Eyes wide open (for now)

"Travel is fatal to prejudice, bigotry, and narrow-mindedness"?– Mark Twain

I’ve recently returned from two weeks of global travel, meeting clients and attending two allocator conferences, one in Washington DC (the Regulatory Fundamentals Group’s Fall Conference), the other in Toronto (AIMAs Global Investor Forum). What’s interesting about such events is not always in what’s said, but also what’s left un-said. These gaps can reveal hidden risks and opportunities.

So, before I forget Twain’s lessons (and my biases reemerge), here’s what I learnt from things both said and unsaid. And?what I wanted to say...

On elections

No incumbent has lost a re-lection unless the economy’s entered a recession. And, no recession has begun with a fiscal deficit of 6%, with job/wage growth, robust consumer balance sheets, rising asset prices and a Fed cutting rates. And yet, every DC democrat I met fears the exception.

The reason? Perhaps ironically: 'the economy'.

It's the economy, stupid

The majority of Americans think they are worse off than 4 years ago (i.e. when Trump was in charge). Why? The cost of living. While the wealthy (and those in finance) see inflation through asset pricing, the rest experience it more in “groceries”. Most workers have not had a real-terms pay rise in decades (save very recently), the bottom 90% take home the lowest share of wages on record ?while?inequality is as high as it was in 1929 and a staggering 60% of Americans are currently living paycheck-to-paycheck .

Add fears about the impact of immigration on jobs and you have fertile grounds for protectionism, which Trump speaks to best. This clearly has the Dems worried.

Unprecedented

The race for Congress is also tight. For example, of the 435 seats in the House, only ~14 are ‘in-play’. If Trump wins, the odds of a ‘red sweep’ rise, where markets may assume the prospect of animal spirits, less regulations, lower taxes, higher equity markets (and a boost for bitcoin) –?that is until higher rates kill the mood. Should Harris win, the odds of a ‘blue sweep’ are smaller, although in this scenario she is broadly expected to keep the Senate.

The outcome here is viewed here as less certain save some political gridlock (excluding taxes, as temporary cuts expire in 2025 and so must be dealt with). If all three flip however – i.e. if Trump takes the Presidency, Republicans the Senate and Democrats the House, then we have no playbook for that. It’s never happened before.?Ever .

But that’s clearly not what the market’s saying currently. Its 'voting', for now it seems, for Trump (see Bitcoin, bank stocks, cyclicals and Trump Media, which has recently doubled from its lows).

They say that markets ignore politics. I’m not sure that’s true? Or not, at least these politics.

Bi-partisanship: China and stimulus

While the outcome of the election is unknown, some common ground is emerging. Taking a hard line on China still gains bi-partisan support, although surprisingly Harris is perceived the more hawkish of the candidates (Trump’s rhetoric on tariffs is generally seen more as brinkmanship). The other likely outcome is expansionary fiscal policy (see above: inequality ala 1929). Trump’s preferred route will be deficit-funded tax cuts, Harris's via the IRA etc., but both pose a risk to the deficit that outside of gold (new highs) few seem concerned with.

Should this be combined with financial repression –?as some think is likely (i.e. real rates are kept negative to ease fiscal constraint and inflate away debt)?–?then I suspect the release valve becomes the USD (it goes lower).

Good news if true for supply constrained real-assets (like gold, copper etc.). And RoW equities.

Where, who, what is Kazan…?

While talking gold (and gaps) no one mentioned Kazan in Russia. Kazan will host the BRICS summit this week, at which there’s mild speculation emerging that a new settlement currency which is partially gold-backed will be unveiled. It shouldn’t harm gold, which remains ascendent as EM central banks in particular add it to their reserves. And should CBs reach similar allocation levels as those seen in the ‘70s, then gold will remain well-bid for some time.

Get Trump, ballooning deficits, a reflating China and US financial repression, and it then goes bid-only.

On inflation

The consensus is: down but not out, suggesting a higher neutral rate through cycle, and therefore a higher assumed cost of capital. Some talked of buying inflation insurance now – ‘fixing the roof when the sun’s out’?– and there’s more talk of real (i.e. CPI+ linked) returns. One interesting take on tail-risk hedging came with respect to China. Despite expecting a negative position, I was surprised at the general degree of pragmatism. ‘Too big to ignore’ being a common refrain. What’s more, there’s a view feeding into the regime change narrative whereby China reverts from being a provider of capital and deflation to the world economy, to one of repatriation and reflation.

