0:00

So in 2022, we saw the rise,

0:02

I think, or the comeback, I should say of trend

0:04

strategies. So these are strategies that,

0:06

you know, basically make money when there is

0:08

a clear breakout in

0:10

prices. And when does that happen?

0:12

Well, when there is a lot of macro volatility, you

0:14

would expect that there are more convex

0:17

reactions in prices and therefore trend strategies

0:19

can actually benefit from this

0:22

a bit. And you can see that trend strategies tend to do pretty

0:24

well during inflationary bouts

0:26

exactly for this reason, because you need to restructure

0:28

the way you think about interest rates and equity sectors

0:31

and commodity prices. And so you have a lot

0:33

of trends developing and you can benefit

0:35

from an allocation to trend.

1:46

All right, welcome to another episode

1:48

of Resolve Riffs where we have today one of our most

1:50

popular guests that we have on a regular basis.

1:53

Alfonso Peccatiello is

1:55

joining us today, otherwise known as

1:57

at MacroAlf on Twitter and

2:00

is the publisher of the Macro Compass.

2:03

Alfonso, welcome back to Resolve Riffs

2:05

and it's great to have you joining us

2:07

today.

2:08

One of my favorite shows, regular listener.

2:10

So always a pleasure to be here.

2:12

Love it. You have been a busy beaver

2:14

as they say in Canada. I know you've

2:16

got a fund you're working on that looks

2:18

like it might be an idea that might be coming to fruition

2:21

in Q4 and you have

2:23

been continually writing, as

2:25

eloquently as you do and as, I think

2:27

you have such great explanatory power

2:29

in your narratives and things like that. So

2:32

let's jump in and talk

2:34

about You know, how did we get here?

2:36

The fiat system and the end

2:38

game, you released a video just today, actually,

2:40

which I thought was a wonderful

2:42

way to sort of set the table of

2:45

what we've been going through over the last 50 years,

2:48

you know, contextually, maybe in a broader sense of

2:50

how fiat currencies have come about, how they've

2:52

developed and you coined a phrase, the wealth

2:54

illusion paradigm. Which

2:56

I thought was a really, really

2:58

interesting concept. So why don't we start there,

3:01

talk through that recent piece you had, and then we'll

3:03

continue through the, through the rest of the show and we'll get

3:05

to, the fund you're working on and how it's going

3:07

to position itself within that

3:10

framework and how asset prices might respond

3:12

and all that stuff.

3:13

All right, let's do that. So the

3:15

piece was called the macro end game, because

3:18

I think, you know, macro investors

3:20

in general, investors, we're always

3:23

inundated with daily news and noise

3:25

and data, and now that

3:27

the market is pretty boring, we can maybe

3:29

take a step back, right? We take a step

3:31

back and we can look at. The

3:34

big picture, answering the million dollar question,

3:36

you know, what is the macro end game?

3:38

Because I think it feels a bit unsustainable

3:40

for many looking at the ways

3:42

we have structured our financial system. When

3:45

you look at wealth inequality, when you look at asset prices,

3:47

it often gives you that feeling that

3:50

it's not really a very sustainable

3:52

equilibrium. Right. It's a bit what

3:54

Minsky would say, artificial

3:56

stability breeds instability

3:58

in the system. That's how many people feel about

4:00

it. That's why maybe they want to have some gold

4:03

or for, you know, more, digital age

4:05

oriented people, maybe Bitcoin. that's

4:07

the feeling I think. Right. And I wanted to

4:09

try and explain how did we get here? Why do you

4:11

have this feeling and whether this system

4:13

can actually be resistant

4:16

or whether it actually breaks?

4:18

And if it breaks, what's the macro end game? That

4:20

was the idea behind the piece. And

4:23

so it all starts, in 1971,

4:26

when Nixon ends the,

4:28

gold pack, right? It basically, collapses

4:31

the gold standard. And what he does back

4:33

then is it basically ends the convertibility

4:35

of gold into dollar

4:37

at the fixed. exchange

4:39

rate. And what happens

4:42

back then is basically that all banks

4:44

and governments in the world that

4:46

were creating new money, and

4:48

I will explain in a second what I mean with that. They

4:52

were also creating new money before 1971,

4:54

but there was a clear limit, a hard

4:56

peg to this because you would create dollars

4:59

out of thin air like a government or a bank does.

5:01

But then there will be a fixed price at which you could

5:04

convert these dollars back into gold. And so you

5:06

had to be careful with the amount of fiat

5:08

money you would create, right? There was a balancing

5:10

mechanism in other words. And

5:12

after 1971, that's not the case anymore.

5:15

So in our system, it's not central banks that

5:17

create inflationary money. And that comes as a

5:19

news for many, but it's government via fiscal

5:21

deficits and banks via lending

5:24

that create the inflationary form of money. We can

5:26

actually spend and how it works. It's pretty

5:28

simple. The government is the issuer

5:31

of the currency. So the United States government

5:33

issues dollars, they control issuance

5:35

of the dollar and what

5:37

they do when they do fiscal deficits is

5:39

they decide to basically, let's

5:42

say, blow a hole in their balance

5:44

sheet. So reduce their net worth around

5:46

deficits and inject this

5:48

net worth into the private sector. So in

5:50

2020. You could open your mailbox

5:52

and find a 5, 000 check from the United

5:55

States that had become basically

5:57

the issuer of this 5, 000

5:59

for you. And you became richer

6:01

because you could cash in 5 thousand dollars at

6:03

J.P., Morgan and have this spendable

6:05

money now all of a sudden to spend without

6:08

having a liability attached to it. You didn't have any

6:10

debt, any mortgage, any loan. Nothing.

6:12

So your net worth went up because the United

6:14

States government decided that its net worth

6:17

had to go down. So it's a simple balancing

6:19

mechanism where the government decides

6:21

to blow a hole in their balance sheet, issue new spendable

6:24

dollars, and you as the private sector will be the beneficiary

6:27

of it. And the second way is bank

6:29

lending, where you want to buy a house of a

6:31

million dollars. You don't have a million dollar cash

6:33

in your bank account, but what you have is a

6:35

job. Or a business. So you will

6:37

produce cash flows over time. And therefore a

6:39

bank can look at your future purchasing

6:41

power and give you credit against

6:44

that now. So basically credit

6:46

your bank account by a million

6:48

dollar money you didn't have before. And

6:51

now you can go and buy a house with

6:53

the newly created million dollar from the bank,

6:56

right? And the seller of the house will now

6:58

have a new bank deposit of

7:00

a million dollar who he didn't have before.

7:02

So the creation of credit. Basically

7:05

allows the balance sheets to grow and

7:07

it injects money into the system,

7:09

although it comes with debt as well, because

7:12

you have a million dollar, but you also have a mortgage

7:14

of a million dollar now. So that's a bit

7:16

the difference, but it still allows you to spend

7:18

more all of a sudden to have more inflationary

7:21

spending power than before. And after

7:23

1971, both the banks

7:26

and the governments were more free

7:28

to actually create new fiat money

7:30

without having to convert. Or

7:32

check the convertibility of this new,

7:34

of the quantity of the fiat money versus a dollar

7:37

because the gold peg was basically. Gone.

