Comprehensive Macro Report: Global Macro Inflection Point

How the labor market is compressing and creating risk for interest rates

The Greatest Risk To Macro:

Since 2008, the entire financial industry has thrived in building 60/40 model portfolios, advising investors to put their retirement into passive funds, and creating rules based asset allocation models that extract returns based on emperitical insights that have been gleaned over time.

The entire industry is built on things in the future acting like they did in the past. The problem with this is that when structural regime shifts take place, macro volatility goes through the roof and breaks all of the rules based systems.

For example, moving into 2022, everyone believed that if stocks went down then bonds would rally and help offset any drawdown. Instead, we saw stocks and bonds sell off as the dollar rallied against major FX pairs. Then, earlier this year, we saw the dollar sell off as equities sold off as well, sending another signal that the regime we are in is shifting.

All of this is taking place as valuations in US equities are back to historic highs (P/S stdv bands below):

The ironic thing about this entire environment is that at almost every step of the way, a recession narrative gets pushed when equities have the smallest drawdown, irrespective of underlying growth in the economy.

What we are really seeing is the convergence of multiple factors that have really never been seen in financial markets before. We are seeing social media and the attention economy become an active participant in markets as rules based allocators are adjusting positioning through an incredibly volatile period of time.

The volatility in this period of time is on BOTH the upside and downside for equities and bonds.

Within this, assets like Bitcoin or gold are being pitched as the only “life raft” to safety through the new environment. The problem with this is that both gold and Bitcoin are being integrated into the legacy financial system of rules-based allocation, where they will be bought and sold based on institutional flows and rebancing which means they will provide less and less diversification benefit.

A very simple question to ask in these periods of time is HOW MUCH is an asset correlated to either stocks or bonds going through melt ups or melt downs? If it is uncorrelated, then it COULD BE a life raft for a small period of time.

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Over time, Bitcoin has consistently had a positive correlation with the S&P 500. Simply put, Bitcoin might have periods of outperformance or underperformance against the S&P500, but this is the same as any other risk asset inside of the S&P500. As assets like Bitcoin get more integrated into the traditional financial system, the correlation to broad risk assets will increase.

As correlations of everything converge, understanding the macro drivers becomes even more important. When everything is cross collateralized together, you basically have total melt-ups and melt-downs based on macro liquidity and changes in interest rates. The only way to adjust to these higher levels of volatility is through active management.

If you want to dig into WHY the volatility of interest rates will be critical to understand, I recorded an entire video on it here:

So, big picture, correlations are converging and we need to have a more precise view of WHAT is driving the large melt ups and melt downs so that we can know HOW to respond correctly. My goal in the remainder of this report is to lay these fundamental drivers out so you have a clear picture of WHERE we are going and HOW to respond.

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Growth, Inflation, and Liquidity:

Growth, inflation, and liquidity are the building blocks for quantifying the moving parts of the economic/financial system. The “problem” is understanding HOW STRONG these forces are, what their sources are (which parts of GDP), and how all of them are interacting together in a complex path path-dependent manner.

One of the key things I want to start with is the relationship between growth and inflation.