Said differently, the best hedge against inflation could be to buy its likely cause: China.

Successful strategy depends on structure

Many allocators believe (like me) that the future is not in the past, and new tools and techniques will be needed to deliver good risk-adjusted (real) returns going forward. And that with the likelihood of a more volatile future, the range of potential investment outcomes increases. This forces allocators to consider different asset classes and investment philosophies (more top-down) and different (more agile) operating models.

Successful strategy is perhaps more dependent on structure than ever before.?And by ‘structure’ I don’t just mean the platforms and processes, but also people (being open to change).

Diversifiers

In terms of diversifiers, orthogonal returns are being sought in areas as wide as sports, cat-bonds, agriculture, vineyards, forestry, CTAs, distress, derivatives, portable alpha, and of course PE, PC and infrastructure. The latter two are attracting most attention, especially for their role in the megatrend of energy transition (although private credit spreads have considerably narrowed, forcing some to consider more ‘quality factors’ and better ‘neighborhoods’. Hedge funds seem to be holding their own, especially in credit where interest rate volatility requires more active security selection –?and provides shorting opportunities. There’s also a trend towards smaller emerging managers who can potentially provide greater transparency and partnership – something our own 50 South Capital is well known for.

Finally, there was one other mega-trend discussed: AI. At the intersection of this and the climate you find another supply constrained real asset, one that no-one discussed:?nuclear .

How to lose friends and influence no one

Note to self: never ever attend an allocator conference and question the sanctity of private equity. It’s a troubled teenager perhaps, but it’s still their favorite child, and its problems will pass. At worst the 'public verses private' debate is a false dichotomy; if top-down and oriented around themes like growth it makes little sense to create arbitrary distinctions. But at best, “it’s immune to the asset-cycle.”

How come?

Well: ‘...Company formation is structurally growing, baby boomers are selling, there’s ample dry-powder, public markets are ‘broken’, companies stay private for longer and secondaries are a legitimate exit mechanism. The liquidity premium will reassert and not being able to change your mind is a feature, not a bug (in an uncertain world?). Oh, and while there is growing demand for transparency from retail, regulators and indexation, such things will not impact volatility, for fractal geometry is redundant.”

While this may be the case, it’s still likely that financial engineering (helped by multiple re-ratings) will make way for the commercial operators, often found in smaller niche or sector specialist areas who are focused on value creation and can leverage their networks to increase exit optionality. That’s probably where the alpha lies. At the other end, I suspect the big-get-bigger, especially now indexation seems likely.

We’ve seen this in public markets, of course. Beta concentrates in size – the index – and alpha in boutiques. The middle gets hollowed out. Where do your exposures fit on this continuum?

Left hanging

Two questions were left unanswered. If we are moving from a world where power no longer concentrates in the US, might equity valuations follow? And might interest grow in offshore markets? If it does, might one consider buying an asset with ample liquidity, some inflation protection, a positive carry that compounds and assumes no price appreciation or leverage? Like dividend compounders in low value markets.

Perhaps that’s simply too alternative.

On markets and ETFs

Interestingly I heard the term re-risking as many times as I heard de-risking when it came to equities. It seems market wobbles in summer pushed some people to the sidelines – where they remain, now fearful of seasonality. Another topic of discussion: ETFs. While not traditionally the domain of institutional investors it appears they are growing in popularity for diversification, cost efficiency, transparency and ease of access to a variety of assets (see above: increased range of potential outcomes).

In terms of active ETFs, while mutual fund transitions probably flatter, the numbers are nevertheless astounding. Not only have broad inflows been strong (+24.3% YTD to $14.46T, a record high), active ETF’s are up 9x since 2019 and are forecast to quadruple again by 2030. Fixed income looks the most interesting area, especially for enhanced yield where being ‘active’ looks likely to go beyond security selection to include other assets (preferreds) and/or activities (call writing, securities lending).

A part of me feels that’s as good a bet as private credit.

But then I’m a little one-eyed and narrow-minded. Or at least I will be once the jet-lag passes.

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