7:40

And when you look at this, you say,

7:43

okay, cool. But the fact that they can,

7:45

doesn't mean they will create a bunch

7:47

of new fiat out of nowhere.

7:50

And this is true because if you think about

7:52

why would government run

7:54

a lot of deficits or the private sector

7:56

demand a lot of credit from banks,

7:59

you would do this if the organic

8:02

growth in the private sector, if the structural

8:05

growth of the private sector. So

8:07

if you see your structural ability to generate

8:09

growth going down, what

8:11

you will be doing is look for an offset. And

8:14

that offset is credit, deficits,

8:17

more money being created to offset

8:19

your inability to create

8:21

strong structural growth. And that

8:23

inability started to surface in

8:26

the 80s. Because the inability,

8:28

and I can share the screen here

8:30

to show what are the drivers of

8:32

long term economic growth, And

8:35

they're pretty intuitive. One

8:37

of the re the ways that

8:39

you can create organic growth in an economy is

8:41

through demographics. Pretty simple.

8:44

If you have more people working productively,

8:46

then your structural GDP growth

8:48

will be higher. So

8:51

one of the ways to create strong organic

8:54

GDP growth is through demographics.

8:56

So pretty simple. If the amount

8:59

of working age population as a percentage

9:01

of total increases, so you have

9:03

more people actually contributing to

9:05

your working, to your labor force, then

9:07

you can have more. Structural growth.

9:09

Vice versa, if your working age population

9:11

shrinks, then you will have less people contributing

9:14

to active economic growth, and your organic growth

9:16

will also shrink. And as you can see from this chart,

9:18

whether you take the United States or even Japan

9:20

or Germany or Italy, up until

9:22

the 80s, the amount of working

9:25

age population was increasing. So

9:27

you add basically a demographics boom

9:29

in the post second world war era that

9:32

led 20 years later, because to make

9:34

a new worker, you actually need 20 years,

9:36

right? They need to be eligible to work. in

9:38

the eighties, you had the peak of this working

9:40

age population growth as percentage of total. So you

9:42

had. happen. So All countries basically ranging

9:44

between 65 and 70 percent of working

9:46

age population as percentage of total.

9:49

But in the eighties, we peaked, basically

9:51

demographics peaked. They remained healthy

9:53

between the eighties and 2000, but the marginal

9:56

growth, the marginal benefit from better

9:58

demographics had exhausted. And if you

10:00

look at the next 10 to 20 years, of course,

10:02

this projection, these projections look blicker

10:04

and blicker. So in the eighties, you had demographics

10:07

peaking, and you also had. The

10:09

second factor that stands behind,

10:11

structural growth, you had productivity also

10:14

peaking because at the end

10:16

of the day, you can have better demographics,

10:18

but if those workers aren't productive

10:21

and if the use of capital isn't productive

10:23

in the economy, you're still going to struggle. Now,

10:26

the good news is, as you can see from this chart,

10:28

that if you look at the decades, like the fifties,

10:30

the sixties and the seventies, and all the ways until the

10:32

eighties, Productivity growth on

10:34

a 10 year rolling basis was increasing.

10:37

So you were becoming. more

10:39

productive year after year,

10:41

and the marginal rate of productivity was

10:43

also increasing. But once you reach

10:45

the eighties and the nineties, this productivity

10:47

growth was still there, but it started

10:49

to decline on a second derivative basis. So

10:52

you were still more productive, but the productivity

10:54

growth benefits were mostly exhausted.

10:57

And so what happened basically is that

10:59

by the eighties and the nineties, you were

11:01

in a situation where the

11:04

gold peg was gone. You could create new

11:06

money. without having a hard pack

11:08

to gold and your structural

11:11

growth forces. Driven by

11:13

demographics and productivity were declining.

11:15

And so politicians had to basically

11:18

find an offset, a way

11:20

to offset this dwindling

11:22

structural growth to make GDP

11:25

growth socially acceptable again.

11:27

And how would, how were they going to eat their

11:30

3 percent real GDP target

11:32

each year? Well, with the use of

11:34

leverage. And therefore they

11:36

said, you know what, we are going to start doing

11:38

it and we're going to lever up the system because we don't

11:40

have a hard peg anymore and

11:42

we can create as much fiat money as we want.

11:44

And so you go into a situation, as

11:47

you can see here, where whatever

11:49

country you actually put, you can use the

11:51

US or Europe or Japan

11:53

or China, as you can see in this chart, as

11:56

long as you look. At the total

11:58

leverage in the system. So you look at the private

12:01

sector, as we said, bank lending,

12:03

private credit, and

12:05

the public sector combined. If

12:07

you look at the use of leverage you can make throughout

12:09

the economy, all biggest economies

12:12

in the world went through the same process between

12:14

the eighties and 2020. They

12:17

all levered up their economies from about

12:19

a hundred, 150% of GDP,

12:21

all the way to 300, or in Japan

12:23

case, even 400% of GDP.

12:26

Yeah.

12:27

right. Wow.

12:29

So that's public and private data as a percentage

12:31

of GDP that you've got on this and you can just

12:33

see, in particular what's striking is that,

12:35

that run in China from, you know,

12:37

sort of post 2008, 100 and

12:41

whatever, 20 percent to 300, just sort

12:43

of catching up to the rest of the developed nations

12:45

in the world, truly, truly

12:47

staggering.

12:48

Yeah, it's quite impressive. I mean, China caught up to

12:50

the game. They had demographics,

12:53

tailwinds a bit later than the others.

12:56

so they, they lasted a little bit longer. They

12:58

had a big productivity boom by joining

13:00

the WTO so they could gain

13:02

share on the global manufacturing

13:04

market and the global trade market. They became

13:07

more productive. But all these exhausted

13:09

for them, let's say 10 to 15 years later

13:11

than it did for the others. So somewhere around

13:13

2005, 2010, they actually

13:15

had to lever up and they did. So very,

13:17

did they ever,

13:19

they, they went ballistic, you know, in basically

13:21

15 years, they covered the ground for three

13:23

decades when it comes to leverage. And

13:25

so basically you went to a situation

13:28

where. Politicians had found the fix.

13:30

The fix was, well, if demographics are coming down

13:32

and if productivity is coming down, we're going to do leverage

13:34

and everybody's going to be fine. Now, one

13:36

issue with leverage is that it makes

13:38

a system, of course, a bit more fragile and

13:41

also to be used as a recurring system, more

13:43

leverage and more leverage and more leverage, you

13:46

need to make sure that the next

13:48

guy who's levering, the next generation who's

13:50

levering is able to do so

13:52

at a marginally cheaper interest rate.

13:55

So if you lever up the system more, more

13:57

and more. And your salaries

13:59

aren't increasing in real terms and your

14:02

structural growth is not that strong. The

14:04

only way to sustain, to

14:06

basically have a servicing,

14:09

ability for this high level of leverage is

14:11

to make servicing costs pretty low, is to make

14:13

interest rates as low as possible. And

14:16

so you went into a situation where the

14:18

system got more leverage, often unproductive

14:20

to be frank. So this leverage went into real

14:22

estate and asset prices. It wasn't really

14:25

used to. generate innovation

14:27

and structural growth. So you had

14:29

this system, these lowered economic activity

14:31

as the entire economy was basically burdened

14:33

by that. And so central banks decided

14:35

to stimulate economic growth and make the system more

14:37

sustainable by lowering interest rates.

