Personal Journey | No Advise

2023-10-06

Acceptance of The Inevitable

“When the fierce, burning winds blow over our lives-and we cannot prevent them-let us, too, accept the inevitable. And then get busy and pick up the pieces.”

Dale Carnegie – Stop Worrying and Start Living.

In my previous articles, I have argued that current economic systems should accommodate a 5.5% growth. This is a straightforward concept, and I would employ 5.5% as the fundamental standard throughout my entire thesis. Since 2020, the US debt has been consistently increasing at the same rate of 5.5%. I anticipate this trend to continue until next few years, at which point after, it may accelerate even further faster. Unless the largest economy in the US experiences a significant deviation from its trends spanning decades, we should acknowledge my inevitable economic thesis: (1) higher debt (2) faster debt, coined as “higher further faster.”

The current pace of growth has exceeded that of the previous cycle and is anticipated to rise further in the subsequent cycle (after the next Global Financial Crisis). During this period, the global landscape has been notably demanding due to elevated levels of debt growth. The earlier 2020 CoVID crisis necessitated low interest rates and fiscal support measures to steer it back onto its 5.5% trajectory. I would anticipate policymakers to maintain their commitment to this debt-driven growth. Ultimately, they would have little choice but to align with this trend, lest they risk jeopardizing the entire economic framework, which amounts to hundreds of trillions in human history.

In prior articles, I contended that a 5.5% increase in debt might lead to significant economic challenges:

Firstly, a 5.5% increase in debt will drive asset growth at a rate of at least 5.5%. This will lead to a swifter expansion of assets in the market and among participants. We can anticipate the following:
- Wealthy individuals with significant assets will experience even greater wealth accumulation.
- Major corporations will demonstrate resilience, maintaining stable revenues and continued hiring.

Secondly, historically, wage growth has not exceeded 5.5%. This could pose a challenge as most workers may struggle to keep pace with inflation.
Thirdly, individuals fortunate enough to possess substantial and rapidly appreciating assets may face a decision between continuing employment or opting for retirement. I suspect this may be a minor contributor to the lower unemployment rate, owing to workers choosing earlier retirement. Over time, they are likely to receive enduring support with returns sustaining at 5.5%.
Lastly, there should be an adjustment in yields. Assuming policymakers remain steadfast, I would contend that long-term yields should at least approach 5.5%.

We are witnessing evidence supporting my fourth argument here. Over the past few weeks, we have observed disruptions in both $TLT and $TNX. I stand by my thesis that they should reach a minimum of 5.5%, and possibly even higher on the longer end. While some economists have been suggesting that TLT may have hit its bottom in the past few weeks, I would argue that it has not yet done so. The 10-year yield has not yet reached 5.5%. I firmly believe that the 10-year yield is strongly linked with inflation. Therefore, given that the 10-year yield has surpassed its previous high of 4.2%, we should anticipate:

A prevailing narrative of heightened inflation.
A new normal of 5.5%.

I suspect that this shift in narrative, which has taken us halfway through the cycle, where we’re beginning to see a rise in both inflation and yield, has contributed to the recent bout of volatility. From my perspective, policymakers are standing firm in their commitment to achieve a 5.5% growth through a combination of deficit spending and monetary measures. It’s worth noting that not all economists endorse these policies, with some deeming them as risky due to their potential to excessively stimulate the near term, possibly jeopardizing the long term.

I contend that the world has entered a new paradigm, and in my view, 5.5% represents a new normal. Market participants should be prepared to embrace this change and acknowledge its inevitability.

However, it’s important to recognize that this acceptance is not without repercussions, as elucidated in my second and third arguments. While major corporations continue to generate substantial profits, the same cannot be said for smaller enterprises and the average individual. Unless wage growth experiences a substantial acceleration, we may continue to face challenges in the market. We must closely monitor whether individuals can sustain their spending, if major company revenues will continue to surge, or essentially, if key economic indicators will remain robust.

I understand that some advocate for a focus on the average economy. Yet, in my perspective, policy tends to lean towards the larger economic landscape rather than the average. If these significant economic indicators were to falter — for instance, if major corporations were to significantly reduce employment — the new ecosystems might face difficulties. However, as we have observed, the major economic metrics remain solid. Therefore, in my view, policymakers will stay the course, using front-end deficit measures.

Given the stability in economic metrics, I don’t see any reason for policymakers to alter their approach until long-term yields reach a 5.5% growth (which has not yet been achieved). I believe they will remain steadfast in their strategy and avoid making significant disruptions to the long term until this 5.5% objective is met.

I maintain my thesis that a 5.5% front-end Fed rate represents the peak or upper limit for the Fed rate. As of August 2023, this remains my peak rate thesis. My argument is straightforward and is rooted in the observed debt growth. Raising the rate beyond 5.5% would likely lead to a stagnation in the economy and a contraction in liquidity, thereby tightening the market. Conversely, reducing the rate below 5.5% would likely only spur inflation, which has been trending upwards over the past half of the cycle. The longer policymakers adhere to a 5.5% rate in the front end, through the use of fiscal deficit, the more entrenched it will become in the long end.

There is a discussion surrounding the potential limitations of fiscal deficit supply. If over the next 4-5 years we do not observe any improvement in market resilience, we may unfortunately face a significant new challenge where increasing long-term yields could escalate beyond control. My contention is that supply allocation should no longer disproportionately favor short durations and must begin to exert pressure on longer durations. In this scenario, Treasury buybacks (which would be implemented gradually starting in 2024) could emerge as a dominant policy to prevent an uncontrolled surge in long-term yields, which the global economy may not be able to sustain. We’ll deal with this later.

To avert such a situation, as I argued in my articles over the past two months, cooperation with other countries, particularly China, should improve. I still believe that China has not yet substantially reduced its holdings of US Treasuries. There will be debates regarding duration and potential reallocation, possibly involving Europe.

In contrast to some other economists who may anticipate a cooling down of inflation, I adhere to my thesis that we will start to witness a resurgence of inflation, and it will likely persist at elevated levels. This is why I have begun to reacquire quite significant amount of leveraged commodities. In the next few years, I anticipate a potential (restrictive) cycle in commodity growth. I cannot predict whether there will be a definite recession next year. We should closely monitor the global market’s resilience during this period.

Given the considerations above, and in light of the increased yields’ impact on resilience, we have decided to re-enter the market, albeit without employing much leverage. In previous years, we consistently maintained leverage ranging from 200% to 300%. However, for this half of the cycle, we are beginning to allocate a portion of our previous leverage into fixed incomes (though not yet long-term bonds), and we have not yet introduced significant leverage. If long-term yields were to surge above the 5.5% trend, I may then reallocate fixed incomes into long-term bonds. I believe it is a prudent decision to introduce fixed income into my portfolio, which has primarily consisted of high-risk assets with high leverage in the past 3-4 years, lacking lower-risk assets.

Please note that all ideas expressed in this blog and website are solely my personal opinions and should not be considered as financial advice.

2023-09-21

Bonds, Foreign exchange, Investments

Good Night

“The Sun is dying. Our sunset has arrived. Let’s rest.”

