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Hedge Fund CIO: “We Have Entered The Most Uncertain Period Of Our Lifetimes”

Hedge Fund CIO: "We Have Entered The Most Uncertain Period Of Our Lifetimes"

By Eric Peters, CIO of One River Asset Management, one of the…

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This article was originally published by Zero Hedge
Hedge Fund CIO: "We Have Entered The Most Uncertain Period Of Our Lifetimes"

By Eric Peters, CIO of One River Asset Management, one of the largest institutional holds of cryptocurrencies.

The Case for Quantum Change

Change is the great constant in human existence. And yet, for reasons we will perhaps never fully understand, we seek its opposite - stability - a state that does not exist. In fact, stability is the one thing we cannot have no matter how hard we strive to secure it. All we can hope to attain is the illusion, so we conjure it, and shelter within. Even still, change finds us, we cannot escape. The passing of another day in a short human life. The gentle shift from summer’s green leaves to September’s hint of yellows, reds. Then one day we find ourselves suddenly old. Engulfed in autumn’s peak.

Some change is undeniable, quantum, jarring. At least we perceive it so. An earthquake shocks, a raging forest fire too. While the forces that lead to such events are imperceptible, their outcome is inevitable, time uncertain. Silent subterranean pressures. Drying tinder. An invisible rise in atmospheric CO2, a warming ocean, the ferocious hurricane. Persistent forces quietly at work, compounding. These dynamics are not limited to the natural world. The intentions of individuals and human culture unleash the same grinding force. It is as much a part of us as we are a part of nature, which is to say, inseparable. Perhaps someday we will break free from the pattern of our origin; so far, there is scant evidence to suggest it.

Each of us, at our core is a mystery; to those around us, to ourselves. Yet nearly all our behaviors are predictable, exploitable. The success of nearly every organization relies on harnessing the power of predicting behaviors. Governments, religions, militaries, corporations, central banks, universities, etc. These organizations maintain control by understanding how to manipulate us at scale. Having attained power, they are unwilling to relinquish it. Established organizations therefore actively oppose substantial change. It is their existential threat.

Those with the courage and conviction to execute on innovative ideas change the world. They are ridiculed at first, dismissed, sometimes persecuted. Socrates. Galileo. A few break barriers, and are afterwards celebrated, sometimes enriched. Einstein. Edison. Even though the rest of us operate at lower altitudes, we too are sublime enigmas, each in our own way. So, although our behaviors are nearly always predictable, they are not entirely. And that is why, when connecting millions or billions of such creatures, we can often model the near future with reasonable accuracy but must recognize that the more distant horizon is highly uncertain.

And this leads me to investing.

There are many investor types. At one end of the spectrum are those who identify tiny anomalies in the prices of various securities and bet they will revert to mean. Such investing requires relatively little imagination, and therefore, enormous leverage is required to generate meaningful returns. At the other extreme are early-stage venture investors who are skilled at recognizing a changing world. They themselves do not generally conceive of that different future; rather, they see it through the eyes of visionaries who do, and then provide modest sums of capital to build it. Their unlevered returns can be enormous. More artistically minded people are often drawn to this investing style. 

Between those poles are countless others. Each bet on outcomes they see as probable relative to what is priced into markets. The biggest obstacle to an investor’s success is in overcoming their own biases, weaknesses, shortcomings. That’s no small task. The fact that most human behavior is predictable extends to our market interactions. The central tendency of most creatures is to follow - traveling in packs, herds, flocks, schools, tribes. This is why most successful investors tend to be deeply introspective. Their study of human nature helps them step outside of themselves. Iconoclast, they learn to lean against the crowd when risks rise wildly relative to rewards, or the inverse. They jump on macro mega-trends as the world begins to change while the herd resists.

