The Sleep Well Portfolio at a Glance

What a Dip!

SPY (Large Caps)

  • It's here… All the fear and doom and gloom. Now everyone is talking about how bad it is and how bad it will get. Some are talking about when the bottom has been put it. Many are already catching the falling knife, only to feel the cuts of buying the dips when things are not the same as last year. Our models still put pressure on large caps and will remain so for quite some time.


  • One Month Risk Calculation – Risk Increasing


TLT (Bonds)

  • The question is… will the Fed raise rates? Well, if play out this situation we can expect 4 rate hikes at least. That is already priced into the yield curve. Now, what happens if they don’t make it to 4? That right bonds will be crazy cheap and rally like a crazy man. What happens if all countries drop rates or stimulate when the Fed raises rates? We will likely see a stronger dollar. Yep, yet another good thing for bonds. In general, bonds still have risk but dramatically less than in recent history. In the short term, we can still expect some swings in bonds plus and minus but the upside is beginning to have a favorable edge.


  • One Month Risk Calculation – Risk Decreasing



GLD (Consumer Goods Inflation)

  • Correlation is fully in swing. Gold is our favorite asset going into an inflationary correction. Rallies will follow and dips will be shallow for GLD. The correlations in gold are holding true to history once again. Gold is very attractive!


  • One Month Risk Calculation – Risk Decreasing



UUP (US Dollar Relative Deflation)

  • The dollar has gained strength lately due to the risk-off behavior in assets. When institutions sell off an exposure without moving into an alternative one immediately they have to move into either short-term bonds or the money market. As more dollars are needed we can short term see strength in the currency. This high demand can move against fundamentals but is likely to be short-lived until we get a weakening in other currencies or a slow down in inflation. Both of which are highly probable in Q2. For now, we stay sidelined. The alternative situation can still play out though… yields continue to rise and the fed tightens to strengthen the dollar before Q2 and we will move into UUP early.


  • One Month Risk Calculation – Risk Decreasing



IWM (Small Caps)

  • Imagine that the SWP or AWAKE was a buy-the-dip strategy. Talk about a burn in small caps, now corrected over 20%. Pricing in small caps is much more favorable than large caps. There is a long way to go for small caps to get a positive allocation but yesterday's correlations were a push in the right direction. Still, we are not likely to see any buy signals in IWM until Q2. We could care less about any bounce until then.


  • One Month Risk Calculation – Risk Unchanged


EEM (Emerging Markets/ Relative Inflation)

  • Now, this is an attractive equity asset if we wanted to go long or catch a bottom, but that is now what we do in the SWP/AWAKE. EEM has positive pressure for this first quarter and we are seeing that play out with the muted selling when American stocks are getting slaughtered. This will turn fast though when Q2 gets here. Beware of the mass-selling we will see in everything emerging in Q2-Q3 2022.


  • One Month Risk Calculation – Risk Unchanged


Drivers for Current Portfolio Allocation

Now that there is selling there are all sorts of people talking about how bad things are. Where were they at the highs? Meanwhile, for 3 months we have been stating over and over that risks were getting higher and buying the dips is getting more dangerous. Fast forward and we might have taken some heat on the perpetual buying machine of irrational speculation, but we for sure reduced the volatility felt in assets over the last 2 weeks. And will continue to create good risk-adjusted returns.

One day doesn’t put in a bottom and one week at a 32 Vix can wipe out a year of returns… IWM, RPAR, NDX, lol. Regardless of when the bottom is put in, I promise you that the portfolio will not get it. AHHHH WHAAT? That’s right the portfolio has never caught the perfect bottom or the perfect top of any bull run, yet we still make good returns over time. The risk is greatest at the turns and lowest in the trends.

The transition from the buy the dip in everything was somewhat challenging last quarter for the SWP/AWAKE. One quarter is just that One quarter… We will see another and another. This quarter the SWP and AWAKE went to cash for the waterfall in every asset over the last 2 weeks. Soon we will strategically develop our asset mixture to the current trend in macroeconomics. Slowing growth/slowing inflation/ slowing relative inflation.

In the environment we have above, it is important to not buy dips in stocks and to buy the dips in risk-free assets. Right now, we have high inflation and slowing growth, which is very favorable to gold in the medium term. We still have 2 months of Q1… our models put Q1 as moderate risk and Q2 as high risk for equities. With that in mind, the market is likely to rally and chop for the remainder of Q1 and drop hard in March/April if this selling frenzy doesn’t push us straight down to those levels first.

