Yields | Equity Market Breadth | Building Portfolios for an Inflationary World の全文書き起こし

instance, most overlook the tax impact of buying those bonds, but nonetheless is driving behavioral finance. 00:02:29.919 --> 00:02:32.639 Outside of equity prices, two things I think about. 00:02:32.639 --> 00:02:34.479 One, systematic risks. 00:02:34.479 --> 00:02:37.360 There's this chart of a declining 10-year yield. 00:02:37.360 --> 00:02:43.360 And effectively every time the 10-year breached its channel, there would be some sort of systematic event. 00:02:43.360 --> 00:02:44.960 You don't know what it's gonna be. 00:02:44.960 --> 00:02:53.919 It tends to be black swan in nature, but it's something like the Yang Kerry trade blowing up or some other forced delevering event. 00:02:53.919 --> 00:03:00.319 So I just think of it simply as rising interest rates build pressure across the financial system. 00:03:00.319 --> 00:03:07.840 And then number two, remember Treasury Secretary Bassens 333, he wants 3% treasury yields. 00:03:07.840 --> 00:03:12.639 At current levels, the US government is like borderline insolvent. 00:03:12.639 --> 00:03:22.719 Maybe not exactly, but I think it was every shift up in the yield curve by 1% added $118 billion to the US deficit every single year. 00:03:22.719 --> 00:03:25.199 Over a decade, that's over a trillion dollars. 00:03:25.199 --> 00:03:32.319 So to balance the books, which the US definitely wants to move in that direction, they want to see a lower yield. 00:03:32.319 --> 00:03:41.759 So we can also look to an environment like the 1970s where, oh, they inflated away debt and interest rates rose dramatically. 00:03:41.759 --> 00:03:45.520 But I think the difference here is debt levels were much lower. 00:03:45.520 --> 00:03:50.639 So rising interest rates would really impact US government finances. 00:03:50.639 --> 00:03:59.680 Maybe they could thread the needle and still inflate away the debt with yields where they are, but I think it's a lot easier to get yields down to two to three percent. 00:03:59.680 --> 00:04:05.039 So it's really an instance where if something is unlikely to persist, it won't. 00:04:05.039 --> 00:04:10.319 And I think just the US government is so incentivized to bring the yields down, they'll find a way. 00:04:10.319 --> 00:04:12.080 So, how might this happen? 00:04:12.080 --> 00:04:17.199 Well, initially people were pointing to oil as driving the tenure. 00:04:17.199 --> 00:04:19.920 Well, oil fell a bit, tenure didn't really move. 00:04:19.920 --> 00:04:26.720 Then we can look to inflation and the hard part on the inflationary side, like we just got job and wage numbers. 00:04:26.720 --> 00:04:28.160 That's certainly not an issue. 00:04:28.160 --> 00:04:29.600 Housing is not an issue. 00:04:29.600 --> 00:04:37.839 So it's really just energy prices driving and flowing through the economy, and rising yields aren't gonna help create more energy or end a war. 00:04:37.839 --> 00:04:42.000 So, yes, this is impacting it, but there's nothing really they can do about it. 00:04:42.000 --> 00:04:51.439 So we look to economic growth, and that seems really the only path to getting out of this situation is they need to slow the economy down. 00:04:51.439 --> 00:04:58.240 Probably it's gonna be a situation where if you remember back to 2023, it's like this soft landing. 00:04:58.240 --> 00:05:04.399 So they want it not too hot, not too cold, but they need to slow the economy enough to bring the yield curve down. 00:05:04.399 --> 00:05:07.360 And the risk there is always like you over-tighten. 00:05:07.600 --> 00:05:09.600 All right, now let's look at equity markets. 00:05:09.600 --> 00:05:16.560 The SP 500 was up in September, but that doesn't paint an accurate picture of what's going on in markets, does it? 00:05:16.800 --> 00:05:17.199 Correct. 00:05:17.199 --> 00:05:20.079 So I would split equity markets into two camps. 