But major transitions rarely happen. So, most investors bet heavily on tomorrow closely resembling today. Simple statistics point to this as the optimal path. It is especially true at the end of major cycles, when the rewards for predicting a continuation of the status quo have persisted for so long that they appear structural, perpetual. Returns for those bets compress through time, requiring investors to explicitly and implicitly leverage their portfolios to sustain performance. When the world changes, they are devastated. Great fortunes are made and lost in the transitions from one cycle to the next as a result. While we often view such episodes as isolated events, they are phases within a cycle, parts of a process, connecting what had come before to what inevitably follows.

And this takes us to the profound shifts now underway.

Investors tend to look at last year’s market collapse as a Black Swan. But it should be viewed as the final phase in a process that started in the late 1980s. An epic earthquake, decades in making. By early 2020, it was evident that monetary easing combined with central bank bond buying was no longer sufficient to spur the real economy on its own. To be sure, rate cuts and quantitative easing could lift asset prices if applied aggressively, but this in turn amplified inequality which contributed to the underlying conditions that afflicted the real economy. The Fed itself was crying out for politicians to engage in aggressive fiscal expansion.

The central bank’s well intended efforts to meet its dual mandate meant it did whatever was necessary to support stable prices and maximum sustainable employment. This had the unintended consequence of relieving politicians of making hard policy choices. The Fed stood ready to offset any and every economic interruption, leaving politicians under little pressure to act in the long-term best interest of the nation. With de minimis political costs of inaction, very little good happened. Special interests feasted. Leadership withered. The body politic followed, frayed.

The problem was not confined to the United States. It had become a global phenomenon. Decades of U.S. dollar dominance as the global reserve currency forced every developed nation to adopt the Fed’s general approach to monetary policy. Failure to do so resulted in currency appreciation, which in turn hurt international trade. In a world fixated on ever-expanding globalization, such a consequence was universally viewed as unacceptable. So, over the decades, global monetary policy converged with Fed policy.

The world thereby entered 2020 with a level of global policy homogeneity unlike any previously experienced. That policy no longer worked. The pandemic provided the most potent catalyst imaginable to catapult developed economies into an entirely new policy paradigm. Had it not been COVID-19, it would surely have been something else. The pandemic allowed even the most dysfunctional global governments and warring political tribes to coalesce around a common economic policy at a scale that will change how the world operates for decades.

By requiring governments to borrow and spend previously unimaginable sums to offset the economic depressionary forces, the pandemic restored politicians to power. Central banks played their part, accommodating the unprecedented borrowing. But it is not central bankers who spend money. It is elected politicians. And after decades of increasing political dysfunction, a wide range of societal, infrastructure, environmental and geopolitical problems had grown to the point that nearly everyone recognized them as such, even as they may have disagreed about how to address them. The pandemic pushed our politicians back into action.

Unlike global bankers, who came to closely resemble one another as their policy frameworks coalesced around the Fed playbook, politicians are a varied species. How each approaches borrowing and spending can differ wildly even within a single country. The way they approach lists of long-neglected priorities naturally varies. What sectors will win and lose, what commodities will rise and fall, what taxes will come and go, regulations too, all such things are now in play. And nations differ. So, what had been a paradigm of unprecedented policy homogeneity, is in a year unrecognizable. Policy is now becoming increasingly heterogeneous.

Were this the only transition now underway in our always evolving world, it would mark the most important change that has occurred in half a century. It has already resulted in the world’s largest economy borrowing roughly 15% of GDP for two years running, with the Fed buying nearly all that debt. The subterranean forces that produced such a shock are manifold and have only just begun to surface. Into this cauldron comes something earthshaking that was conceived as a response to these same forces. It manifested in 2009 and is so utterly revolutionary as to be initially incomprehensible to almost everyone.

Blockchain technology.

In twelve short years, the blockchain ecosystem has grown to include 6,000+ protocols with a market capitalization over $2 trillion. Many are built to replace something incumbent institutions presently do; only faster, cheaper, and more securely. Some protocols are built to do things we previously considered impossible. Still others do things not previously imagined. Many pioneers have generated the kind of wealth only amassed in periods of great disruption, transition. They are not cashing out; they have only just started. They see a world very different from what has been. They have a revolutionary mindset, a broadening view of what is possible, and the wealth to bring their dreams to life. They are not afraid to fail. Many will of course. But not all. Their spirit is extraordinary, the ambition breathtaking.

