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Feast & Famine

Updated: Oct 31, 2023

A good debate on things Macro in last few days, “Buy the dip in Energy and sell the spikes in Growth/Tech – for the next 10 years! “


Nutstuff has been for nearly 2yrs enamoured with energy (coal especially and Drillers/Svcs) & basic materials, and over the secular long-term horizon 2022 to 2032 that is the right call, but I am being told that the people who control what we call “money” (central banks) have decided that they will do ‘anything it takes’ to prevent the very inflation on which my bet

depends.


Bannister feels sure that the central banks are willing and able to trigger a demand destroying recession to prevent me from making a positive return, and we all know that investors “cannot heat or eat relative performance.” Until the central banks give up the fight, Barry tells me I am perched on the leading edge of a bear trap. A better strategy now is to accumulate cash and wait for the bottom of the bear trap in the 2023 recession.


The Fed (and most investors) do not even realise when policy has gone too far. Mistakes are unconscious, because to do so consciously isn’t a “mistake.” The error comes in 2023 around 2.5% fed funds. Futures for Dec-2023 are already at 3.15%.I have all the charts if wanted that show a 0% real fed funds rate (e.g., 2.5% fed funds, 2.5% Core PCE in a slow-down) would likely trigger a massive 2nd wave down for the stock market, probably another -25-35%

in 2023. And the nominal Neutral rate is so far out of the question that it isn’t even realistic to expect to get there.


So, cumulatively 2022-23 you are looking at -55% for SPX in real terms. Not really different from 1940-42, 1973-75, 2000-2002. If the central banks are willing and able to trigger a demand-destroying recession to prevent you from making a positive return”. Then a Key question for me therefore on energy is this: Does a common or garden recession in

the "West" actually destroy enough demand to counter the current supply deficit?

As it is, I simply don’t think it is likely that the central banks do engineer a “common” recession.


There is too much asymmetry in the system based upon weak debt structures. As such, zero real may not be the cracking point. In fact, there is enough error distribution around what zero real is that would be enough to lead to a policy mistake. But, the central banks seem to think the world is Markovian, ie. There is no path dependence to the future impact of decisions on outcomes. Because we have had no significant deleveraging of the system since before the ’08 crisis, I think future outcomes are highly path dependent. Bank balance sheets may appear better but the risks that banks were running pre-08 have largely shifted to central bank balance sheets. IF there is a Black Swan here, it is that central bank balance sheets matter in amplifying downside risk.


What is also key however is to appreciate is that the amount of systemic leverage is much higher than what is wasback then (Non-financial credit as a %GDP was 135% then and now is 290% and the ratio of central bank balance sheet to GDP is literally 5x what it was in 1979).


The real economy has been consumed by the financial economy. One can say that is the cause of inflation expectations but what is different between the current environment and the previous gross expansions of the central bank balance sheets is that some large portion of the expansion of Fed balance sheet funded direct transfers to consumers rather than just feeding financial leverage. That is over but it will take time to trickle its way into demand and credit expansion.


I just think there is a massive difference in systemic leverage which changes the symmetry of likely payoffs to declining credit growth, shrinking negative real yields and declining asset prices. There really is no Goldilocks here because we are balanced on the end of the needle. I doubt consumers and the markets will be able to ignore central bank tightening for as long as they did in 1979-1980.


So, yes a barbell is always best in a volatile scenario. Volatility should remain high over the medium term. Which names to include on either end of the barbell is the key. However, a barbell is usually high beta versus low beta, growth vs dividends. I have a theme barbell. Yes, it is working due to outsized returns on individual names. I wonder if I need to add more stable names, such as maybe yes a JNJ, which has traded in a 10% range, 2.55% dividend yield with approx. 6% dividend growth and low debt to assets. There are others like this aswell. Where my work is currently. Basically feast and famine is fine but maybe I want a few more boring “menu of the day”!


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