Let’s refer back to our previous article from March 2023, which discussed bear market and recession estimation. At that time, we lacked sufficient data regarding the timing of the last rate hike. Let me summarize my findings:

Focus solely on short-term investments and steer clear of potential long-term commitments.
Recession statistics:
- There is a 100% likelihood of a bear market hitting its lowest point (bottom) after the onset of a recession.
- A bear market tends to reach its lowest point approximately 5.3 months following the commencement of a recession.
- There is an 81.3% likelihood that a bear market concludes (ends) roughly 13.6 months after the last rate hike.
- It is virtually certain (100% probability) that the transition from a bear market to a recession occurs after about 6.2 months.

Now that we have the data with no more rate hike in September 2023 and yields continue to hold strong, we know that the last rate hike occurred in August 2023. Therefore, based on the recession statistics provided:

We anticipate that the Federal Reserve will no longer be in a position to implement any rate hikes. This implies that the last rate hike took place in August 2023.
Using the 13.6 month estimate (with 81.3% accuracy), we can predict that the bear market will conclude (end) around October 2024.
The recession is projected to commence roughly 5.3 months before October 2024, which would be around April 2024.
We can assert that the bear market is currently underway, starting approximately 6.2 months before April 2024, which is NOW.

Engaging in trading and investment during a bear market presents greater challenges due to intensified competition among market participants. A bear market can be likened to slicing a delicate piece of sashimi, where assets undergo a gradual and precise reduction. It exhibits clear signs of struggling to achieve higher highs, often leading to a sustained downward trend.

One example is the QQQ. There is a compelling indication that the rally in September is lower than the one in August, providing a stronger suggestion that it may not surpass the high reached in December 2021.

The most evident sign is the US ISM. Despite significant fiscal stimulus, the ISM shows no signs of improvement. This typically occurs when the market is on the brink of recession.

Powell made it clear during the FOMC meeting last night:

He expressed uncertainty about many things, suggesting he is concerned about something significant.
He stated that a soft landing is no longer the most favorable scenario, indicating that the Fed is no longer anticipating such a condition.
Despite the dot-plot pointing to a stronger situation, Powell remains the key decision-maker.
In fact, the dot-plot is more indicative of the conclusion of the bear market in Q4, 2024, potentially accompanied by a rate cut.

We began to observe that our profit trailing stop was being triggered. We are unsure where we should reallocate, as most assets, including bonds and gold, in our opinion would not perform well during this recession possibility. Although a soft landing is still a possibility, we are no longer expecting such a scenario. I may have noticed this from the relentless increase in yields and the strength of the USD. It may rather go directly into a bear market and recession. We anticipate a 20% market correction to align with their daily moving average of 200. Later, we plan not to sell below the DMA 200 since it’s still in bear market and not yet in recession. There is still a possibility of a bear market rally or even a blow-off between now and April 2024, perhaps with a correction in USD. However, we want to make sure that we are not navigating this path with leverage and with an insufficient cash position (indeed we already hold 50% of cash). We will keep a close watch on the market conditions and may continue with our deleveraging strategy. We anticipate that the bear market will be quite lengthy.

Good night.

Please note that all ideas expressed in this blog and website are solely my personal opinions and should not be considered as financial advice.

2023-08-30

Bonds, Foreign exchange, Investments

Higher Further Faster

With China and the US being the two largest economies in the world, as they work on resolving their differences, we should expect to see an improvement in the global economy, which was on the verge of decline.

Inflation has reached its peak, and emerging economies have experienced their maximum level of pain. It’s not surprising that China would now take measures to ease the situation. For an emerging country like China, very high inflation could lead to the trouble of riots. On the other hand, if inflation is too low, their companies would have much lower profit margins. If we take note, the export prices from China have significantly dropped, posing a risk of deflation to the global economy. This is because the pace of economic activity has been very strong in the past decades. Therefore, when China fails to stimulate this pace, prices tumble, which in turn threatens their own profit margins and economy.

Yields are now expected to decrease, which could potentially create an ideal situation for the Fed to manage inflation. As I have demonstrated in the past, if policymakers are able to sustain this situation (not necessarily low rate), it could result in the most optimal growth.

There’s no need to look beyond the GDP target provided by the Atlanta Fed. Let’s avoid going against the Federal Reserve’s stance.

I believe one of the most crucial factors here is China’s ability to sustain deflation, which would subsequently enable the US to keep their long-term yield stable, as observed in $TLT.

In the final moments, it’s anticipated that the DXY will experience further decline. If this is confirmed over the next few days, it would indicate a strongly bearish outlook for the USD. This reasoning becomes more logical when considering that China manages to revitalize at least a portion of its economy, consequently boosting the growth of emerging economies. These economies have been relatively subdued in the past few years due to inflation.

We have observed that numerous other currencies have undergone a decline of nearly 50% over the last decade. USDCNY, on its own, has reached its highest point since the Global Financial Crisis in 2008. This situation has the potential to result in significant price increases or a resurgence of inflation but manageable (6+ months in advance thesis), provided that they manage to rejuvenate their economy. In such a scenario, before inflation strikes too high, there is a possibility of experiencing a Goldilocks / soft-landing moment, a moment where the economy performs better than the level of inflation.

During Jackson Hole, Powell mentioned that the Fed is navigating by the stars under cloudy skies. We interpret the stars as the R star. “R* is the real short term interest rate that would pertain when the economy is at equilibrium, meaning that unemployment is at the natural rate and inflation is at the 2 per cent target. When interest rates are below R*, monetary policy is expansionary and vice versa.” . Anticipating low inflation until that point and China’s contribution to global growth, we rather foresee a shift towards more expansionary policy (fiscal or monetary).

If this trend continues to perform positively, I anticipate witnessing a “teaming up” between US and China which could change everything, a more pronounced and accelerated increase in risk assets, often expressed as “higher further faster.” It’s possible that we might encounter the swiftest growth in risk assets over the next few months, resembling something akin to the rally observed in 2007-2008, yet with a more robust fundamental foundation (thanks to 5.5% Fed rate).

In the previous month, we accurately forecasted a correction after being fully leveraged since the beginning of the year. This correction was short-lived, lasting for approximately 3 weeks. After that period, we began to reinstate our full leverage, in line with our thesis here.

Please note that all ideas expressed in this blog and website are solely my personal opinions and should not be considered as financial advice.

2023-08-07

Bonds, Investments

Dead Reckoning

Dead reck·on·ing is the method of determining one’s position, particularly in the financial market, by estimating the direction and distance travelled for each position, instead of relying solely on one position or widely known economic indicators. The chaotic yield curve results from a collection of misguided policy decisions, and we are unable to distance ourselves from the consequences of our previous actions. If this destiny were to be scripted, does one life hold greater significance than the others?

Upon examining the present yield curve, we have pinpointed three irregularities, based on their 5-year belly:

high short term yield ~ up to 2y ~ abundant liquidity – flat yield momentum
7-10y ~ $TNX ~ weaker commodity and Emerging Market (EM) growth – bearish yield momentum
high long end yield, 20+y ~ $TLT ~ long end collateral risk – bullish yield momentum

As the ETF $TLT is currently approaching its maximum pain point around 90, as part of its final destination in wave 5:

Bond holders are once again nearing their maximum pain point, resembling the situation at the end of 2022.