The most revolutionary aspect of these technologies is that they allow for fully decentralized power. In their purest form, they are built to operate without central control. They allow the planet’s 7.9 billion people, connected through the cloud, to interact, exchange value, information, property rights, encrypted data, and do things we have only started to imagine, securely, without a centralized authority. Such change presents an existential threat to every organization operating with a centralized control model, which is nearly every single institution.

Some incumbents will attempt to co-opt these systems, harnessing their efficiencies, while distorting the protocols to achieve centralized control. Such is the vast power of these technologies that this path holds the potential to lead the world toward a dystopian future. Beijing appears to be pursuing this path, reflected in the implementation of its central bank digital currency. Perhaps the West will take a different path, one that reflects its values and the source of its strength, providing the space for a Cambrian explosion of these new private technologies. Allowing them to flourish - all within a sensible regulatory framework - bringing with them innovations and efficiencies that we are only beginning to glimpse. Such a path holds the potential to produce another Renaissance. Where this all ultimately leads is impossible to say.

And this brings me to investment strategies for the decade ahead.

The most important thing to internalize when constructing portfolios for the coming years is that we have entered the most uncertain period of our lifetimes. It is even possible we are at the dawn of the period of greatest change for the past few centuries. This is almost inconceivable, considering the bruising pace of transformation we are living through now. Our natural inclination, our human bias, is to deny this possibility. But as investors, it is our job to step outside ourselves and survey the landscape objectively. A fair accounting of the range of potential outcomes when looking out over the coming decade or two spans from dystopia to Renaissance. It would be unsurprising, with so much uncertainty, for sentiment to swing from expectations for one such extreme toward the other, multiple times.

Prices move over the longer-term to reflect fundamentals. The big moves happen because the future is materially different from the present. When that gap is not properly recognized and therefore not priced into today’s market, a large trend becomes inevitable. Of course, nothing is truly predetermined, and so sometimes price trends, once underway, can themselves distort the future. Such dynamics can either temper trends or amplify them reflexively. The latter can extend to such wild extremes that prices then reverse with equal force and severity.

Given the change ahead, and the reluctance of people to accept it, let alone recognize it, one should expect large moves in prices. Trends. Such an environment will reward the artistically minded, the venture investors, and those prepared to break with what is now seen, after decades of growing policy homogeneity, as investing orthodoxy. It should come as no surprise that at the outset of such an environment, investors in digital assets and the companies that are focused on these new technologies have produced extraordinary returns. That trend has only just begun.

There will be enormous trends in other assets as well. Volatility markets will naturally present exceptional opportunities. Talented discretionary investors with unconstrained mandates, open minds and disciplined risk management should produce tremendous returns. An exceptional way to systematically capitalize on such an environment at scale is by deploying capital to trend-following strategies (CTAs). By removing the emotion and bias that handicap discretionary traders, and by spreading bets across many individual markets representing all the major asset classes, systematic trend-following strategies can profit in bull markets, bear markets. Renaissance. Dystopia. Extreme outcomes in either direction. The strategies are agnostic to the outcome, passionless, open minded, adaptable.

Systematic trend following has arguably just had its worst decade in the past century. The decade coincided with peak policy homogeneity, with central bankers expending extraordinary efforts to produce stability. Now trend strategies are generally shunned by investors, even as the world is transforming. Unsurprisingly, such strategies had their best decade of the last century in the tumultuous 1970s, producing tremendous returns in a period when inflation devastated most investment portfolios. After decades of low and stable prices, a return to a higher inflation regime appears not only likely, but it is a stated policy goal. None of this is to suggest we are headed for a repeat of the 1970s, or any other historical period for that matter. Systematic trend-following profits from great change, and it need not be a repeat of some previous regime.