14:40

This was the trick to continue

14:42

levering up the system. Without having

14:45

effectively the leveraging episode like we

14:47

had, for example, in Japan, a system which

14:49

was highly leveraged to the real estate market in the eighties.

14:51

And when the bank of Japan, Japan raised rates,

14:53

you then had a deleveraging episode who lost it for

14:56

decades. So the West didn't want that.

14:58

And they said, well, you know what? We're going to cut rates

15:01

and accommodate this process as we speak.

15:04

And that's what we did.

15:05

Yeah. And so that

15:07

it obviously, well, it's

15:09

unlikely that that can go on forever.

15:12

but maybe also walk through the steps

15:14

of the wealth illusion effect

15:16

that you talk about and how that continues

15:19

to go through maybe the stepwise example

15:21

that you used in the house purchase and to

15:24

let people sort of get their minds wrapped around that.

15:26

Yeah, correct. So one chart

15:28

before we walk through the example to visualize

15:30

what I just said. If you look at the U.

15:32

S. and you look at government and private

15:34

sector debt as percentage of GDP, which is

15:37

in blue on this axis inverted. So

15:39

the lower you go, the more private

15:41

and public sector debt in the U. S. right. We

15:43

were at 180 percent in 1998

15:46

in the U. S. Real interest

15:49

rates in orange. On the right hand

15:51

side, were at about 4%.

15:53

So with the US running 180%

15:56

of private and public sector data, percentage

15:58

of GDP, we could run in the US

16:00

with about three and a half to 4% real

16:02

interest rates. Okay, let now, as

16:04

the US became more and more leveraged and

16:07

more and more leveraged, let's say all the way until

16:09

today with the US running 250%.

16:12

of private and public sector, that

16:15

as percentage of GDP, real yields have been

16:17

for the last decade, somewhere around 1%,

16:19

roughly 50 basis points to 1%. Now

16:22

the Federal Reserve has hiked interest rates much further

16:24

in this specific economic cycle, which

16:26

makes the system Arguably a bit

16:28

fragile, right? Because what you're having is

16:31

a decent level of leverage in the system

16:34

with real interest rates that are higher

16:36

than what the equilibrium of the last 30 years

16:38

between these two variables would suggest. But

16:41

real, really, the other effect of

16:43

doing this is boosting house

16:45

prices or asset prices in general. So

16:48

I'm now sharing part of the article I wrote

16:50

just to make people visualize as well

16:53

the figures that I'm using. If

16:55

you bought a house in the US, let's say in the early nineties,

16:58

right? let's assume for a second

17:00

that the bank would have lent you a hundred percent

17:02

of the purchase value. That's not standard, but please

17:04

bear with me just for the sake of the assumption.

17:06

Okay. So let's say, In

17:08

the nineties, you wanted to spend 1, 000

17:11

a month in mortgage installments. Okay.

17:13

And let's say that in the nineties, the actual

17:15

third year mortgage rate back then was about

17:18

10%. Okay. So you had to pay

17:20

a 10 percent nominal mortgage rate for 30

17:22

years. And with a 1, 000

17:25

mortgage installment budget per month,

17:27

that meant at these interest rates

17:29

that you could buy a house worth about 120,

17:32

000 a month. dollars back

17:34

in the nineties. Okay. Now let's

17:36

bring this back 30 years for, forward. Okay. And

17:38

let's go specifically to 2021.

17:40

I just want to show you the peak euphoria

17:43

of this, wealth illusion paradigm, as I

17:45

call it. Let's say that you are

17:47

in 2021 and you still want to spend a

17:49

thousand dollars a month in mortgage

17:51

installments. That's your budget. But your

17:53

30 year mortgage is now 3%. So

17:56

you do your cocks and all of a sudden you can afford

17:58

a house worth 240,

18:00

000. This is double

18:02

the price in the nineties. So effectively

18:05

by lowering nominal interest

18:07

rates over time, you have

18:10

allowed another generation to

18:12

lever up more and more and more.

18:14

Specifically to double the amount

18:17

of the 90s and be able to afford the

18:19

same price. And so what you have achieved is

18:21

a continuous use of leverage

18:23

and injection of leverage into the economy, which

18:25

makes not only the new buyer feel like he

18:27

can afford new credit simply because

18:30

interest rates have gone down, specifically the

18:32

old buyer, particularly happy because

18:34

his house price is now doubling

18:36

price. and still can

18:38

find a buyer because interest

18:40

rates are much lower than they were in the

18:43

90s. So the combination

18:45

of lower interest rates and injection of credit

18:47

into the economy makes this

18:50

offsetting effect basically,

18:52

or what I call the wealth illusion paradigm,

18:55

actually go further and further. And the reason why I

18:57

call it the wealth illusion paradigm is that where

18:59

you're forced to rapidly reverse this

19:01

interest rate story and move back

19:04

from 3 percent to 7 or 8

19:06

10 percent and stay there for a while. So

19:08

find a new equilibrium borrowing rates,

19:10

a bit like it happened in Japan in the nineties,

19:12

you're facing the risk. Yeah. That you have

19:14

to reverse this wealth effect and

19:17

basically deleverage the entire system.

19:21

So how do you see, what

19:23

are the potential paths forward

19:26

on this? I mean, we've got the tremendous amount of debt.

19:28

I'm sure the other thing that comes to mind for me too

19:31

is the initial conditions, right? So again,

19:33

you started with that many years

19:35

ago with very low interest rates. much lower debt

19:37

across both public and private

19:39

sectors. So you've got this space in front

19:41

of you to lever up. You've got high

19:44

interest rates going to low interest rates. So you

19:46

have this sort of perfect storm of

19:48

opportunity to create the wealth

19:50

illusion effect. What happens

19:52

going forward from here? When we're at 5

19:54

percent interest rates, do we need a massive

19:56

productivity growth? are we going to

19:58

see, you know, some sort of, the classic,

20:01

there's three ways out of it, you know, debt, you can

20:03

be austere. Nobody likes to do that. Nobody

20:05

gets elected. You can default, or you can sort

20:07

of debase the debt and

20:09

inflate it away. So those are kind of the three

20:11

paradigms that people talk a lot about. How

20:14

do you see us resolving this in the past

20:16

forward, given the current set of circumstances?

20:18

I mean, what, what politicians are doing right now

20:21

is while the central bank is trying

20:23

to act somehow responsible

20:25

by raising interest rates to fight inflation, that

20:27

puts a lot of burden on a highly leveraged

20:30

system. And so what's happening on the

20:32

other side is that governments are coming in with

20:34

fiscal injections, right? They're being much more

20:36

friendly on the fiscal side, hoping to basically

20:38

balance out this tightening from

20:41

The Federal Reserve and other central banks and come in

20:43

support in the private sector on the other hand of it.