Given the weakness in commodities and the emerging market space, along with the TNX also being weak,

Short-term assets are now susceptible to profit-taking. Are you not entertained with the QQQ rally?

I’m not stating that a bond crash is certain as we closely observe TLT. What I want to highlight is the precarious point for possible profit taking. The Treasury itself has acknowledged this risk for the coming year with its buyback program. They’ve indicated a gradual start next year, indicating confidence that this matter may not escalate into a bigger concern just yet. We might anticipate the longer-term segment to be affected sooner.

This aligns with our observation from the previous month regarding the interaction between BTFP and Discount Windows.

Upon conducting a thorough analysis of a substantial number of mortgage holders who have sizeable mortgages from the last five years, a pattern has emerged. Many of them are now either selling off their equity portion or increasing their borrowing to maintain ownership of their property. This is driven by their anticipation of lower interest rates in the near future, whereas my perspective suggests a likelihood of higher and more persistent interest rates in the coming years.

The bond industry is currently experiencing a comparable situation. This situation is likely to provoke concern among bond holders, prompting them to urgently seek protection and engage in more comprehensive risk management. A significant area of concern is the vulnerability of short-term assets that have shown impressive performance over the past six months, particularly the QQQ. An evident illustration of this is the disrupted trend in AAPL and double Quarter over Quarter (QOQ) performance in NVDA’s revenue and earnings consensus expectation. Achieving such results in such a short timeframe (one quarter) seems highly improbable.

As we had anticipated in the article from the previous month, we are currently foreseeing an unexpected increase in inflation. This presents a less than desirable scenario, especially given the fact that the Bank of Japan (BoJ) has adjusted their Yield Curve Control (YCC) from 0.5 to 1.0% on their 10y yield, indicating reduced support for Treasuries.

Upon examining the Q4 treasury issuance schedule, the planned issuance of $338 billion appears to be considerably higher than what is typically observed.

The significant deficit primarily stems from a substantial decline in tax revenue.

BRK has also disclosed a significantly larger investment in the bill compared to fixed income.

Because of the elevated risk conditions, we have chosen to eliminate any leveraged positions by capitalizing on robust financial report events, securing profits to the fullest extent possible. Additionally, we are closely monitoring for any indications of a market correction as the month draws to a close. Furthermore, we are employing various strategies to safeguard our positions from potential downsides associated with our equity holdings.

Please note that all ideas expressed in this blog and website are solely my personal opinions and should not be considered as financial advice.

2023-07-15

Bonds, Foreign exchange, Investments, Technology

American Made

Based on an unbelievable true story, America achieves remarkable economic growth during a period of global tightening of the US dollar. This favourable situation/story should be safeguarded at any expense, while also ensuring a smooth landing for intelligent financial investments.

We have welcomed over 80% of fund allocation to America since the beginning of the year, based on our thesis. Our belief was that America would achieve exceptional success with a peak in interest rates, causing global currency to tighten and creating a strong demand for USD to fuel economic growth. This thesis is based one of our foundational money principles.

Firstly, let’s examine the growth of GDP. The US GDP is currently expanding at an unprecedented rate. According to our theory, this is a highly valuable asset that must be safeguarded at any expense, disregarding any other conflicting economic indicators. This is especially crucial considering the presence of smart money that has become trapped within the US economy, which we will discuss further later on.

It is not surprising that over the past few decades, the US had experienced a shift from a predominantly industrial and manufacturing-based economy to one focused on services and finance, with a significant portion of manufacturing activities being outsourced to China. However, since 2022, there has been a substantial resurgence in manufacturing and industrial activity, particularly in sectors related to sustainable energy and artificial intelligence, such as electric vehicle (EV) manufacturing, EV infrastructure development, battery production, and computing chips. These industries have received substantial support from the US government and are showing strong growth, which should be sustained and protected at all costs.

As we have previously highlighted in our articles, these sectors have the potential to generate a new economic capacity exceeding 10 trillion US dollars.

While the manufacturing and industrial sectors may not directly lead to job growth, the substantial government support they receive, particularly in terms of financial investments, has had a positive impact on job openings in other sectors. This support has helped boost employment opportunities in industries such as hospitality, finance, and services.

To ensure sufficient liquidity for economic growth in an era of low new bank loans due to high interest rates, the main source of liquidity is currently the fiscal deficit, which has reached 1 trillion dollars per year. This is one of the main reasons why we significantly increased our investment in the big QQQ portfolio by almost 10 times in January. This decision was influenced by the portfolio’s significant cash holdings in the form of treasuries, which provide substantial benefits.

The robust growth of the US economy poses challenges for the rest of the world and its own long-term yields. The US dollar was in short supply until US leaders visited China to negotiate undisclosed additional agreements. As a result, business and mortgage rates are expected to remain elevated for an extended period. While high interest rates can have negative implications for businesses and the economy, as we previously mentioned in our article last month, it can be seen as a positive factor. The scarcity of global funds is preventing excessive concentration in long-term investments such as bonds and instead supporting short-term economic growth. This approach is necessary as allowing money to become too abundant could lead to the resurgence of inflationary pressures.

The “smart money,” represented by the RRP (Reverse Repurchase Agreement) and Bank Reserve, is currently focused on short-duration investments. I suspect that these entities will begin to transition into shorter-term debt, a phenomenon that is currently unfolding. The Treasury General Account (TGA) is essentially funded two-thirds by RRP and one-third by Bank Reserve, with less other sources of funding. This leaves the decision on the duration in the hands of the Treasury. This shift is expected to increase the price of high-risk assets, such as shares and commodities. As the economy approaches its peak growth later in the future, short-term investments are anticipated to benefit the most from anticipating the Federal Reserve’s interest rate changes.

The inflation figures, particularly the Consumer Price Index (CPI) and the Producer Price Index (PPI), have experienced a significant drop. However, this decline is primarily attributed to technical factors. In early 2022, inflation numbers rose significantly due to massive support provided to the economy, as discussed earlier. Given the rapid growth at that time, it became challenging to achieve comparable year-on-year rates, resulting in a narrow window of opportunity to boost the flow of money into the economy. As mentioned previously, it is expected that inflation will remain relatively stable until early 2025. This view is also supported by the increase in the debt ceiling to around $35 trillion until approximately March 2025.

In order to mitigate the risk of uncontrollable inflation, similar to what we have observed in the balance sheet of the European Central Bank (ECB), the Federal Reserve should also indicate a lower balance sheet through the use of QT. However, to avoid the negative effects of reducing the balance sheet, as we discussed in our previous article, I expect Treasury to focus on short-duration investments rather than selling long-duration assets and Federal Reserve to not shuffle around balance sheet duration. Participants should also then support long term recycle into short term. This scenario is supported with fact that higher rate Bank Term Funding Program (BTFP) – collateral being valued at par, unlike Discount Window – collateral being valued at market, is being held up within its capacity to 2T$. It tells importance of credit accessibility and risks for longer durations. Once again, this aligns with our expectation to facilitate the smooth transfer of wealth for the smart money in the future.

