WOTE Asset Management: October 13, 2024
Rising odds of Trump 47 has changed the tactical equity landscape, but introduces the risk of an aggressive UST bear steepener. Quick feet.
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Discussion
About
WOTE Asset Management (WAM) is the reporting vehicle for my personal investment strategies, and this update - the cadence of which depends on market conditions - acts as a central repository for my current views on the business cycle, the SPX outlook, and tactical risk management, and how I’m positioned across my strategy suite. More frequent updates to my views and positioning can be found in the Current Views section of The WOTE.
Archive
WAM Strategy Suite Update
I started The Weight of the Evidence (WOTE) back in December 2022 as a way to publicly document my cross-asset market views, but kept my personal investment strategies separate from the site until launching WAM in November 2023. I launched WAM as a silo’ed reporting vehicle to create a public performance record for my cross-asset market research process, and it’s been an interesting process journey. Up until this last week I managed the following five strategies through WAM:
WOTE US 60/40
WOTE US Core Equity
WOTE US Long/Short Equity
WOTE US Core FICC
WOTE Special Ops
Prior to forming WAM in November 2023, I managed my personal money through a combined portfolio of the three strategies above in bold. When I launched WAM I broke my portfolio up into its three components - stock picking (Core Equity), market analysis (Long/Short Equity), and options (Special Ops) - and added two more strategies (60/40 and Core FICC) to create a five-strategy suite that neatly covered the entirety of my cross-asset market research process.
The problem I’ve run into over the course of this year is that I don’t actually use the 60/40 and Core FICC strategies for my own personal capital management. I don’t over/under-weight equities in a 60/40 manner - instead, I back into my equity exposure by taking care of liquidity needs first, build out an income portfolio, then the rest is allocated to Long/Short, Core Equity and Special Ops for equity exposure and the over/under-weighting of equities comes naturally from the Long/Short and Special Ops strategies. And for Core FICC - like I said above I manage the fixed income portion of my capital according to income opportunities, not in a hedge fund-like go-anywhere manner; as such, WOTE Core FICC existed merely to track my FICC views, and it has become a distraction.
All year, in fits and starts, I’ve been shifting The WOTE away from “process for the sake of process” toward “make money first, ask process questions later”. And that shift was largely completed with my wholesale move into Chinese equities in late September. Though I monitor cross-asset market conditions daily, and will always have a view of the SPX outlook, right here and now an over/under-weight view of SPX is just not relevant to how I’m currently thinking and positioning. So…
This week I decided to shut down the WOTE US 60/40 strategy; and while I was at it I decided to shut down WOTE US Core FICC as well. Any highly opportunistic FICC ideas, such as Gold, will be run through WOTE Special Ops, a much more natural fit than trying to manage a dedicated opportunistic FICC strategy.
I’ll have more to say about the three core remaining strategies that comprise WOTE Asset Management - WOTE US Core Equity, WOTE US Long/Short Equity, and WOTE Special Ops - in an end of the year update sometime in early January.
Table of Contents
Business Cycle (free)
SPX Outlook (free)
Tactical Risk Management (paid)
KWEB Discussion (paid)
Positioning (paid)
Business Cycle
October 13 Update
I do not have a wholesale business cycle update, but there are key changes going on at the margin of the macro backdrop that are worth calling out here in the context of what I wrote back on September 20 (below).
My number one goal with establishing a view of the business cycle is to determine the downside risk to the S&P 500, as outside of recession SPX tends to persistently move higher with drawdowns limited to -20%. Since the Fed has shifted into a stance of policy that will protect against recession likely at any cost, recession is firmly off the table until an exogenous shock hits or YoY realized inflation rises to the point that it forces the Fed to re-tighten policy at the expense of the labor market.
