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Top Traders Unplugged
SI399: AI, Inflation and the Portfolio That Refuses to Sit Still ft. Alan Dunne
01:11:50
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- [00:01]
A
Welcome to Top Traders Unplugged. In markets, success doesn't come from predicting what happens next. It comes from being prepared for what you can't predict. In each episode we go deep with some of the world's most thoughtful minds in investing, economics and beyond to understand how they think, how they prepare and how they decide and the experiences that shaped how they see the world. No noise, no no shortcuts, just real conversations to help you think better and invest with confidence.
- [00:36]
B
Welcome and welcome back to this week's edition of the Systematic Investor series with Alan Dunn and I, Niels Caster Blaassen, where each week we take the polls of the global market through the lens of a rules based investor. Alan, it is wonderful to be back with you this week. Hope you're doing well. I see you dress well for the occasion.
- [00:52]
C
Yes, delighted to be supporting the Tough Traders Unplugged Gilet. So thanks very much for that. Not wearing it more broadly outside the home office. Yes, but maybe we'll be brave enough to do that in time.
- [01:05]
B
Yes, no, absolutely. We got a very solid lineup. Thanks very much to you where we're going to be tackling a few new topics as well as a world exclusive if I'm not mistaken. So before we dive into any of that as, as you know by now, I love to hear what's kind of been on your radar, what's called your attention in the last few weeks maybe.
- [01:31]
C
Well obviously AI is one thing that's dominating all of the conversations and definitely that's something, you know, I've been thinking about and writing about and we'll get into that a little bit later. But just I saw an interesting article just yesterday that I thought was worth highlighting from Greg Ape, who's an economics correspondent with the Wall Street Journal, just on how much AI is distorting everything with respect to the US economy and the economic data. And in the article he highlights that. I mean based on his calculations that the AI economy in the US grew by 31% in Q1, but the non AI economy was basically flat, just highlighting how much of an impact it's having obviously in terms of Capex spending, et cetera. But actually if you dig a little bit deeper, maybe the impact is not so dramatic because a lot of that spending is going overseas in terms of imports to places like Korea, etc. So that's another dimension. And then obviously the way earnings are being distorted as well. Q1 earnings on track to be up 27% but the MAG7 to be up 61% and the rest just up 16%. So again, another distortion. And then he was talking about like from a construction spending. Obviously we're seeing data centers all over the place, at least it seems to be. But he was saying that actually they're concentrated. The construction of data centers is very concentrated in certain areas in the U.S. 33 counties account for 72% of the data centers. So he was making a point. Well, if this all kind of unwound the impact on say construction employment more broadly might be that impact and that great. And another point was the total share of labor. So basically from I suppose the percentage that wages account for in total output fell to 54% in Q1 and that was the lowest since records began in 1947. So all of these factors highlighting to how much AI is a challenge, I guess for policymakers in that it's having such a transformative impact on the economy, but also on the data as well. I mean, he does conclude that if it all ends, it might have that much of an impact on the economy. I'm not sure I was convinced by that argument because he didn't talk about what would happen to the stock market and the possible wealth effect from that. So. Interesting article. And definitely, you know, the conversation about the positives and negatives will continue.
- [04:14]
B
Yeah, no, exactly. I think that that, that's kind of also my, my key takeaway every time I hear about AI is just the fact that we have this one technology. But there are so many very strong, very different opinions about its long term effect. And also speaking of data centers, and this is just something I seem to remember from having read other stories in recent weeks, but kind of given the fact what's going on in the Middle east, kind of the location of data centers, meaning that you suddenly realize that you've put, you know, an important data center in a region that is not as stable as you would have thought and all the impacts that the, you know, changes in the world that's happening right now, it's also having, we're going to talk about kind of the global macro picture very shortly. But you know what, I also caught a little bit of a story on AI and I don't know if you've seen any of the same, but it's actually nothing to do with its productivity or all of that. It's actually from some of the transcripts from the court case between elon Musk and OpenAI, which is going on right now. And it's kind of fascinating what happens when you put executive executives under oath, especially if someone has written a diary along the way and you can kind of poke, poke your, Your, your eye into what was really being thought maybe at the time. So, you know, it's a fascinating, it's a fascinating event, if, if nothing else. And some of the statements that has come forward, I think are pretty, pretty extraordinary actually. But you know what, I would have thought something else would have been on your radar. So I was expecting you to say something like council election in the uk, as you are much closer to them than I am. But I did see some headlines. They're pretty spectacular.
- [06:13]
C
They are. I mean, I thought about raising that one. I didn't want to comment too much. Obviously the results are still coming in, but it certainly looks like a big swing towards Reform uk. And obviously know Keir Starmer has already been under pressure, so this was not unexpected. But I, I saw a headline that he is vowing to, to, to stay on. I mean, we'll see if that's, if that's feasible. But, you know, I mean, it's confirming the shift that we've been seeing for the last while, a shift to the right, a shift towards more, you know, I suppose nationalistic policies. Not just in the uk, you see it in Germany, you see it around lots of places. So not, not a shock, but certainly very, very notable results.
- [06:59]
B
Now, from an economic perspective, I don't know if you have an opinion about this. I did see some headlines about putting pressure on yields in the UK and so on and so forth. I mean, do you think that there is, I mean, we've had the trust moment in the UK already once. I mean, do you think a shift like this. And again, I'm not expecting you necessarily to have a strong opinion, but do you think that this might actually kind of put additional risks that we haven't thought about when we think about the UK economy?
- [07:33]
C
Well, I mean, it was certainly the case going back at the end of last week. Yields were touching up above 5% gilt yields. So certainly that was highly topical in the sense that obviously as yields go up, that takes more money to service the debt and the risk is you get a vicious cycle. Now, looking at the markets today, guilt yields are down, so the market, the gilt market, at least is comfortable with the result. I mean, you know, Reform UK is a relatively new party, they've never been in power, so what they really stand for from an economic perspective remains to be seen. But, you know, and the initial reaction from markets is positive. But, you know, I suppose the thing is, obviously there are, you know, they tend to be an anti immigration party. But the reality is in the UK across Europe we need immigration to boost the labor force to, you know, long term growth is a function of productivity and labor force growth. So if you, if you don't attract foreign workers then you have nobody to do a lot of the jobs that you want to do. Tends to push up inflation, you get labor shortages, et cetera. So you know, I mean there's that dichotomy from what may work from a, a social policy perspective and what's optimal from an economic policy perspective.