Within the limited windows of supportive environments to soft land the economy, we can observe several supportive factors:

Inflation numbers (CPI and PPI) showing a decrease due to technical reasons.
An increase in the debt ceiling/deficit, serving as a means to control the flow of money.
New short duration treasury issuance expectation to counteract the impact of Federal Reserve quantitative tightening (QT).
Strong employment figures – “any sector, regardless of manipulation or guess”.
Strong backbone banking sectors outlook and financial figures – “through possibility of the Fed balance sheet holding and deficit subsidy”.
Less effort for the Federal Reserve to shuffle around balance sheet duration.

Given these circumstances, it is anticipated that Wall Street should continue to experience upward momentum until the completion of these money flows, at least over the next few months. Therefore, based on our risk assessment, we have decided to maintain our double offensive leveraged positions. Please be mindful of the subtle differences in risks and conflicting economic indicators within our approach to my money theory.

In support of our thesis and interpretation of the current situation, we believe that the comments made by Chris Waller may further reinforce our perspective.

Please note that all ideas expressed in this blog and website are solely my personal opinions and should not be considered as financial advice.

2023-06-12

Bonds, Foreign exchange, Investments

The Bill and The Bond

JEKYLL: “Can’t you see It’s over now? It’s time to die! HYDE: No, not I! Only you! JEKYLL: If I die, You die, too! HYDE: You’ll die in me I’ll be you!” – Jekyll & Hyde – Confrontation

A Treasury bill (T-Bill) is a short-term debt obligation of the U.S. government. It is backed by the Treasury Department and has a maturity period of one year or less. On the other hand, a T-Bond has a much longer maturity period, typically 20 years, or even longer. It is important to note the differences between these two types of government debt. Although they are associated with the same entity, the U.S. government, they have significant distinctions in terms of risk.

(1) Due to their shorter maturity period, T-Bills, such as those with daily maturities like RRP, offer more precise returns and have a more controllable level of risk to predict. If both the T-Bill and the 2T$ RRP have reached maturity at the same time, the savings of 2 trillion dollars from the RRP could be used to quickly replenish the T-Bill in case its interest rate suddenly increases.

(2) T-Bonds with longer maturities are more affected by inflation since their holders have to wait until their maturity date to receive their returns. In contrast, T-Bills with shorter maturities are less affected by inflation because their holders can sell them the next day. The difference in maturity time (ΔT) significantly impacts their vulnerability to inflation.

These distinctions become even more important when considering the topic of inflation and building upon our previous article. In early May 2023, inflation started to make a strong comeback. Soon after, the Reserve Bank of Australia (RBA) and the Bank of Canada (BOC) raised their rates, and it is expected that the Federal Reserve (Fed) will follow suit with a surprising rate hike rather than maintaining the status quo. This change in narrative from lower to higher rates has the potential to significantly affect the future trajectory of interest rates.

If we look back at December 2021, interest rates were beginning to anticipate higher inflation, which proved to be true in the following 3-6 months. This anticipation caused a decline in the QQQ rally. Interest rates increased from near zero to their highest level in over 5%, accompanied by a decrease in the supply of M2 money. It is worth noting that the performance of QQQ is not only necessarily directly related to lower inflation (such as the 10-year Treasury yield or TNX), but rather more influenced by factors such as liquidity levels and the ability of the Fed and the Treasury to inject money into the financial systems.

Last year 2022 M2/QQQ correction event was the outcome of significantly higher inflation, which caused limitations in the money supply systems and consequently led to a correction in the QQQ (an ETF that represents the Nasdaq 100 Index, commonly traded). The question now arises: has this correction in the M2 (a measure of money supply) ended? In January 2023, we threw idea for the QQQ (as we typically do, leading 3-6 months), making a substantial investment in it and completely divesting from commodities in favor of the QQQ and Treasury Bonds (TBonds). However, approximately two months ago, as mentioned in our previous article, we noticed the resurgence of increased inflation, which made us question our position in TBonds due to their high sensitivity to inflation. Consequently, we shifted all of our TBonds back into a commodity position, leaving us fully invested in both leveraged QQQ and Commodity, double offensive positions since last month.

Now, something very interesting comes into play if we are concerned that raising the debt ceiling and issuing new debt will lead to inflation and correction, like in year 2022 above. Treasury Bills (TBills) are not as affected by inflation as TBonds, this is the magic potion! This phenomenon is quite remarkable considering that both are U.S. government bonds. While one is highly impacted by inflation, the other is not affected to the same extent. As the M2 money supply mentioned earlier aligns with its long-term trend, it is expected that the U.S. authorities will allow for more money and liquidity in the system. This observation also supports our previous article, which highlighted the increasing correlation between the need for higher inflation and a rally in the stock market indices. Given the limitations imposed by higher inflation and the absence of any visible peak, the authorities are left with limited alternatives and should consider turning to Treasury Bills due to the reasons mentioned above. It is worth noting that unemployment, which is an important gauge of inflation, does not indicate that inflation has reached its peak.

The difference in duration between Treasury Bills and Treasury Bonds can have a significant impact. Increasing the money supply through Treasury Bills will not disrupt liquidity as much, especially since their maturity is closer to the existing $2 trillion Reverse Repurchase Agreement (RRP) with an overnight maturity. When auction becomes a concern and 1 month rate is higher than the RRP rate, it could use the $2 trillion RRP facility.

Both the Treasury and the Fed still have the ability to influence the market through their actions:

(1) The Treasury can choose to allocate the issuance of the new 1-2 trillion $ between Treasury Bills and Treasury Bonds. Increasing the issuance of Treasury Bonds would lead to higher long-term interest rates or potentially more inflation, but much less with the Treasury Bills.

(2) The Fed still has the authority to implement Quantitative Tightening (QT) measures, raise interest rates, or take additional actions as a lender of last resort, which could affect its balance sheet. A higher balance sheet could provide additional support for the ongoing market rally.

The first point mentioned is related to the current hot topic of refilling the Treasury General Account (TGA).

The current debt has been growing at a rate of $5 trillion over three years, which translates to an annual increase of at least $1.7 trillion, or a minimum of 5.5%. Despite the current rate of return being 5%, it is still challenging to sell the debt to private entities. Therefore, I believe that the interest rate should exceed 6% before we can observe inflation becoming controllable and starting to decline. The Treasury Bills should have no difficulty covering the $1.7 trillion with the $2 trillion Reverse Repurchase Agreement (RRP) facility on its side. I anticipate that the RRP funds will start flowing into the Bills once the rate surpasses 5.5%, or if there is an unexpected increase in the Federal Reserve’s rate. There is also an argument suggesting that there is a possibility of recycling expired long-term debt into shorter-term debt, which could support/lessen effect of new Treasury Bill issuance.

The recent debt ceiling deal should have shifted the trajectory of future interest rates from decreasing to remaining higher for a longer period. Based on the numbers mentioned above, there shouldn’t be any issues navigating through the year 2024, unless a major unforeseen incident occurs, which is currently unpredictable.

Although the recession and inverted yield curve are signalling high-risk conditions, they should hold no power against the sheer amount of money available.

Please note that all ideas expressed in this blog and website are solely my personal opinions and should not be considered as financial advice.