20:45

Now, can this work? Again, yes,

20:48

it's a fragile equilibrium as long as

20:50

bond vigilantes and markets

20:52

don't start questioning this gigantic

20:55

use of fiscal stimulus in a pro cyclical way

20:57

and start wondering, you know, let's put a

20:59

premium on long bonds. Let's see what happens there,

21:01

for example. So this could be a release valve

21:04

for how the system becomes all of a sudden

21:06

very, very fragile. But

21:09

going forward, let's even assume. that

21:11

we go back to a situation where you

21:13

have a perfect soft landing, it's disinflationary,

21:16

so the Federal Reserve can cut rates all the way

21:18

to 2%, right? So we go

21:20

back on this treadmill basically of

21:22

let's try to put new leverage at cheaper

21:25

interest rates, okay? Even if

21:27

we go towards that, okay? There are limitations

21:29

because as you said, the private sector is much more

21:31

leveraged than before in general, not specifically

21:33

in the United States, but if you look around the world,

21:36

that is the case. you are in a situation

21:38

where you then slowly, but surely move back towards

21:40

low interest rates. So your ability to lower

21:42

interest rates further. Right.

21:45

So there are obvious limitations and

21:47

this is why I think people feel uncomfortable

21:49

with the system. Right. They feel it needs to crack.

21:52

So then my, my, the piece was there to

21:54

try and answer the question, what

21:56

is the macro end game? What are the solutions to this?

21:58

Right. So I see three. The first

22:01

one is. Politicians would show

22:03

up and say, sorry, guys, we're going to clean

22:05

up the mess. So we're going to go with a

22:07

gentle deleveraging. They would like to be

22:09

gentle, but with a deleveraging process,

22:12

I think that's pretty much politically unviable because.

22:15

You would have to deleverage

22:17

a wealth illusion effect system

22:19

and a levered up system

22:21

that has benefited two generations. That

22:24

will be a disaster. And even if it's true

22:26

that let's say after 2028

22:28

in the US, the majority of voters isn't going to

22:30

be The boomers or the people who benefited

22:33

most from this still, they would account

22:35

for like 40 percent of the voters. So I'm not

22:37

sure that any politician would volunteer

22:40

to actually deleverage the system. Would you agree with

22:42

me?

22:42

Yeah. And I think that the political system

22:44

in the U. S. is quite unique with all of these,

22:47

baby boomers and even older generations

22:50

holding positions of power politically.

22:52

And you have this massive voting group called

22:55

the millennials and why are they going

22:57

to endure austerity for

22:59

their grandparents? Like, what, what's the

23:01

motivation for them to eat this

23:03

particular shit sandwich so

23:06

that, that older generation, which is clinging

23:08

to power in a political

23:10

sense and driving the bus still,

23:12

and still votes predominantly much

23:15

more than the millennials vote. it's a very

23:17

unlikely scenario where we get the,

23:19

you know, austerity deleveraging without

23:21

some sort of, War,

23:24

some sort of call to action that, you

23:26

know, sort of solidifies the population across

23:28

the generations. So I agree.

23:31

I think you're right. And specifically China has

23:33

recently tried to deleverage a bit their system

23:36

and they're not doing particularly well as a result.

23:38

I mean, the Chinese real estate market was

23:40

valid at I think trillion

23:43

dollars at the end of 2021. That's

23:45

bigger, a bigger market cap than the U S

23:47

stock market. And then Xi Jinping said,

23:50

well, you know what, that's a bit too much, right? Should we try

23:52

to deleverage this sector? And China,

23:54

which is a centrally planned economy, still

23:56

got a lot of backlash from

23:58

this, you know, attempt at deleveraging.

24:01

So it's very hard in general

24:03

to deleverage a very leveraged system. And on top

24:05

of it, it wouldn't really benefit the status

24:07

quo, I would argue so. Politically unviable,

24:10

low, low likelihood. What's the second solution?

24:12

The one we were suggesting, hinting

24:14

at before, which is wealth redistribution.

24:17

So what you do there is you don't try to necessarily

24:19

deleverage the system, but you simply

24:22

try to shuffle around basically

24:24

the wealth distribution. So you do targeted

24:26

fiscal policies to make sure that some

24:28

of the wealth that has been allocated to a certain

24:30

cohort of the population gets moved

24:32

around basically to another cohort of

24:35

the population. So wealth redistribution.

24:37

That's it. In my opinion, this is more politically

24:39

viable simply because the majority of voters

24:41

will be very happy with wealth redistribution,

24:43

let's be frank, but it is also a very

24:46

volatile outcome because when you redistribute

24:48

wealth, you're also changing basically

24:50

the consumption patterns in the economy. So you're

24:53

moving money towards the right direction. the

24:55

higher core, the cohorts of the population

24:57

that are the more, they have the highest propensity

25:00

to consume basically. So what you're

25:02

doing there is you're really applying

25:04

tectonic shifts at our economic resources

25:06

are allocated. That's a very volatile outcome,

25:08

which I think is still politically viable and likely.

25:11

And what this does is it brings more vol,

25:13

more inflation risks, more stagflation risks

25:16

to the economy. So I think this is an outcome

25:18

where this could be. The macro endgame

25:20

or a step towards the macro endgame. And

25:23

I think that investors aren't necessarily

25:25

prepared in their portfolio for more

25:27

periods of inflation vol, more periods

25:29

of stagflation. I think this could be

25:32

one of the most likely solutions. What do you say?

25:34

Yeah. I think that, that was also talked

25:36

about a little bit in the, fire and ice

25:39

by HL man piece, if

25:41

anyone wants to look that up, where they looked at

25:43

inflation volatility previous

25:45

to sort of 1990 versus what we've had

25:47

from 1990 to today, and,

25:49

you know, correct me going from memory,

25:52

but inflation volatility has been post

25:54

1990 has been half

25:57

of what it was in the previous

25:59

period. So, you know, you had a couple

26:01

of world wars, you had a great depression, you

26:04

didn't have quite the coordinated central

26:06

bank efforts, and you didn't have this wonderful

26:08

starting place where you'd ratcheted rates up to 18

26:10

percent to purge the system of

26:12

debt, and then set the stage

26:15

for a wonderful, levering

26:17

of the economy. So, you know, yeah,

26:19

I think that's, that is, that's An interesting

26:22

scenario. What always triggers

26:24

my thoughts in this is the really

26:26

rich seem to figure out ways

26:28

in which to work around a lot of

26:31

these, these situations. So,

26:33

you know, as much as you have smart people in government trying

26:36

to think through ways in which to,

26:38

make the tax system more fair and redistribute

26:40

wealth, at the same time, you have very wealthy

26:42

individuals who have, you know, legions

26:45

of lawyers and tax structures set

26:47

up. To simply counter, counteract

26:49

those policies and programs, but it's

26:51

not to say that it's not possible. It's just, you

26:54

know, you kind of have to have buy in from everybody

26:56

that we're going to do this. and

26:58

then you've got, you know, the geopolitical

27:00

side of things where, nations are

27:02

competing with one another. You have the Japanese scenario

27:05

where you've got the yen falling through the floor,

27:07

making that particular economy pretty

27:09

competitive. And then what are the, What's the game

27:11

theoretic of all the economy economies

27:14

of the world trying

27:16

to redistribute wealth at the same time, but also trying

27:18

to compete with one another.

27:21

I think you're totally right. It's much easier said than

27:23

done. Nevertheless, a potentially

27:25

likely outcome or more likely than the first

27:28

one. The third

27:28

Well, there's going to be levers, right? I don't think

27:31

any one of these, is going to be the thing.