- [09:01]
B
I'm not saying that this is a similar situation but like eight weeks ago or so we had an election in Denmark and actually there was a new party that was elected to the Parliament. It was led by someone who broke out from another party, right? He formed his own party and he actually got above the minimum number of votes. So he. And then you get four seats out of 179 in the parliament and they are actually also on the far right and anti immigration everything. The fun part of this is that after only a few weeks now the three other members have left the party. So now the chairman is all by himself in his party. But there we are. That's democracy. Anyways, let's talk about some trend following what's going on in that world right now. My own trend barometer finished yesterday at 55. That's still pretty strong. So. And it's been pretty consistent I have to say for a while now. And I think that is reflecting what we've seen so far this year in terms of performance, I think, I mean so far we're what, seven, eight days into May and it looks kind of uneventful overall. Still a lot of volatility of course. And so there's different leadership in the portfolio and also very much dictated by what's happening in the Middle east it seems right now. But you know, something like Japanese equities continue to do really, really well. And maybe, I mean of course equities in general had a really strong month in April and some of those markets are continuing into May. And then of course we have the metals that seem to have found some new energy, so to speak. And so but anyways, I think overall it's probably a pretty flat month. I do see that Coco has found some revised energy to the upside and that's probably hurting trend followers right now because of the longer term trend that it's been in to the downside. Other than that, I think the main thing that seems to me that's going on in the trend following space is the shift in exposure to fixed income. I mean it has been difficult, we've talked a lot about this in the last couple of years, but there's been a somewhat decisive shift from Q4 to now in terms of not only reducing long exposure but actually going reasonably short is my estimation and kind of lining up to a more inflationary world. That may not happen of course, so we may have to change the exposure, but that seems to be the biggest shift. I would love to. Well, let me run through the numbers then you can go into your macro view but you can tie it into the trend following as well, if you wouldn't mind. But as of Wednesday 6 May, the numbers are as follows. They're pretty flat actually. Beat up 50 up 2 basis points only in May, but up 9.84% so far this year. The Stock Gen ct index down 7 basis points but up up 10.14% so far this year. Trend index very similar, down 8 basis points, up 10.05% so far this year. And the Short Term traders index is up 62 basis points and up almost 6% so far this year. However, in the traditional world, MSCI World is still doing well up 1.76% as of last night, up 7.69. We have the US aggregate bond index that's pretty flat though. 12 basis points to the upside and 40 basis points up for the year. And then we have the S&P 500 of course total return up 1.79% so far this month and up 7.59 so far this year. And as I mentioned, if I just look at kind of month to date, big, big moves in the markets, Coco, by far the biggest one up 23% so far in May. To the downside, maybe not so surprising, we have a bit of weakness in the energy complex given the fact that there seems to be a little bit more quiet. Maybe it's quiet before the storm coming out of the Middle east right now, but love to hear your thoughts on trend where what you see and then we can migrate that into kind of your usual global macro picture and maybe related to your latest substance.
- [13:35]
C
Yeah, I mean I think in terms of trend following, you know, overall, you know we've had a positive period last number of months. I mean you touch on the the fixed income exposure and I think that does tie into kind of what I'll talk about from a macro perspective because obviously what we've seen in markets go back to the end of February, there was this big Focus on the Citrini Report the disinflationary impact of AI I remember being at Iconnections conference speaking to some macromanagers. People were speculating oh, maybe the Fed might cut rates more aggressively given this disinflationary impulse from, from AI. Then obviously we had the shock of the Iran war and it became very apparent quickly that the central bankers couldn't be cutting rates in an environment where energy prices were spiraling higher and maybe even have to tighten policy. And at the same time a lot of funds across macro or V had steep their positions on effectively betting on lower short term rates. So that was a big interest rate shock which obviously impacted trend following from that side. But I mean not, not massively. At the same time you had the trends in the energy market which was a positive offset, you know, notable, you know, just like it's been a positive period. But some of our colleagues in the industry, you know, who run at very high levels of volatility we won't name but you know, producing exceptionally strong performance. I just saw in the latest return. So certainly some managers really capitalizing on those moves up in the energy complex. But as you say, I think the one area that has continued to be difficult has been fixed income. And we went from that disinflationary narrative to the stagflationary narrative and that's obviously ebbing a little bit now as the market seems to be looking through that scenario a little bit. So I think it remains favorable. Ironically, if you look back over the last 12 months now it's looking at one of the stronger periods for trend following. And I was actually at a conference yesterday, somebody was talking about it and they're saying, oh yeah, well if you look back it's been a strong period for trend and you can explain it by reference to whatever they said. And I was like, and I had to laugh to myself because only 12 months ago you were trying to explain the poor performance of trend by reference to some random factors. It just shows you, it's just so, so difficult to anticipate when we're going to see these strong runs of performance. But we know that they come along. So yeah, I mean, I think the narrative around performance, you know, is positive, but you have to take it a little bit with a pinch of salt.
- [16:36]
B
Yeah, no, absolutely. But you also wrote your a substack about kind of the global macro environment right now. What are your sort of main thoughts?
