Capitalizing on Anticipated Rate Cuts in an Overpriced Market: The Risk-Reward Sweet Spot with Treasury Bonds
As the Federal Reserve hints at a more dovish stance and the likelihood of further rate hikes diminishes, we recognize the potential for the financial landscape to change. With inflation seemingly on a trajectory towards normalcy and stock valuations creeping back towards potentially overvalued levels, we believe an attractive risk-reward opportunity is presenting itself within the U.S. Treasury market.
The central focus of this opportunity is the U.S. 10-Year Treasury bond (Gov10). Currently priced at 95.25 with a yield-to-maturity (YTM) of 3.96%, we see potential for significant upside under the right circumstances
In assessing the potential returns of investing in Gov10, our central thesis hinges on the direction of inflation and, subsequently, its impact on the Gov10's YTM. The Federal Reserve has reiterated its commitment to a long-term inflation target of 2%. Their unwavering stance suggests that they are likely to utilize monetary policy tools to steer inflation towards this target over the medium to long term.
Nevertheless, in our calculations, we have opted for a more conservative approach. Instead of assuming a reversion of the Gov10's YTM towards the 2% inflation target, we assume that it falls to 2.6% in the next 24 months. This approach allows for some persistence in above-target inflation, which is plausible given recent trends.
Given this assumption, we believe there is room for the YTM of the Gov10 to decrease, which would lead to an increase in its price.
Using the formula for calculating bond prices:
Price = [C / (YTM / 2)] * [1 - (1 + YTM / 2) ^ -2n] + [F / (1 + YTM / 2) ^ 2n]
where:
- C is the annual coupon payment ($3.38),
- YTM is the yield to maturity (2.6%),
- n is the number of years to maturity (10), and
- F is the face value of the bond ($100)
we estimate that if the Gov10's YTM declines to 2.6% over the next 24 months, the price of the bond would increase to approximately $107.29. This potential change represents a total gain of about 19.94% over the two-year period, including the bond's coupon payments.
To calculate this total gain: Total Gain = [(New Price - Old Price) + 2Coupon] / Old Price Total Gain = [(107.29 - 95.29) + 23.38] / 95.29 ≈ 19.94%
Annualizing this total gain, we derive an Internal Rate of Return (IRR) of approximately 9.39% per annum. This annualized return is attractive, especially when juxtaposed with the current yield of the 2-year Treasury bond at 5.4%.
Moreover, should this yield contraction occur more rapidly than anticipated – say, over 18 months – the annualized return would improve further to approximately 12.64%.
Additionally, it's crucial to consider the positioning of this trade within a broader portfolio context. The proposed strategy could act as a hedge against adverse market scenarios.
For instance, let's consider a scenario where market conditions deteriorate and a recession emerges. Currently, the markets do not fully account for this possibility in their valuations. The materialization of a recession would likely prompt a market sell-off. However, such an environment would also likely lead to a 'Fed Put', a situation where the Federal Reserve steps in to support the economy by cutting rates. Consequently, the value of the Gov10 Treasury bond would likely increase, given its inverse relationship with interest rates
Finally, while historical data suggests that bonds do not necessarily provide accurate long-term inflation predictions, they do reflect the market’s inflation expectations. If these expectations normalize and align more closely with the Federal Reserve’s targets, we could expect the Gov10 YTM to decline by 100 to 150 basis points.
In conclusion, investing in the Gov10, considering the current market dynamics and potential inflation trajectory, offers an appealing risk-reward balance. Not only does it provide a meaningful return potential, but it also serves as a plausible hedge against negative market scenarios, thereby reinforcing the defensive stance of a diversified portfolio.
The Sea Change in Finance: Navigating Interest Rates, Volatility, and Credit in a Sticky Inflation Era
In an era where the term austerity seems to have faded into the archives of economic history, the specter of sticky inflation is rising to the fore. We are witnessing a world where fiscal spending and global expenditure are increasing at an unprecedented rate, bringing us into a new economic phase that demands our attention.
As the Federal Reserve and European Central Bank (ECB) grapple with sticky inflation, interest rates are set to rise. Both institutions will need to continue their hikes, possibly even exceeding 6%, to keep inflation in check. With consumption and restaurants booming in the Eurozone, the UK stands in contrast, struggling with unique challenges of its own.
