***The following is an excerpt from my Weekly Market Prep note and chart pack sent to Collective members every Sunday. If you’re interested in learning more about our premium research service, click this link here. We’re running an enrollment period that will go until Sunday. Hit me up if you’ve got any questions***

Does your positioning match your views? 

Mine don’t… And that’s a problem. 

I was asking myself this question throughout the week when the market was selling off, and our portfolio was selling off even more. 

Sure, we’re still mostly in cash (roughly 60%). And our nominal net market exposure is only around 20%; if you account for our uncorrelated futures and forex positions (long wheat and USDCNH) and then net out our Nasdaq short. But even this low nominal exposure can be deceptively risky if the names you hold are high beta, especially in risk-off environments, which a few of ours are.

There’s a constant balancing act in this game where one has to try to position according to their base case views but also harmonize across other possible outcomes. Not to mention a certain level of portfolio volatility is just the cost of doing business — the key being you know how high a costs you’re you’re willing to pay, and then play accordingly… All of this is made more challenging when the environment is noisy, and the cone of probabilities is wide (read: conviction is low) like it is now. 

And then there’s the matter of path dependency and competing timeframes, which we discussed in A Bunch Of Plonkers This is what makes managing in the current environment feel like a high-wire act through a hurricane. 

I still lean bullish over the next few weeks. But my confidence in that path drops every day the market sells off, and bonds fail to catch a bid. There’s a good chance we’ll have to get through this week’s FOMC first before participants are willing to step in and buy.

But I’m not anchoring too much to any opinion in the short-term. I’ve learned that when uncertainty is high, it’s usually best to overweight against your longer-term view (ours being that we’re in a cyclical bear). 

Stanley Druckenmiller gave a talk recently at my former employer, Palantir Technologies (here’s the link). He and PLTR CEO Alex Karp talk geopolitics and markets. 

Druckenmiller says he thinks markets have likely entered a decade-long sideways volatile regime, similar to the late 60s through mid-70s. We briefly touched upon this idea in The Game Has Changed… where I shared the following chart showing CPI, 10yr yields, and Household % allocation to equities. 

I’m not much into making big macro predictions, as I prefer to just play the odds… With that said, a decade of sideways chop and vol would be in line historically with where we sit in both our long-term debt and policy cycles. 

It’ll all come down to how inflation plays out from here. Are we in a new inflationary dynamic? Will regionalization and reshoring, increasing conflict and climate change, and new populist-driven labor versus capital dynamics place us in a secularly sticky inflationary regime? Or will debt, demographics, and technology pull us back to the low inflationary world we know? 

I can make arguments for both, though I lean towards the former. And it’s not entirely an either-or. Whatever unfolds will be a dynamic process with lots of cycling back and forth. 

It is clear, though, that we’ve crossed the chasm into some new kind of regime. One that will continue to show its colors as it develops and unfolds from here.

The power of fiscal policy has been (re)discovered. Politicians are unlikely to put that tool back in the box anytime soon. And geopolitically speaking, I’d wager that the trend over the next decade isn’t towards more peace and cooperation. .

Dalio wrote in a recent note (link here) that he expects CPI will stay quite sticky over the coming years. He writes: 

Right now, the markets are discounting inflation over the next 10 years of 2.6 percent in the US. My guesstimate is that it will be around 4.5 percent to 5 percent long term, barring shocks (e.g., worsening economic wars in Europe and Asia, or more droughts and floods) and significantly higher with shocks. In the near term, I expect inflation will fall slightly as past shocks resolve for some items (e.g., energy) and then will trend back up towards 4.5 percent to 5 percent over the medium term.

Zeus knows whether Dalio will be right and, if so, for how long. But it seems a reasonable take to me and a potential outcome worth exploring. 

Here’s a busy chart I created. It shows the SPX (black), its TTM PE ratio (light red), its average PEs for both rising and falling inflationary regimes (rust-colored dotted lines), and the CPI (orange line) and Effective Fed Funds Rate (green line). 

A higher inflationary regime would necessitate a higher equilibrium for interest rates. And since markets are a relative game and pricing works through risk-premia spreads. Higher rates equal lower average multiples on stocks. 

