The Sleep Well Portfolio at a Glance
Here comes 2023
· SPY (Large Caps)
o As the stock market crash continues to finish off 2022 we keep our eye on the horizon. After a bond yield spike historically the dollar will go through a depreciation phase. Stocks can be a favorable asset in this environment as cash truly turns to trash. The risk to stocks though is still falling GDP. Pair that with disinflation and we have a good mix for a stock market crash starting 2 weeks ago. Sure there will be times of ups and denial but it’s here. The worst of the recession for stocks is now through April if everything stays the course. That means the Fed also.
o One Month Risk Calculation – Risk Increasing
· TLT (Bonds)
o This week bonds got the reality check they needing. Yes bonds are a good asset when growth is slowing but not the best. Gold is much better in recessionary inflations as a hedge and even as a growth asset. That doesn’t mean we cant use them. Here soon inflation will slow at a pace that generates some attractive yields vs stocks and investors will accelerate stock selling to buy bonds. This is the natural flow of capital when an asset like bonds provide real return vs risk over growth assets. Stage 3 (Collapse Stage) coincides with yields dropping. Not in just one or 2 weeks but as a rate of change in the longer term. That time is now. I see a TLT allocation in our near future.
o One Month Risk Calculation – Risk Decreasing
· GLD (Consumer Goods Inflation)
o As we saw over the last 2 weeks gold doesn’t fall like bonds in the “risk off” times. Stocks down, bonds down, USD flat, Gold up. This is the action we will likely continue to see as risk managers continue to rotate out of stocks and the Fed continue to tighten into a severely slowing economy over the next quarter. The primary macro reason for investing in gold is due to its relative value to the dollar and its lack of correlation to economic growth.
o One Month Risk Calculation – Risk Decreasing
· UUP (US Dollar Relative Deflation)
o The USD will have its day again. It will be in the depth of despair, when all hope is faded and the darkness washes over the stock market only to leave a sea of red in its wake. This is the only time the USD will rise in an inflationary collapse stage. Sure we can use in briefly but risk are very elevated for this asset now. We will only get a allocation to UUP in the event of crash signals and a mass selling frenzy. This is because even gold can suffer from pure risk off moves in panics. But one thing hold true. When assets get sold the are first converted into currency. That currency in USD due to it being the reserve currency.
o One Month Risk Calculation – Risk Increasing
· IWM (Small Caps)
o Growth was here in Q4 2022 but with a fast-rising yield curve and a tightening Fed we were reluctant to fully commit until it was a little late. That is ok we will be invested for the next bull market and that time is not now.
o One Month Risk Calculation – Risk increasing
· EEM (Emerging Markets/ Relative Inflation)
o EEM is by far the most exciting asset I am watching. Most of emerging markets have had maximum pain over the last year and a half. This is due to the the USD being a vacuum for capital. As the dollar strengthens vs other currencies it attracts capital from riskier emerging markets and into US based assets. Historically this helps prop up US stocks but the deleveraging phase of the this debt cycle has been very aggressive. Now that we are on the backend of the central bank tightening cycle capital can be moved back to other countries without too much fear of a strengthening dollar.
o One Month Risk Calculation – Risk Decreasing
Drivers for Current Portfolio Allocation
Dollar weakness and disinflation are the offspring of deleveraging debt cycles. Soon the tides will move out and so with the capital from the shores of the US. Emerging markets are our top asset on deck for the next growth cycle. Until that happens though Gold, TLT, and UUP with dominate the portfolio. There is still a lot of volatility out there amongst the assets but gold has some of the lowest. To top it off gold also performs historically well after a large bond spike.
The bond spike we had this year is the largest in modern history for a reserve currency. This is partly due to the largest amount of printing and debt monetization done by a reserve currency nation in modern history. But the why isn’t relevant. What is relevant, is how to invest is such unique times. So far this year we have reduced the drawdown in almost every long-only asset by using the USD as a hedge or even moving into cash entirely. We haven’t been perfect but the portfolio has performed as intended for such a unique recession.
The traditional school of thought would have been to use US bonds, Gold, and commodities all year long to find growth. Well, all of those have crashed as well. This has been one of the most epic global deleveraging cycles I’ve ever studied, much less lived though. Now we get to go through the collapse stage when growth really slows but inflation doesn’t turn into deflation. Deflation would help guide the Fed to lower interest rates but that will elude us. Inflation will likely remain above 4% next year and growth will be negative in Q1 and Q2. The Fed will likely stop tightening but the momentum of capital flows into other assets and even emerging markets will be to great to overcome without some severe pain.
May you ADAPT to markets and Sleep Well,
SWP Team
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May you ADAPT and profit,
Wayne Klump
Managing Partner