The real concern is that the swift, generous monetary policies in response to the current economic situation may set the stage for future crises. It's only a matter of time. Short-term interest rates alone aren't enough to create tighter financial conditions. Most old mortgages have locked in favorable rates. This environment may even facilitate a carry trade, with short-term interest rates higher than long-term ones, creating a "reverse yield curve."
The key to navigating this shift lies in understanding Quantitative Tightening. Central banks are trying to "break the system" slowly with gradual rate hikes, avoiding the need for early market rescues. Unless things break down entirely, no immediate rate cuts are expected.
Fast forward to a future with a potential 5% interest rate in the next few years. This scenario would necessitate a major repricing of many financial assets, a shift that hasn't occurred yet. Caution is warranted.
Now, if we imagine a trajectory where the 10-year yield heads towards 4-4.5%, we can foresee a surge in market volatility. This increase would impact various sectors, especially those heavily reliant on favorable interest rates for funding, REITs, and Tech companies. If the market refuses to revert to the mean, existing policies and business models will likely need an overhaul to survive.
Credit is another arena requiring keen scrutiny. While it's been relatively stable, I predict an increase in default rates in the coming months. While I don't foresee a double-digit rise, some pressure is undeniable. In such an environment, government bonds don't offer a compelling spread, making them less attractive.
In terms of investment opportunities, certain areas within the credit sector show promise. For instance, defensive high-yield sectors in Europe could offer value, though one must act quickly as opportunities can be fleeting. Banks too present an intriguing prospect. However, I advocate for caution and recommend positioning against certain REITs and tech SPVs, which may struggle in this changing environment.
Preserving a healthy cash reserve is advisable. Treasury and high-grade financial bonds are potentially good choices, offering an added layer of protection against volatility. If we experience an increase in volatility, well-diversified portfolios are expected to fare better.
Our current global financial situation is shifting from a low-inflation environment to a persistently higher one. In such a landscape, private bonds may find support from governmental bodies. However, with soaring inflation, the freedom to cut interest rates as liberally as in the past is dwindling. It's crucial not to overleverage, to stay invested, and to make sound, careful decisions in these challenging times.
In summary, while the market environment is undoubtedly tough, it's filled with opportunities for those who can navigate the storm. This era demands prudence, adaptability, and a keen eye for shifting trends. Protecting against volatility and unfavorable valuations is key while uncovering potential growth areas. This changing tide may be challenging, but it is also a time for growth and evolution for savvy investors.
In light of these market conditions and potential risks, as an investment professional, I'd like to outline four primary strategies I would consider for a well-balanced portfolio. Each position is aimed to mitigate risks and capture potential opportunities in this changing economic landscape.
- Defensive High-Yield Sectors in Europe: There may be pockets of opportunities in these sectors. These are expected to provide yield in an uncertain environment.
- Government Bonds and High-Grade Financials for Protection: These are primarily seen as defensive measures against potential instability and volatility. They are not expected to provide significant returns but rather to offer safety and stability to the portfolio.
- Short Positions in REITs and Unstable Tech Business Models: There's an expectation of an industry shake-up due to rising interest rates. Short positions in both real estate investment trusts (REITs) and tech businesses, particularly those with unsustainable models and questionable long-term free cash flow projections, could serve as a hedge against potential downturns in these sectors.
- Maintaining Cash Reserves: Cash reserves are critical for flexibility, enabling quick responses to market changes. They also provide a safety net in case of unforeseen market turbulence.
Remember, in this volatile environment, it's key not to overextend positions. While there are potential opportunities, it's crucial to have the means to stay invested without risking excessive exposure.
Originally published on Medium
Allocation under modern portfolio theory and some value investing lessons to apply
Allocation under modern portfolio theory and some value investing lessons to apply
Underlying the basics of the modern portfolio theory risk is perceived as the standard deviation of the asset’s price in the market. However, this is entirely different when saw from the value investing perspective. A value investor considers risk as a permanent loss of capital while, under the modern portfolio approach, the assumption is that investors are risk-averse and therefore need to be compensated with a reasonable premium for each extra unit of risk they take.
