Broad Market Thoughts and Portfolio Construction
Broad Market Thoughts and Portfolio Construction
Home sick after a 20 hour travel day and 12 hours of sleep, so take everything I say here with a grain of salt.
I’m looking to get back into trading and investing after a break of about 12 months from taking it very seriously.
Today I started thinking about what type of portfolio I would put together if I had $X to invest and i wanted to lay out my money in a way that I felt confident about.
That led me down a rabbit hole of looking into various portfolio balances. And that led me down the rabbit hole of thinking about what types of environments each asset class does well in, and why each portfolio balance performed the way it did on a year-by-year basis.
I stumbled across a really interesting chart that I wanted to talk about and think about:
The top box here is m2 money supply (real) * M2 money velocity. It’s a REMARKABLY straight line from 1959.
The second box is the correlation coefficient between the top value, and QQQ (the Nasdaq ETF). Again, what’s remarkable is how much time it spent at or near 1.0.
Here it is again against a bunch of other asset classes:
So what can we take from these charts?
Risk assets broadly are correlated extremely closely with the expansion of the money supply.
Bonds have always been fairly correlated with it as well, until the 2021 hiking cycle. Higher money supply*velocity → lower rates → Bonds up, until eventually the government has to raise rates, which tightens money supply, and bonds crash. Eventually there is going to be a big adjustment here too where the amount of debt being issued by the US starts to cause bond buyers to require higher rates. Much to think about here.
Gold SHOULD have been up only with the money supply. But it hasn’t been. There’s a little nuance here if we dig into the charts. I’ve got a closer look at gold below. It ran way way up after the gold standard was removed, then cratered and stayed flat for a while. If you remove that from the chart the correlation is a lot closer. But it’s still not perfect. There was a lot of USD strength in 2012-2013… even while the money supply expanded.
BTC really has too short of an existence to say much, but it’s my belief that it will behave like a very volatile risk asset. Still, this chart pretty clearly shows the BTC v M2 situation.
Lastly we have to remember that the market should be responding to the rate of change, rather than the absolute value of the money supply.
I think the market realizes that a return to the relentless expansion of the money supply is inevitable and has been aggressively front-running that change in the rate of change.
Some Broad Thoughts
So we are pretty clearly in a regime where the government will continue to overspend, and that is pretty clearly an environment that is very good for risk assets. There seems to only be one end for that regime which will be a crack in the treasury markets. That crack could be a good 10-15 years out, or even longer. It’s hard to imagine a war breaking out that would be sustainably bearish for risk assets, because it would simply result in additional money printing.
I guess the caveat here would be if we had a return of inflation that would cause the market to radically reprice the expansion of liquidity… but that just doesn’t seem to be happening (yet)
How can inflation stay low in a world where money supply growth will be accelerating with no end in sight? The only hope here will be for the US to remain the most powerful economy on a relative basis, such that the USD can also continue to remain strong on a relative basis. Therefore, paradoxically, a serious drop in DXY is something to watch for as BEARISH risk assets in the long term.
The US is performing a balancing act where it is getting away with it’s horrible fiscal policy because it’s still the best place around. Have to watch US GDP on a comparative basis with the other big economies. If somewhere else emerges are a viable alternative… watch out for a sea change. But with China having it’s troubles, Japan and the EU not really growing at all… the US is by far the best game in town.
The Main Takeaway
Party on in risk assets until something changes or breaks. Watch in the short/mid/long term for:
The US Markets and economy losing their global “goldilocks” flavor. As soon as there’s another viable place to put your capital, it could be a day of reckoning for the US’ fiscal policy (if it ever happens).
Anything that could be consider a consequence to US fiscal policy, IE treasury markets coming under stress or inflation coming back.
A break out either way for the DXY. A weak DXY could signal that markets are finally caring about US fiscal policy, while a strong DXY could lead to (or front run) a liquidity pull back.
Anything that could cause a liquidity crisis which would be a shock to risk assets.
Portfolio Thoughts
VFIAX: Vanguard 500 Index
PULS: Ultra short bonds
Crypto: 50/50 ETH and BTC. Will get more exposure here I’m sure being a degen in “discretionary”
Discretionary: This is where I will make my degen and occasionally excellent trades.
This has a solid sharpe ratio depending on how far back you take it. A lot of that is from the explosive growth of ETH and BTC which may just not continue ofc.