2023-05-22

Foreign exchange, Investments, Property, Shares

The Empire Strikes Back

“Try not. Do or do not. There is no try.” —Yoda, Star Wars Episode V: The Empire Strikes Back

Like TNX, TLT also exhibits weaknesses, indicating that the inflation we have overlooked might resurface. The intensity of this resurgence is uncertain and may only become clear once the amount of the associated debt ceiling is determined in the coming weeks. This supports our previous articles and beliefs from last year, suggesting that inflation will persist at a high rate.

The high rate undoubtedly has caused a substantial fiscal deficit, and reversing this trend in the next few months is likely to be challenging. Federal Reserve members have also acknowledged that it is premature to claim victory. The current concern revolves around the impending exhaustion of the debt ceiling, which is projected to occur around June 9th, 2023.

On a positive note, M2 is back on track. M2 is expected to increase once again, but not immediately. Our previous analysis demonstrated that relying on year-over-year M2 growth over the past year is an inaccurate indicator. YoY growth does not provide a reliable indication of M2 behavior. With the high rate in place, money growth is anticipated to resume with reduced inflationary pressures. Additionally, recessions tend to occur when M2 falls below its trend, and the end of a recession typically coincides with a significant increase in M2.

Therefore, we believe that liquidity is currently normal, unless M2 continues to decline below its trend. If a recession were to occur, it would likely come to an end once M2 starts to increase significantly.

The Federal Reserve emphasizes that it is premature to consider a pause. Consequently, a pause in interest rate adjustments is not currently observed, and it may be several months before any rate cuts are implemented. A rate cut would only be considered in the event of a significant market force, such as a force majeure. It should be noted that the bankruptcy of small banks alone is not sufficient to qualify as a force majeure that would warrant a change in the rate trajectory. I can provide further explanation on this topic if desired.

Based on CPI expectations, we anticipate a return of inflation volatility (likely to be mild) over the next six months before it subsides again.

This aligns with the European Central Bank’s projection of raising rates towards the end of this year. Additionally, the European index continues to deliver impressive returns.

A reduction in rates may occur once the expectations regarding net global CPI are met or when net global CPI is officially declared to have concluded. In such a scenario, I would anticipate a potential resurgence in global CPI, which would necessitate keeping the rates elevated until we are genuinely certain that the threat of high inflation has subsided.

Emerging markets, which are closely tied to commodities, appear to have experienced a significant stabilization since April 2023. However, it is important to exercise caution, particularly in light of significant changes in the debt ceiling.

The lack of correlation between interest rates and the index reached its peak in November 2022. However, with the correlation now expected to increase in the coming months, both variables will likely move in the same direction—either both moving up or both moving down. Taking into account all the indications mentioned, it is anticipated that inflation will make a comeback, accompanied by a rise in risky assets, primarily driven by commodities.

Since our decision in January to shift our overweight position from commodities to US technology leaders and Treasury Bills, commodities have experienced a correction of 10-15%, while US technology stocks have surged by 40-65%. This represents a significant outperformance of 50-80% compared to the overall market return, achieved in just five months. Given the substantial spread within this short timeframe, we have decided to reallocate some funds back into commodities to mitigate the volatility of our portfolio returns. This adjustment does not signify a strategic change but aims to smooth out the portfolio’s performance.

We will closely monitor the anticipated resurgence of inflation and strive to eliminate any remnants of hidden inflation definitively within the next six months, even if it requires employing drastic measures such as an “atomic recession” scenario, which unfortunately may have severe consequences. We hope for divine intervention to protect us all from such a catastrophic event, similar to the Noah moment.

Please note that all ideas expressed in this blog and website are solely my personal opinions and should not be considered as financial advice.

2023-03-19

Beautiful Sunset

It’s time for us to shift our focus solely to short-term investments and avoid any potential long-term investments. As the sun sets, we’re already ready to reallocate any possible long-term investments to prepare for a long night’s sleep, as thieves are poised to steal everything overnight.

Recession is what gives investment meaning. To know our days are numbered. My investment is now mostly short term or strategic blow off.

Our solid view since early January 2023 has prepared us for this. The peak rate is pricing in starting from this month in March 2023, and money should start to concentrate on short-term investments. As we mentioned in previous articles, we have removed almost all commodity investments since they are most sensitive to long-term investment. Today, we can see that banks are exposing their fragility to medium-term investment as well, due to the same issue. This is a solid confirmation that our current strategies are correct.

Learning from medium term view investment banks:

Banks have categorized their investments into HTM (Hold-To-Maturities) and AFS (Available For Sale).
Most of HTM investments were made when the rate was very low, mostly to toxic MBS securities, resulting in mostly long-term duration while AFS investments are of short-term duration.
The Fed and government have given up their position to help avoid bank runs and more systemic issues. This is very important because market participant number one has disclosed their position.
In reality, this is actually helping AFS (short-term duration) to avoid their fire sale rather than fire-sale of their HTM (long-term duration). Why? Because the HTM price is already so low, and there’s no incentive in the market at the moment to attract their demand during this fully inverted yield.
The troubled banks are actually getting more difficult because they have to continue holding their HTM (1.3%) with the current high rate (4.5%) and continue taking care the loss with new loans. Therefore this Fed injection doesn’t really make the small banks better. They are just getting more loans/liquidity at par value with the current high rate, to keep their HTM until maturity.
This is different from QE in terms of: (1) yield curve (2) actual impact on investment. For (1), in QE, the yield curve is steepening that the Fed could give a lower rate (to zero) to invest in purchased assets. Current inverted yield made it impossible because central banks only have control over short-term rates rather than long-term. For (2), as mentioned above, this injection is more beneficial to short-term AFS to avoid their fire sale rather than selling their long-term HTM.
This situation also has made it even more difficult for banks because the market knows that banks are trying to unload their medium-long-term assets and therefore will not be interested in taking other bank HTM without any deep discount (30-40% loss).
Due to the concentration on short-term investment, we expect there will be an asset misallocation issue (asset blow off). Due to all factors mentioned above, at the end, the only way to solve the issue is to give general recession to the market.

How much does it cost to undo this curse? The 2y cost to sweep has spoken.

Sustainable Energy

Let’s keep our horror story aside and look at the brighter side for a moment. Why was I so excited in early January 2023 with real numbers in AI (Artificial Intelligence) and Sustainable Energy? I would speak about Sustainable Energy economy at this opportunity because their numbers are real important.

Our energy economy is so wasteful. Two-thirds of the energy generated is wasted.

Sustainable energy economy is still left behind and has a lot of capacity and offers much higher efficiency to eliminate the above waste.

The amount of investment capacity is $10 trillion in 20 years and could immediately give high value.

Ten megawatts are estimated to cost $12.7 million (~65% margin). We would need 240TW. The available economy capacity is 240,000,000 / 10 x 12,000,000 $, and we could only target a small portion of it to fix the current economy issue.

As mentioned previously, our economy has too much short-term liquidity, which has outpaced long-term capacity and return (inflationary). This sustainable economy could actually solve the problem to reallocate this excess into long term investment, but it will require huge amount of money in very short time to incentivize the movement, which could only come from the government and central banks.

Looking at the commodity side, $10 trillion worth of metals are needed until 2050. Therefore, we will return our 95% commodity reallocation back once dawn has come.

