Weekly Paid Newsletter 02/06/2022

Get Better Next Recession Performance By Owning These 3 Assets

The economy is transitioning into a new phase in which consumers, companies, and investors will have very little help from central banks to keep their balance sheets growing freely.

We are already beginning to see this in recent weeks, where the major indices have retreated between 10-15% from the highs reached just a few months ago.

The momentum we have had in the markets over the last two years has been reflected in the share prices by only two factors. First, the $8.9T increase in the Fed's balance sheet, and second the $2.8T increase in the U.S. federal deficit (implying a near tripling between 2019 and 2021).

Both stimuli are being cut, and stock prices, which reflect future expectations, are beginning to feel it.

The markets pick up this excessive spending through inflation, driving commodity prices through the roof and creating a massive distortion between the real economy and stock prices.

For its part, the Fed has done its best to keep rates as low as possible. Were it not for the inflation data they report month after month, and they would continue to keep rates at "zero" for a couple more years.

Low rates while inflation remains sky-high is one of the most significant risks facing the market. Keeping rates unrealistically low for longer than necessary and raising them precipitously can damage the economy in an unprecedented way, especially since inflation is at 40-year highs while rates are at historic lows.

The Bank of England has already begun raising rates, and the Fed is close to doing so. On the other hand, the ECB looks set to keep them at zero for another season.

From my humble point of view, what the ECB is doing is a real danger as it exposes the euro in a big way. More so, seeing the indebtedness of some EU countries: Italy, Greece, Spain, etc.

If inflation were to rise, it could ultimately deteriorate the fundamentals of companies. This would cause companies to start defaulting and thus damage the economy like a house of cards.

What can the individual investor do?

We have a devastating picture. But let's look at the asset classes individually:

• ❌ Equity Market: the SPY and the QQQ, the two largest ETFs globally, suffered the most significant capital outflows over the past week. These capital outflows highlight investors' lack of confidence in the market. It will most likely always be an excellent investment in the long term, but as we enter a deflationary market, we could see the share price not reach ATH again for a long time (a.k.a. Japan).

• ❌ Emerging Markets: the deterioration in China's growth is hurting emerging markets very directly. Especially in commodity exports. In addition, these markets are highly correlated with the leading global markets and their policies.

• ❌ High Yield: defaults could begin if energy prices decline. The energy sector has done well throughout 2021. The cost of electricity is at record highs. But a demand reduction, in addition to a drop in price, could collapse this type of bond.

• ✅ Gold (and Silver): one of the least hopeful. Its price has already begun to rise in a very uncorrelated way with the stock market. Many experts put the cost of an ounce of gold at $2,000 by the end of 2022. These forecasts are useless. However, it is always advisable to have 10% of one's portfolio in this asset.

“Gold and silver is money, everything else is credit.” – J.P. Morgan

• ✅ Volatility: Knowing how to buy volatility with Long Gamma will make you as decorrelated as possible from the market. There is no other asset that has historically benefited so much from recessions.

  It is the most anti-fragile asset there is. Knowing when to sell and how to do it the best possible way can make any investor sleep easy.

• ✅ Crypto: It is a bad investment in the short term due to the high correlation with the options market. However, it is one of the best options in the long term, far from being a bubble.

  Many people compare it to tulips. However, behind high volatility, there is the technology behind it. It is a compelling technology that benefits all humans, giving us more freedom to decide about our money and making us much freer from central banks.

  This Wednesday, I introduced you to a way to invest very profitably in one of the market's leading crypto. Many years from now, we will regret this opportunity.

It isn't easy to choose one or more of the above. The strength lies in the middle ground and knowing how to use each of the market's tools.

We have an asymmetric portfolio that gave us excellent results last year (+30%), and that benefits significantly from a possible recession that is still to come.

Knowing how to mix all these pieces with little risk is an art, but of course, it can be done, and the individual investor can undoubtedly benefit from it.