I will start of by addressing the global macro environment, then head over to sectors and major asset classes prior to explaining my expectations for the next few quarters. Then I will briefly present the current portfolio and its performance before I end by saying a few words about the crypto algorithms.
The macro situation
As I write this report, the overall macro picture seems rather grim. After unprecedented monetary and fiscal stimulus during the Covid outbreak in 2020, we have seen trending inflation. The mix of money printing and handouts combined with lockdowns and supply chain disruptions have created inflation numbers not seen in forty years, yet the FED funds rate remains near zero. According to market expectations, the FED is to raise the interest rate by half a percent point in both May and June and then continue with quarter point moves during the second half of this year. This will in my estimation probably create a recession, and the yield curve have already signalled it.
A flat or inverted yield curve is a signal that something is broken. It is not natural for long term rates to be lower or equal to short term rates. In the chart above, you can see the US 10-year rate minus the US 2-year rate. When it goes negative (inverted), the stock market tends to crash a few months later.
There are other rate spreads to watch out for too. In fact, they all matter. The strength of the recession signal is increased with multiple inverted spreads. One can assess this by watching the whole yield curve.
Chart 1 and chart 2 provides examples of healthy yield curves. In such environments bond-investors are rewarded for buying duration.
Chart 3 and chart 4 are inverted or flattish. This is the rare circumstances which historically precedes recessions or crashes. Chart 3 preceded the dot com crash and chart 4 preceded the great financial crisis of 2008.
Chart 5 is the current yield curve. It is not fully inverted, but rather flat and several rate spreads were inverted a few days ago.
One year ago, the stimulus checks provided huge sale growth compared to the 2020 Covid-shock. This time around, inflation is taking its toll while the stimuli growth year of 2021 makes a horrible year over year comparison. Growth is thus slowing, inflation is trending, and rates are increasing. This is not bullish. At least not for duration assets like growth-stocks and bonds!
The de-globalization is also accelerating with the West cancelling Russia’s dollar reserve assets because of Putin’s war on Ukraine. This, combined with several other sanctions, is an act of financial war which may cause other nations to reconsider their dollar assets. If a sovereign nation can’t rely on its reserves, one may argue that they are not sovereign at all. We saw the same thing on a lesser scale with the trucker demonstrations in Canada. Prime minister Trudau unbanked the demonstrators to force them to comply. The money system has indeed turned into a weapon.
The crypto market
It is possible to construct a narrative that such totalitarian acts by the state would urge its inhabitants to diversify into bitcoin and other crypto assets. I will leave such storytelling to others and rather focus on the repeatable mining-cycle.
Fact is that the bitcoin to dollar value have followed a four-year cycle with a rather predictable pattern. To understand the pattern, please get the following:
- Major cycle tops are marked with red vertical lines.
- Major cycle bottoms are marked with white vertical lines.
- The mining halving dates are marked with green vertical lines.
- The blue vertical lines mark the date of breaking previous cycle highs.
These vertical lines repeat in a four-year cycle, not perfect, but very close too being so. If history is a guide, we should expect bitcoin to crash more then 60 % from today’s price levels by the end of the coming winter. As the white vertical lines also indicate, such price drops are a beautiful buying opportunity.
The short term is grim indeed, but it rhymes with the past and fits the overall macro picture explained in the previous section. Crypto is not a safe-haven trade, but rather a risk on trade not unlike the Nasdaq. If we plot the two together, it is obviously a strong correlation as well.
Long term followers know I used to hold approximately 45 % of crypto assets in this portfolio. Currently I hold nothing, but I expect to return to a huge allocations in the future. I do believe the current monetary paradigm is ripe for disruption, and crypto do have a major role to play in that regard. Long term I am very bullish, but considering the overall macro environment and where we are in the mining cycle, I expect most crypto assets to perform poorly the next 8-12 months.
Value stocks
As rates increase and growth drops, investors have traditionally sold growth stocks and rather invested in value. I define value as companies with strong balance sheets and great earnings in the present at relative low valuations. Oil companies are perfect examples of such, and this sector is up almost 44 % YTD!