We are at a truly unique moment in human history, headed as always, into the unknown but with an unusually wide range of possible outcomes. This is a time of existential risk for those unwilling to adapt, and a time of extraordinary opportunity for those of us prepared to embrace quantum change. In periods of such profound transition, it is the case that the investment strategies that profited most handsomely in the old regime, suffer in the new. And as with all natural phenomena, those that struggled, have their day in the sun.

Eric Peters
Chief Investment Officer
One River Asset Management

Tyler Durden Sun, 09/12/2021 - 19:30

Economics

Commodities and Cryptos: Oil slumps, Gold rebounds, Bitcoin plunges

Oil Crude prices are sharply lower after Evergrande debt default fears triggered a flight-to-safety that sent the dollar higher.  Evergrande’s woes…

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Oil

Crude prices are sharply lower after Evergrande debt default fears triggered a flight-to-safety that sent the dollar higher.  Evergrande’s woes are threatening the outlook for the world’s second largest economy and making some investors question China’s growth outlook and whether it is safe to invest there.  In addition to risk aversion flows pumping up the dollar, some investors are anticipating further hawkish signals that the Fed will set up a formal November taper announcement on Wednesday. 

Complicating the move in crude prices is the surge to record highs for UK gas futures.  Europe does not have enough gas and the energy problem could intensify if the early weeks of winter are cold. 

The US Gulf of Mexico production continues to recover from hurricane season, with now only 18.3% of offshore production being shut-in.  The oil market will still be heavily in deficit early in winter and if more demand comes that way, energy traders will buy any dip they get with crude prices. 

Gold

Gold’s rout is taking a break as investors run to safety over concerns Evergrande’s debt default concerns could spillover.  Gold got a boost as Treasury yields plunged, with the 10-year yield falling 5.4 basis points to 1.307%. 

Gold’s rally could have been much higher if not for the reports that Senator Manchin may be thinking of suggesting Congress take a “strategic pause” until 2022 before voting on the $3.5 trillion social-spending package.  Considering stocks are about to have their worst day since October, it is very disappointing that gold prices are only up around $10.  Gold may continue to stabilize leading up to the FOMC decision, with the next move likely being further downside.  Gold could struggle until the Fed finally starts tapering asset purchase.  It is then that it may start acting more like an inflation hedge.    

Bitcoin

A retest of the September low came far too easily for Bitcoin.  The fallout from the Evergrande is putting a tremendous dent in risk appetite that is sending everything lower. Cryptocurrencies, despite all the volatility, have been the best performing asset of the year, so it should not surprise Wall Street they are the first asset sold in the beginning of China-driven market selloff.    

Retail traders remain bullish, albeit many have capitulated in locking in some profit.  Some traders are anticipating a short pullback, while some lunatics are readying to buy more after tomorrow’s full moon.    

In El Salvador, President Bukele tweeted “We just bought the dip. 150 new coins!”  El Salvador’s total is now 700 coins and that enthusiasm has yet to be matched by other countries.   

If Bitcoin breaks below the $40,000 level, it could see momentum selling have it eventually return to the $30,000 to $40,000 range that it was in earlier this summer.  

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Economics

Asia’s Largest Insurer Hammered As Investors Sell First, Don’t Bother To Ask Questions

Asia’s Largest Insurer Hammered As Investors Sell First, Don’t Bother To Ask Questions

Few were surprised to see that the crash in Evergrande…

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Asia's Largest Insurer Hammered As Investors Sell First, Don't Bother To Ask Questions

Few were surprised to see that the crash in Evergrande dragged down property names (one among then, Sinic Holdings, crashed 87% in minutes and was halted), banks exposed to the property developer (according to report there are over 120), with the contagion spreading to commodities directly linked to China's property sector (such as Iron Ore which plunged 10%), as well as FX of commodity-heavy countries, one ominous decline was that of Asia Pacific's largest insurer, Ping An (whose name literally and unironically means "safe and well"), which dropped 3%, following a 5% drop on Friday, and hitting a four year low on concerns about its property exposure.