Let’s say an asset has a 10% mean return; nonetheless, the stream of return is not constant because it varies from month to month and fluctuates with a standard deviation of 5%. A modern portfolio approach would try to optimize or, to say better, judge performance relative to risk. This means that if you have a return of 10% but a 5% standard deviation, your risk/return ratio would be 2. Consequently, the modern approach is basically a mathematical model that defines risk as to the standard deviation and judges the stock from how it fits the portfolio and its risk/reward ratio.
A value investor does not approach risk in the same matter. In value investing, risk is defined by the health of the balance sheet, not from the beta of the stock. For instance, a value stock, which is usually a depressed one, has a potential theoretical drawdown of 50%. There is no intention from a value investing perspective in trying to time a better entrance on the stock. A value approach would analyze the stock making a single bet in a concentration of a few stocks without studying the impact of the volatility of the single bet on its own overall basket of stocks.
The latter is impossible for a modern portfolio theory trader or fund manager. They need to understand the risk/reward ratio of the stock and how it would impact the portfolio. Therefore, decisions are not taken on the stock’s quality only but on how it affects the overall position. So you could end up adding assets to your portfolio, not because you believe in the potential of appreciation but for the sole reason that the investment could have a negative covariance on the portfolio and stabilize the overall position. Or maybe because it could reduce the volatility of the portfolio without affecting the expected returns, which should indeed be the purpose of optimal asset allocation.
So buying a stock can have different meanings and purposes depending on your approach style.
If we would be robots, we could theoretically adsorb a drawdown of 50% without even blinking and adding a position to average down cheaper stocks. I try to do that, and I am among a few who are able to absorb such pressure without panicking.
The majority of investors cannot do it that way, they panic and sell when stock prices decrease to reduce what they call risk, and they try to cash momentum buying higher when the portfolio is green. I never buy on a good day or sell on a bad one. I try to do the opposite. Investors are moved by fear. When they experience significant drawdown, they illogically tend to sell at a lower price.
The only way you have to avoid that is to be confident about the stocks you own. Behind that confidence, there should be knowledge and conviction of your investments. A deep understanding of what you own is the only energy that can help you beat stupidity and indefinitely hold a “falling” asset.
When applying modern portfolio theory, hedging would help an anxious investor to navigate through volatile times. I had seen many investors breaking down in volatile times, even when they did swear to hold. I saw them literally in tears quickly selling because they were afraid to lose it all. Selling when stock presents less risk (because it is cheaper) due to the general market condition is silly. But it does happen every day, not only to amateurs but to professionals.
Before choosing your investment style, try to think about what is adequate for your stomach. The stomach is what you need in a difficult moment to adopt a particular investment style and being successful at it. To have the stomach is more important than technical knowledge, but technical expertise gives you the stomach to handle those difficult times.
As you build your portfolio, you must know your risk sensibility and, of course, your concept of risk before anything else. A simple approach to portfolio construction thought for weak stomach investors is the “All Wheatear Portfolio,” made famous by Ray Dalio. I love Ray Dalio, I love his philosophy, and I like him as a person. I believe he is honest, and I learned a lot from him on macroeconomics and how the economy works. But the All Wheater Portfolio is for people who want to have peace fo mind, even though I don’t think it did very well under the recent crises.
The “All Weather Portfolio” could work for me when I get to my 70’s. It assumes that you don’t know what is going to happen, and you have a portfolio that could perform or preserve your wealth in all scenarios: deflation, inflation, recessions, and so on. Another issue with Dalio’s approach is that Bond, which was used as a negative covariance to balance the risk of stocks, now would have a different meaning under the current monetary policy.
What Dalio does is to mix all the assets trying to move the weights of such investments in a way that fits its biases towards a particular macroeconomic view. Then if it is not right, it does not take a big hit. Still, if he is correct, then it makes money but not with the impact that it would make if he would go all-in on a particular asset.
Lets’ be clear and pragmatic; this means that you can do 7% to 8% a year if your biases are centered because your view would allow an asset allocation to favor a particular scenario. Or to make 4% to 5% when your preferences are wrong, but you will never experience a drawdown.
