresolve.com, on Returnstacked.com, where we have a ton of research videos, podcasts that, uh, will continue to help you out in your journey. Okay. Thanks everyone, and we'll see you next week. I.
rock on.