Hello Alf, First of all thanks for writing another valuable article :).
If previous iteration of 'don't fight the fed' actually meant 'valuation seems to be a bit crazy across the market, but fed is printing and will do more printing if things go into wrong direction so buy anyway'. What would be then ideal long strategy for' 2022 don't fight the (this time angry and tapering') fed?
It seems to be that equities are in general doomed for bad performance - growth with high multiples because of DCF re calibration, value equities because of (often) increased debt servicing costs.
Real estate will definitely suffer from higher yield environment,
Gold/Silver would be an interesting choice for stagflation scenario but I am not sure what's the case for upcoming year of tightening. I also don't see any extra upside in long TLT.
I see however few interesting opportunities for speculation:
* Short All the unprofitable tech zombies
* Short home builders equities?
* Curve flattening instruments (one you already play)
* Short copper/industrial metals
* Long China - already super negative sentiment + still room for credit impulse growth.
* Long Brazil - healthy positive interest rates, upcoming elections, high exposure on energy/agriculture commodities
* Short on particular European markets exposed to Russian bonds
Adam, you basically managed to summarize my big picture macro views and most of my preferred expressions in one single and concise comment :) there is little where to hide if you are a long-only investor.
If I think like (ex) fund manager maybe I should look for some lead fund management role now? :)).
Everyone is looking right now at FED and US bond market but there are interesting things happening elsewhere:
* Recent hawkish remarks from ECB (are they really able to do anything as they seem to be trapped/fucked more than FED with their debt burden?). BoJ still keeps their yield curve control.
Regarding Europe, do you think it would be possible for ECB to somehow control European bond markets and at the same time curb credit action for private sector in order to fight inflation?
For example some sort of QE/yield curve control for gov bonds and increased reserve requirements for commercial banks to limit credit action for private sector (especially mortgages).
Tactical trade with 1-2 year timeframe horizon as industrial metals consumption drops when there is an economic slowdown (my backtests confirmed that, it is also worth checking where copper/copper mining stocks were back in 2015/2016). Long term perspective for copper is extremely bullish due to the EV/ESG transition.
How do you think about the coming de-globalisation era and thus potential increase in labour market participation as western developed nation cannot just push all labour intensive work to cheaper countries?
De-globalisation would definitely be somehow inflationary, but not sure about the uplift to real GDP. Perhaps some increase in participation rate, but offset by major drops in global trade?
offset by major drops in global trade? if you onshore supply chains again you have overall a higher participation rate albeit less efficient for the entire economy?
Yep, you might be able to engineer a higher participation rate that way but it's going to be much more inefficient for global productivity and GDP growth
Hi Alf. Great article. Also great interview with Adam Taggart. Quick question. On your spreadsheet of positions, you reference monthly vol. Where are you obtaining this number? Realized or implied volatility? Thanks for any help.
Great work Alf. Quick one: I've seen the St. Louis Fed publish 10yr Inflation Expectations. But can seem to find your index for 30y US PCE inflation expectations. Is this published? Or a variable you have constructed yourself?
Great work, Alf. Appreciate your insight as always. FWIW - ETH statistically backtests as a better short with the coming macro environment instead of BTC
Just one question, why do you think that this is an environment where equity risk premium needs to be repriced higher? As opposed to what is reflected in the distribution mean, 5.5?
How does one think about mortgage rates in this environment? Rising interest rates mean variable rates will increase 0.25% * the number of rate hikes, but fixed rates already have 3-4 fed hikes baked in. Thanks for your thoughts.
Hi! Mortgage rates are the sum of expectations for Fed Funds rate and credit spreads.
30y bonds incorporate expectations the Fed is going to hike to about 2% and that's it, and credit spreads are overlaid on this -> current 30y mortgage rate at 4.2%.
If the Fed goes with actively selling Treasuries to ''steepen the curve'' with QT, 30y yields could temporarily rise (risk premium) and credit spreads would widen further, with 30y mortgage rates going >5%.
If they don't do that, I expect credit spreads to lead a residual additional increase in 30y mortgage rates which I expect to stabilize below 5%.
Seems like given recent UST curve shapes that the market is expecting the Fed as it pertains to QT to only sell its short dated UST security holdings. At least today's move suggests that 2-10 now 19bps again
Hi Alf. I am having trouble using your "1 sigma" stops to determine appropriate position sizes. Suppose I want to allocate (hypothetically) $100,000 in total to your portfolio. So for the short IWM my stop should be 7% away and that should correspond to 2% of my total capital, therefore the amount of IWM that I should be short would be 100000 x 2 / 7 = $28571. Similarly the amount of HYG that I should be short would be 100000 x 2 / 3 = $66667. Is that correct? Because those two positions alone then seem to be a very large fraction of my total funds, leaving very little to allocate to other positions.