- [16:46]
C
Yeah, well, I wanted to talk about that kind of collision that we're seeing in markets at the moment. Between two huge shocks and two secular trends, one being AI and the other being the conflict in the Middle East. Because taking the latter conflict like that which pushes up oil prices is what economists call an adverse supply shock. It pushes up the price of things and it reduces output. So that's in economic models this aggregate supply curve is shifting to the left, which is not good. It obviously creates stagflationary pressures and that tends to be obviously very negative for financial assets. Obviously it's bad for bonds, higher inflation. It also tends to be bad for equities as well. And obviously the big period of stagflation was the 1970s and we saw negative real returns for bonds and equities. So it also creates a big policy dilemma for central bankers because we've seen this before. If you go back to 2008, you remember oil prices spiked. The European Central bank raised rates in May of 2008 and then by October of 08, higher oil prices were one of the factors contributing to the downturn. But we also had the global financial crisis and then the ECB were a obviously cutting rates by the end of the year. So at the moment we've got that dilemma of how do you respond to higher energy prices? You know, the classic response is to look through it because they won't necessarily generate second order effects as economists call it. But you know, people are more sensitive to higher prices at the moment because we had the experience of inflation during COVID So there is that risk of, of inflationary expectations getting de anchored. So that's one issue. At the same time, obviously it's a shock that creates distributional impacts. It doesn't affect everybody the same. Obviously the US is probably more insulated to the shock than Europe or Asia. And obviously lower income households are disproportionately impacted because gas is going to be a bigger percentage of their budget relative to wealthy people. So there's all of these. It's not just a simple adverse supply shock. There are distributional impacts, there are geographic impacts, but it does create a policy dilemma. But I think that's accentuated at the moment by the fact that we have this AI positive supply shock. And AI is exactly the opposite in the sense that in theory it pushes the aggregate supply curve out. We can produce more with the same resources. So that's higher output at lower cost. Now what's interesting about that is this has been a narrative that Kevin Warsh has been very quick to talk about, or at least he was when he was in the running or when he was interviewing. He's very quick to highlight the disinflationary impact of AI. Last year he called it a transformational moment, we're on the cusp of something extraordinary, etc. And his, his, his interpretation of it was that it provided the potential for rate cuts. And both Warsh and members of the US Administration have been, you know, highlighting this parallel between this productivity boost that AI will give and the productivity boom that we saw in the 1990s. And when, you know, you had Alan Greenspan's New Economy and for Warsh, then this justifies potentially lower rates. He hasn't said it as vocally or as, you know, as clearly in his testimony hearing, but the suspicion is that's his belief. But of course, Obviously in the 1990s, yes, Greenspan initially did hold off raising rates, but by the end of the decade, he was raising rates. And that's because there's not just a supply element to this productivity shock, there's a demand element. And the demand element is obviously the spending on CapEx, on data centers, on chips, on all of the AI infrastructure, which is very real at the moment. So that in itself is an inflationary impulse. If anything, that impulse is getting stronger. Based on the most recent earnings that we're hearing from the hyperscalers, we're now talking about maybe over a trillion dollars of capex spending next year that's grown consistently over the last while. So again, for policymakers to kind of differentiate between the supply elements and the demand elements. And I think the other point is that we've had both of these types of shocks before. We had the productivity shock in the 90s. We had the stagflationary shock of the 70s. I don't think we've had a shock or a period where we've had both of these shocks at the same time, which creates an even greater level of uncertainty and difficulty for policymakers. And all of this is happening at a time when we're already in a new macro regime of high debt levels. And whenever you get any kind of a shock, the initial impulse is, well, what kind of bailout or what kind of policy response do we need when we get higher energy prices in Europe, people always want subsidies. One of the upshots of the Iran crisis is obviously more military spending. The US Are taking their troops out of Germany now, so inevitably that puts more of an onus on them to spend more. So I think what's interesting about these two shocks is that they both play into this tendency for more and more spending in response to any kind of Shock, even take AI. If workers are displaced, will we need universal basic income? Will we need fiscal supports, training, et cetera? Again, it does require a fiscal response. Equally on the energy price shock, it's requiring a fiscal shock. So all of these things, in my estimate, are increasing that bias towards further spending at a time when we've already got fiscal pressures. So you asked about UK yields. Yes, they seem to have dodged a bullet this time. But around the world, this kind of tendency towards higher fiscal spending and inching towards fiscal dominance continues to be one of the big themes and trends. So I think that's maybe the side effect from both of these shocks that maybe is not getting as much attention as it arguably deserves.
- [23:31]
B
Well, I think there's a couple of thoughts. Just to add to that. The other thing about the, the 2000 period, I know it officially came a little bit later, but what helped them out was of course, the fact that China became the production hub of everything. Right. It was massively deflationary, probably more so than AI could could. I mean, I.
- [23:53]
C
That's right, sure.
- [23:54]
B
But, but it, it's a. That was a strong force. The other thing, when I hear you talk about AI being deflationary, I'm also thinking, yeah, true, but it's also very energy heavy in terms of consumption. And at a time where there's a war going on in a hot spot for energy, you kind of question which force is the strongest of the two? Is it the quote, unquote efficiencies we can have in having AI to write whatever it writes for us, or is it the fact that it's really taking up a lot of energy that we don't necessarily have right now because of the supply? So I don't know if they're completely opposing this, is what I'm trying to say.
- [24:42]
C
And I think another dimension of it is it's not impossible that you could have. Obviously, at the moment, the market is tending to look through this crisis and assume that we'll see a resolution. But if we did see further stagflation, a stagflationary impulse from higher energy prices and an economic downturn, I mean, that could accentuate or accelerate AI adoption and you might see more job losses, et cetera. So I think the two forces are intertwined. Obviously there's the energy dimension, but there is the labor market dimension as well.
- [25:16]
B
Yeah. And then finally, I think that's something we certainly can't ignore. I mean, there's probably not been as much military spending as we have right now for decades on a Global scale. And that's definitely, or at least usually it is, inflationary. But then again, there's nothing to say that equity markets can't do well in an inflationary period. It's just up until a certain point. And it usually relates back to what interest rates end up doing. That's right, I imagine. Yeah, yeah, yeah. All right. Well, let's stay with the macro theme, Alan, because our friends over at Graham Capital, they also released, well, they released kind of two papers that are new to us. One is on trend following, we may not touch it so much, but the other one you highlighted, which is again, kind of on the macro dispersion, I would say, and, and maybe kind of relates back to what goes on in, in our industry. Tell me what your thoughts and what your takeaways were.