This is great for Mama and Papa or anybody that does not have enough stomach. I prefer to get richer or die trying, but I can stomach the drawdown. I want to deeply study the market, generate a firm conviction towards a macroenvironment or stocks, and chase my 100-million dream. I am not that far away anyway, and I would not embrace mediocrity for the sake of fear, don’t do the same, but I am this way.
I don’t invest what is needed to live but to make me jump to another level. I am searching for greatness, so I need to make something spectacular out of my portfolio. I will do what it takes and digest the drawdown as I have done until now because I am pretty sure the results will follow. I don’t believe in being cautions in periods of monetary loss policy unless the risk of systemic fall of the system and crack of the US dollar as reserve currency materialize.
The tail risk can be hedged not only by crypto but with assets allocated in emerging markets and alternative superpowers like China. The best hedge you can have is the ability to deeply understand what you own and keep studying your equity every day.
Value Investing is dead and is not worth pursuing, but some of its lessons are extremely valuable. We can take things from value investing, which would help us to understand the real meaning of risk and the foulness of selling your asset under the market’s pressure—the importance of a long-term perspective.
From the other side, trying to buy as a value investor does is foolish. To find a top-class business with a strong moat for a low price, based on its sustainable earnings and get free growth. Growth is that thing that makes it foolish and useless for any P/E calculation; price-earnings means nothing versus growth. If you grow exponentially, then what the point of price-earnings is?
In order to understand a company to insert it into your portfolio, you need to apply two elemental principles. The first is to understand that particular business, its potential, scalability, competition, and moats deeply. The second one is to know yourself.
Before you choose what kind of investor you are, understand what stomach you have towards volatility and if you can learn how to manage it with the knowledge of the assets you own. If you don’t have the stomach and the time, then embrace peace with a neutral All Wheater Portfolio. But don’t try to mix assets randomly without a proper plan, because that indeed can be the receipt for catastrophe. Know yourself and know your assets, have a plan before start playing.
About Antonio Velardo
Antonio Velardo is an experienced Italian Venture Capitalist and options trader. He is an early Bitcoin and Ethereum adopter and evangelist who has grown his passion and knowledge after pursuing the Blockchain Strategy Programme at Oxford University and a Master’s degree in Digital Currency at Nicosia University.
Velardo manages an 8-figure portfolio of his investment company with a team of analysts; he is a sort of FinTweet mentor, people interact with him online, and he has more than 40,000 followers after his tweets. He has built a fortune in the great tech years and put together a tail strategy during the pandemic that allowed him to take advantage of the market drop. “I did not time the market, and I did not think this was even a black sworn,” he says.
On the side of the financial markets, Velardo has a unique combination. He was a real estate entrepreneur that developed several projects in Tunisia, Miami, Italy, the UK, and many other countries and cities. But he has always been passionate about options trading. Still, contrary to the volatility player and quant trading, he always had a value investing touch in his blood. Antonio studied Value Investing at Buffet’s famous business school at Columbia University. Even though the central concepts of value investing are antagonists to the venture capital pillars, Antonio’s approach tries to bridge elements of both worlds in order to seek alpha. Velardo has learned the importance of spotting pure growth stories and taking advantage of their S-Curve position. This is an essential element of Velardo’s approach as he looks forward to embracing great tech stories at the right time of the adoption cycle. This applies to stocks but also to blockchain projects.
Portfolio diversification and hedging under the new paradigm
Portfolio diversification and hedging under the new paradigm
Understanding the current situation in the market can give you an edge on where to invest, what type of long-term investment goals you could have, and how to organize and diversify your portfolio. Fed is starting to show that their power is limited and fiscal stimulus is needed in order to solve the coronavirus damages to the economy. So, now the Government needs to implement a new policy that changes the view of the deficit. Indeed, a new modern view of the deficit is urgently required.
If debt keeps piling, selling debt (Treasury) may become an issue. In the long-term, the reserve currency status of the US dollar can be threatened. Fortunately for the USA, the other three reserve currencies are all facing the same problem. Therefore, Gold, Equity, and other assets are attracting money flow.