The high inflationary regime that persisted from 65’ into 81’ saw an average market multiple of 13x TTM PE. While the most recent secular period of declining inflation and rates has had an avg PE of 18.6x. The current TTM PE is 19x. 

Fed funds futures are currently pricing in a fed rate of 4.3% by Spring of next year. Ballpark, this feels about right considering where the labor market and wage growth are. Not to mention, the inflation print last week showed that everything the Fed had been citing as important over the past year, is hitting new highs (see chart below).  

This tells me that we can ignore the Pollyanna’s calling for a coming Fed shift. It ain’t happening… Not anytime soon…. Yes, CPI will continue to fall. But the Fed is not going to directionally change course on rates until CPI is back at target for “some period of time” or until the markets really break… 

There will be no “soft landing”. There will be lots of upside and downside vol over the coming months. We could very well run 20% higher here in the S&P. That wouldn’t be out of the ordinary for a cyclical topping process. 

We could also just as easily drop another 20%+ from where we are. This is what I expect we’ll see at some point over the next 12 months. And this would be right in line with the average bear market, which is a -39% drop from peak to trough, a bear cycle TTM PE low of 11x (we’re at 19x today), and average duration of six quarters (we’re three quarters into this one).  

These are best-case scenarios, in my opinion. Because if we just look at the stats during the higher inflationary periods, then the average PE trough is, in fact, much lower. 

The Generals are always the last to go… But when the mighty fall, they fall hard… 

On Slides 12 and 13 I lay out the technical and fundamental case for why the OG FAANMG stocks are headed much lower, and why these will be driving force behind the next major leg down in the broader market … 

***End of Excerpt.****

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Brandon Beylo

Value Investor

Brandon has been a professional investor focusing on value for over 13 years, spending his time in small to micro-cap companies, spin-offs, SPACs, and deep value liquidation situations. Over time, he’s developed a deeper understanding for what deep-value investing actually means, and refined his philosophy to include any business trading at a wild discount to what he thinks its worth in 3-5 years.

Brandon has a tenacious passion for investing, broad-based learning, and business. He previously worked for several leading investment firms before joining the team at Macro Ops. He lives by the famous Munger mantra of trying to get a little smarter each day.


Investing & Personal Finance

AK is the founder of Macro Ops and the host of Fallible.

He started out in corporate economics for a Fortune 50 company before moving to a long/short equity investment firm.

With Macro Ops focused primarily on institutional clients, AK moved to servicing new investors just starting their journey. He takes the professional research and education produced at Macro Ops and breaks it down for beginners. The goal is to help clients find the best solution for their investing needs through effective education.

Tyler Kling

Volatility & Options Trader

Former trade desk manager at $100+ million family office where he oversaw multiple traders and helped develop cutting edge quantitative strategies in the derivatives market.

He worked as a consultant to the family office’s in-house fund of funds in the areas of portfolio manager evaluation and capital allocation.

Certified in Quantitative Finance from the Fitch Learning Center in London, England where he studied under famous quants such as Paul Wilmott.

Alex Barrow

Macro Trader

Founder and head macro trader at Macro Ops. Alex joined the US Marine Corps on his 18th birthday just one month after the 9/11 terrorist attacks. He subsequently spent a decade in the military. Serving in various capacities from scout sniper to interrogator and counterintelligence specialist. Following his military service, he worked as a contract intelligence professional for a number of US agencies (from the DIA to FBI) with a focus on counterintelligence and terrorist financing. He also spent time consulting for a tech company that specialized in building analytic software for finance and intelligence analysis.

After leaving the field of intelligence he went to work at a global macro hedge fund. He’s been professionally involved in markets since 2005, has consulted with a number of the leading names in the hedge fund space, and now manages his own family office while running Macro Ops. He’s published over 300 white papers on complex financial and macroeconomic topics, writes regularly about investment/market trends, and frequently speaks at conferences on trading and investing.

Macro Ops is a market research firm geared toward professional and experienced retail traders and investors. Macro Ops’ research has been featured in Forbes, Marketwatch, Business Insider, and Real Vision as well as a number of other leading publications.

You can find out more about Alex on his LinkedIn account here and also find him on Twitter where he frequently shares his market research.