- [26:23]
C
Yes, as you say, there has a couple of new papers released recently, maybe not all in the last week or two, but one was a paper on a primer on trend following, which, as you say, is a very good and comprehensive overview of all of the points about how it's done, portfolio impact, et cetera, all of the considerations around that. And then the second paper around macro across markets, monetary regimes, which is quite interesting as well and timely, I think, in the current context. And it's really, I mean, looking at the case from in what types of environments do macro strategies tend to perform best? And putting some, I guess, a bit more rigor on that, I think we would all kind of say the 2010s was a tough period for macro. It felt like there wasn't a lot of dispersion in the world. There wasn't a lot going on from kind of a divergence, like all the economies grew and contracted or slowed. There was no real contraction, but slowed at the same time. So they look at this in a little bit more detail. And I mean, essentially it boils down to kind of three main points. One around the measure macro alpha and how it behaves in terms of monetary policy activity. And I guess it supports the intuitive expectation that the more macro and monetary policy activity in terms of rate hikes and rate cuts that you see, you can see in the data that macro alpha is higher for more activity, which makes sense because obviously if interest rate trading is one of the big sources of volatility of opportunity, I guess, for macro traders. So if you've got more central banks being more active, that creates more opportunity, just almost by definition. But the data supports that in periods where you're seeing a lot more the number of rate hikes or cuts up to in the double digits, you tend to get much higher macro alpha. And then the second thing is around monetary policy dispersion and volatility, which again is is a similar point in terms of how volatile rates are. And I guess as well it's related to the point of different cycles across different economies will also tend to generate opportunities not just in interest rate markets, but also I guess in currency markets as well. Currencies would also be a key point of the opportunity set for discretionary macro as well. And then they look at macro returns across different monetary policy regimes and that's quite interesting because they look at performance in easing cycles and tightening cycles and in periods of policy stability. And they look at performance in easing cycles before a cut and after a cut and before a hike and after a hike. So there's some interesting takeaways from that. Generally, macro has done better and I would say probably the same for trend following in easing cycles. I mean, from a tightening perspective, what you tend to see is that macro tends to do better before hikes relative to a 6040 portfolio. So that makes sense, I guess, if you get a shock and as the market starts to price in hikes, 6040 portfolio will tend to underperform. But that kind of macro volatility and interest rate volatility can create opportunities in fixed income and in other markets as well. Equally on the cutting side, the macro tended to do better post a cut as opposed to a pre cut. But I thought definitely interesting the very notable performance of macro in easing cycles. And I guess that's related to the fact that easing cycles are obviously typically recessionary periods. And if you get a very strong and notable recession, you're going to get repricing across many markets. And that creates obviously trends, it creates opportunities. So I'd imagine that's a similar outcome for trend following across there too. So I think what does that mean in the current environment? Obviously we've seen, I think in the last number of years a bit more divergence in terms of the rate cycle than we have. Obviously rates have come from zero to being notably above zero and more volatility in the rate itself. But equally we've had more independent moves, I would have said between the Fed and the ecb there haven't been as much in tandem. And then places like the UK have obviously been influenced by their own policy issues and obviously the BOJ has been tightening policy at a time when the trend in rates, say in the US has been for lower policies. So there are some very clear divergences there and all of those have been opportunities for macro. So I think, think, you know, generally dispersion is, is a theme that, that, that that is seen as favorable for, for hedge funds and macro in general. And, and, and the data presented in this paper certainly supports that, that idea.
- [32:17]
B
So if I'm not remembering incorrectly, they focus on kind of the, the changes in interest rate stability, tightening, you know, cutting, et cetera, et cetera. But there's one thing, maybe there's a small distinction here. Love to hear your thoughts on this and that is the role of inflation. Now. So at Dunn, we did a slightly different study because we have a 50 plus year track record. We've kind of traded through different environments in that sense. And I'm not going to name performance numbers as such, but what I can say is that the period between 1982 and 1999, 17 years, was by far the strongest. Now obviously there are so many factors that goes into it, but if you just look at that, and to me thinking back then, I seem to remember that that period was not necessarily high interest rates. Right. So I would call it relatively low and inflation was not crazy, but it wasn't stable inflation. And I think, I don't know what your thoughts are, but I think to me it seems like, because it also ties into why maybe the period from 2010 to 2018 was much more a challenge for trend followers. For example, macro, where you had not only low interest rates but you had very stable inflation, nothing was going on and all of that. So I wonder if in fact maybe the key driver, if I can put it like that, is more so inflation and how stable it is rather than whether central banks are actually cutting or tightening or keeping rates stable. Because I do sense there is a little bit of a distinction between the two and how markets react to that kind of news.
- [34:08]
C
Yeah, I suppose the period 82 to 99, I mean rates were quite high at the start of that period. Obviously rates shot up at 1980, Volcker, 1979. So it was really kind of the second half of the 80s, rates really started to come down. So I mean you did have, when you have very high rates like that and when rates start to come down, that creates very strong opportunities obviously in fixed income because you start to see a bit a trend. But also you've got, you know, very good, you've got good carry when the yield curve is very steep as well. So that provides a very good source of opportunity as well. Yeah, I mean obviously in theory, interest rates respond to inflation, inflation, volatility or Inflation trends. So I'm not sure, it's hard to distinguish. I mean I think the 2010s were unusual in that rates were pretty much anchored on zero and we had that very low level of inflation and low level of inflation volatility. So there was no core inflation was stuck at 1.5%, 1.6%. The central banks were trying to to inch IT up towards 2% with quantitative easing, et cetera but I mean that was clearly a tough period. But yeah, I know people draw this distinction between anticipated and unanticipated inflation and that can be a relevant part of it but I mean for me it's really the volatility and the magnitudes of the moves in interest rates that tends to be from my perspective that the main driver of the opportunity set for trend and for macro it's funny because
- [35:53]
B
of course people might say well hang on, equities have gone up since 2007 or 8 whenever or 9 actually 3-9-09 it's gone up. Must have been a fantastic time to be a trend follower in equities. But all I can say is that's not where trend followers have made any money really compared to other sectors. So sometimes the optics can be a little bit deceiving in terms of what looks like a great trend but actually when you get to the minutia it's actually not so easy to capture as a trend follow and, and as you say, I mean sometimes I can't remember which rate hike cycle it's it, it was but it I think the recent one where they started oh sorry rate cut cycle where they started cutting rates but actually since then market rates in the longer end has actually gone up. So, so this is what I meant by you know, sometimes maybe inflation does does dictate more in terms of real market opportunities other than what obviously the short end might do. But anyways, interesting stuff. Anything else? Any other takeaways? I know it ties into the next thing we're going to be talking about. Well, we also have a question in between but we have another article or maybe a paper I guess an AQR paper.