27:33

The other thing is it's probably going to be a combination

27:35

of, some of these three things together in some

27:37

way, shape or form, but definitely

27:40

more of this one.

27:41

the third one is simply kick the can

27:43

down the road, right? So pretend that nothing's going

27:45

on and have the system lever up a bit further,

27:47

maybe try to cut interest rates or try

27:50

to control the situation like today where interest

27:52

rates are high, but fiscal deficits are trying to

27:54

pick up the slack. And I think that's what

27:56

this is. politicians probably go the most for

27:58

because their objective number one is to preserve the status

28:00

quo. So as you said, there are like three, ways

28:03

to face this going forward. And I think

28:05

number three, preserving the status quo is what politicians

28:07

want. but it's going to be a bit more,

28:10

you know, interval by, step number

28:12

two, which is wealth redistribution policies to

28:14

try and gain more voters and try to make

28:16

the system a bit more balanced. So what

28:18

I'm looking at is situations where if

28:20

you think about how to. Positioning a portfolio

28:23

for something like that. There's a chart in

28:25

the article that shows the, LCTM,

28:27

NAV, the net asset value of a dollar

28:29

invested there. and, you know, if you would understand

28:32

straight in 1994 and what LTCM

28:34

was doing was basically,

28:37

levering up on, on

28:39

illiquidity and relative value, that really was

28:41

more illiquidity, illiquidity premium than anything

28:43

else. You would say, look, if these guys keep doing

28:45

this, At some point, they're going to blow up,

28:48

right? There's going to be a situation where they're going to blow

28:50

up and. You

28:52

had to wait four years until

28:54

that payoff came, right? There is a chart that says you

28:57

can basically mirror it if you're trying to bet

28:59

against them and you will lose money, lose money, lose

29:01

money, lose money, lose money for four years, and

29:04

then you would make a ton of money, right? And then

29:06

I say, look, if you want to Time

29:08

or trade the micro end game as

29:10

a binary outcome. Basically

29:13

what you're looking at is potentially

29:15

a few decades of under

29:17

performance on the performance on the performance. And

29:20

none of us are in the business

29:22

of underperforming for more than

29:24

actually a few quarters, unfortunately, how the financial

29:26

industry is set up nowadays. So,

29:29

so we have to find ways to incorporate,

29:31

I think, these probabilities into a

29:33

framework, into a portfolio so

29:35

that. You can build something that is relatively

29:38

well balanced that doesn't necessarily underperform

29:41

while you preserve some convexity

29:43

towards a scenario where

29:45

one of the, of this macro end game solution actually

29:48

pops up. Right. And I think that's the aim.

29:50

And it's important to pass it through as a message. Don't

29:52

binary trade something,

29:55

which is potentially decades to

29:57

go because it's going to cost you a fortune

29:59

to do that. And maybe the payoff comes

30:01

way too late for you to actually be able to benefit

30:04

from it.

30:05

Exactly. and there's a lot in

30:07

that. so LTCM, the

30:09

Thai bot, the Russian ruble,

30:12

and then the Fed's decision

30:14

by Greenspan to

30:16

loosen because the financial

30:19

global system was in jeopardy

30:22

was probably one of the causes

30:24

of the NASDAQ going from 2000 to 5000.

30:28

Right. We have the correction in 98. LTCM

30:31

gets worked out. There's a massive

30:33

injection of global liquidity. And

30:35

then you have a technology bubble that

30:38

is to some degree what

30:41

the U. S. may be facing yet again, in

30:43

that if we have something that causes

30:45

a global breaking of

30:48

something, and then the

30:50

U. S. has to decide whether

30:54

prioritizes the global stability

30:57

over. The U. S. inflationary

30:59

stability. So how much will the U.

31:01

S., if it had to loosen rates because

31:03

something breaks globally, what

31:06

are the implications for an inflationary

31:09

situation for the U. S. population?

31:11

And for those, that large swath of voters that

31:13

isn't rich, you know, if you're living

31:15

paycheck to paycheck, 25 percent increase

31:18

in the cost of living is, is extremely

31:20

difficult and is heartfelt.

31:22

And you have a vote in that. So

31:25

there's lots of, Unintended

31:27

consequences that come from the central

31:29

bank's interventions and these three levers

31:32

that they're trying to work through, kick the can,

31:34

slightly de lever, redistribute wealth

31:38

in a world where inflation volatility goes

31:40

up dramatically, which then of course,

31:42

I think as you're alluding to, and I

31:44

will, second is that now you

31:46

need a framework that considers all of those

31:48

issues, that considers the implications to

31:51

asset prices. How are you

31:53

going to balance those exposures? How are you going to? Add

31:55

a global macro framework to

31:58

your asset allocation system because

32:01

we are not today starting at

32:03

18 percent interest rates going to zero.

32:05

We're not sitting at a very lowly

32:08

levered economy. We're

32:10

sitting at, you know, high rates at a high

32:12

levered economy. Sure. We've got some ability

32:14

to cut, but that is what makes

32:17

global macro so popular or so potentially

32:19

profitable in thinking

32:21

through how you might balance your exposures.

32:24

And as you say, you don't want

32:26

to bet on these things in a binary fashion. You

32:28

want to think through the probabilities of them

32:30

and probability weights, some of your thinking,

32:34

and you probably need a base portfolio to think through,

32:36

to think about bets against a base portfolio

32:38

as well.

32:39

Yeah, so I would say the first step to

32:41

do here is to say, if

32:44

I get somewhere

32:46

along the road, a higher probability of one

32:48

of these macro end game outcomes to

32:51

become more likely, how is my

32:53

portfolio going to react to a mental

32:55

stress test basically of one of these, right?

32:58

So let's say that, for example,

33:00

let's not even talk about the macro end game, but the simple

33:03

situation where inflation picks up

33:05

and in 2022, it was the result

33:07

of 2020 and 2021, not

33:10

wealth redistribution, but simply fiscal interventions

33:12

to make sure that, you know, that

33:14

the system could continue to exist during

33:16

the pandemic. And so the result was inflation

33:19

because the U. S. ended up doing too much and there were

33:21

supply bottlenecks and so on and so forth.

33:23

So what happened back then? Well, as my

33:25

friend Dan Rasmussen from Verdat

33:27

Capital, he has a very good chart where

33:29

he goes back, I think, 150 years

33:32

and looks at the three year rolling correlation

33:34

between bonds and stocks. Right.

33:36

And then he looks at, that

33:38

level of correlation pending.

33:41

or conditional of the level of core inflation

33:43

that is prevailing, right? And then it's a very simple chart

33:46

where you see this negative correlation existing,

33:48

mostly in periods where inflation is between

33:51

one and two and a half percent. You know, when inflation

33:53

is between one and two and a half, bonds and

33:55

stocks are negatively correlated. It makes all the sense in

33:57

the world because if something goes Poor,

33:59

let's say in earnings or in the real economy, the

34:01

central bank will cut rates. You know, they have

34:03

inflation at their target level with

34:05

actually even maybe lower, so they can and will

34:07

cut the interest rates and this will benefit bonds.