Weekly Topic of Interest

“Behavioral Conditioning”

With the SPY down over -10% this week and IWM being down over -20% it’s a fun time to dig into how we have been trained by recent history. I studied behavior analysis in college and surprisingly, it is one of the single most influential subjects in my life. Behavior is comprised of an organism’s action in response to external stimulation. For example, if I knock on your door… you answer your door.



As the knocker, I have now been trained to expect you to answer when I knock. What happens when the environment changes though? What happens if you are busy and don’t want to answer your door? I expect you to answer still… if you don’t answer I will knock again… Then maybe one more time a little louder. As the knocker, I have always been rewarded for knocking on your door. Why did I knock again and again after you didn’t answer? This is called an extinction curve. When we are trained by our environment with rewards or pain after exhibiting some action, we will continue to expect the same outcome until it is proven otherwise.



All last year investors were trained to buy any volatility spike or dip in stocks. Over and over again it has been drilled into investors' memory. Even if the investor didn’t buy the dip, they felt the pain from not participating in the gains. Both pain and pleasure curb our actions. After a year of huge gains in stocks and massive selling in bonds, we have a perfect situation for behavioral concretization. In essence the inability to adapt to a changing environment due to the strength of prior behavioral conditioning. It's like getting hit with medusa’s gaze… it happens and we are victims to its power over us.



Wait, what does that have to do with the stock market? After last years’ behavioral conditioning of investors, many have been unaware of the changes that have taken place in our current macroeconomics environment. The beginning of last year was like you answering the door when I knocked. This year, or at least the first 2 quarters of this year, are as if you were not home to answer the door when I knocked. In the stock market scenario… the dip happens and the investor is trained to buy, but things are different this time… Growth is slowing, yields are higher, inflation is elevated and slowing… vs last year yields were low, inflation was rising, growth was accelerating. Today the investor buys the dips unaware that no one is coming. What does the investor do? The same thing I did when you didn’t answer the door… knock/buy more, and buy more as the market falls. Inevitably the investor feels so much pain that they must stop knocking and take a large loss.


The same thing happens in any investment. The SWP/AWAKE began to move into alternative last quarter during selloffs, only to be met with massive speculative buying in large caps. This has now been trained into us, that when we move into alternatives expect the market to rally and the portfolio to lose short term. On an individual level, this would be an uncomfortable feeling when allocating on a new week. After years of running the SWP, I have learned to follow the process and trust the models. Inevitably either the market transitions or the models adapt, either way, the recent past will be radically different than the near-term future when running an adaptive portfolio.


https://www.boldbusiness.com/human-achievement/climate-change-solutions-companies-saving-environment/ This is the investor phycology of market transitions from rallies to stalls and drops. We can avoid this whole trap if we just pay attention to the environment and change our behavior with it. Maybe we see that there are no cars outside the house we are knocking on. The SWP/AWAKE have looked in the driveway of the market's house and know that this time is different. Buying dips is risky until we see some cars out-front. The market told us late last year to expect different results in 2022 and different results we have definitely received. No need to get stuck in old behaviors and turned to stone while taking extra risk when we can see no one is home today.

Wrap Up

Markets go through cycles and this time is the same as it always is. The dips got riskier and inevitably broke to the downside. Now that bonds and stocks are risk-adjusted to each other, we are likely to return to our correlation relationship. Bonds will likely rally as stocks fall and vice versa. That is until yield drop too far from inflation. Long-term bonds are very risky due to excessive monetary stimulus.
As inflation slows this year, yields will slow with it. This is favorable for bonds and risky for stocks. Time will tell how this plays out, but one thing is for certain… the environment is very different from last year.

Gold is a favorable asset to hold when inflation remains elevated and yields drop. This is the exact situation we are faced with this year. Expect a lot of Gold and Bonds in the portfolio until Q3. Pending how fast the transition is, we could get favorable pricing in EEM, IWM late into 2022 for a strong recovery in 2023. There is a lot of wiggle room until then and the market changes fast, so hang on tight it’s going to be a volatile ride this year.

May your assets grow and you Sleep Well,

Wayne Klump