- [37:11]
C
Yeah, I think it's linked to this paper as a. I discuss it, it'll be clear but this is, it's an interview with Jordan Brooks who's the head of multi asset at aqr and this interview appears, it's with Frank Fibozzi, he's a well known author and I think it's in the Journal of Finance or one of those and I mean it's A it's quite a short six, seven pages. I think it's well worth a read and it really summarizes quite nicely a lot of the things that I would certainly agree with in terms of multi asset portfolio construction. And philosophically, I mean he sets it out quite nicely at the start. The challenge of portfolio construction is a bit like what you learn in economics. Economics is a trade off between objectives and alternatives and choices and you've got constraints. And the portfolio construction problem is similar to that in the sense that okay, everybody has an objective and then they have various assets that they're willing to invest in the various alternatives or choices that they have. And that range varies depending on the portfolio you're managing. And then there also may be constraints as well which in certain product types you can trade certain markets, certain types of investors say don't use leverage or you can't use leverage. So that can be a constraint as well. So effectively it's a similar kind of problem. Obviously the more varied sources of investment opportunity you use that increases your opportunity set. So for example, he obviously runs multi asset. If you limit your multi asset trading, say to long only asset, then that's a certain limitation. Whereas if you introduce long short strategies that brings in more flexibility and then obviously using leverage, return stacking, et cetera also brings in greater flexibility into the portfolio as well. He makes an important point that I try and make as well. So it's always encouraging when somebody else is agreeing with you and that is that he talks about strategic asset allocation and tactical assets allocation and he makes the point is that.
- [39:40]
B
Can you just interrupt? Yeah, maybe for people who might be newer to the show, why don't you just distinguish between the two so they understand what you mean when you use.
- [39:49]
C
So very often people will set their strategic asset allocation and say over the long term we want to be say 60% in equities and 20% in fixed income and 10% in gold and 10% in alternatives or something like that. And they say that's what we think is the right strategy over the long term. But we recognize that the market opportunities will arise and at certain stages it might make sense to tilt those exposures somewhat. So that means very often people will then think, well, our tactical asset allocation is to be a little bit underweight equities and a little bit overweight bonds. And then you take your strategic and your tactical together and that gives you your overall portfolio exposure. Now, now what you tend to find particularly in the multi asset space and maybe in the, I suppose the high net Worth or the private banking space. Yes, you'll see people bringing in tilts. They're overweight or underweight, but they tend to be quite marginal. They go from 60% equities to 57% equities. Big deal. Yes, there is optics, but there's not a huge portfolio impact fact. And he makes the point that one of the most powerful and transparent approaches to tactical asset allocation is trend following. And I think that's a very good observation because people often think of trend following as something different. I've got my 60, 40 and I've got my trend. It's this alternative source of return. But you have to look into it and look within the trend following. What is it doing? It is trading bonds and equities as well. So it's tactically adjusting your asset allocation. So it is a simple, transparent, effective, powerful, systematic approach to tactical asset allocation that will modulate your bond and equity exposure and give you exposure to currencies and commodities. I mean, from a return perspective. He also does make the points that we have highlighted before, that it does behave well. It has in the past behaved insurance like it has obviously had some of its best periods of performance in equity bear markets. So in theory you would think you would pay for insurance for that kind of return profile, but you don't, obviously. So that's because it has a positive return over the long term. He also talks about inflation in terms of what we're talking about now. And he draws an interesting distinction between core inflation and food and energy inflation and highlights that bond markets tend to do badly with both higher core inflation and higher food and energy inflation. Equities, according to his research, can do fine with food and energy price inflation, but tend to struggle with higher core inflation like we saw in 2022. And commodities tend to do better with higher food and energy inflation because I guess they're closer to those products. But equally then that is another case for trend as being another component of the portfolio that can help hedge the inflation risk. Because obviously if you have equities and bonds, you're effectively short inflation risk essentially. So you need to address that. Another point that he made in this paper, which is something else I've been thinking about recently and relates to what we've seen in the markets is you can do all of this and you can diversify your equities with bonds, maybe with gold, with trend, with macro, and you think you've got a very well diversified portfolio and then you can get a month like March where everything. I'm not saying every Trend in macromanagers suffered losses. Some did well, but many of them did do badly. So it got me thinking about that. Essentially there can be a discomfort of diversification in the sense that you can build your portfolio to capitalize on lowly correlated assets and strategies, but at times by chance, everything will do badly. At the same time, it doesn't necessarily mean that it's been badly constructed. I know we know about the phenomenon of correlations going to one in times of stress. I think that's more likely with certain strategies more than others. But for a trend in March, essentially we had a rate shock in March and some trend following managers, some macro managers, suffered losses. Now we had a rate shock back in 2022 and many of those strategies did well just by virtue of initial positioning. So there will be times when you've constructed the portfolio well, but just by chance, everything suffers losses at the same time. So he calls this death by a thousand cuts. So it's one of these things that you basically can't hedge or you can't eliminate all the discomfort from investing. Why do we diversify equity risk? Because you're trying to avoid a major equity bear market. You're trying to avoid a lost decade, and I think that makes sense. But what you trade and you're trying to avoid the pain of those major bear markets, some people are happy to take them, some people say, no, I'm equities, all equities. For the long term, if you get up to 50% downturn in the equity market, fine, and that's okay. But if you're the kind of investor who's trying to avoid that, you do it by diversifying. But you are basically substituting one type of pain for another type of pain. And the type of pain you get with being a diversified investor is the periodic shocks when everything does badly just by chance, even if you've constructed the portfolio well. So I think that's something to bear in mind. It doesn't mean it's a failure of diversification. It's just part of the discomfort of diversification.