34:09

And therefore this negative correlation exists very,

34:13

very well, very well documented through decades

34:15

when core inflation is between one and two and

34:17

a half percent. But the chart

34:19

also shows how, the

34:21

correlation turns positive. when core

34:23

inflation is above 3 percent and particularly

34:25

when it's very volatile, you know, and ranging between

34:27

two and four and three and five, and then

34:29

the correlation becomes positive. And that's exactly what

34:32

we saw in 2022, right? So stress

34:34

testing your portfolio mentally would

34:36

basically bring you to a situation where if you're running

34:39

only bonds and stocks, I'm sorry, but you have two

34:41

items. They're both going to go down at the same

34:43

time. And I'm

34:45

going to, I'm going to also say that the 60 40 portfolio

34:47

is 85 percent equity ball in the first

34:49

instance. And so, you know, your job is

34:51

also somehow correlated to the business cycle

34:53

and to equity and to earnings. And so if everything

34:55

is falling down and your job is more at risk

34:58

and your portfolio is facing a 20 percent drawdown,

35:01

I'm going to argue that is not necessarily

35:03

a robust framework to invest,

35:05

especially if you think these vol

35:07

events. So let's say wealth

35:09

redistribution, fiscal deficits, high inflation,

35:11

low inflation, more volatility is going

35:13

to pop up, right? You need something else.

35:16

You need to mental stress your portfolio before

35:18

we even talk about. Sources of uncorrelated

35:20

returns, so alphas like carry or

35:23

trend or global macro, we first need

35:25

to fix the beta. Like do you have

35:27

exposure to, different beta

35:29

elements that will contribute to

35:31

stabilize your returns if

35:34

the macro environment is not what you have

35:36

seen for the last, 10, 15 years. So

35:38

this inflationary growth driven by the U

35:40

S if you have any other outcome, which

35:42

is maybe inflationary growth or deflation

35:45

or growth outside the U S is

35:47

your portfolio from a beta perspective,

35:50

prepare to really benefit from

35:52

this environment, different lenses.

35:54

So, so, so right on the mark

35:56

there, Elf, the way you

35:58

get to the current situation we're in is

36:00

you have this positive reinforcement,

36:03

this recency bias where investors

36:05

have been treated so well by a disinflationary

36:08

growth environment, market cap

36:10

weighted strategies are

36:12

now way over in the disinflationary

36:15

growth camp. If we take the S& P

36:17

500 and say, well, okay. You

36:20

know, we use a lot of energy in

36:22

our global economy. And,

36:25

you know, it's said that an AI search

36:27

now takes 17 times more energy

36:29

than a Google search once did. So we

36:31

have a very energy intense economy.

36:35

Yet, if you look at the S& P

36:37

500 at the moment, 4 percent

36:39

of the S& P 500 is energy.

36:43

2 percent is materials. So

36:45

what is your hedge in the situation

36:48

where we get into a stagflationary environment

36:50

where the cost of inputs to production

36:52

energy and so on are rising

36:54

rapidly? That takes profits out

36:56

of the rest of the 96 percent

36:59

of the S& P 500. And

37:01

you've got nothing in your portfolio that is

37:04

adding positive returns if

37:06

you're in a stagflation environment where growth

37:08

is threatened by maybe the cost

37:10

of inputs or debt or other things. So

37:13

you have a totally imbalanced portfolio.

37:16

You're basically letting the maniacs run the asylum

37:18

here, right? But

37:21

it feels okay right now. 2022

37:23

was just like a little appetizer in

37:26

that scenario. So, I

37:29

mean, people have this recency bias. What

37:32

has been the, you know, sort of Pavlovian

37:35

or habit based response that they've had

37:37

over the last 20 years, they've been trained very well

37:39

to buy the dips. I think,

37:41

you know, you probably get a Pavlovian response

37:43

in a growth, threatened environment where bonds

37:45

do rally. In some way, but I

37:47

don't think that rally is going to be what it has been in

37:49

the past because if you're

37:52

injecting that stimulus, then

37:54

on the other side of the equation is, okay, well, who's going to pay

37:56

off the bonds? Like how do we pay off all this debt

37:58

that's accumulated? And what's the credit

38:00

rating on those bonds? So how do you

38:02

fill out the portfolio? Like we have

38:04

this, you know, largely sort of, maybe

38:07

we've reached peak passive, peak

38:09

market cap, which has been dominated by

38:11

a disinflationary growth environment, which means largely

38:13

US equities are the largest piece of any

38:15

sort of market cap portfolio. How

38:18

do we protect ourselves going forward? What do we need

38:20

to incorporate? And what do we do in a

38:22

global macro framework from your perspective

38:25

in order to round this out?

38:27

Look, I think on the betas, your most famous

38:29

betas are equities bonds. And I would say

38:31

there is commodities as well as a beta you can try to

38:33

achieve and potentially the dollar, which is an

38:35

interesting beta as well. And then you can,

38:37

you know, just look at, for example, on equities, you

38:39

can do a internationally diversified

38:41

to protect you against the outcome that growth comes from

38:44

outside the U S. you can do, equal weight

38:46

rather than market cap weighted to make sure that,

38:48

you know, you have a broader exposure to the

38:50

equity market. And on bonds,

38:52

you know, you can do. different points

38:54

of the curve. So especially through futures,

38:57

you can use very little cash to get your bond

38:59

exposure and get, a certain

39:01

amount of volatility out of the bonds because often,

39:03

you know, in the 60, 40, you will target intermediate

39:05

bonds. They have very low duration, very

39:07

low sensitivity to move to interest rates.

39:10

And therefore you will need a ton of them

39:12

to make sure that they contribute actively

39:14

as a defender in this inflationary environment. So

39:17

again, through futures, you can structure that in a more

39:19

interesting way than just targeting

39:21

your five or seven year bonds. And

39:23

then you have commodities. And then we go towards

39:26

the more defensive side of things. Okay.

39:28

What if there is inflation, for example, so how

39:30

do we work around that? If

39:32

there is inflation, you can think of

39:34

commodities, but you can even think of strategies

39:37

that actually benefit from inflationary

39:39

environments. So in 2022, we saw,

39:42

the rise, I think, or the comeback, I

39:44

should say of trend strategies. So

39:46

these are strategies that, you know, basically

39:48

make money when there is a clear

39:50

breakout in prices. And when does

39:52

that happen? Well, when there is a lot of macro volatility,

39:55

you would expect, right, that there are more

39:57

convex reactions in prices and therefore

39:59

trend strategies can actually benefit from

40:02

this a bit. And you can see that trend strategies tend to do

40:04

pretty well during Inflationary

40:06

bouts exactly for this reason, because you need to restructure

40:09

the way you think about interest rates and equity sectors

40:11

and commodity prices. And so you have a lot

40:13

of trends developing and you can benefit

40:16

from an allocation to trend. So we are now

40:18

moving from the structuring the beta in

40:20

a smart way, sizing it correctly

40:22

through futures, looking at international diversification

40:26

into more Let's say the

40:28

alpha side of things or the uncorrelated stream

40:30

of returns or the defenders. And

40:33

so when you look at defenders, I think trend does

40:35

a great job at being a potential defender.

40:38

And then there are strategies that are a mix of defenders

40:42

and, uncorrelated stream of returns. And I

40:44

think global macro is in that category

40:47

because a good global macro strategy,

40:49

what it does is it looks at.

