Navigating The Bermuda Triangle Of Macro Investing - Forbes

Macro investors like me usually have a trove of indicators, relationships, and models that guide us through the inevitable trends, cycles, and interplay among the various asset classes. It is how we come up with asset allocations and favored securities inside the asset classes. There are, of course, always curves in the road, new paradigms, and other peculiarities in the asset markets but navigating through the next two quarters is like navigating thru the Bermuda triangle. Many of the gauges seem broken and the charts have too many coffee spills to decipher. The objective is to sail through without getting too far blown off course.

The nexus of the COVID rampage, a completely chaotic US election, and an emerging new paradigm at the FED is uniquely difficult to interpret. COVID alone presents incredible investing challenges. We are still down in GDP yr/yr and many segments of the service economy are flat on their backs. We are entering the period here in the Northeast where people head back indoors, and cases are beginning to increase. However, we are much better at treatment, so perhaps the fall looks dramatically different than the spring. But perhaps not. Meanwhile, unemployment is stubbornly high and reaching the “likely to be high for a long-time’ moment. Sure, a vaccine may be announced by year end but seeing the vaccine distributed and accepted? Feels more like a 2-3Q’21 event. It all matters to investing because macro investors have different playbooks for down GDP versus up GDP. If the stock market weren’t so expensive, and highly concentrated in a handful of mega names, it would be easier to look through the valley of GDP and corporate earnings. But the stakes are much higher at these equity valuation levels and levels of debt in America. The equity gauge on the dashboard seems broken.

Ah, the election is here as well. At this point, the market is beginning to anticipate a blue wave sweep. This is evident in the type of stocks outperforming recently like Solar stocks and Cannabis stocks. But one of the better indicators since 1900 would say the jury is still out. If the Dow is up from the end of the last convention (August 27 this year) to the election, the incumbent party has a great shot at retaining power. It is not perfect, but it did predict Clinton’s loss in 2016. As of today, the Dow is up 0.3% from August 27. There is also the uncertainty of when and if we will have a declared winner. Remember the uncertainty that originally surrounded the Democrat Iowa caucus this year when it came to declaring a winner?

For allocators, the elections matter because we may be seeing the lowest capital gains rates for a generation. A blue sweep would mean they would likely enact their publicly stated policy of doubling long-term-capital gains rates. Certainly, some people sitting on massive gains will sell some before year end if that is the case; moreover, the Democrat plan also eliminates step-up in basis at death. The elections are coloring the timing and scope of a new COVID relief package. The numbers are anywhere from sub a trillion in the Senate to $2.2T in the House. These numbers are massive and the timing matters to allocators because we already see incomes weakening and spending at risk as the prior programs expire. Good luck discounting the words of the politicians or the outcome of the election.

And now for the Federal Reserve. The FED has been busy all year. They have ballooned their balance sheet to $7T and have started down the slippery slope of direct cash payments to companies and individuals. It is all small potatoes for now, but will we look back and mark this year as the beginning of MMT (Modern Monetary Theory) implementation? And, of course, the dual mandate has become incredibly twisted in theory. Historically, it was full employment consistent with price stability. Now, in a nutshell, it is lower unemployment than we ever thought possible and let us have some real inflation. It is an epic shift, but so far there is absolutely nothing being done. They declared the shift and promptly took no additional actions to achieve either goal. I suspect they will be heard from loudly post-election. Meanwhile, since monetary policy changes work with a multi-quarter lag, they may not affect the real economy much during the next two quarters. Rather than fly based on their words, let’s wait for some actions and adjust course.

So, how to navigate through the triangle safely? We believe that diversification is the answer. We are moving to ensure that stocks don’t become too high a percentage of our clients’ mix by taking advantage of today’s tax rates and booking some gains on a very expensive set of large cap growth names. We suggest 40% maximum of your portfolio in full beta stocks. We are keeping some high-quality bonds at a minimal level near 20% but favor long-term treasuries for a trade if the Fed increases their QE program. We think it wise to own a lot of gold, north of 20%, to account for inflation returning later in 2021 and the possible increased implementation of MMT. And, finally, do not worry about holding cash or truly uncorrelated alternatives in the 10-15% range. One of the major asset classes may crash in the triangle and we think cash could be a very useful tool. Bon voyage!!

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