Based on the piling of debts, it’s not attractive to invest in the Treasury because you would have a negative real yield. On the other side, the Treasury is losing its diversification purpose. This could cause a spiral in which eventually a sell-off would be strong and could potentially lead to an increased interest rate that could be catastrophic for the economy.
Being long is the wiser thing to do. However, you cannot forget to be fully diversified by asset class and country but also to ensure your portfolio against what many call a “tail risk.” Tail risk is an event that can create a dramatic sell-off, which is not like a simple market correction because it can have profound consequences furthermore. Taleb Nassim says that if you don’t have a tail risk insurance, you don’t have a portfolio.
Tail risk can be insured in multiple ways by shorting some asset classes as a percentage of the portfolio via ETF or the use of options. Also, choosing to invest in a portion of the portfolio which is inversely proportional to the market. Tail risk protection is not free, but it will impact a small percentage of your performance. However, like most insurances, if materialized, you would be happy you had it.
Being greedy and not accepting to spend money on protection would be like buying a beautiful house with no insurance. Imagine if a fire burns the house down, you would have lost it all forever. You can never be entirely sure; rare events sometimes happen, so better be assured!
Hedging in other currencies and countries, especially for the US market, is vital. Bitcoin could also be a way to find exposure to a hedge against the reserve currencies’ status. People sometimes go too far and place all their wealth or a significant portion of it in such instruments, losing sight of what is risk and how to manage it.
Assuring tail risk has a cost, but if the diversification is appropriately done by calculating the correlation between assets, it doesn’t cost anything. You can diversify, lowering volatility without reducing the expected returns.
So there are two types of hedging. The first one comes down to hedging against tail risk through a specific strategy. For example, shorting an index with a percentage of the portfolio to offset long positions in Equity or taking a position in derivatives to cover your portfolio in case of a strong sell-off in the market. The other hedging type is done by organizing a diversification and decorrelation of the portfolio without lowering the expected returns.
About Antonio Velardo
Antonio Velardo is an experienced Italian Venture Capitalist and options trader. He is an early Bitcoin and Ethereum adopter and evangelist who has grown his passion and knowledge after pursuing the Blockchain Strategy Programme at Oxford University and a Master’s degree in Digital Currency at Nicosia University.
Velardo manages an 8-figure portfolio of his investment company with a team of analysts; he is a sort of FinTweet mentor, people interact with him online, and he has more than 40,000 followers after his tweets. He has built a fortune in the great tech years and put together a tail strategy during the pandemic that allowed him to take advantage of the market drop. “I did not time the market, and I did not think this was even a black sworn,” he says.
On the side of the financial markets, Velardo has a unique combination. He was a real estate entrepreneur that developed several projects in Tunisia, Miami, Italy, the UK, and many other countries and cities. But he has always been passionate about options trading. Still, contrary to the volatility player and quant trading, he always had a value investing touch in his blood. Antonio studied Value Investing at Buffet’s famous business school at Columbia University. Even though the central concepts of value investing are antagonists to the venture capital pillars, Antonio’s approach tries to bridge elements of both worlds in order to seek alpha. Velardo has learned the importance of spotting pure growth stories and taking advantage of their S-Curve position. This is an essential element of Velardo’s approach as he looks forward to embracing great tech stories at the right time of the adoption cycle. This applies to stocks but also to blockchain projects.
Before COVID, decorrelation in the portfolio could be achieved by having Treasury or Bond. So the demand for Treasury had sense also in a diversification process. Now it doesn’t, and this represents a problem for portfolio managers. The issue with a low-interest rate is not only about the return but about not having the demand for the Treasury as a proper uncorrelated instrument to insert in a portfolio.
The covariance of the Treasury changes against Equity as the interest rate approaches zero. This is my perception: monitoring the correlation between the Treasury and Equity will give us a hint on the perception of inflation and could eventually help us to spot an Equity bubble in the market.
The decorrelation has not always been as it was in the last decade. When we analyze the covariance (for covariance, I mean how an asset moves in relation to another asset) between Equity and Bond, a positive covariance is negative for portfolio diversification because it does not create any benefit. In contrast, a negative covariance will be positive for the portfolio because, through diversification, those negative covariance assets can reduce the risk without affecting the expected returns (a value investor would probably kill me).