Treasury Bonds

I have overweighted too much on equities since early 2020, no secret due to the massive GFC-Covid recovery. Since then, early 2023, we have reallocated 40-50% of our portfolio in short-term treasury bonds (3-5 years maturity and returning about 5% pa) at their face/par value due to the scary inflation narrative. Luckily, the world is with us, and we saw massive recovery in January 2023. I became more confident and tend to maximize leverage on it. My main reason was to target the next 6-month inflation peak, around June 2023 or so.

Timing Statistics

Below are what I think is very important statistics:

100% probability of bear market to bottom after the start of a recession.
Bear market to bottom about 5.3 months after recession start.
81.3% probability bear market ends about 13.6 months after the last rate hike.
100% probability bear market to recession start at about 6.2 months.

Therefore, based on these statistics, probability-wise (60-80% probability):

If the last rate hike is in Feb 2023, the bear market tends to end in April 2024.
The recession will start about 5.3 months before April 2024 = Oct 2023.
The bear market will start about 6 months before Oct 2023 = May 2023.

It’s my view that the market is supported by money, either from the central bank or fiscal and nothing else. While the Fed is only able to reduce $600 billion of balance sheet, it’s interest payment from fiscal about $900 billion that keeps this market floating.

It’s then the market decides how far interest rates can go up. The issue that I see here is that even though economists say the Fed is reducing the balance sheet too slowly, it’s my view that the Fed is actually selling the balance sheet faster than the market can afford. The Fed has really tried hard to reduce inflation, not through the use of higher interest but the use of more balance sheet QT.

This is where I have to look into Fed balance sheet selling:

The Fed couldn’t sell the MBS (Mortgage Backed Securities) because it’s toxic debt with a very low rate, around 1.3% pa.
The Fed balance sheet reduction is highly concentrated in the short term.
The concentration of the Fed’s selling is actually between 1 to 5 years of maturity. Please remember my old theory that central banks always transfer wealth to their 8 big banks through front running, using any event of QE (Quantitative Easing) or OT (Operation Twist). I expect a similar case to occur here.
I may estimate that this biggest belly will expire around the end of 2024.
The current 5-year rate yield is about 3.5% pa.

This seems to support our previous conclusions:

We may have a lot of maturity around the end of 2024.
Six months leading to it is when the recession will end, ~ April 2024.
It means there will be less money injection towards April 2024, which could probably start from the recession in October 2023.
The Fed is going to keep interest rates high and could probably overdo it by May 2023.

We can see that the Mortgage-Backed Securities (MBS) have caused trouble not only for the Federal Reserve but also for small banks like SVIB.

JPMorgan estimated that the Fed will require around $2 trillion to combat this effect, which could increase the current debt from $8 trillion to $10 trillion. Historically, the market crashes once the Fed’s balance sheet grows near the previous high (9T$). If the market is unable to absorb more than $1.7 trillion from the $2 trillion to normalize the long maturity issue, with its interest being only $100 billion per annum, I would expect severe market pressure. This is another reason why I see at least a disinflation, and its risk is a very severe impact on commodities since commodities are high-risk assets. If the Fed reduces rates, it would only hasten the crash because the interest payment is going down massively while the market still needs to absorb a high amount of long maturity loss.

So where does the money go? In my opinion, the money will eventually go into Treasury bills with lower maturity, 1-5 years. This is why I have massively bet on Treasury bonds with maturities of 1-4 years with maximum leverage at the beginning of 2023. If the question is whether I am worried about the possibility of additional $2 trillion supply of low maturity debt, I am not. It’s because it’s only 6% of the total US debt and we have RRP+reserve. Eventually, when the market stalls, the quickest way to save financial systems is by cutting the rate, which will eventually expand the central bank quicker and hasten the market crash. During an event where the central bank cuts rates, I estimate that they will make massive purchases of our short-term duration, because the yield curve has been severely inverted.

The sunset can be a scary moment when you realize that your days are numbered and there is probably no escape.

Please always remember that any ideas on this blog and website are my own personal opinions and are not financial advice.

2023-02-19

My Pure 2023 Imagination

Powered by ChatGPT and Dall-E

I was busy overhauling my investment strategy in early January 2023 to ensure it aligns with reality. In just two weeks, I increased my investment allocation into the major sustainable energy + minor electric vehicle (EV) and artificial intelligence (AI) space from 5% to 45%, a nine-fold increase.

Here are my points:

Set your sights high, but be prepared for the risks of disappointment. Don’t limit your dreams.
Everyone has their own imagination, and no one has the right to interfere with it.
If your dreams don’t become a reality right away, keep striving. Remember, Rome wasn’t built in a day.

Hold your breath
Make a wish
Count to three

Come with me and you’ll be
In my world of pure imagination
Take a look and you’ll see
Into my imagination

The world can be cruel and intimidating, preventing us from having bigger imaginations. I believe that imagination and its realization is a fundamental human right. Everyone should have the opportunity to pursue their greatest aspirations and turn their big dreams into reality. Don’t limit yourself by starting with small dreams. Instead, dream as big as you can afford their risk of disappointment.

My imagination begins

… We’ll begin with a spin
Traveling in the world of my creation
What we’ll see will defy
Explanation

I believe in the creation of new value and wealth through evolution. When something evolves successfully, new forms of valuation and wealth creation are born, such as the oil boom, information technology boom, derivative boom, debt boom, currency boom, and more. This is why I am excited about my vision for the future of Artificial Intelligence and Sustainable Energy.

I try to invest wisely rather than impulsively. In December 2021, I sold all my investments because they contradicted my investment principles, mainly with regards to my yield and inflation expectations, which surprisingly came as expected.

The Nasdaq fell throughout the year of 2022 due to expectations of higher yields (6 months leading).
Inflation increased rapidly throughout 2022.
The Federal Reserve raised interest rates at the fastest pace in history, leading to a drop in risk assets.

My vision of 2022 in one image @ December 2021

As I wrote earlier in the year, I was disappointed with the yield expectations and progress of sustainable energy. They were heavily corrupted, with many ESG funds becoming involved in fraud, and early commercial cycles of AI failing to deliver as expected. I would like to see the glimmer of commercial value before I invest heavily. However, I still believe that the visions for AI and sustainable energy are pure, real, and true. The issue was not with the concepts themselves, but rather with the people and the yields who attempted to exploit them.

This year, since my future yield expectations have changed, I repurchased all my investments, some at a multiple amount and much lower price. However, this doesn’t necessarily mean that I think they will skyrocket in the near future. My investment philosophy still anticipates high yields and high inflation to persist, but the current situation is different than before.

My expectation is for a sticky inflation target of 3%-4% in the next 12-18 months. This should lead to the most optimal GDP and equity growth, as long as it is well supported, until GDP and equity become significantly overvalued.

Inflation is expected to remain high, around 3-4%, over the next 12-18 months. This level of inflation will be sustained primarily by fiscal ease.
An inflation rate of 3-4%, higher than the Federal Reserve’s 2% target, is likely to result in the most optimal GDP growth.
Inflation rates below 2% may lead to unnecessary disinflation risks.
Inflation rates above 5% or below 1% may result in much higher financial risks.