- [46:09]
B
Yeah, no, I mean, definitely. And again, it really depends on the lens that people are viewing this. I remember a couple of instances if we take the most recent one, right, where yeah, March was, you know, not. It wasn't a great month for equities. On the other hand, the month after it made it all back plus something and had one of the best months in, in. In, you know, in a long time with trend following. Yeah, we corrected a small amount of the last six months returns and then we went straight back in April and made new all time highs in, in many indices. It also, I don't know if you remember, I think was it in 2018, early 2019 or maybe it was early 2018 where we had that Volmageddon and where managers lost a lot of money in February of 20, I think it was 2018. Having said that, they had made a lot more money going into that month, the prior four months. And so basically just correcting some of that. And so, so it's kind of funny because a couple of days ago we published the first, another world premiere, I think the first conversation with Jack Swager on his new book that he wrote along with George Coyle. And so the next generation of market wizards, you should definitely go and check out that interview that Moritz had with them. And what they talked about is that a lot of these market wizards, people who have made, you know, built fortunes from very small amounts to initially start with when they look at their track records, I mean it's like 30, 40, 50 plus percent drawdowns along the way and, and, and maybe, maybe you've solved it, Alan, and that's exactly what you're going to tell me next. But of course we are all trying to get decent returns without too much pain. I think that's just human nature. Right. But I think it has to be with reasonable discomfort. It cannot be without any discomfort unless you are a medallion fund or some of these multi strat funds that seems to have, seems to be doing something. Although I think a lot of it is just down to the fact that they are making markets and maybe they're kind of capturing flows that the rest of us will never see. So I don't know. But, but it just has, you know, drawdowns comes along the ride and in trend following for sure, we know that. But it doesn't stop the strategy from making money. And I do think there's been an, I don't know about you, I do think there's been an improvement or maybe an better acceptance from institutional investors that yeah, these drawdowns, they're just part of how this, it's kind of the DNA of the strategy. And I think when I started out in this industry, people didn't really want that at all. And now I feel that they accept it because they know they're getting something different.
- [49:20]
C
Yeah, no, I agree. I mean, absolutely. That's my point. Yeah, you can't, you can't hedge all the discomfort away. It's just you are trading different types of discomfort. But it is part of the journey. And no, I agree with you on trend. I think there is more acceptance of the profile in particular in the institution space, maybe, maybe less so in the wealth space. I think it's still evolving, but definitely, you know, based on the experience of the last three or four years, obviously 2022 was really strong. And then with a few flattish years, you know, I think institutions have stayed with us and obviously captured this run up we've had in the last 12 months.
- [50:01]
B
Yeah, no, absolutely. Well, I mean, one way, kind of the wealth base of investors have embraced it is by stacking trend with, say, equities or bonds. And Corey Hofstein, who's well versed in this industry and he and his colleagues kind of coined, I think, the return stacking term, even though, as I'm sure he's the first to admit, this has been around for a long, long time. And the people over a standpoint who kind of reinvigorized the whole industry of combining equities with Trend Back in 2020, I think just. And now we have a lot of return stacking products. And that's great to see. But he sent in a question, actually, he put it on LinkedIn and we always have to be careful when a smart person like Corey asks us a question. So I hope you prepared well for this one and I'd love to hear your answer. He's writing, I'm clearly biased on conversations relating to the whole return stacking trend concept, but I always enjoy a good debate as to whether Trin should or should not trade certain markets when it is stacked versus when it's not stacked. I think that's a very interesting question and I can't wait to hear what your research tells you.
- [51:27]
C
Good question. And I can only surmise what he's getting at. But I mean, for a lot of people, obviously you use return stacking to track or sorry, to stack, stack trend on say, equity markets. So I'm assuming then the question is do you trade the equities in your trend as well as having the equities on the standalone side? And I mean, from my perspective, the answer is yes. But equally, I know obviously some trend managers who at times haven't traded equities for that reason because it's seen as a complement or I guess a diversified. And I guess it comes back to what I've been saying that what is the. I think they're two very different things. I mean, you made a point about look at the returns from equities since 2009 and then look at the trend returns in equities since 2009. Now, I think that trend followers have probably made money, but it's not trend. Exposure in an asset class is very different to that asset class return because you're going long and short. You can get chopped around. It'll be better at times, it'll be worse at times. So I see there's two different things. You've got a structural beta exposure where you're extracting a risk premium. You're getting a different risk premium by applying trend to that market. Obviously, the trend risk premium or style premium, whatever you want to call it, or the return, it stems from behavioral biases, et cetera. And it is better when it's applied across a lot of markets. But to my mind, what you're doing with having trend is you're modulating the equity exposure as well as being a diversifier. So from my perspective, yes, it does make sense to trade equities when you're stacking it. And I think the other point is that if you're stacking it over a number of asset classes, that makes sense as well. And that comes back to the point we're talking about with Jordan Brooks's comment about strategic asset allocation and tactical asset allocation. So if you have equities, bonds and say gold in a portfolio, and you then stacked trend on top of that, what have you got? You've got a strategic asset allocation plus a tactical asset allocation plus some additional trend exposure to currencies and commodities. So wouldn't that be a good idea?