Zero covariance does not really provide any benefit to the portfolio. There are many debates about this, but this is not the time to dig deeper into that. Bitcoin, for instance, does not show a decorrelation from the market in the short term. In the past few months, it has been quite correlated to the NASDAQ, and it does not provide, at least in the short-term, any hedge for the portfolio.
My problem with Bitcoin in the short-term was indeed not being able to optimize my portfolio by creating an inverse correlation with my Equity. By adding Bitcoin, I increased my overall volatility without benefiting from the negative covariance because it has recently been quite correlated to the market.
However, correlation within assets is not always linear, and macroeconomics changes can modify the covariance between them. This means that Bitcoin, instead of a threat to the US dollar as a reserve currency, could even start to decorrelate from other Equity behaviors, creating, therefore, diversification.
My issue getting back to the Treasury is that any asset class is moved by the demand towards it. If the negative covariance with Treasury will change as Treasury approaches Zero and debt will pile up even further going towards MMT dynamics, what would be the reason to have such an asset in the portfolio?
How would that affect the currency reserve status of the US dollar? If the crypto market could become more useful than Gold in shorting the US dollar, as macroeconomics change to a new paradigm under which portfolio immunization can be obtained, the demand of crypto could be driven by the necessity of decorrelation from the Equity. Until now, however, crypto does not have these characteristics, and the expected inflation and the relation Bond/Equity may provide us a guide in the future for when the paradigm might switch.
Welcome sell-off!
Welcome sell-off!
I have always loved the sell-offs. It makes a line between the fools that simply try to ride the momentum and the proper long-term investors that are not scared about the volatility. Still, they act on it, taking advantage of the volatility to gain a position that, with time down the line, will indeed make a difference.
If you don’t know why you bought a stock in the first place and just bought it thinking it will go up, you then will drop it when it does not, and you deserve to lose money. I don’t blink when I see my stock dropping but evaluate if the market is cheap enough to have another bite. As many would have told you, I only sell when the fundamentals have changed, or when the market is willing to overpay ridiculously. In that case, I might just let it go, but sometimes even that is not easy or right either.
For instance, I recently have trimmed my Apple’s position, and the split momentum added billions of market cap without any fundamental reason. The valuation was too rich, I had Apple from a price of $69 pre-split, so when I sold part of it at $510, people would think I did great. Well, I have learned that you never sell compounder. However, I have spotted some others with lower valuation, it was a tough decision to take, very hard to let part of my Apple shares go, but finally, I did it. If the market would drop a bit more, I would probably buyback.
Besides the diversion, let’s look deeper into what the market is telling us, what is happening, and what my move will be.
I was exploring some statistics and, while diving in numbers, got impressed by how the media is altering the information to satisfy their cheeky agenda, which is definitely not your financial freedom but the opposite. They need to scare you in order to get things cheaper. Wall Street and the media have an alliance, I think, which has the purpose of scaring mom and daddy’s money.
Please don’t trust the misinformation of those panic disseminators but instead look at the numbers by yourself, learn where to find them, and how to interpret them.
Congress hasn’t yet come to an agreement. The payroll tax has been suspended through an executive order, but if Trump is reelected, it will likely be tax forgiveness. Otherwise, double taxes would need to be paid, and this could create some small frictions on the market.
The fantastic best news was the monetary policy. Powell is telling us what to do, he is our guide, and is saying “don’t worry, right now we don’t care about inflation, we would allow inflation to rise above 2%.” In case it does, to keep up for some time, and also, Powell had many times in his interventions said that their model is not working correctly, they are not even sure that inflation would rise that quickly. They are much more worried about deflation than inflation. That’s the message we need to collect in order to invest.
We are going to experience a very bullish market in the next two quarters. After some corrections, in the next few months and for all 2021, we are going to see assets inflating, and we need to take advantage of those movements because we won’t see prices so low anymore in some of the equity.
This week the unemployment number dropped to single-digit. We are doing really well, 8.4%, which means that 2.8 million dropped in unemployment, which is a massive number. Many small businesses are bankrupting and restarting companies, so there is this new trend, and I think many young entrepreneurs are just reorganizing themselves, especially in the US. I am not concerned about how harmful bankruptcy could become for the economy at this stage.
