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Short Equities, Macro Outlook, FED Rate Hikes
When will the bear market end and when will the FED stop hiking?
A lot of exciting things to touch on in this piece!
First, the macro report I did is here: it helps frames things if youre a new subscriber
And I shared that I was shorting equities in this piece:
I shared my S&P500 model and that it indicated a sell signal. From the sell signal, we have had a moderate pullback. It was a great set up and the execution went really well.
The long bond trade I mentioned a couple of publications back hasn’t been working out as great which we will get into. The simple premise was that equities were priced for a perfect scenario at 4200 which was unreasonable. Anytime the market acts like this, you take the other side of it.
In terms of bonds, the primary driver of the short-term sell-off has been forward rate hiking expectations. A really good person you should follow on this dynamic is Jose from Thriddio Asset Management. He wrote a piece recently on how the forward curves are pricing expectations of FED hikes/cuts:
Also, if you are looking for a really good global macro long/short hedge fund manager, he is your guy!
The main chart Jose provided was about the timing of the rate hiking/cutting cycle. The futures in the chart price expectations of future rate cuts or hikes by the FED. Basically, into the end of 2023, we don’t see the market indicating a high probability of rate cuts taking place (that’s the orange line). However, notice the white line in the chart below, its indicating a marginal change in cutting during 2024.
While this pricing can change, what is the market saying? No rate cuts this year but rate cuts in 2024. This helps us to see how the market views things THROUGH TIME and not just statically.
Does any of this really matter?
I know forward expectations of rate hikes or interest rates might seem a little theoretical but historically, interest rates can cause nations to rise and fall. Many people focus on politics but it’s really financial flows or disequilibrium in the macro environment that frame how politics take place. Just think about the inflation narrative and the pressures placed on politicians and the FED right now! That came from a disequilibrium between the amount of money and goods in the system.
This introduces opportunity because politicians who control spending usually try to make decisions based on idealogy until they are constrained by their budgets. However, when they make decisions based on idealogy as opposed to what is wisest financially, it creates opportunities for people who know how these two dynamics interact.
Granted, politicians control regulation which can change HOW capital flows in the financial system but it’s really important to understand the constraints politicians are under.
“The End Game”
A lot of narratives have been going around about “The End Game” or the new world order occurring since there is so much debt in the system right now. While there are elements of truth to the risks surrounding the amount of debt in the system, what is more important is how to position a portfolio incrementally as any future catalysts take place. We really don’t know the timing of any horrible events in the future. Perma bears have been drawing attention to the risks in the financial system for decades. The whole point is to manage the risk during any period of time. We can’t really sit in a bunker or sit in cash for decades. Even cash is an asset with a return that can be negative sometimes.
Active Management Answer:
A lot of these problems that exist bring us back to the need for active management in financial markets. The first publication I wrote touched on this active management dynamic: here
2022 showed investors that there is a trade-off to simply sitting in passive products as both stocks and bonds sold off. As we progress through the rest of 2023 and into 2024, this dynamic will likely show itself again. When there is a higher frequency of growth, inflation, and liquidity shocks, there is a necessity to make more active decisions to maintain the same returns.
We can already see that managing the risk of the FED cutting or hiking is a very difficult dynamic. We haven’t even touched on underlying delinquency risks, the consumer deteriorating, or corporate debt!
Not to worry!
I will be sharing more on these specific topics and framing how we should think about them correctly. I will also share some principles for having a strategy to manage exposure to different risks that take place through the economic cycle.
Thanks for reading!