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Current Views & Positioning
Business Cycle: May 22, 2024. With the 4-week moving average of US initial jobless claims far from the critical +20% YoY level that would suggest a recessionary bear market decline of at least -35% in the S&P 500 is odds on over the next 1-2 years, the US economy continues to act as a durable floor beneath corporate profits and equity prices. The one caveat, and it’s a big one, is that a strong US economy also puts a floor under inflation. Further, with the fiscal authorities running an unprecedented peacetime deficit of 5-10% of GDP with the economy at full employment, and now commodity prices breaking out across the board, risks are very high that inflation has entered the dreaded “second wave”. How the Fed responds to this second wave will be key to the outlook for the business cycle as we get closer to 2025.
SPX Outlook: May 22, 2024. April’s correction in asset prices provided a critical window into FEDeral government policymakers’ election year mindset. I posited in the March WOTE Report that policymakers would not allow SPX to correct more than -2.54% at any point peak-to-trough, which obviously proved incorrect in April with SPX falling more than -6%. But I do not believe I was as far off as it appears. I believe the Israel-Iran conflict temporarily removed policymakers’ ability to control markets, but it didn’t take long for them to regain control: 1) Yellen sold a “put” in a very clandestine manner, coordinating with foreign central banks to devalue the US Dollar; 2) the Fed dovishly surprised markets by tapering QT more than expected; 3) despite the appearance of a hawkish projected TGA level, Yellen managed to ramp equities in a straight line in May with a $200+ billion TGA QE program in the wake of the April liquidity drain via tax payments; and 4) as soon as the April CPI report showed a modest tick down in YoY Core PCE inflation, the Fed went soft, communicating through Timiraos that a September cut is on the table. Long story short, the FEDeral Government Put is out in full force, and SPX is headed to 6000 in a straight line. As discussed this weekend, SPX is even more compelling on the long side at 5300 today than it was in March because policymakers have shown their hand.
Tactical Risk Management: May 22, 2024. From a tactical risk management perspective, I do not want to be all-in long here after this big run up. Not until SPX returns to key moving averages through time or price. Just this week BTC was unable to hold its breakout, rates have proven sticky, IG CDX is sticky, and VOL is starting to firm up. I don’t believe these divergences are good for more than a quick 1-2% spike down in stocks, but they warrant caution here in the very near-term.
FICC: May 22, 2024. Strongly favor being short the long end of the UST curve over owning commodities, since a breakout in commodities will be inherently self-defeating as a result of higher long-term rates and/or more aggressive FED action in response to rising inflation. See the latest WOTE Quant report for more discussion and analysis on this.
Positioning: May 22, 2024
WOTE US 60/40: Benchmark weight 60/40 SPLG/BIL
WOTE US Long/Short Equity: Benchmark weight 100% SPLG
WOTE US Core Equity: Benchmark weight 100% SPLG
WOTE US Core FICC: -100% short UST 20s via the TBF ETF
Discussion
As discussed last week, I’m still in incubation mode with The WOTE as I try to figure out how best to conduct buttoned-up cross-asset market research for an outside audience while managing my own money. The two aspects of The WOTE have not meshed nearly as well as I had hoped, so I need to make some changes. Change #1 is a more flexible portfolio construction process that allows me to more freely manage positioning on a tactical basis using a combination of research conducted via The WOTE, outside resources, and my own read of the market. My default positioning, no matter the outlook, will be a neutral benchmark weight until I find high-probability asymmetric set-ups. For WOTE US 60/40 that means a 60%/40% split in SPLG/BIL; for WOTE US Long/Short Equity and WOTE US Core Equity a 100% weight in SPLG; and for WOTE US Core FICC a 100% weight in BIL.
Change #2 is a mindset shift around The WOTE. Heretofore I have labeled it as a cross-asset market research “platform” - a site that CIOs could go to for high quality cross-asset market research backed by the direct incentive to use the research for alpha generation. Viewing the site as a platform led to too much rigidity in the portfolio management process once I rolled out WOTE Asset Management last fall. Rigidity is good only to a point, especially for my investment “personality”. I need flexibility to be creative - that’s how I think, write, and manage portfolios best. This really came into view this weekend watching a Tiger Woods clip about his creativity in his short game. In the clip below he walks through the many different shot iterations he has in his arsenal and says he is at his best when he can be creative. BINGO.
Alpha generation comes in many forms and flavors. It could come from a differentiated longer term view about the business cycle; it could come from a differentiated medium-term view on FEDeral government policy; or it could come from a shorter-term tactical view. Any form of one or all of those views may warrant a long or short position, out-sized or not out-sized depending on the risk/reward. It’s a big disadvantage to be boxed in, and since last fall I have boxed myself in.
Change #3 is how I construct the core SPX market outlook that sits at the center of my process. Rather than break the outlook down into three durations - structural (2 years), cyclical (12 months), tactical (8 weeks) - I’m going to go back to what I’ve successfully done in the past: construct the outlook using structural and cyclical analysis, and then risk manage my positioning using tactical market analysis. This process will look as follows:
Change #4, illustrated below, is a reconfiguration of The WOTE site in a way that naturally and precisely fits how I execute my process across the portfolio management, outlook construction, and tactical risk management functions.
This reconfiguration of the site is a follow-on to change #2 discussed above: The WOTE is a journal of my process, not a platform for sale. The one problem is that there is no longer a clean overview of my current views and positioning available at the top of the site. To mitigate this I will more regularly update the “WOTE Asset Management Home Page” that is always pinned at the top of the WAM channel - starting today.
Strategies
These are my five US-centric personal investment strategies.
WOTE US 60/40
Benchmark: 60% SPY, 40% BIL
Discussion: The WOTE US 60/40 strategy is designed to isolate my performance over- and under-weighting equities versus fixed income in the context of a US 60/40 portfolio.
WOTE US Core Equity
Benchmark: SPY
Discussion: The WOTE US Core Equity strategy is designed to isolate my performance in equity sector selection in a fully invested US equity portfolio with a SPY benchmark. This portfolio would typically comprise the equity portion of the WOTE US 60/40 portfolio, but for performance reporting purposes I want to break the investment process into its component parts.
WOTE US Long/Short Equity
Benchmark: SPY
Discussion: I do not short individual equities, so the vast majority of the short exposure in this strategy is to indices and sectors, but primarily the key indices SPX and NDX. When 200-300% long exposure is warranted, the strategy can be aggressively long select sector ETFs and individual securities.
Benchmark: SPY
Discussion: Highly aggressive, options-based strategy.
WOTE US Core FICC
Benchmark: BIL
Discussion: Go-anywhere strategy within USD-based FICC markets.
Performance
See prior discussion here.
Disclaimer
NOT FINANCIAL ADVICE
The Weight of the Evidence (The WOTE) newsletter (inclusive of anything and everything publicly and privately associated with it, no matter how tangential) contains the author’s own thoughts and opinions on financial markets. The WOTE is for educational and entertainment purposes only and none of the content or ideas should be taken as financial advice. The author is not responsible for any financial gain or loss that you may incur by acting on the information provided. You are solely responsible for making your own investment decisions and should do your own due diligence in regard to opinions and ideas on the markets to form your own personal view and form your own trades. For investment or financial advice, consult with a registered investment advisor and/or financial advisor. By reading The WOTE you are agreeing to these terms, and acknowledge it is for sharing the author’s thoughts and opinions on financial markets. Your trading and investing style, preferences, and risk management may significantly differ from the author’s.