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.
Our previous publication, “The Four Monetary Quadrants,” revealed how the volume and price of money deeply influences asset allocation. We now shift gears to the transition between one quadrant and another. Specifically, how to collapse model risk, select asset classes, and still sleep well at night.
Start by clearing out the dead wood!
Back in the late 70s, Charles Gave realized asset classes are very sensitive to two major macro variables: growth and inflation. Thus, he suggested a Four Quadrants’ framework for portfolio construction: inflationary boom, inflationary bust, disinflationary boom and disinflationary bust.
Here, we propose to mirror the concept, crossing volume and price, but from the monetary angle: the amount of liquidity vs. the remuneration of such liquidity.
A new “Quadrants’ representation” emerges to drive asset reallocations.
Information technology changed the world from knowledge transmission bottlenecks to instantaneous access and worldwide diffusion of non-events. Does this drastic change help investors decide between buying equities or bonds?
Well, look to our Youngsters!
The economy and stock market’s profitabilities do not always walk hand-in-hand. In 2020, for instance, to the surprise of many observers, we saw the former collapsing and the latter booming. Is it possible 2021 might see the opposite?
A protest movement in France named the “Gilets Jaunes” (Yellow Jackets) began in October 2018 due to a tax increase on fuel. The movement was populist, widespread, and spontaneous, and only weakened in 2020 due to coronavirus lockdowns.
Was 2.6 cents per liter extra tax on gasoline such a big deal?
The answer is yes. Inflation on a household’s constrained expenditure can unleash the “Gilets Jaunes multiple,” and kill consumption and stock markets.
The risk has now crossed the Atlantic.
In a stable regime where finance and economy grow in parallel, cash and oil are two forms of free energy which, in theory, should be fungible. Since early 2020, however, the central banks from the US, Europe, and Japan, issued 40% excess cash on average out of the blue to fight the deflationary consequences of the pandemic.
Cash and oil are unlikely to remain fungible: you can print cash, but you can’t print oil.
A few months ago, with a mischievous look in his eyes, Charles Gave noticed the S&P 500 was paying one gram of gold per annum in dividends!
What kind of hidden information lies behind this coincidence? Scarcity, efficiency, and the competition between them in asset markets.
In a series of three publications in February 2021, we explained how accelerating inflation – not simply high inflation – had been awfully bad news for equities for 140 years. Some of our readers argued that rather than inflation, interest rate was the key driver of equity behavior. If central banks continued using their purchasing power to cap government bond rates at low levels, equity markets should be fine.
Here, we refocus our analysis on interest rates, and our conclusion remains the same: last round for equities!
Unlike most physicists, value investors should welcome negative mass.
Financial assets carry a mass, just like objects in physics. Some are heavy, others are light, and a few carry a negative mass, a key property for efficient portfolio construction.
Today, the energetic approach tells us more: the expected return of value stock indices outpaces growth indices for the first time in ten years.
Benjamin Franklin believed in free trade. “No nation was ever ruined by trade,” he said, adding, “even seemingly the most disadvantageous.”
Now fast forward to equity markets today; world trade in volume is one of the seven macro rules embedded in the artificial brain of TrackMacro, Gavekal-IS’ software providing real-time investment portfolios.
Last month, TrackMacro issued a “strong” signal on trade. World trade is anticipated to boom.
Does this mean equities should rally?
Some forty years ago, Charles Gave introduced the “Four Quadrants” concept, used by generations of investors to drive asset allocation in global investment portfolios. The concept crosses inflation and growth to cluster four macroeconomic situations: inflationary boom, inflationary bust, disinflationary boom, and disinflationary bust.
Here we revisit the concept with a scientific eye, applied to ecosystems. We focus on the second derivative of economic production or asset prices, i.e. the acceleration or deceleration of growth and inflation, intentionally ignoring the levels of inflation and growth. A new “Four Quadrants” is born, bridging macroeconomy and simple mathematics. It massively amplifies Charles’ discovery decades ago.
What is it telling us? That the US game on equity price-earnings’ expansion is over.