Real estate prices are increasing in many parts of the USA. People are buying in the countryside and taking advantage of low-interest rates. They purchase real estate based on their mortgage payment, not based on prices. If their mortgage payment is convenient enough, real estate goes up in the USA, especially the RE related to the demand, which is personal and not motivated by investment reasons.
About Antonio Velardo
Antonio Velardo is an experienced Italian Venture Capitalist and options trader. He is an early Bitcoin and Ethereum adopter and evangelist who has grown his passion and knowledge after pursuing the Blockchain Strategy Programme at Oxford University and a Master’s degree in Digital Currency at Nicosia University.
Velardo manages an 8-figure portfolio of his investment company with a team of analysts; he is a sort of FinTweet mentor, people interact with him online, and he has more than 40,000 followers after his tweets. He has built a fortune in the great tech years and put together a tail strategy during the pandemic that allowed him to take advantage of the market drop. “I did not time the market, and I did not think this was even a black sworn,” he says.
On the side of the financial markets, Velardo has a unique combination. He was a real estate entrepreneur that developed several projects in Tunisia, Miami, Italy, the UK, and many other countries and cities. But he has always been passionate about options trading. Still, contrary to the volatility player and quant trading, he always had a value investing touch in his blood. Antonio studied Value Investing at Buffet’s famous business school at Columbia University. Even though the central concepts of value investing are antagonists to the venture capital pillars, Antonio’s approach tries to bridge elements of both worlds in order to seek alpha. Velardo has learned the importance of spotting pure growth stories and taking advantage of their S-Curve position. This is an essential element of Velardo’s approach as he looks forward to embracing great tech stories at the right time of the adoption cycle. This applies to stocks but also to blockchain projects.
Indeed the price of lumber is high, and its continually increasing. Prices went from $300 to a pick of $934, and this makes a strong case for USA builders and demand for housing.
Even the ISM manufacture index is doing well.
Money is moving across asset classes, and the young entrepreneurs are making money at a pace never seen before. Once the election volatility is over, we will be, especially if Trump gets reelected, on a path toward the sky.
The big swap you might have already noticed is between the old type of stock and the new one. Older stocks that did not spend in innovation or made strategic acquisitions are suffering and are going to be destroyed by the new innovative and disruptive businesses.
There is a lot of rumor about how financials are cheap, how Well Fargo and Chase are cheap, but why don’t we try to listen to the market that is suggesting us to look at the disruption and how companies like Paypal or Square have changed the payment system? With all this activity on the DeFi market, I expect to see many more older-type of banks getting to the same place that the oil companies are now. Banks, if they don’t invest in innovation through acquisition, will not be able to survive or will shrink dramatically under the new FinTech disruption.
I am currently selling my Well Fargo shares, a small position, and take advantage of this sell-off to increment my position in Square.
Bonds are dead. Bonds are not even working as a hedge, and producing real negative returns, listen to what Powell has been telling you. If you want to survive and conquer your financial independence, you have to be able to swallow this volatility, and the only place where you can have returns is in equity. Change your frame of mind about risk; volatility is not risk. Risk is buying something you don’t understand, just hoping that it will go up.
I welcome this correction; it is there to eliminate all those short-term gamblers, the fools that believe the market only goes up and don’t know what they buy. Education and information is the only thing that can keep you alive in a volatile market. You need to have a thesis based on research and understand why you are holding that equity. Like Damodaran says, when the market drops intensely, you need to know why you are holding, and valuation is the only thing that can save you.
If you don’t know the value, at least try to understand the reasons behind your investments. For instance, you could invest in a disruptive company that you know is going to change the existing paradigm and therefore increase in value, as we spoke above about FinTech.
With the new monetary policy, the P/E valuation, as I have written in my precedent articles, will change. Especially for tech companies, we will experience a new paradigm under which the P/E will need to be approached differently, because the growth in the middle of the disruption will be accelerated, so multiple will be higher than what it is in our old paradigm. Don’t forget that P/E makes sense only if it is correlated to growth. At higher growth, we would obviously justify a much higher P/E.
