"A Gothic Horror In The Middle of a Pretty Good Time" | Protect The Pile: Episode 6

Key Concepts

• Market Resilience & Rotation: Despite geopolitical uncertainties, the market demonstrates resilience, but is experiencing a rotation away from momentum, growth, and the “MAG7” towards cyclical sectors.
• International Exposure: Hedgei Asset Management is overweighting non-US markets (Japan, South Korea, Latin America) based on quantitative signals.
• AI Investment & Hyperscalers: Questions are emerging regarding the profitability of AI investments, leading to a re-evaluation of hyperscaler companies.
• Crypto Market Correction: A significant correction in the crypto market ($2 trillion in market cap loss) could have deflationary effects.
• Dollar Dynamics & Geopolitical Risk: A concerning negative correlation between the dollar and the market, coupled with rising geopolitical risks (Russia/Ukraine, Taiwan), suggests a shift towards a weaker dollar and higher interest rates.
• Trump’s Impact on US Policy: A potential second Trump presidency would likely accelerate a shift away from globalization towards a more nationalistic, transactional approach, aligning with a growing consensus within US institutions.
• Globalization Reassessment: A “great rebalancing” is underway, with a growing recognition that the benefits of globalization have been overstated.

Market Overview & Economic Indicators (February 6th)

As of February 6th, the S&P 500 was slightly over 1% off its all-time high despite global uncertainties. Market breadth is generally good, with over 60% of stocks in the S&P 500 and Russell 2000 above their 200-day moving average (“moving monkey”). However, the NASDAQ shows weaker breadth (around 40%) due to its concentration in the “MAG7” technology stocks. Volatility remains stable (“chop bucket”), while sentiment has pulled back to neutral, despite increasing put buying indicating underlying fear.

Economic indicators point to a “quad one” backdrop – strong growth and low inflation. Implied inflation (TIPS) is at 2.3%, while true inflation is at 1%, significantly lower than the CPI at 2.7%. Food and gasoline prices are down 12% and 8% year-over-year, respectively. Both manufacturing and services PMIs are above 50, and jobless claims are near lows. The US dollar is down 1% year-to-date and 8% year-over-year, contributing to a recent energy price breakout. Liquidity remains loose, with three-month annualized growth near 12% and year-over-year growth at 10%.

Portfolio Strategy & International Allocation

Hedgei Asset Management has deliberately overweighted non-US markets in its model portfolios, driven by quantitative signals rather than a desire to “sell America.” Increased exposure has been allocated to Japan, South Korea, and Latin America, anticipating a benign global backdrop. This strategy was implemented in December and adjustments began being promulgated as of the recording date.

Market Dynamics & Factor Performance

Recent market selloffs have been led by underperforming momentum, growth, and earnings-revising stocks. While historically strong performers, these factors are currently facing headwinds attributed to degrossing, regrossing, and positioning adjustments. A rotation is occurring from large-cap growth to more cyclical sectors.

The “MAG7” & the AI Debate

A disproportionate amount of capital inflows has gone to the “MAG7,” driving market concentration. Questions are emerging regarding the capital intensity and future profitability of these companies, leading to a “crackup” in performance divergence. The initial cloud businesses (like AWS) were unprofitable for years before becoming profitable, suggesting a similar investment period may be necessary for current AI ventures. Success in AI requires companies to possess computer infrastructure, unique data, and efficient distribution. Neil How described a shift in investor perception of hyperscalers using Edward De Bono’s “jigsaw puzzle” analogy, suggesting a new piece of information has caused a re-evaluation.

Crypto & Stablecoins

The crypto market has experienced a significant implosion, with $2 trillion exiting the top 10 market caps. This could have a deflationary impact due to wealth destruction and a shift in investor risk appetite. There is increasing focus on stablecoins and their potential to disrupt traditional banking, with Tether increasing its holdings of gold and US Treasuries as backing.

Dollar, Geopolitics & Trump

A concerning negative correlation exists between the dollar and the market, deviating from historical norms. The US is potentially moving towards a new era of lower dollar value and higher interest rates due to declining capital inflows and a need for increased domestic savings. Geopolitical risks are rising, particularly Russia’s potential actions in Eastern Europe and the implications for NATO.

A second Trump presidency could significantly impact the markets. David Salem suggests assuming no view is truly fixed regarding Trump’s policies. Neil How argues Trump’s long-standing isolationist tendencies are a consistent element of his approach, even if involving economic sacrifices. Trump’s worldview is described as transactional and zero-sum, prioritizing short-term gains.

The Shifting Landscape of US Economic & Foreign Policy

Trump’s policies represent a departure from decades of globalization towards a more nationalistic, transactional approach. America’s historical prosperity was fueled by attracting capital and labor, benefiting from the “exorbitant privilege” of the dollar as the reserve currency. However, this also led to the hollowing out of the American middle class due to cheaper labor from countries like China after its entry into the WTO. Trump correctly identified the dangers of a free trading system exploited by China, which strategically scaled up industries and gained a “stranglehold” on resources like rare earth metals.

A “great rebalancing” is underway, with a growing consensus that the benefits of globalization have been overstated and a need to reverse course. This alignment gives Trump’s policies “heft and weight.” Future US-China relations under Trump are anticipated to involve four in-person meetings between the leaders, potentially facing an impasse over Taiwan similar to the stalled negotiations between Putin and Zelenskyy.

The discussion briefly touched on the vulnerability of modern infrastructure to an electromagnetic pulse (EMP).

Cultural Observations

The segment concluded with a discussion of memorable Super Bowl halftime shows, highlighting Prince (2007), Eminem (2022), Whitney Houston (1991), The Who & Tom Petty (around 2008/2009), Kendrick Lamar, and LL Cool J’s recent album featuring Eminem. Generational archetypes were defined as Boomers (1943-1960) and Gen X (around 1961).

Conclusion

The discussion paints a picture of a complex and evolving global landscape. While the market demonstrates resilience, significant shifts are occurring in factor performance, international allocations, and geopolitical dynamics. The potential for a second Trump presidency adds another layer of uncertainty, potentially accelerating a move away from globalization. A key takeaway is the growing recognition that the benefits of globalization may have been overstated, prompting a re-evaluation of long-held economic and foreign policy assumptions. Investors are advised to navigate these changes with a flexible and informed approach, recognizing the potential for both opportunities and risks.