In its quest to achieve a “soft landing”, the Fed is managing the US economy on a string: as soon as growth, inflation expectations, and animal spirits look like they want to break out to the upside, the Fed steps in with incrementally hawkish policy guidance; and as soon as “they” look to be sustainably breaking to the downside, the Fed turns dovish. Since the FOMC cut Fed Funds by 50 in September, the bond market subsequently raised its estimate of December 2025 Fed Funds by 50 in response to better than expected labor market data, stickier than expected inflation data, and higher oil prices, bringing the entire UST curve, real and nominal, with it. The Fed has responded to this change in data by taking a 50 off the table for November and opening the door to skipping a cut altogether. But unlike past bouts of reacceleration that the Fed cut off with threats of tighter policy, the current round of threats are of “less easing” not “more tightening”. With TIPS break-evens already starting to move, the Fed risks placing itself in a box if President Trump is elected on November 5.
In last week’s Week Ahead I discussed the Trump/Harris policy uncertainty overhanging the equity market. Well, this week it appears that uncertainty has been relieved (see below), IMO the single biggest driver of this week’s strength in equities and rates…which brings me to the above discussion about the Fed putting itself in a box. IMO, the combination of Trump 47 unleashing economic and market animal spirits and Chinese fiscal stimulus is going to act as rocket fuel to inflation expectations, resulting in an aggressive bear steepener at the long end of the UST curve. Given the US economy’s sensitivity to long end rates, the push-pull of Trump 47/Chinese fiscal vs. rising rates is going to make for a volatile macro path over the next 6-12 months. How far realized and expected inflation rise over the next year will directly impact the probability of a FED-induced recession. For now, the economy is safe.
September 20 Update
It was always difficult to imagine the US economy falling into recession with a 5-10% fiscal deficit in place, but with the Fed now looking to rather aggressively support the economy, outside of an exogenous shock it is exceedingly difficult to construct a coherent recession narrative. More important than narrative construction, the hard data support a robust economic outlook ahead.
Continuing claims are running at 2% YoY, and at the current trajectory look set to start falling on a YoY basis. Historically, 15-20% YoY and rising is the set-up for recession.
On the FED front, after an extended period of UST curve inversion the 3y/10y curve is now dropping in a manner firmly suggestive of monetary policy being at the economy’s back.
Far and away the biggest risk to the economy is a second inflation wave - as discussed well by Darius Dale below - but that is a risk to manage at a later date.
SPX Outlook
October 13 Update
The number one issue for the S&P 500 is valuation. At 5815, SPX closed Friday at 21.2 times $274 2025E EPS. And that $274 estimate assumes 16% growth off the current $236 estimate for 2024.
Sure, valuation isn’t a “catalyst”, but the set-up is in place for a grind down to 17.5x fair value by late 2025 driven by: 1) flows out of the US equity market from foreign investors taking profits in the near- to medium-term over-hyped AI Trade…flows exacerbated by 2) a resurgence in the Chinese equity market driving global equity investors to cut back on their Chinese equity underweight, if not go outright overweight; and 3) the above-discussed aggressive bear steepener at the long end of the UST curve creating risk-free long duration expected return competition for the SPX earnings yield.
The bull case for SPX looking out toward the end of 2025 is three-fold: 1) the US economy continues to expand, 2) the “Fed Put” is firmly in place as long as realized and expected inflation remain well-anchored, and 3) if the US debt ceiling is suspended until the second half of 2025, over $700 billion of TGA liquidity is set to flow into financial markets over the course of the first 7 months of 2025 (the equivalent of $100 billion/month of pure QE liquidity). The bull case assumes that LAG493 takes the lead while MAG7 digests the 2024 AI spending boom.
The bubble mania case is four-fold: 1) the data allow the Fed to cut Fed Funds down to 3-3.5% by late 2025, 2) UST 10s and 30s stick around 400-425, 3) TGA QE injects $100 billion/month, and 4) the AI Trade takes yet another leg higher on the back of “crazy insane” demand for NVDA’s Blackwell products.
Regardless of the direction SPX takes over the NTM, even with the liquidity floor of TGA QE in place two-way volatility is likely to be very high all year. In a nutshell, I will be very comfortable going max long/short into sentiment/positioning extremes, especially with seasonal window support.