The selling took place even though the company issued a statement Friday saying that its insurance funds have “zero exposure” to Evergrande and other real estate companies “that the market has been paying attention to.” Real estate accounts for about 4.9% of Ping An Insurance’s investments, versus an average 3.2% for peers, according to Bloomberg Intelligence.

“For real estate enterprises that the market has been paying attention to, PA insurance funds have zero exposure, neither equity or debt, including China Evergrande,” Ping An said in a statement as it rushed to reassure investors.

While it may have no exposure, Ping An does have RMB63.1bn or $9.8bn in exposure to Chinese real estate stocks across its RMB3.8TN ($590BN) of insurance funds, and took a $3.2BN hit in the first half of the year after the default of another developer, China Fortune Land Development. The insurer is also head of the creditor committee for China Fortune Land, which specialises in industrial parks in Hebei province and suffered from delayed local government payments. One of its restructuring advisers, Admiralty Harbour Capital, was hired by Evergrande this week.

At a time when any Evergrande counterparties or even rumored counterparties are immediately deemed radioactive, Ping An's plight demonstrates how acute and widespread the selloff could become in China if Beijing fails to intervene.

“I expect a lot of financial institutions could be hit by the worries” about Evergrande, said Zhou Chuanyi, a Singapore-based analyst at Lucror Analytics. "As long as a financial institution has exposure to developers, Evergrande should take quite a significant share of that."

Yet as the market waits for some response official response, hopeful that Beijing will step in, we discussed earlier that China's policymakers have instead sought to crack down on excessive leverage across its vast real estate sector over the past years, which makes up more than a quarter of the economy, imposing a firm threshold known as the "3 Red lines" which developers must adhere to, and which has meant most developers are limit to % or 5% debt growth at best. 

For now it remains unclear how far the contagion will spread, although if Beijing stubbornly refuses to intervene, expect much more pain as capital markets seek to force Beijing's hand by make it unpalatable for the CCP to suffer even more selling which could spark social unrest.

“The price action across several asset classes in Asia today is horrendous due to rising fears over Evergrande and a few other issues, but it could be an overreaction due to all of the market closures,” said Brian Quartarolo, portfolio manager at Pilgrim Partners Asia.

As discussed earlier, Xi faces a tricky balancing act as he tries to reduce property-sector leverage and make housing more affordable without doing too much short-term damage to the financial system and economy. Mounting concerns that he’ll miscalculate are spreading ever-further beyond China-focused property developers and their suppliers.

“It’s what the Chinese would describe as trying to get off a tiger,” said United First Partners research Justin Tang, best summarizing Beijing's lose-lose dilemma.

Tyler Durden Mon, 09/20/2021 - 15:28
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Economics

Summarizing China’s Short Term Economic Outlook

Wells Fargo Economics analyses the extent of the current slowdown, and contemplates the impact on regional economies. Here’s the heat map: Source: McKenna/Guo,…

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Wells Fargo Economics analyses the extent of the current slowdown, and contemplates the impact on regional economies. Here’s the heat map:

Source: McKenna/Guo, “China Economic Gauge and Sensitivity”, Wells Fargo Economics, 20 Sep 2021, Figure 1.

From the report:

Our dashboard (Figure 1) suggests the short-term outlook for China’s economy is indeed deteriorating, consistent with the multiple downward revisions we have made to our GDP forecast over the past few months. Given the signals our gauge is showing, we believe easier monetary policy could be the next major policy move from the PBoC, and another RRR reduction could be imminent as authorities look to offset some of the deceleration.

This report is in line with the Goldman Sachs report (discussed here).

Wells Fargo highlights Singapore, South Korea and Chile as most sensitive to growth developments in China (on the basis of exports). Looking more broadly at “beta’s” of equity returns and currency values as well as export dependence, the list of at risk countries expands to include South Africa, Brazil and Russia as well.

 

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