00:05:20.079 --> 00:05:25.120 And I mean, this has been the framework for the past couple of years: AI and non-AI. 00:05:25.120 --> 00:05:30.399 So Meta released Muse last month, reigniting the excitement for the AI complex. 00:05:30.399 --> 00:05:34.079 Muse is like an AI personal assistant in your pocket. 00:05:34.079 --> 00:05:42.160 I wouldn't say it's revolutionary, but it's been onboarding more users onto AI and other AI uses. 00:05:42.160 --> 00:05:48.000 And we've seen the download trajectory of Muse is actually faster than Chat GPT. 00:05:48.000 --> 00:05:51.920 So AI continues to move at the speed of light. 00:05:51.920 --> 00:06:00.639 And the AI complex is inherently going to be narrative driven as the market grapples with is this a bubble or is it not a bubble? 00:06:00.639 --> 00:06:13.759 And increased use cases are ultimately going to increase demand for compute, which is going to prop up the entire complex because then the hyperscalers spend more money, and most companies within these supply chains are going to benefit. 00:06:13.759 --> 00:06:20.160 For non-AI stocks, the equal weighted SP 500 is now down seven weeks in a row. 00:06:20.160 --> 00:06:25.600 The SP 500 is just 2% off its highs, but the average stock is down 17%. 00:06:25.600 --> 00:06:38.639 If you decompose the sectors from last month's performance, you had tech and communication services in the green and then everything in else in the red, with the majority of sectors down more than 5%. 00:06:38.639 --> 00:06:41.279 If you looked at the WrestleMan worse. 00:06:41.279 --> 00:06:44.319 The Russell 2000 was actually in mid-August. 00:06:44.319 --> 00:06:48.399 So a month and a half ago, it was up almost 27% year to date. 00:06:48.399 --> 00:06:50.639 Now it's up only 15%. 00:06:50.639 --> 00:06:57.519 Pretty much the exact same as the SP 500, and it's given back almost half its gains year to date. 00:06:57.519 --> 00:07:00.639 And this is really just a function of multiple compression. 00:07:00.639 --> 00:07:03.759 Nothing has really happened on the economic side. 00:07:03.759 --> 00:07:07.199 There's been no earnings releases, so no

concern. 00:07:07.199 --> 00:07:10.160 And earnings have been the thing driving markets thus far. 00:07:10.160 --> 00:07:23.199 And even if we had taken a step back and looked at the market going into this month, the market actually had run into some multiple compression, and it's all earnings that are driving the show. 00:07:23.199 --> 00:07:28.560 So as we approach Q3, potentially we see a world where earnings take hold again. 00:07:28.560 --> 00:07:31.360 It gives the market something to fixate on. 00:07:31.360 --> 00:07:40.079 And then maybe you get a double whammy of falling yields, which would do even more work and allow potentially for multiples to mean revert. 00:07:40.079 --> 00:07:44.959 Again, the risk is just like there's over tightening and the economy slows too much. 00:07:44.959 --> 00:07:49.839 And then you really end up in an issue where the government has to spend more money. 00:07:49.839 --> 00:07:52.079 And that's probably another good point. 00:07:52.079 --> 00:07:57.120 We talk about an elevated yield curve and this multiple compression. 00:07:57.120 --> 00:08:03.680 Realistically, if the government wants to cool the economy, they need to figure out a way to cut fiscal spending. 00:08:03.680 --> 00:08:06.079 And it's the easiest lever to pull. 00:08:06.079 --> 00:08:10.319 And then just lastly, the other thing I'm watching is midterms. 00:08:10.319 --> 00:08:12.319 So no more red sweep. 00:08:12.319 --> 00:08:15.279 The market will appreciate the certainty post-midterms. 00:08:15.279 --> 00:08:24.399 If you look at any seasonality chart, the market tends to rally beginning around now as the market no longer has to deal with the uncertainty of midterms. 00:08:24.399 --> 00:08:29.759 And we we're likely to get a gridlocked Congress, which you know what could allow markets to rally. 00:08:30.079 --> 00:08:35.039 Now for our last topic, oil prices and inflation seem to be rising again. 