Hi Frank! Indeed, I use leverage. The total gross leverage I am using at the moment is about 2.7x. I use options and futures to structure some of my trades.
For instance, you could buy $2000 worth of puts on IWM: this way, your maximum loss can maximum be $2000 but your potential profits could be much larger.
Not Alf but I think you should calculate it in following way: historical 1 month standard deviation for instrument let's say bitcoin is 10% Current price of bitcoin is ~40000 so 10% of it is 4000$. You want to limit your looses to 2% of capital or 2000$. So your position sizing in bitcoin should be 0.5btc so that 10% move on on instrument which is now 2000$ means stop loss cutting your loss at 2% of disposable capital.
Beyond the messaging to markets, is there a political component to this? My thought: Powell still hasn't been confirmed by the Senate. With all the crises du jour from the Ukraine, possible COVID increases, et. al., Powell may not get confirmed before November And if the Republicans take the Senate, is he more likely to get confirmed eventually by looking more hawkish?
The best post-Fed analysis I have seen.
Thank you :)
No problem, I really appreciate the way you express your ideas, as you know already.
Hello Alf, First of all thanks for writing another valuable article :).
If previous iteration of 'don't fight the fed' actually meant 'valuation seems to be a bit crazy across the market, but fed is printing and will do more printing if things go into wrong direction so buy anyway'. What would be then ideal long strategy for' 2022 don't fight the (this time angry and tapering') fed?
It seems to be that equities are in general doomed for bad performance - growth with high multiples because of DCF re calibration, value equities because of (often) increased debt servicing costs.
Real estate will definitely suffer from higher yield environment,
Gold/Silver would be an interesting choice for stagflation scenario but I am not sure what's the case for upcoming year of tightening. I also don't see any extra upside in long TLT.
I see however few interesting opportunities for speculation:
* Short All the unprofitable tech zombies
* Short home builders equities?
* Curve flattening instruments (one you already play)
* Short copper/industrial metals
* Long China - already super negative sentiment + still room for credit impulse growth.
* Long Brazil - healthy positive interest rates, upcoming elections, high exposure on energy/agriculture commodities
* Short on particular European markets exposed to Russian bonds
Cheers,
Adam, you basically managed to summarize my big picture macro views and most of my preferred expressions in one single and concise comment :) there is little where to hide if you are a long-only investor.
If I think like (ex) fund manager maybe I should look for some lead fund management role now? :)).
Everyone is looking right now at FED and US bond market but there are interesting things happening elsewhere:
* Recent hawkish remarks from ECB (are they really able to do anything as they seem to be trapped/fucked more than FED with their debt burden?). BoJ still keeps their yield curve control.
Regarding Europe, do you think it would be possible for ECB to somehow control European bond markets and at the same time curb credit action for private sector in order to fight inflation?
For example some sort of QE/yield curve control for gov bonds and increased reserve requirements for commercial banks to limit credit action for private sector (especially mortgages).
short copper/industrial metals as a tactical trade as they ran hot but long investment looking out this decade?
Tactical trade with 1-2 year timeframe horizon as industrial metals consumption drops when there is an economic slowdown (my backtests confirmed that, it is also worth checking where copper/copper mining stocks were back in 2015/2016). Long term perspective for copper is extremely bullish due to the EV/ESG transition.
why are you pointing out 2015/16?
Hi Alf
Superb article
How do you think about the coming de-globalisation era and thus potential increase in labour market participation as western developed nation cannot just push all labour intensive work to cheaper countries?
That would then bring real GDP growth back?
De-globalisation would definitely be somehow inflationary, but not sure about the uplift to real GDP. Perhaps some increase in participation rate, but offset by major drops in global trade?
offset by major drops in global trade? if you onshore supply chains again you have overall a higher participation rate albeit less efficient for the entire economy?
Yep, you might be able to engineer a higher participation rate that way but it's going to be much more inefficient for global productivity and GDP growth
Hi Alf. Great article. Also great interview with Adam Taggart. Quick question. On your spreadsheet of positions, you reference monthly vol. Where are you obtaining this number? Realized or implied volatility? Thanks for any help.