40:52

idiosyncratic opportunities popping up

40:54

around the world because of macro volatility.

40:56

So it doesn't necessarily need a trend

40:58

to develop somewhere, but it needs

41:00

a set of idiosyncratic opportunities

41:02

available. These might be in the shape of

41:04

the yield curve. You know, interest rates are priced

41:06

between countries, maybe Europe versus

41:08

the US, maybe in equities

41:11

versus each other. So Chinese equities versus

41:13

US equities. It just needs a set

41:15

of idiosyncratic opportunities that are popping up.

41:17

because of more global macro volatility,

41:20

right? And so it's a strategy that can

41:22

do well, let's say in normal

41:24

times, but it's expected to do particularly

41:26

well when there are clusters of volatility,

41:29

right? And that's, it's a mix between

41:31

a relative value, neutral

41:33

type of strategy and a defensive

41:36

payoff, which tends to do well, particularly

41:39

when macro volatility is picking up. So you think

41:41

of all this potential stream of returns and

41:43

you guys with the return stacking concept

41:45

are popularizing. That worked very well, I think,

41:47

because you basically are very optimal

41:50

in how you spend your cash to obtain your

41:52

beta, your SMP, your bonds,

41:54

your standard beta, right? You

41:57

obtain that with little cash, and then you all

41:59

of a sudden freed up some of your notional

42:02

to invest in the strategies, which you, as you correctly

42:04

say, you can stack on top of your betas. And

42:06

then you have your standard balance

42:09

portfolios betas, plus your SMP. Your

42:11

new attackers, your new uncorrelated strategies,

42:13

your new defenders in an alpha format

42:16

because you have freed up the cash to allocate to

42:18

those.

42:19

Love that. And so for those who might be listening

42:21

that aren't sure or don't know what managed futures

42:23

are and that sort of thing, there

42:25

is on the Return Stack portfolio solutions,

42:28

webpage, we published a managed futures trend

42:30

following sort of a educational

42:32

piece to help, you know, elucidate

42:34

some of the things that, that, ALF's talking about

42:36

here as well. And the other thing in

42:38

trend is that you can be long or short.

42:41

And I think that's another thing that benefits as

42:43

well as the position sizing you

42:45

talked about, right? So it's, you know, it's not

42:47

a, capital allocation of 40%.

42:50

You do it on a risk allocation. So you can

42:52

size your bonds to have an impact on your portfolio.

42:55

That's beneficial during those dark times.

42:57

One other string I want to pull back into

43:00

this to make it very clear for people

43:02

out is we were talking about

43:04

inflation volatility previously.

43:07

When you have very low inflation volatility

43:09

and you have a stable environment from the late 80s

43:12

until 2022,

43:15

you don't have a lot of these dislocations.

43:18

They just occur less often, and

43:20

it makes those types of managed futures

43:22

and trend following strategies, they just have less opportunity.

43:25

But if you look outside of those periods,

43:27

pre 1990, and now post

43:30

2022, what you get are

43:32

these dislocations created

43:34

by fiscal policy,

43:36

central bank policy, the realities

43:38

of debt and leverage in the system,

43:41

where these types of strategies that Alf

43:43

was talking about Actually have

43:45

more of an opportunity to import

43:47

that important value to the portfolio.

43:50

So not only do you need to structure your beta

43:52

thoughtfully to think through all of the allocations

43:55

and the different regimes that may occur, but

43:57

then your hedge or your explore portion

43:59

of your portfolio that that attackers and

44:01

defenders actually has more

44:04

opportunity to provide greater value.

44:07

In this current paradigm.

44:08

Yeah. Also the reason why I am

44:11

launching my global macro hedge

44:13

fund as well in the fourth quarter of this year.

44:16

If you look at how politicians are using

44:18

fiscal, it used to be

44:21

actually a. anti cyclical,

44:23

lever, right? I mean, politicians would look at the economy.

44:26

If it would weaken, they would do more fiscal deficits.

44:28

It would, if it would strengthen, they would pull

44:30

a little bit back. Now it's not the case.

44:32

It seems to be more a feature than a bug

44:34

or an anti cyclical tool. It's just all

44:36

over the place. And this increases the

44:38

chance that there's going to be more macro ball down

44:40

the road. And if you look at changing demographics and

44:43

you look at, you know, the green transition,

44:45

there are so many moving parts out there

44:47

for which I think. Macro vol is going

44:49

to increase. And so you look, if

44:52

you have this view that macro vol is going to

44:54

increase, then as you said, you not only have

44:56

to look at your betas very carefully, but also

44:58

consider an allocation to other

45:00

strategies, more on the alpha side,

45:02

let's say that are able to diversify

45:05

your return. So global macro, for example, did

45:07

particularly well in 2022. a year, which

45:09

was very, very volatile for macro in general.

45:11

And then it saw your betas do particularly

45:14

poorly. So that's bonds and equities. They did particularly

45:16

poorly and global macro did very well. If

45:18

you expect more years ahead that are

45:20

as volatile potentially, then you

45:22

need stabilizers in your portfolio. I personally

45:25

expect a lot of macro vol, and that's the reason

45:27

why my macro hedge fund launches in Q4.

45:30

Yeah. And let's talk about how you've thought through

45:32

the structure there. We've got about 10 minutes

45:34

left to kind of sit and explain

45:37

to us how you've thought through your betas. And

45:39

well, first of all, are you stacking betas and

45:41

alphas together? How are you thinking through the beta

45:43

side? How are you thinking through the alpha side? And then how are

45:45

you combining the two? And I think if you can, you

45:48

know, enlighten everyone on that and then Obviously,

45:51

if you do see this and you are interested in,

45:53

in what MacroAlf is talking about

45:55

for later this year, make sure you get in

45:58

and send them a DM or, you know, get

46:00

on Substack and get on the

46:02

macro compass and let them know. and, yeah,

46:04

make sure you're in line for when, when the launch

46:06

occurs. But yeah, take us through the structure.

46:09

Yeah. So, so for me, the aim is the

46:11

following. If I launch a global macro strategy,

46:13

do you need me to run beta for you?

46:16

The answer is no, you don't. You don't

46:18

need me to run beta for you because I'm

46:20

not paid for that. You can achieve beta, for example,

46:23

to return stacking products in a very

46:25

cheap and efficient way or in any other way

46:27

you prefer, but it's generally pretty cheap to

46:29

get intelligent exposure to beta,

46:32

I would say. So, I

46:34

instead am running strategies that are market

46:36

neutral. They try to have a filter for

46:38

S& P 500, treasury beta, the standard

46:40

beta, to have as little beta exposure

46:42

as possible in the fund, and to instead

46:45

deliver a stream of return, which is positively

46:48

skewed as we would define it. And it

46:50

benefits the most during clusters of macro

46:52

volatility. So this is a strategy that

46:54

Basically looks at idiosyncratic opportunities.

46:57

It looks at interest rates, at equity markets,

46:59

at currency markets, at commodity markets

47:01

from a global perspective, and it tries to

47:03

identify this location. We

47:05

think in probabilities. So we always look

47:07

at different scenarios. We have various models that

47:09

look at. Scenarios and how markets

47:11

are pricing them in probability terms where

47:14

consensus is. And we try to look

47:16

at potential catalysts for these locations.