With the war and sanctions of Russia still ongoing, we may see further upside. Yet, it is a very geopolitical and difficult trade to implement. Since a recession seem imminent, we should also consider the impact of oil demand. It tends to deteriorate during recessions, but will the demand destruction outpace the impact of war and sanctions? I am not sure; thus, I will refrain from acquiring too huge a position in the oil and commodity market. Selling these positions all together may also prove unwise as the inflation protection these positions serve could spark a very much needed portfolio gain if the historically stagflationary impact of war is to materialize. I have chosen to hedge my inflationary commodity positions with a huge short allocation to duration assets and consumer discretionary.
Gold
During stagflation and war gold have historically been a great asset. Toss in the unsustainable government debt and negative real yield (nominal rates minus inflation is highly negative), and you have yourselves a very bullish setup for gold.
Yet gold have performed poorly. We have not even gotten new all-time highs, something that puzzles me all things considered.
Several central banks have acquired huge amounts of gold recently, the latest being Egypt which added + 64 % (2 703 million USD) to its balance sheet. My belief in gold is at least shared among central bankers of many sovereign nations.
When the gold price goes up, streaming companies like Franco Nevada follows next. Then major gold miners like Barrick Gold and Newmont gets a bid followed by the junior mining space further out in the cycle. I expect the gold price to rise a lot in the coming years and I will add to my precious metal allocation in the order explained above if true signs of a bull market plays out.
Expectations versus the future
As stated in the previous sections, I expect a broad bear market as the FED tightens into a recession. I expect value to outperform growth, crypto to crash and gold to steadily rise as sovereign nations adds more of it to its balance sheet and possibly backs their national currency to it. It may however not play out like that. Everything is always a possibility, but everything is not equally probable or priced in. Prior to writing this report, I checked with the bitcoin maximalist types on twitter. They still expect bitcoin to rise, and they base it on both narrative and some quantitative chain analysis. There are always opposing views in the market and that is of course what makes a market. My framework for understanding the market is based on a lot of input from various services and experts in addition to my own knowledge and biases. As I have been wrong multiple times before, I have learned to size positions in a prudent matter. If I am wrong, I will make sure not to blow up!
The future is less clear then usual. One may argue the FED will stop hiking rates as the market eventually will crash. This is not speculation. It always crashes when the FED hikes rates aggressively – especially into a slow-down or a recession. Will Powel pivot again? Will the money printer go Brrr to stop the crash?
I believe the answer to that question will be revealed during the next six months. Until then, speculation is all we have got, and my guess is, they will not! I believe the pain of inflation for the Biden administration is immense and that he will have to do everything in his power to address it. That includes, crashing the stock market. Most people have not benefited from the monetary expansion, which have made the rich richer and the poor poorer. The inflation is now at truly unsustainable levels and there are several historical analogues to this inflationary era that have ended in violent revolutions. The latest example is the “Arab spring” of 2010. This incident was also preceded by great food inflation and the people growing tired of government corruption.
If Powel pivots and turns on the money printer as the market crash, all assets will of course go straight up, and inflation will possibly reach levels barely seen since the Weimar Republic.
Active trades and portfolio performance
The portfolio broadly holds about 30 % precious metal assets, 19 % commodities and commodity providers, 21 % short equity positions and 17 % volatility benefactors like VIX futures and high frequency market makers. Details are provided below:
These trades have protected this portfolio from the volatility from major markets thus far this year. Consider the following:
- S&P-500 is down 7,84 % YTD
- Nasdaq 100 is down 14,87 % YTD
- Bitcoin is down 12,56 % YTD
- TLT is down 18,52 % YTD
At the same time this portfolio is up 2,64 % YTD. That is not great on its own, but considering the relative performance to the broader market, I find the performance acceptable.
The next generation of my crypto algorithms
The next generation of my crypto algorithms are still being fine tuned for future deployment. I do not think it’s urgent to own crypto in this environment, but I do think it is wise to prepare for the next cycle. If the market changes, I will of course change my mind. I may buy or short crypto if I find the trade attractive. As of now, I do not.
I will look more broadly into the crypto space for the next generation of algorithms. I have already created more than 50 such algorithms and they are all trading live on another crypto exchange. I will not implement any of them on eToro until I am more confident in the market and the algorithms, and I do not intend to deploy more than a handful. I write this primarily to let you know I am still working on it.
Only 13 of the new 50 algorithms are in a buy position and the old algorithms are close to suggesting short. If I were to add a position now, it would be a short position.
If you want to learn more about the portfolio and its strategy, consider heading over to this section of my blog:
https://www.frihetsfondet.com/category/the-crypto-portfolio/
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