As you may be aware of by now, we like to build a foundation of top-down macro themes over longer time frames and then optimize specific risk management strategies to fit the nature of the themes. Asymmetrical risk/reward analysis updated in real time is king when it comes to investment performance. Therefore, while theme development is critical, specific catalysts to trigger these themes play heavily into timing and position sizing.
With that said, here are 9 of our key macro themes going forward from this early stage in 2018:
- Bonds under pressure & cash is not king: deteriorating sovereign, corporate, and consumer debt health globally will increasingly become a nagging problem without easy solutions as interest rates rise. The math behind government balance sheets and increasing global debt will haunt outsized holders of fixed income investments and cash. Given the fact that the US dollar is still the leading reserve currency, it has the most to lose out of the majors. Diminished US hegemony will accelerate the dollar’s fall from grace as it transitions from a dominant economic position to a shared power role. The greenback will eventually need to fall enough to correct much of the currently massive balance of payments deficit.
- Did we say 2% target? We meant dynamic price level targeting: Central bankers, led by the Fed, will eventually dip toes in the market waters by effectively advocating for moving the inflation tolerance goalposts higher using technocratic policy shifts paired with jargon downplaying the negative side effects of any such actions. The blind spot of today’s Keynesian economist lever pullers is the extent to which their preferred financial repression solutions will backfire with unintended consequences. The 2017 historic bitcoin/cryptocurrency rally was the first notable crack in the dam.
- Stuck behind the curve: The Fed may slightly increase their stated pace of normalization this year given the less dovish FOMC member composition (even though financial conditions continue to ease in reality) but it won’t be fast enough. Excessive levels of debt will prevent their willingness to risk triggering market crashes with sufficient monetary tightening. When given the choice of risking yet another epic crash of “everything” with a sharp increase in interest rates vs. allowing higher inflation and more extreme imbalances, today’s central bankers are going to chicken out when the “moment of truth” looks them in the eye. Their greatest fear is another 2008-esque crash that sets off a domino wave of bankruptcies in a global economy leveraged to the hilt. Thus, the likely future actions of G10 economy central bankers are why “safe” fixed-income assets and bank deposits may actually be more dangerous in real terms than traditionally “riskier” assets which tend to rise with inflation. Individuals will want to ditch their cash for alternative stores of value such as gold, commodities, prime real estate, and cryptocurrencies, if the levers of financial repression (ie. forced negative real savings and wages) are cranked up even more by the central bankers behind the curtain.
- Commodities are back in business: commodity ETFs could become the new stock indexes when it comes to effortless price levitation. As inflation and interest rates rise, stocks will hand over the baton of market leadership to commodities in our view.
- Big banks – caught between cyclical uplift and secular disruption: reduced regulation headwinds and widening net interest margins will help banks in the near term, but their business models will be put under structural pressure by fintech and blockchain technology seeking to cut out or reduce the middleman. The smartest banks with continually evolving technologically-driven business models will survive and prosper. Others will fade in a quickly changing financial landscape.
- Financial repression is golden: 2018 will be a huge year for gold. Where real interest rates go, so too does gold (inversely). If inflation and financial imbalances continue to rise and central bankers don’t have the courage to sufficiently take away the punch bowl by initiating notably higher nominal interest rates as we suspect to be the case, gold will shine brightly. Ten-year inflation forwards are rising faster than interest rates. Additionally, geopolitics have recently only had a modest impact on gold prices but risks are clearly tilted to the upside on that front. While there do exist notoriously mysterious, gigantic short gold futures block orders that seem more intent on impacting price than receiving reasonable fills, the gold market has more powerful bullish tailwinds at work than has been the case in years.
- Morning in Southeast Asia: Second tier EM economies in Southeast Asia, particularly Vietnam and Indonesia, are in a Goldilocks phase of growth, development, demographics, and the secular business cycle. Less sophisticated manufacturing has rotated from China as labor prices rose there, just as you’d expect, while China transitions to a more consumer-driven, advanced economy capable of providing the demand for products it used to manufacture. Tourism is booming in Southeast Asia well into a double-digit growth trajectory year-after-year. As long as China can avoid a debt deleveraging hard landing, Southeast Asia is an attractive home for investment capital.
- Continued political gridlock, incompetence, and strain: the outsized influence of money in politics, global trade friction, “my nuclear button is bigger than yours” Tweets, hyperinflation in Venezuela and others, discontent in Iran, surveillance, capital controls, corruption scandals, unprecedented central bank intervention, widening wealth disparity, refugee crises, and general failures in managing government budgets and affairs will continue to plague confidence in institutions globally. This will allow the forces of populism on both the left and right to bubble closer to the surface. Nothing is more inflationary than a populist political regime gaining control of the budgetary purse and currency. Keep your eye on potential shifts in political power and public sentiment.
- Growth Blockbusters: Blockchain, marijuana, AI, labor automation: explosive growth and innovation will continue in these industries. Phase 2 growth will require a more critical deep dive into specific technologies, protocols, and companies than in Phase 1. Simply adding “blockchain” or “AI” at the end of titles sold with vague, cliche jargon will not cut it forever. The fluff will eventually get parsed out and burned while the innovation continues at a breakneck pace for more legitimate actors. The lowest hanging fruit has been picked but there is plenty to go around one level up for those willing to put in some extra work.