- [54:03]
B
You might call it like a regime adaptive fund or something like that. But Alan, before we get to that, because this is where we're heading with the world exclusive, I think I want to make one more comment to that and why I agree with you that equity should be part of your product even when you stack it on term on top of equities. Because I think what we sometimes forget, it's not just the return we can get from the equity as a equities as a sector, but it's part of the correlation matrix that many managers apply. And it may from time to time simply allow us to take either more or less risk in other parts of the portfolio, and that's where the returns might come from. So it's not as as simple as saying, oh, we're always losing money when equities go into a crisis. Sure we will initially, without a doubt. But that equity allocation, if we're long, might have allowed us to have much more bond exposure, which might then be the one that gives us the boost in performance that we're looking for or something else in the portfolio. And this is what makes it complex. I think that that trend followers mostly, I mean it's a bold statement to say, but I think people will mostly agree that an, an unconstrained construction of a trend program is a better. It's a, it's your best ideas product. You shouldn't try and constrain it as much as I know that some people do because of commercial reasons. But if you ask a, a researcher, I would, I would guess that they would say no, I don't want to constrain anything in my design. I don't know. So. And I think when you stack things and obviously maybe Corey will comment on this when we publish this episode, you know, may. I don't know if they constrain it or not, but it would be interesting because he's obviously an expert in, in, in that side of things. But I wouldn't have thought that trend followers wouldn't necessarily want to constrain the equity exposure and then therefore if you think trend following as a concept works really well in a stacked portfolio, then yeah, you should keep it. Anyways, that kind of leads me to where we've been going all along and that is to this world exclusive Ellen and I'm delighted to give you the floor to tell us about how investors can kind of solve some of these challenges that we've been talking about for many, many years.
- [56:39]
C
Well, obviously of utmost priority to save the world inclusives for top traders unplugged. So certainly wanted to hold off on any announcements and we appreciate that. So a number of months ago, I think it was before Christmas, I was on talking about our Regime Adaptive paper which effectively is incorporating all of the concepts we've been talking about today, both strategic asset allocation to traditional assets and pairing that with. With adaptive tactical strategies such as trend following and using concepts such as return stacking to enhance the portfolio efficiency. And we've moved forward with launching a fund, the Regime Adaptive Fund with that exact philosophy. So exciting development, something I've been keen to do for a while. Well and I mean it's very much at trying to bring this thinking, what I think is an institutional grade portfolio construction process to a wider audience, particularly the high net worth market where I think it's needed. I mean if you look across Europe in particular, multi asset is a very popular asset class. But multi asset tends to be very much vanilla kind of what we're talking about, what Jordan Brooks talked about in his paper very constrained to long, only short inflation risk under allocated to commodities, under allocated to tactical strategies. So portfolios like that don't have a mechanism to respond if we go through structural changes such as in correlations. And that's the merit, I think, of embedding strategies like trend following in an asset allocation fund. The challenge for investors is always the behavioral challenge of holding these strategies because as we've been saying, the returns can come in lumps, you can go through periods of underperformance versus beta and that's all part of it. And that could be challenging if you're on an investment committee or a board. So I think there is a huge merit of embedding alternative strategies within the one portfolio alongside primarily equities, but also other diversifiers like bonds and gold for portfolio resilience and robustness and to deliver all of that to a high net worth market that doesn't really have a whole lot of options in terms of, you know, all weather type offerings that are truly adaptive. So that's been the philosophy. It's very, very excited to, to move forward with it. And, and hopefully it's something that investors will value.
- [59:36]
B
Yeah, and, and you're giving what people need, but in a package that they want, which is usage, I understand, which is something that is very, certainly in my experience, a lot of people are very comfortable with that wrapped and it makes it fairly easy to distribute. Of course. I'm curious in order to build a portfolio like that, I'm curious a couple of things if you, if you're allowed to talk about it. And that is how does the allocation between the various components kind of change? And is it a mechanical rule set that does the change? And, and how many parts, how many strategies managers do you need to build a kind of a robust portfolio like that?
- [60:25]
C
So basically at the asset allocation, it is very much a strategic asset allocation in the sense of sizing the different components relative to their volatility, et cetera. So in risk terms, I think in terms of 40% of portfolio risk is to growth assets or Equity Equities, 20% of portfolio risk to diversifying assets, bonds and gold. And then 40% of portfolio risk is to trend following, which is the adaptive tactical element of the portfolio. So that's at a strategic level and obviously, and that's in risk terms. So obviously the volatilities correlations have to be estimated over the medium term and size accordingly. What that means though in terms of the experience for an investor is that that it's the trend following that drives the tactical element of the portfolio and shifts the overall portfolio positioning. So there is a core strategic long position in equities and to a lesser extent in bonds and gold. But obviously the exposure to trend following will give you exposure to all of those markets as well as other commodity markets and currencies. But the trend exposure will fluctuate as you know, long and short, and that drives the overall positioning of the portfolio. So what we've seen in terms of the historical analysis of the portfolio is the equity beta fluctuates quite a lot from in excess of one to negative at times depending on the trend. Not just in equity markets, but in other markets as well. That's really the point in terms of delivering something that is truly reactive to investors. We mentioned that tactical asset allocation in a lot of funds means going from 60% to 58%. When you allocate meaningfully to trend in the context of an overall portfolio, it delivers meaningful tilts into the overall portfolio positioning. Obviously that doesn't work all the time. As we know it will protect you at times, times it will provide benefits at times. Like historically we've seen that 2022, 2008, et cetera. Obviously in choppier markets you won't need that protection or it will come at a cost. But that's the trade off. What we've seen over the long term is that pairing of tactical trading from trend following with long only beta from equities and from other markets delivers a higher risk adjusted return over time. But it also gives an inbuilt mechanism of adapting. If we do see major strategic structural trend changes in markets, obviously the trend followers will adapt and respond to that. So I think from speaking with investors, that's one thing that really resonates with people. Everybody is conditioned, everybody in the advisory world is conditioned to tell our clients, stay invested, it, it'll be all right, okay, it's going to be volatile, but the markets go higher over the long term, which is true. But in the long run, we're all dead. As John Maynard Keynes says, what is the long term? The big risk that investors have to worry about is not a 2022, it's not a Covid that was over in a few months. It's a 50% type drawdown in the equity market like we saw in the financial crisis, like we saw more or less in 2000, 2002, or a lost decade of the early 2000 and tens or the 1970s. So the big risk you have to think about is what's the probability of that event okay. It's not zero. How significant it is is something you have to decide for yourself. So just saying stay invested, it'll be okay. We're not going to do anything. It's not a great message. It's what I hear from a lot of investors. So the fact that trend following embeds a course of action, a series of steps that will be taken to respond to market trends does, you know, guarantee that there is some response taken when the market moves. And I think investors find that appealing.