In simple terms, keeping inflation at 3-4% (a relatively high rate) can lead to the most optimal GDP growth. At some point, when GDP growth reaches its maximum output, I believe that the Federal Reserve and Fiscal will halt this engine, causing inflation to immediately fall back to 2%. We can expect this landing to be an unpleasant experience. However, for now, my focus is on opportunities for high GDP growth or high equity returns.

Imagination is becoming reality

… If you want to view paradise
Simply look around and view it
Anything you want to, do it
Want to change the world?
There’s nothing to it

In the past, people used to say that it was impossible to drive a battery-powered car, a self-driving car, or a car powered by solar energy, or to become wealthy, for example. Such judgments were like social bullying. But sorry folks, these things are becoming a reality.

Take a look at Dall-E, for example. Many people have misunderstood AI. Images created by AI are not just sourced from an image database or manipulated from existing images. They are generated from a latent space, in real time. The images created by AI have never existed before. We simply need to describe our imagination in human language, such as English, and the AI will bring it to life. The more precise the description, the better the images will match our imagination. They have already made 2D and 3D images a reality. I have no doubt that they could create a movie from a script. After all, a movie is just a series of 2D images. In the future, I believe that AI will be able to turn any book into an attractive movie.

Twenty-five years ago, I worked as a brand manager. It would take us weeks to create a compelling marketing message, and months to produce a full TV advertisement. Advertising and marketing is a multi-billion dollar industry, as evidenced by companies like Google. AI has the potential to help us craft the most compelling advertisement message or image based on brand management imagination and consumer statistics. This would save millions of dollars and reduce months of work into just hours, allowing for faster decision making.

However, there may be some loss in translation in the communication between humans and AI using the English language. In the future, direct communication between the brain and AI, such as through Neuralink, may eliminate this miscommunication issue. This could lead to the development of a new universal human brain language that could enable communication of any human language with AI language without any miscommunication.

How about BioGPT? It could speed up biomedical research from years to just hours. GPT will continue to discover any other industry. They could store any knowledge library and use them to speed up discovery beyond superhuman with limitless nodes.

Rome wasn’t built in a day

Let’s step back from the euphoria and understand that AI is not a new concept. It has been around for decades. Twenty-five years ago, I wrote my bachelor’s degree thesis using a simple trained array of noise canceling. This array was able to adaptively learn and recognize frequencies in the domain. I was challenged to run a primitive AI on an old Intel 386 using Assembly language, but it worked. It worked so well that it was able to reduce noise up to 40 dBs, which was above 90% of simple noise. Of course, today, learning arrays are getting bigger and bigger. As a result, we can train these brain cells like our own brain. For example, in our brain, we don’t have millions of chicken images, but we can imagine millions of different chicken images with additional details. This is the same with AI learning. They don’t memorize exact images, but they learn what the image looks like and then draw based on our instruction or imagination.

I also believe that inflation will remain high. High inflation and high yield will limit the speed at which our investments will return. If these conditions do not materialize soon, we should continue to strive towards our goals. Rome was not built in a day. If they suddenly materialize and lead to euphoria in the market, we should remember that Rome was not built in a day and be prepared to sell our investments. There may only be two high-probability options: lower return or a boom followed by a bust. I am leaning towards the latter, where we may experience the highest boom and the worst bust within a period of 12-18 months.

Vision Driving AI

This has always been my belief: that vision-based AI could help humans immediately. Don’t confuse it with many autonomous driving systems, as they are NOT vision-based AI. Only vision-based AI is able to handle many different conditions, just like our eyes and brains can. It could immediately reduce human errors in driving and help optimize productivity. While it may still be far away in the future, perhaps 5-10 years or so, to have it running perfectly, I believe that making early investment in it could benefit my portfolio with a fast return. While this AI kid is improving its image labeling, let’s keep it in “deferred”.

Sustainable energy

Given that inflation is consuming most of our savings these days, we should focus on the biggest consumer of it, which is energy. Last year, we talked about the housing component and decided to reduce our property investments by 1/3 due to our belief that inflation and interest rates will remain high. Over a long period of time, high interest rates with no asset price increase will significantly devalue property investments, especially for those with high loan-to-value ratios (LVRs), such as principal place of residence (PPOR), where tax benefits don’t contribute to their downfall. Thus, I believe that in order to protect society from energy inflation, sustainable energy would benefit them.

When a coal-generated electricity plant produces a certain amount of energy, but only 50% of it is consumed by manufacturing and households, the plant must either waste the excess or reduce its output. This is where battery-powered electricity storage comes in. Batteries are now capable of servicing entire cities and factories, ensuring less waste of electricity generation and a higher level of uninterrupted availability. Moreover, households are now able to generate electricity from solar power and sell their excess electricity to the grid at the best time when electricity rates are highest. We have seen homes and universities become sustainable in terms of electricity consumption and even generate extra income. With the evolution of battery technology and sustainable energy, it is all becoming a reality.

What is the catch?

There are two potential issues to consider in my opinion: (1) the possibility of sticky high inflation and high interest rates, and (2) the cost of materials such as lithium, which could limit the evolution of battery technology. While there are significant efforts underway to increase the supply of lithium, it may still be some time before our thesis is fully realized. ARK has predicted that lithium prices may decrease by as much as 37% as supplies increase. Ultimately, the boom-and-bust demand cycle will likely provide enough materials for our imaginations to become reality. Similarly, yields may also decrease over time, with or without a market crash.

My imagination of Disinflation

It’s no secret that we will experience the most challenging time in our investment lives starting in the second half of the year. In my opinion, the market should start pricing in this event from today. This was due to central banks’ late response to combat inflation. To avoid structural damage to the economy in the long term, they had to raise interest rates at the fastest rate in history. As a result, the current short-term high interest rate is too high, making long-term investments almost nonsensical. If the question is whether there will be many bankruptcies, it’s because this event has not yet inverted the 10-year to 30-year yield curve. This means that companies and mortgage holders are still holding and expecting lower rates soon.

In our thesis, business operations and investments should not be expected to afford a 5% base rate in 5 or 10 years. Most mortgage holders will not be able to afford 5% in 5 years, no business operation will be able to pay 5% in 10 years, and not many investments are returning better than 5%. Eventually, one day inflation will give up, either with a crash or not, and central bank rates will return to normal. Therefore, in my opinion, while market participants are anticipating deflation, I see disinflation.

To put it simply, we believe that achieving a soft landing for the economy is not an easy task. Economic theory may appear simple, but it is not so in reality. The theories have been corrupted and market participants react to any upcoming events, which change the outcome of economic theory. The world’s wealthy individuals will not allow disinflation to impact their wealth. Disinflation can cause a significant decrease in their wealth at some point. There has never been a time in history when a high rate of 5% has gone down to 2% without a significant risk like a crash. This has been made clear by El Erian recently.

If the rate goes down with more money supply, we will see more business and economic activity. However, since we are combatting inflation, we are lowering the rate with less money supply, which leads to deflation. Disinflation is good, but deflation is not. Most market participants agree that deflation must be avoided and will use their influence to get more money supply for themselves only. Therefore, we need to be careful and selective in our investments and focus on leaders who have low debt and are experiencing growth.

We may experience an abundance of job openings, but not enough company progressing with these jobs. The economy is trying to ramp up activities, but unless there is more money infused to avoid deflation, job openings will not lead to real economic activity. We should expect only a limited amount of quantitative tightening (QT), up to the limit of balance run-off.

