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The Shortage Economy & Correlated Beliefs

Updated: Nov 2, 2021

  • An important element of our process is having a sense of the prevailing bias or consensus beliefs. That is particularly important when it results in crowding and when there might be unintended correlation in portfolio positions


An important element of our process is having a sense of the prevailing bias or consensus beliefs. That is particularly important when it results in crowding and when there might be unintended correlation in portfolio positions. Judging consensus beliefs is not an exact science. Positioning data can help. However, it is often the case that extremes in beliefs and positioning are accompanied by asymmetry in valuation. There are also cyclical (tactical) and secular considerations. The latter will clearly be a more persistent influence on asset class performance.

In the immediate aftermath of the 2008 crisis, an important behavioural effect on investors was “volatility aversion” or the desire for assets with perceived stability (low standard deviation) of cash flow and returns. That also likely contributed to a reduced investment horizon (or time frame) and the emergence of risk parity and volatility targeting strategies. Within equity it encouraged demand for companies with low volatility factor characteristics (less cyclical and often the opposite of the “value”). In a world where trend growth was perceived to be lower, it also encouraged demand for companies with strong secular growth. Those characteristics often overlapped with the “momentum” factor (the technology and communications sectors have often been a large weight or more than 40% of the momentum factor index in the United States).

There was also a correlated belief in the rates markets. Through the 2008 crisis and in the immediate aftermath, fixed income markets still expected that the Fed Funds rate would be positive in real terms. While the crisis caused a deep recession, the assumption was that rates could mean revert to pre-2008 levels. However, as Gerard Minack noted last week, the European crisis, double-dip contraction and the post 2012 weakness, forced markets to lower the decade-ahead outlook for rates. A negative real Fed funds rate has been persistently priced since 2011. By mid- 2016, the prevailing bias was that this was a permanent state. However, it was probably not until the pandemic that markets lowered the end-decade forecast for the Fed funds rate from lower-for-longer to lower-for-ever.

From a behavioural perspective, the correlated belief that rates are lower-for-ever has encouraged some extreme valuation anomalies and positioning in markets. The most notable is in assets with long duration, whether that is in fixed income or equity with cash flows a long way into the future (stocks based on hopes and dreams). It has also likely encouraged investors to take on short convex positions. That is, sell volatility in all its forms and allocate capital to “carry” related strategies in the credit and fixed income markets.

For investors that could prove a monumental mistake. It is plausible that the pandemic could mark a secular trend change. The pandemic was the catalyst for a shift to fiscal-led cycle management that could lead to higher through- the-cycle real interest rates. To be fair, some of my former colleagues at M&G in London argued that this process might have started in mid-2016 around UK Independence. However, just as the prior decade showed how long it took for permanently lower rates to be embedded in consensus beliefs, the end of lower-for-longer will not happen overnight.

Tactically, the Economist Cover this weekend suggests that there is elevated fear that shortages in the global supply chain will lead to more persistent inflation. Stated differently, the consensus belief has started to doubt the “transitory” thesis put forward by central banks and others. The big picture point for markets is that if inflation becomes more persistent that is likely to force a major change in markets everywhere. Most notably it will underline the point that fixed income provides as hedge for equity in recessions, not inflationary episodes.

the shortage economy
The shortage economy

Ordinarily, the Economist is an excellent contrarian indicator. Once the story or theme has made the front cover it is likely well appreciated and priced into positioning and sentiment. That might be true in segments of the energy markets. However, at the current level of real and nominal yields it is probably not priced into fixed income. Neither is it priced in the equity or volatility markets that could be most affected by persistent inflation and a sharply higher discount rate.

Tactically in the very short term, while the September employment data on Friday in the United States was disappointing at a headline level. Upward revisions to the prior months, lower unemployment and higher wages suggest that the Federal Reserve probably remains on target to commence normalisation away from emergency policy conditions in November (liquidity withdrawal and eventually higher rates next year). In a regional context we would also expect liquidity and growth conditions to improve again into year end. That probably sets up another phase of higher yields and outperformance of value and cyclical equity. If inflation becomes more persistent and there is a secular shift in rates next year that could prove disruptive for a number of correlated positions and lead to a phase of higher cross asset volatility. Where is the greatest volatility?: follow the leverage.

Content contributed by Nick Ferres, Advisory Board Member of Conduit Asset Management Pte. Ltd. All information contained in this document is sourced from public source documents, media releases and not from Conduit Asset Management Pte. Ltd., (the “Company”). All due diligence onus, including and not limited to that related to legal and financial documentation, rests on the investor. This document is intended for distribution to “institutional investor” and "accredited investor" types as per definition by the Securities and Futures Act (Cap. 289) of Singapore, or to those who would qualify as such, under one or more of the categories of “institutional investor” and "accredited investor" so described therein. The information and data contained herein are strictly confidential and for information purposes only, and shall not be construed as investment advice, an offer, or solicitation, to deal in any securities. The information is not to be reproduced or transmitted, in whole or in part, to third parties, without the prior consent of the Company. This information is not directed at or intended for distribution to any person or entity who is a citizen or resident of, or located in any jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation or which would subject the Company to any registration or licensing requirement. This information has not been reviewed or authorized by the Monetary Authority of Singapore, or any regulatory authority elsewhere. Consequently, you should not act or rely upon the information contained herein without seeking professional counsel. The information contained herein may contain statements that are not purely historical in nature, but are “forward-looking statements”. This includes, among other things, projections, forecasts, targets, samples or proforma investment structures, portfolio composition models and hypothetical investment strategies. These forward-looking statements are based on certain assumptions and actual events may differ from those assumed. Neither the Company nor any of its respective affiliates make any representations as to the accuracy of these forward-looking statements or that all appropriate assumptions relating thereto have been considered or stated and none of them assumes any duty to update any forward-looking statement. Accordingly, there can be no assurance that estimated returns or projections can be realized, that forward-looking statements will materialize or that actual results will not be materially different or lower than those presented. Please note that the Company and/or its related companies, and investment staffs, may from time to time hold direct or indirect economic interests via non-controlling stakes into underlying Funds’ Investment Advisory Companies that control the Funds into which the Conduit Partners’ Capital Fund invests. Past performance is no guarantee of future results, and there is no assurance that the investment’s objectives will be achieved. In addition, certain financial information is contained herein. While the Company has made reasonable efforts to include information from sources that it believes to be reliable, the timeliness, accuracy and completeness of the underlying information, and any computations based thereon, cannot be assumed. While the Company has attempted to minimize errors, it has not verified, nor does it guarantee or warrant, the accuracy, validity, timeliness, completeness or suitability of such information and data. The Company is not responsible for any trading decisions, damages or other losses related to the information or its use. Please note that our references to a “Tradeflow USD/EUR Series” herein is made specifically to the CEMP – USD/EUR Tradeflow Fund, ISIN NUMBER: KYG1988M6375/KYG198751300. Conduit Pte. Ltd. is a part owner the referenced commodity trade finance fund’s investment advisor, Tradeflow Capital Management. The Company is currently invested in, and receives compensation for referenced Fund distribution and rebates on direct Fund investments from the Conduit Partners’ Capital Fund into the CEMP – USD/EUR Tradeflow Fund. For references to “VPAM Asian Macro” herein is made specifically to the “Vantage Point Asian Macro Fund”, the Company received compensation for the referenced Fund distribution and rebates from Vantage Point Asset Management Pte. Ltd.


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