00:08:35.039 --> 00:08:38.480 Andrew, how do investors prepare for re-emerging inflation? 00:08:38.799 --> 00:08:39.759 This is a good question. 00:08:39.759 --> 00:08:47.600 So first let me explain the dynamics that ultimately hurt asset prices and it ties into the portfolio construction conversation. 00:08:47.600 --> 00:08:58.399 So what you tend to see in these inflationary environments is commodities appreciate in price, which then commodities are large input into inflation calculations. 00:08:58.399 --> 00:09:04.159 So inflation then rises, and then the yield curve and interest rates follow. 00:09:04.159 --> 00:09:10.799 So as we found out in 2022, most portfolios contain a hidden bet on low stable inflation. 00:09:10.799 --> 00:09:14.480 And this is why effectively everything was down in 2022. 00:09:14.480 --> 00:09:18.879 Equities, credit, private equity, real estate, etc. 00:09:18.879 --> 00:09:22.559 They all benefit from good growth and low inflation. 00:09:22.559 --> 00:09:34.320 So the first thing you want to do is evaluate your portfolio and see how much exposure do you have to highly levered asset classes and the asset classes previously mentioned. 00:09:34.320 --> 00:09:44.639 You can also look, I think like a backhand exercise is just look at how these asset classes performed in 2022 as a good sense. 00:09:44.639 --> 00:09:47.679 If you want to expand that exercise, expand it to the 1970s. 00:09:47.679 --> 00:09:54.399 And there's some good papers out there that evaluate how various different asset classes perform during various inflationary shocks. 00:09:54.399 --> 00:10:03.120 The hardest part for your average investor is really that inflation breaks the classic stock bond diversification relationship. 00:10:03.120 --> 00:10:08.720 So typically how the 6040 portfolio works is if my equities are down, my bonds are up. 00:10:08.720 --> 00:10:11.279 That's what makes it such a nice, simple framework. 00:10:11.279 --> 00:10:13.919 But in an inflationary world, what tends to happen? 00:10:13.919 --> 00:10:18.320 Inflation hits, interest rates rise, it hits the value of your bonds. 00:10:18.320 --> 00:10:23.039 And then next thing you know, it hits the value of your equities through multiple compression. 00:10:23.039 --> 00:10:27.200 So both sides get hit at the same time and there's no diversification. 00:10:27.200 --> 00:10:30.960 And as we know, diversification is only free lunch and investing. 00:10:30.960 --> 00:10:36.559 So if you're going to own equities, you want to skew towards value equities. 00:10:36.559 --> 00:10:44.240 This is because, as I've spoken about in this podcast, these inflationary and high interest rate periods, they tend to hit multiple. 00:10:44.240 --> 00:10:52.320 So if you're investing in these high multiple stocks, there's just less margin of safety than buying at something at eight to 10 times earnings. 00:10:52.320 --> 00:10:54.720 So that's the first thing you're going to want to do. 00:10:54.720 --> 00:10:57.519 Next thing you're going to want to do is probably sell your bonds. 00:10:57.519 --> 00:11:10.080 But again, in a broader portfolio construction context, the issue is if we do get a deflationary environment or if we do get a major financial crisis, there's a reason to own bonds. 00:11:10.080 --> 00:11:19.840 And I think that's the beauty of the all-weather framework that we use, that no matter what's happening in the world, we own something that is going to be benefiting from the economic environment. 00:11:19.840 --> 00:11:26.799 So turning more to pure play inflation, the best thing to own in these periods, as mentioned, is commodities. 00:11:26.799 --> 00:11:33.440 And that's effectively because definitionally commodities are a large part of the inflation calculation. 00:11:33.440 --> 00:11:37.679 So if commodities are up, that actually is the one driving inflation. 00:11:37.679 --> 00:11:41.519 And the thing is, commodities are grossly underowned. 00:11:41.519 --> 00:11:45.440 So one of the things I look at is the UBS family

