Two weeks ago, a friend of mine lost his tennis racket on the highway. The racket fell right out of his bag attached to the back of his motorcycle. He quickly took the first exit, returned to the spot, pulled his motorbike into the emergency lane, and spotted his racket lying there on the highway. Did he end up crossing the road to retrieve it?

Managing risk does not mean forecasting.

Will the financial market crash?

This is anyone’s guess; the future is unpredictable. But what about the risk?

Given the inflationary shock on oil developing month after month, the odds of a 50% drawdown on the S&P 500 have been multiplied by a factor of 100.

For seven months in a row, Gavekal-IS macro, monetary, and behavioral models remained very equity-friendly, serene as a Tibetan monk. In the meantime, Gavekal-IS publications displayed a series of macroeconomic warning signals building up for a potential climax around August or September. See for instance February’s “Inflation: The Equity Nightmare,” and “US PE Expansion: Game Over!” publications, and May’s “Economic Boom and Financial Bust.”

Today, Gavekal-IS models crossed the Rubicon: criticality is ahead, risk-off!

Countries that have found the optimal balance between freedom and equality benefit today from the highest revenue per capita, as shown in our last publication, “Equality vs. Freedom.” They are all located in Northern Europe, slighting extending to Switzerland, the Netherlands, and Luxembourg as well.

What is their secret?

Our previous publication, “The Equation of Willingness,” highlights a missing equation from the Modern Portfolio Theory driving economic performance. The equation balances economic freedom and market integration. The first term favors a Schumpeterian growth, while the second, a Ricardian growth.

In this letter, we experiment with the equation throughout the world to identify countries and economic zones that have found the optimal trade-off for value creation.

And the winner is… Northern Europe.

Behind the decomposition of assets’ returns in alphas and betas lies an equation of willingness, and a conceptual mistake. It hides the fact that economic growth per capita originates in innovation (Schumpeter) or optimization (Ricardo), with different outcomes. The mistake could misguide companies and economies to over-optimize their production systems, increase their fragility, and eventually, collapse.

One year ago, facing the largest bond bubble in history, Gavekal-IS published “Bonds. Which Bonds?” focusing on four investment alternatives to US fixed-rate treasury bonds to protect income portfolios:

The four positions generated more than 20% alpha against US bonds, on average, which now raises the question of a possible over-extension of their outperformance.

Keep? Sell? Who knows?!

Ten years ago, Nobel laureate Daniel Kahneman described two systems the brain uses to form thoughts in his best-selling book, Thinking, Fast and Slow.

System 1: Quick!… Think about a color, and tool… And the winner is: red hammer! Quick!… Think about a safe asset class…. And the loser is: bonds!
System 2: Here, we propose a method to enhance bonds’ expected returns, in any circumstances. Slow, logical, effortful.

This method is embedded into our TrackMacro App. If you have 90 seconds to spare in system 1, first watch the TrackMacro video!

As for any economic indicator, monetary polices can be viewed from two interdependent yet different angles:

A major “price” signal took place two years ago, announcing the debasement of major fiat currencies and the awakening of gold. Since then, gold has spiked 40%. A “volume” signal took place just one week ago, announcing a second wave of world liquidity in USD intimately correlated with the second wave of the COVID pandemic.

The consequences of the “volume” signal on asset allocation (if it lasts) could be as significant as the one on “price” some two years ago.

Gavekal-IS is excited to announce the launch of its new TrackMacro 3.0 application! The app is downloadable on the website with free access for one month. TrackMacro 3.0 is a major technical step concentrating years of financial research in portfolio construction.

So, how does it work?

Gavekal-IS proposes a 3-dimensional perspective on portfolio construction: macroeconomic, monetary, and behavioral. In each dimension, we straightforwardly consider which of two opposing economic theories is in the ascendancy:

Today, the world votes for Smith, Keynes, and Markowitz.

Roulette players place bets on a number, from 0 to 36. They are deemed winners when the ball lands on the said number. A fair gamble? Not really. Roulette has a trick.

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