- [64:38]
B
Yeah, no, absolutely. Just our curiosity and I don't know if it's possible to say anything about this, but what kind of volatility will a product like that, that do you think might have. Because we can't talk about, we don't know what performance. We can't talk about performance volatility we could talk about. Is there. Do you have an, an idea of what to expect?
- [64:59]
C
Yeah, about 10 to 12% is, is the expectation. So about 2/3 of the equity market volatility.
- [65:06]
B
Yeah, no, absolutely. And do people just go to their local bank branch and say, I've heard about raf and they would think no, the, the Royal Air Force that know.
- [65:15]
C
Hopefully, hopefully the Regime Adaptive Fund will become a household name in time. But I appreciate it's not there yet, but people can reach out directly and we'll be able to discuss it with them and, and hopefully it will appear on more platforms, etc very soon.
- [65:29]
B
Absolutely. We'll certainly follow it closely. That's. That's for sure. Anything else, Alan, today that in this first week of May 2026 that we need to, we need to address anything we've missed in our outline.
- [65:45]
C
No, I'm trying to remember. I mean, obviously we didn't really talk about the equity market and the buoyancy of the equity market which has really been very pronounced and I think without going on about the fund too much, but I think there is a real dilemma for investors at the moment of as we talk about the risks in markets and I think people in the trend world and the macro world were always very attuned to risk and what might go wrong. And the risks are plenty out there, but the market continues to make new highs. So the question is how do you construct a portfolio to participate if it continues, but protect yourself if it doesn't? And I think that's what investors are grappling with at the moment. So yeah, I mean it's been so notable that buoyancy in the equity markets among. There's always kind of the sense of the idea of the wisdom of the crowd. So does the market know more than us? Because you listen to all of the podcasts about the Straits of Hormuz, et cetera, and it feels like there's an impending crisis coming, but the equity market just keeps powering higher. So is it the wisdom of the crowd or the madness of the herd? I'm not sure.
- [67:01]
B
No, exactly. And last time we had Jim on, he was kind of talking about how he felt that maybe markets were being manipulated right now so their more collateral being built up because of a future, you know, quote unquote crisis or whatever. I think the interesting thing to me is, and I think maybe I talked about that last week as well, I think what April made very clear, and early May for that matter, is that there's just a lot of other things going on. The way we thought about macro in the old days and how it impacted markets and, and all of that, you know, when, when the Bundesbank was out talking, you kind of KN markets we're going to do, things have changed and it's much more driven by flows and positioning and all sorts of other things. And I actually think, and I know this is obviously completely biased speaking, but I actually think this environment lends well to these type of strategies that really don't make any predictions and really just follow along, so to speak. And I've said this a couple of years ago when, when we started seeing much more of a deglobalizing world, at least that's the good thing about podcasting, Alan, is if you said something that's right, a few years later, you can go back and point at it. I'm sure people will do the same. When I said something that's completely wrong, but anyways, I'm pretty sure I said that I felt very optimistic about trend following even after all of these years. Now it hasn't really played out with massively strong returns, but, but in the long run, I think that we, I think we're in a good spot and long may it last, so to speak. Yeah. Should we leave it?
- [68:49]
C
Let's not get too carried away.
- [68:51]
B
Exactly. Absolutely. This has been great and thank you for bringing all the topics we discussed, your preparation, and of course, thanks for the world exclusive. And I wish you really well, you and your colleagues with the, with the new launch. I'm sure it's going to be great and very. It'll be very interesting to see some of the concepts that we talk about actually manifested in a, in a product people can buy. I think that's fantastic. Anyways, for those of you who want to go and and show your appreciation for Alan, go to your favorite podcast platform, leave a rating and review and that certainly helps a lot more people find their way to listen to the wisdom of Alan and all the other co hosts. Of course. Next week I'm joined by Yorv and a very special guest from one of the largest asset managers in the world. Let's leave it like that, so make sure you send in some questions. I can tell that the theme will be related to trend following. I think it's fair to say, but if you want to join into the conversation info at Top Traders Unplug is the right email to do so at. Anyways, from Alan and me. Thanks ever so much for listening. We look forward to being back with you next week. And as always, especially at a time like this, take care of yourself and take care of each other.
- [70:13]
A
Thanks for listening to Top Traders Unplugged. If you feel you learned something of value from today's episode, the best way to stay updated is to go on over to your favorite podcast platform and follow the show so that you'll be sure to get all the new episodes as they're released. We have some amazing guests lined up for you and to ensure our show continues to grow, please leave us an honest rating and review. It only takes a minute and it's the best way to show us you love the podcast. We'll see you next time on Top Traders Unplugged. This podcast expresses the views of its hosts and the guests appearing on the podcast as of the date of its recording, and such views are subject to change without notice. Top Traders Unplugged do not appear have any duty or obligation to update the information contained herein. Furthermore, Top Traders Unplugged make no representation to its accuracy and it shall not be assumed that past investment performance is an indication of future results. Moreover, wherever there is a potential for profit, there is also the possibility of loss. This content is made available for educational purposes only and should not be used for any other purpose. The information contained in this podcast does not constitute and should not be construed as investment advice or an offer to sell or a solicitation to buy any security or related financial instruments in any jurisdiction. Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third party sources. Top Traders Unplugged may believe that the sources from which such information are obtained are reliable. However, Top Traders Unplugged cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. This podcast, including the information contained herein, may not be reproduced, copied, republished or posted in whole or in part in any form, without the prior written consent of top traders.
- [71:45]
B
Unplugged.