47:18

We say, look, if the market, for example,

47:20

from let's take a look at the Fed funds today,

47:22

right? And what the market is thinking about the distribution

47:24

of these returns of these outcomes for the Fed. I

47:26

think it's a good example for how we think

47:28

about it. So if you take a look at

47:30

this chart right here, it shows

47:33

the distribution of probabilities,

47:36

the top chart here for Fed funds future

47:38

in 12 months from today. So we're

47:40

looking at what the market thinks Fed funds will

47:42

be in 12 months from now. But

47:44

instead of looking at one number, we're looking

47:46

at the probability distribution. Okay.

47:49

So I derive this by looking at options

47:51

that are underlying the future contracts. And

47:53

what it's telling me now, if you look at the summary

47:55

table here, is that the recession in the

47:57

U S or cuts that are in line

48:00

historically with the recession in the U S are

48:02

priced by the market at a 5 percent

48:04

probability. 5%.

48:06

So what do I think about that probability?

48:09

Well, historically you have a recession

48:11

in any given year with about a 10 percent chance.

48:13

You have a recession every 10 years in the US.

48:15

Okay. So now you're getting this tail price

48:17

at the 5 percent probability. That's relatively

48:20

cheap, I would say. And also you, you start thinking like,

48:23

I don't think the U. S. will be in a recession necessarily

48:26

in one year, but if you think in probabilities,

48:28

you just need this distribution to shift

48:30

a bit over time your way and you can structure

48:33

option payoffs that will pay very handsomely

48:35

if that transition happens. And

48:38

then you look at this and you say, Hey, the modal

48:40

outcome of this distribution, the most observed

48:43

outcome is actually zero cuts.

48:46

So the market is fully gone in now

48:48

on the idea that the Federal Reserve will

48:50

not cut interest rates at

48:52

all over the next 12 months. Actually,

48:54

there is even a tail right here for hikes.

48:58

So now the market is starting to price in a relevant

49:00

probability that the Federal Reserve might hike

49:02

rate, a modal outcome

49:05

of no cuts at all, and an

49:07

only 5 percent probability of a recession

49:09

going forward. So now how do

49:11

you think about this? It's like, okay, if I need

49:13

to take a position here. Then

49:15

I can think of an, of a structure that might

49:17

bet on the idea. The economy may be weakens

49:19

a little bit going forward. It doesn't need to end

49:21

in a recession, but as long as this distribution

49:23

shifts to the left over time, shifts towards

49:26

more cuts, you can benefit from

49:28

it, even if ultimately you don't have a recession,

49:30

just by understanding our consensus

49:32

position, how the tail surprised and

49:35

thinking in probabilities. That's what we do

49:37

a lot in the macro fund and in the framework

49:39

we have created.

49:40

Right. And you're doing that across, I'm assuming,

49:43

the rates, some stocks, but not,

49:45

not in a correlated sort of beta buy

49:48

and hold type of thing. All

49:50

the commodity space,

49:51

Currencies. Correct. So, so we trade

49:54

mostly futures because it's the most liquid way

49:56

to do that. We will then do swaps and other

49:58

derivatives where it's the most optimal way to express

50:00

this, but we will do it correct across asset

50:02

classes and across geographies. And

50:04

the idea is to identify these dislocations and

50:07

see how the market is, the consensus

50:09

is pricing certain distribution finds this

50:12

dislocation and get in. So if there is

50:14

macro ball, if there are these classes of volatility,

50:17

you have positions on that might. Allow

50:19

you to benefit from it and actually

50:22

You serve the role in the client portfolio

50:24

and the role is, and when your betas are

50:26

not working because of that cluster of volatility,

50:28

you are there to offer them diversification

50:31

benefits and actually upside returns.

50:34

And then last question, I know because we're

50:36

running out of time here, but how do you think

50:38

about the assembly of that,

50:40

sort of, set of trades? So you're going to see

50:42

some stuff in the rates world. You might see some opportunities

50:45

in commodity space and then a currency trade or

50:47

two, something in, in equity

50:49

vol world or. You know, relative

50:51

value or whatever, whatever it comes up. How

50:54

are you thinking about positioning those trades

50:56

across the entire portfolio?

50:57

So what we do is we apply

51:00

a inverse volatility mechanism

51:02

to size the trade. So we are looking basically

51:04

at having a set of uncorrelated

51:07

trades in the portfolio, all contributing

51:09

the same amount of risk and volatility to the

51:12

fund. And the idea is very simple.

51:15

You never know when you're right and you'll never know

51:17

when you're wrong, right? You only set positions

51:19

on based on your initial idea

51:21

that your expected value is positive, but ex

51:24

ante, we're going to see what's positive or what's not. So

51:26

the idea is you size them all in a way

51:29

that they contribute equally to the risk of

51:31

the portfolio because As a

51:33

macro manager, you are right 50

51:35

to 55 percent of the times, unless

51:37

you're selling volatility, which is not what we do.

51:40

You are right. 50 to 55 percent of the

51:42

times. So what you want is that when

51:44

you are right, actually, the

51:46

specifically, sorry, when you're wrong, each

51:49

of these uncorrelated trades can contribute Only

51:51

to a maximum capped amount of

51:53

loss in your fund, right? But

51:55

when you are right, you have strategies in place, either

51:58

through an option payoff or a trailing, profit

52:00

strategy to be able to extend the

52:02

right side of your returns. And so by

52:04

doing this, even being right, only 50 percent

52:06

of the times, as long as the portfolio construction

52:08

and the risk sizing process is accurate, you

52:11

actually can get positive, positively

52:13

skewed returns at a fund level.

52:15

absolutely. And that's a bit of an ensemble

52:18

as well, where you're taking many, many sources

52:20

of information and sources of return, combining

52:22

them together. You get the noise canceling out, you

52:24

get some signal in there, you get some positive returns.

52:27

And, and you've got a very diversified

52:29

portfolio that is quite different

52:32

from traditional betas that make

52:34

it so complimentary in a portfolio.

52:37

Yes. And for me, it's really simple.

52:39

I'm a, an open book over to being on social

52:41

media through research. So also

52:43

for this, adventure, pretty simple.

52:45

If anyone is interested, they can shoot me an

52:47

email, fund at the macro

52:50

compass. com is the address. The

52:52

macro compass is the symbol that you see there on

52:54

my back. So you can't miss it. Fund at the macro

52:56

compass. com. You send me any message,

52:58

I will take a look at it. We can have a chat. I'm

53:00

very open. Part of the

53:02

diversification, I would say of this fund is that. I

53:05

will be the opposite of your standard macro manager

53:08

who you only hear during tax season, maybe,

53:10

and through some investment letters. I'm very open

53:12

to discuss the ways I can help potential

53:15

investors. So just send me a message

53:17

and I'll pick it up.

53:18

Amazing. Thanks so much, Alf, for your time

53:21

today. And, as he said, the Macro

53:23

Compass on Substack, as

53:25

well as, at MacroAlf on Twitter

53:27

is where you can find this, brainiac of

53:29

the macro world. And one of our favorite

53:31

guests, I'll thanks so much for joining us again today.

53:33

And, we look forward to chatting in the future.

53:35

It's been a pleasure. Thanks again.