Russian Roulette Is Not Our Favorite Game

Use recent weakness to cover some shorts as geopolitical headline ping-pong in coming days will make bulls and bears go mad. Look to sell rallies for the larger down move as the Fed remains trapped.

My mind wanders often. I like to envision where the world is going to be in 2-3 years and then try to invest alongside structural trends that are in place to take us to that future. I do a lot of 1+1+1=10 thinking, piecing together “signposts” that I am seeing from disparate markets/countries/industries in order to weave together a narrative about the state of the world and where markets are headed. I am reminded of something that Stan Druckenmiller said in his 2015 “Lost Tree Club” speech referring to a mentor of his who told him to “visualize the situation 18 months from now, and whatever that is, that’s where the price will be, not where it is today…Never, ever invest in the present.” Often early, seldom incorrect. Risk manage accordingly along the path.

My post out last week entitled “Russia isn’t attacking Ukraine. They (and China) are attacking the US$” was evidence of this train of thought.

Russia isn't attacking Ukraine. They (and China) are attacking the US$

I see the end of $ hegemony on the horizon. I think our enemies are actively trying to pursue an agenda that will accelerate the demise of the US$ as the unilateral reserve currency and help foster in the end of American dominance in the global arena. As more countries are able to purchase commodities, particularly in oil, in their own currencies and settle transactions in a neutral reserve asset (like gold now, maybe bitcoin later), we will start to see currencies trade more on a current account deficit or surplus basis. The US, with its massive deficits, will see the $ weaken in order to over time improve America’s competitive position globally in order to run more balance trade account. I believe this weak $ trade is the structural trade to embrace for the coming next several years and I anticipate being short US$ for years to come.

However, along this path toward some vision of the future, markets will undulate, countermove, zig and zag in various directions, creating compelling narratives both for and against this structural path. As traders, we need to be nimble, keeping pace with the shifts in the winds and understanding the narratives of the day so as not to get stopped out of our positions along this path to an end state. Booking PnL along the path is paramount to staying in the game. My former boss at SAC reminded me constantly to book winners and move my feet while respecting the price action. And when my portfolio was overearning vs. its normal distribution potential, I needed to be very mindful that a potential reversal was on the horizon. And geopolitical events can often act as catalysts to change short-term trends as markets start to become hyper-focused on every twist and turn in the saga. When more eyes start to focus on something, the Sharpe ratio of the trade falls. When Sharpe ratios are likely to fall, we need to be playing with lower gross exposure and look for opportunities to size back up again to play for our structural plan.

Our negative bias to start the year has been handsomely rewarded thus far. Our portfolio has been overearning, which is a good thing, and we still think there is plenty of room to go before the market catches up to our view. However, everyone has now become a Russia/Ukraine political expert. Every word out of Putin is being magnified, low liquidity markets are moving with violence in both directions based on whether he coughs one way or the other. I think we have a view on how things ultimately end up. But the path to get there can be arduous and treacherous, especially for our bearish mindset. I want to be bearish because we believe that the Fed will have to continue to tighten to arrest domestic inflation in the US. Our post “In Search of the Fed Put” laid out our thesis.

In Search of the Fed Put

I contend the Fed put is LOWER. This environment of tightening financial conditions to stop inflation expectations in society from running away should lead to lower prices for most financial assets. However, the current market is trading something different now. The Russia/Ukraine saga is top of mind. While the risk off environment stemming from the conflict has accelerated the path toward my desired end state on a very short term basis, prices are moving in “my” direction for the “wrong reasons.” I see investors getting more concerned, as volatility rises, investor sentiment indices weaken and prices are heading lower. A short-term capitulation event is approaching. And the potential for a counter-trend move higher is starting to grow. As a result, I am using this weakness today to cover some short exposure and sell some gold and will look to size up positions again as the elevated political tensions start to alleviate themselves. I want to be fully sized again into the March Fed meeting where I contend the actual start of the Fed tightening cycle will finally smack investors in the face with the realization that the Fed’s support for the equity market is beneath its need to stop inflation from becoming even more of an election issue for the current administration. Trade Carefully.

*Important Disclaimer: This blog is for educational purposes only. I am not a financial advisor and nothing I post is investment advice. The securities I discuss are considered highly risky so do you own due diligence.