Realized volatility using a 5y history, calculated on monthly rolling observations.
Great work Alf. Quick one: I've seen the St. Louis Fed publish 10yr Inflation Expectations. But can seem to find your index for 30y US PCE inflation expectations. Is this published? Or a variable you have constructed yourself?
I build it myself but derive it mostly from 30y market implied inflation swaps
Very interesting
Thank you!
I suspect Powell's tone will change after the midterms. Powell is an unconfirmed chair and Biden is holding a gun to his head to focus on inflation.
It could be, to a certain extent
Hi Alf, just curious. In the equity risk premium model, why don't you choose US 10 year yield in the equation? Any specific reasons? Thanks!
Because most listed companies continue to produce cash flows for more than 10 years, and I need to discount those as well.
Great work, Alf. Appreciate your insight as always. FWIW - ETH statistically backtests as a better short with the coming macro environment instead of BTC
I know. I just found it easier to short BTC :)
Great piece. Thanks!
Thanks for reading!
Best post out there on the topic
Very kind!
Fantastic article, Alf!!
Just one question, why do you think that this is an environment where equity risk premium needs to be repriced higher? As opposed to what is reflected in the distribution mean, 5.5?
Hi Kel!
The growth impulse has been slowing down for a while and Central Banks are hitting the brakes at the same time.
QT removes reserves from the system while adding net collateral back on top.
I would expect risk premia to trade at least above their long-term mean.
Could you elaborate what you meant by “adding net collateral back on top” ?
Thanks I’m advance !
How does one think about mortgage rates in this environment? Rising interest rates mean variable rates will increase 0.25% * the number of rate hikes, but fixed rates already have 3-4 fed hikes baked in. Thanks for your thoughts.
Hi! Mortgage rates are the sum of expectations for Fed Funds rate and credit spreads.
30y bonds incorporate expectations the Fed is going to hike to about 2% and that's it, and credit spreads are overlaid on this -> current 30y mortgage rate at 4.2%.
If the Fed goes with actively selling Treasuries to ''steepen the curve'' with QT, 30y yields could temporarily rise (risk premium) and credit spreads would widen further, with 30y mortgage rates going >5%.
If they don't do that, I expect credit spreads to lead a residual additional increase in 30y mortgage rates which I expect to stabilize below 5%.
Thanks Alf!!
Seems like given recent UST curve shapes that the market is expecting the Fed as it pertains to QT to only sell its short dated UST security holdings. At least today's move suggests that 2-10 now 19bps again
Also is there a way to invest in "2s 10s flattener" without using futures - e.g. an ETF?
long TLT and at the same time short on 2y duration bond etf?
I use futures with underlying 2y bonds and 10y bonds for this trade.
Lyxor had a flattener ETF that they closed, and they still have a steepener ETF (STPU).
Puts on this ETF could be a way (although expensive).
Futures are the easiest way to replicate this trade.
Hi Alf. I am having trouble using your "1 sigma" stops to determine appropriate position sizes. Suppose I want to allocate (hypothetically) $100,000 in total to your portfolio. So for the short IWM my stop should be 7% away and that should correspond to 2% of my total capital, therefore the amount of IWM that I should be short would be 100000 x 2 / 7 = $28571. Similarly the amount of HYG that I should be short would be 100000 x 2 / 3 = $66667. Is that correct? Because those two positions alone then seem to be a very large fraction of my total funds, leaving very little to allocate to other positions.
Hi Frank! Indeed, I use leverage. The total gross leverage I am using at the moment is about 2.7x. I use options and futures to structure some of my trades.
For instance, you could buy $2000 worth of puts on IWM: this way, your maximum loss can maximum be $2000 but your potential profits could be much larger.
Not Alf but I think you should calculate it in following way: historical 1 month standard deviation for instrument let's say bitcoin is 10% Current price of bitcoin is ~40000 so 10% of it is 4000$. You want to limit your looses to 2% of capital or 2000$. So your position sizing in bitcoin should be 0.5btc so that 10% move on on instrument which is now 2000$ means stop loss cutting your loss at 2% of disposable capital.
Beyond the messaging to markets, is there a political component to this? My thought: Powell still hasn't been confirmed by the Senate. With all the crises du jour from the Ukraine, possible COVID increases, et. al., Powell may not get confirmed before November And if the Republicans take the Senate, is he more likely to get confirmed eventually by looking more hawkish?
There is definitely some politics behind this major hawkish shift since late 2021. Agreed.