The Sleep Well Portfolio at a Glance
Stocks Crashing Again! -> We Enjoy Safety!
SPY (Large Caps)
You know that positive data coming out… Yeah, that just got wiped out. Fed reiterated that they will be even more aggressive than they posted in the Fed minutes. Stocks like accelerating growth, easing monetary policy, and accelerating inflation. Currently, we have decelerating inflation, not to be confused with high inflation and stalling growth with a tightening monetary policy. This is a typical stagflation setup. Stocks tend to chop heavily in this environment as capital desperately searches for new places to avoid the loss of purchasing power in a slowing economy. On the bright side… general consumer sentiment did go up.
One Month Risk Calculation – Risk Unchanged
TLT (Bonds)
This has all the makings of a self-feeding cycle of inflation. When yield continues to spike in the face of a strengthening dollar it is a cause for concern. Typically, when we get a strengthening currency it positively impacts the risk calculation in bonds due to the strengthening currency’s position on the world stage improving. This time we are seeing rates clime regardless of the massive strength of the Dollar. This is primarily due to the aggressive global printing leaving all currencies inflating vs real assets. When inflation cools off more in the coming months we will likely see a stall in rates. Until we see the capital flows improve bonds are a very hard “no go”.
One Month Risk Calculation – Risk Unchanged
GLD (Consumer Goods Inflation)
We called it well! We have been scaling out of our very aggressive gold position for a few weeks now. Gold is now correcting strongly. Macro-wise gold is still very much in favor. Currently, the models are temporarily pulling its allocation as inflation begins to slow and real rates begin marching to the positive direction.
One Month Risk Calculation – Risk Increasing
UUP (US Dollar Relative Deflation)
Here we go again! The dollar continues to strengthen just as we have called for all year. The models continue to be bullish on UUP. We are currently at very elevated level in UUP but with other assets having extremely elevated levels of volatility our best bang for buck is UUP.
One Month Risk Calculation – Risk Unchanged
IWM (Small Caps)
Testing the bottoms again! We continue to "out" call for being out of IWM. Even with their relatively attractive prices being down 20% from the highs, they are still high risk.
One Month Risk Calculation – Risk Unchanged
EEM (Emerging Markets/ Relative Inflation)
Same story here… EEM has been out of the portfolio for a year now, and thankfully the SWP has sidestepped a whopping -28.28% drawdown in EEM. We are optimistic about emerging markets in the future but that time is not now. They are oversold and can bounce but we don’t play that game with our stable portfolio investments.
One Month Risk Calculation – Risk Unchanged.
Drivers for Current Portfolio Allocation
Traditional Portfolios continue to struggle in this environment. As seen in the chart below we can see that most portfolios are break-even or at a loss since the SWP went public. It’s a sad day for the investors that are unaware of the forces at play. Not only are they taking the risk of volatility in their portfolio but they are also losing massive amounts of purchasing power. This goes for those that are sitting in cash as well.
Compounded, being in cash over the last two years has netted a loss of -12.16% due to inflation. Inflation is the silent killer of returns. The portfolio continues to move into assets that will preserve our wealth and give us the highest probability of returns for the risk we take.
Volatility in Markets has spiked over the last week. VIX is above 30%, this has historically been bearish. Markets don’t always go up and lows do occasionally break. In bear markets, it happens more often than in bull markets. If the lows do break the next reasonable stopping point in the S&P is 3800.
Inflation is set to slow a few percent over the next few months. This slowing of inflation is a headwind for gold and the models have reacted in kind. Growth in GDP looks to continue its stall, this is a headwind for stocks. What is left then? International? Nope, not with the dollar climbing… that leaves us with Dollar investments that are unaffected by rates. You guessed it… UUP. Let the magic of the SWP/AWAKE effortlessly adapt to the so-called “unprecedented” times in markets.
Weekly Topic of Interest
The Theory of Relativity: Inflation Edition
We changed the financial world in the 70s. In the 1970s President Nixon took the US Dollar off the gold standard. A gold standard is a form of commodity-backed currency. This idea of a commodity-backed currency is where you can exchange the paper currency for the backed commodity. This eliminates the ability to print money excessively due to the ability for conversion to arbitrage the spread.
In the 70s the US had hit the end of the road with inflation leftovers from large government spending during WWII. It was becoming apparent that there were more US Dollars in circulation than there were in Gold. Just as in the bubble collapse of the Mississippi bubble investors quickly rushed into hard assets like gold and real estate. As the price of gold denominated in the inflating currency skyrocketed it further reinforced the selling of the domestic currency and exchanging it for Gold. Today we have seen gold rise sharply but not take off. Why is that? It comes down to relativity. The change that was made in the 70s affects us now more than ever. This is because all currencies are floating now. This is when the currency is no longer tied to a hard asset or commodity. By doing this we have theoretically achieved an environment in which you cannot arbitrage the reserve currency and now governments can print at will.
This sounds great right? Free money forever and there is no stopping it. A quick jog down memory lane leads us to Rome. Rome attempted to devalue its currency as well. They did this by using cheaper metals in the coins but claimed they had the same purchasing power. Inevitably the empire could not satiate the gluttony of government spending and fell.
Relative currencies are thought to not have this problem. The idea is that as long as my currency is relatively similar to my trading partners historically then I can print without consequence. This is because the purchasing power of goods and services in relation to other countries remains the same. The one downfall to this is that goods and services originated or created in the domestic country’s currency will rise. This is because relativity to other currencies has no impact on how much it costs to buy a lot of land. Therefore, hard assets that do not cross international borders will rise in value relative to the currency.
There are ups and downs in history and we will begin to question what money is and what is the best form of it is. For now, we are beginning to see the cracks form in the financial system with bonds crashing worldwide. Russia has begged its currency to gold temporarily and oil is now being contracted in other currencies. Times are different for the Dollar, but we are still in a relative world. That means as the dollar strengthens versus the countries that we get raw materials from and/or services from will remain deflationary. As for US assets, it is extremely inflationary until we can outsource more. One tail of caution though… when the US dollar begins to devalue vs other currencies inflation in all forms will rise, leading to higher yields and decreased purchasing power for the currency just as it did in Rome.
Wrap Up
Volatility is elevated and markets are testing the lows again. The Dollar is still strengthening while gold is falling. Everything is marching along just as it always has historically.
The next stages of the cycle will be more inflation and higher debt costs. Historically that has been bearish for tech and small caps.
On the brighter side, there is a huge incentive to invest and buy assets due to the high levels of inflation worldwide. Investors will remain wary of bonds/cash due to its negative return. This net effect can keep assets up as long as leverage can be maintained, and volatility doesn’t cause margin calls.
We will continue our climb regardless of what the market does. When stocks want to play again, we will use them, until then the water is warmer in Forex.