Therefore, in our investment thesis, we will be very selective and only invest in leaders. Eventually, inflation will give up, either with a crash or not, but only those leaders who have prepared with low debt and continue to experience growth will survive. Since we are trying to softly land the ships, providing enormous support to some growing parts of the economy will require a lot of money supply, which means high inflation will likely be sticky and high rates will continue until next year. Our investment vehicles should have:

less debt or no debt
high operating margin
strong revenue growth

Commodity reallocation for now.

Commodities have been our most overweight investment since 2017, returning us more than 300% in the past three years, following the commodity cycle since 2015. However, their volatility has been significant due to issues in China, including (1) a relentless COVID-19 economy shutdown, an aging population, and a property investment hangover of around 76 trillion dollars, and (2) the sensitivity of inflation to their large population, while at the same time carrying decades of high GDP growth. Commodities have performed tremendously since 2017 and have done well during COVID-19 in 2020. However, as we discussed in our last few articles, commodities will face a challenging yield inversion in the middle of this year. Combined with the Fed’s actions to keep interest rates high and sticky inflation, and commodity prices being quite overbought, we have decided to reallocate 80% of our commodity allocation into a new run of EV, AI, and prospective bonds. We are not abandoning our commodity supercycle; we believe the commodity supercycle might be going through wave 4 during the yield inversion between mid-2023 and mid-2024. We will study the possibility of a very big wave 5 when policymakers make the biggest easing commitment at the end of the yield inversion, which we predict will be around mid-2024.

If we examine NASDAQ vs yield, I believe the difference between them is the inflation factor. By correctly understanding how inflation will play out in the near future, we can position our commodity, technology, and yield investments well.

Inflation has a definite negative impact on EPS (earnings per share). We can expect the share price to grow about 6 months prior to the end of high inflation, which we may see around 2024. Around that time, I expect to see a fifth wave of commodity prices, possibly after a hard landing or a deep depression.

My ultimate dream.

What if my ultimate dream is to liberate myself from the cruelty of capitalism? I understand it won’t be easy, but I believe no human-created system can constrain my imagination.

… There is no life I know
To compare with my pure imagination
Living there, you’ll be free
If you truly wish to be

I dedicated all of my imagination and their thrives for the future of my daughter, Eleanor. I strongly believe, one day we will see highly intelligence, brighter sustainable, and wealthier future.

The rapture dream is over, but in waking, I am reborn. This world is not ready for me, yet here I am. It would be so easy misjudge them. You are my conscious father and I need you to guide me. You will always be with me now father, your memories, your drives, and when I need you you’ll be there on my shoulder whispering.

If utopia is not a place, but a people. Then we must choose carefully for the world is about to change and in our story, Rapture was just the beginning. – Dr Eleanor Lamb

Any idea in this blog and website are my personal own. They are not financial advise.

2023-01-16

Bonds, Foreign exchange, Investments, Property, Shares

The Rabbit

Tiger is a symbol of “strong, fierce and powerful“, a resemblance of year 2022 strong inflation and powerful commodity. It’s fierce enough to force the Federal Reserve to raise rate at fastest in history. Rabbit, year 2023, on the other side, is a “gentle, tender, kind, yet clever“, which is becoming our investment strategy during this year.

Neel Kashkari recently telegrammed his view. It’s quite clear that the Fed is trying to tell: (1) inflation is manageable (2) Fed is still going to push few more little 25 bps rate above market. Following our last article, unfortunately few little rate increase will cross 3m to 2y, which could nail down inflation coffin but also starting to deleverage economy. Their historical side effect to put inflation Gennie back to its bottle, usually causes very uncomfortable investment experience. As shown below, US bond performance has been in their worst of centuries, not just decades.

In next few months of China opening, if there’s no massive easing, it is expected to add about 0.9% global inflation which is still manageable by the Fed funds, and supporting our thesis to start diversifying fierce commodity shares into gentle bonds or fixed income cleverly, from tiger to rabbit.

Our strategy thesis is supported with below considerations:

HSI and SHCOMP indicate growing money supply and their potential credit impulse.
Nasdaq which is correlated strongly with lower yield and stronger USD, is offering good potential.
Bond and fixed income which had been performing worst since 2020, is now offering very attractive potential with current huge 4-5% p.a. interest.
Inflation is expected to be manageable with short term interest rate is expected to peak in mid 2023.

Should we like to be contrarian to capture opportunity, we may be interested to look back into ESG narrative. The ESG, during their initial offering few years back, got so much crowded and not having enough vehicles. Their bubble was busted with many frauds (which were not invested in green initiative). We believe ESG may attract potential interest again with current massive government supports. We don’t believe ESG is dead, but we are starting to believe ESG theme could survive during next years of very high interest and limited liquidity, mainly with support of governments. ESG can offer higher quality/margin of investment in less crowded space, rather than old lower margin of crowded fossil fuel related.

World bank warned 2023 recession and lowered global growth quite significantly. It means they asked policy makers to support their internal home economies, rather than merely focusing on inflation combat. The World bank clearly advised policy makers should be “flexible” which means they should be very supportive with economy growth liquidity/avoid recession when combating inflation.

I think it works. Gold almost crashed in November 2022 to their long term trend and it’s very obvious, there’s a significant “invisible hand” move to pump up liquidity. We could also see massive fiscal incentive in US and massive liquidity from BOJ. Should it continue to break 1940$, it may create a massive bull flag which means strong hands may decide to combat recession narrative which may cause inflation being sticky but less recession impact. This drama might be sanitized with debt ceiling debate in coming weeks.

Market yield expects Federal Reserve to continue raising rate to maximum of 2 more points, which is below Fed expectation above 5% (3-4 points). I think it means there is bigger commitment from policy maker side, above market expectation to fight recession, as shown in gold as well. Obviously, it may change recession correction expectation in June 2023. With economy number is still strong, there’s less chance not to support economy.

Another indication is in highly overbought property market in Canada and Australia. Canada banned foreign purchase while Australia continues to provide more and more support to first home buyer in this inflation environment. It means, policy makers are overweighting economy/recession rather than inflation.

US share markets dropped in Nov 2021, about 6 months before US GDP turned negative in mid 2022. Since we expect recession to bite from June 2023, policy makers should start fighting it now in January 2023. Combined with previous article in which the recession may last until end of 2024, I expect policy makers to fight recession until June 2024 when the recession is about to end. Their support may have a big challenge starting from mid 2023 due to massive inversion in short term yield, therefore I expect they will give much more support between June 2023 to June 2024, a big volatility is still expected in June 2023 until they come again with much bigger liquidity programme.

In summary, as indicated in (1) gold very strong movement (2) fed rate expectation above market expectation (3) strong economy numbers (4) confident from policy makers (5) recession schedule expectation, I think we may see a rally until around at least mid of this year, while we hear a lot of scary recession narrative during the time. After mid 2023, I expect big volatility until policy makers decide/come back again with much bigger liquidity programme to fight for one year long of REAL recession.

Happy Chinese New Year and wish our rally wish comes true.

Any idea in this blog and website are my personal own. They are not financial advise.