office survey. 00:11:45.440 --> 00:11:52.000 And it's like your average family office owns only 2% commodity and real asset exposures. 00:11:52.000 --> 00:11:53.840 So everybody's underweight. 00:11:53.840 --> 00:11:58.399 Even living through 2022, nobody is prepared for this world. 00:11:58.399 --> 00:12:04.559 Most are skewing towards things like growth equities, which are actually on the opposite end of the spectrum. 00:12:04.559 --> 00:12:06.480 And look, it's just recency pies. 00:12:06.480 --> 00:12:09.440 They've done so well over the past 40 years. 00:12:09.440 --> 00:12:11.919 People just extrapolate that into the future. 00:12:11.919 --> 00:12:14.720 Next thing I would look at would be stores of value. 00:12:14.720 --> 00:12:16.320 So something like gold. 00:12:16.320 --> 00:12:21.440 Maybe you could even look at something aspirational as a store of value like Bitcoin. 00:12:21.440 --> 00:12:25.519 But the challenge is, is like every episode of inflation is going to be different. 00:12:25.519 --> 00:12:35.600 In 2022, gold didn't do great, whether that's because a lot of the returns were pulled forward in 2021 or they lagged and we're seeing the rally now because of it. 00:12:35.600 --> 00:12:41.840 The issue is if there's a sharp rise in interest rates, you may suffer from that substitution effect. 00:12:41.840 --> 00:12:46.159 Then we can look at things like breakevens and inflation-link bonds. 00:12:46.159 --> 00:12:48.799 So breakevens should do pretty well here. 00:12:48.799 --> 00:12:58.240 And a break-even is effectively you're long the inflation-link bond and short the treasury to extract the inflationary tracking component of the inflation-link bond. 00:12:58.240 --> 00:13:04.639 The challenge is what we're seeing right now is breakevens aren't moving despite inflation moving up. 00:13:04.639 --> 00:13:17.039 And we're seeing everything flow to real yields, which, you know, maybe this is a function of markets are thinking CPI might be manipulated lower and you know the inflation tracking component won't benefit. 00:13:17.039 --> 00:13:29.039 And then looking at inflation-like bonds, well, they did pretty terribly during 2022, which despite what the name might suggest, it turns out inflation-like bonds have duration. 00:13:29.039 --> 00:13:33.279 So that's why we would look at something like break-evens probably to return well. 00:13:33.279 --> 00:13:41.440 But inflation-like bonds could do quite well in the world where there's yield curve control and they wouldn't be impacted by inflation. 00:13:41.440 --> 00:13:45.360 The quants who tend to write these papers, they always love trend following. 00:13:45.360 --> 00:13:50.000 But I think of it more broadly that you know what hedge funds do okay. 00:13:50.000 --> 00:13:58.320 Multistrats were one of the few sort of categories of investments and broader absolute return hedge funds that were up in 2022. 00:13:58.320 --> 00:14:15.120 Now, these aren't broadly available to retail investors, but these can be very valuable in a from a portfolio management construction, despite the fees, because again, there's no duration and they can provide diversification benefits when everything else is selling out. 00:14:15.120 --> 00:14:18.240 And then every inflation episode is going to be different. 00:14:18.240 --> 00:14:25.679 So you want to take a basket approach on a little bit of all these types of asset classes if you believe that inflation is coming. 00:14:26.000 --> 00:14:34.720 So to summarize the three topics we're looking at this week, rising yields are the most important factor in financial markets right now, from our perspective. 00:14:34.720 --> 00:14:39.759 Equity markets continue to be bifurcated between AI and everything else. 00:14:39.759 --> 00:14:47.200 And finally, commodities tend to be the best inflation hedge, but there are a variety of exposures to seek in an inflationary world.