Before talking about a bubble, let’s understand the new paradigm, especially for those disruptive companies that will change the world. Those corrections will be an excellent chance for us in the long-term to accumulate stocks at a discount. Hold tight and enjoy the trip. I hope on Tuesday the sky keeps falling because I need to buy more, and I love sales.
Investing under the new paradigm
Investing under the new paradigm
Why are you so scared and worried about the budget deficit?
How many trillions of budget deficit can the government sustain? An infinite number of trillions if we speak about the USA government and the dollar. However, not without consequences, but let’s go by order and understand how to take advantage of the new paradigm we are living under.
If the government spends $100 into the economy, and it taxes $30, then the remaining 70 dollars are on someone else’s book and pocket. The deficit is always good for someone, that is for the people that did not have money, and it’s, on the other side, terrible for the savers in that currency.
A great investor in today’s paradigm is someone that finds an opportunity to short the dollar. Your real job today as an active investor is to follow the Fed wind, check where it goes, and take advantage of their policy. How you do that? You short the dollar. You find all possible ways to trade a fiat currency with asset or medium of exchange that would produce future cash flow or will be recognized as a better store of wealth.
Businesses producing future cash flow most likely means that inflation will be dealt with. In 20 years, the new iPhone would, for sure, cost more numerically speaking that the one today. Businesses are a way to short the dollar because their cash flow will adjust for inflation. Gold, from the other end, is just perceived as a better store of value than the worthless dollars, but gold will not produce cash flow.
What did we say above? The deficit for the government is just money in someone else’s pocket. So, why don’t you take advantage of that extra money in the economy? It will go somewhere, and they will be spending so to produce more cash flow, increase sales, and promote innovation.
Investors fail to understand the nature of the deficit budget, its consequences on the economy, and how to take advantage of it regarding your asset allocation. MMT clarify that, in a simple sentence, “USA Government does not have financial constrain, it can print as much as it wants, and should just replace its artificial constrains, with a real constrain which is inflation.”
Can printing go too far?
Absolutely, to the point of creating real inflation, but the Fed “should not monitor the inflation.” At least according to their expectation inflation model (that frankly is not even a proper model), but through a full-employment policy. To be fair to the MMT people, the Fed does not have an appropriate model of working of inflation, and fiscal policy could monitor inflation by draining money supply with taxes or setting a new system in place to avoid bubbles in particular sectors.
Even if the government “disagrees” with the MMT policy or ideas, the Fed agenda and the government fiscal stimulus are effectively following them. What else could they do? I don’t disagree with that. I don’t blame the Fed, I just follow the wind and short the fiat currency in the smartest way possible. I invest by keeping in mind that my first objective is shorting the dollar. The consequences of money printing will be two, weaker dollars and money flying in the pocket of the smarter and younger, who will spend in technology and luxury products.
Investing in companies providing such services will guarantee that the future cash flow will be considering inflation. Let’s look at diversification and the world economy. Where geographically allocate my wealth? While USD is a reserve currency, the USA can manage to print trillions to crate stimulus, and eventually later manage the inflation efficiently. That is not possible for other countries in emerging markets and particularly South America.
Hyperinflation based on inflation expectation, contrary to the USA, is highly possible in South America. Most countries there tend to fight economic depression with money printing. Those are hard spots that I would consider shorting at any chance I have. Because, unless they don’t find political leadership able to guide through the crisis, they will be in trouble for many many years.
If you, as a country, have debt in a foreign currency and do not have the means to produce and sell products that attract dollars, you will be in serious trouble.
Investment thesis
My investment thesis for the next years is:
- Invest in USA equity, in particular, tech companies.
- Take debt in USD and Euro to finance businesses and Real estate. Fiat currency will be cheaper and will create, with time, a significant spread between its cash flow that will adapt to inflation. Its intrinsic value will be lower every year.
- Not hold bonds in my portfolio. Those will not be a hedge anymore versus my equity. I would only own junk bonds that I genuinely believe will not face bankruptcy and will be recovering.
- Have a small amount of crypto and very little gold.
If you would like to go deeper into this and have a broader view, I recommend one of my last articles called “What does Bear not understand about the market’s current situation?”
About Antonio Velardo
Antonio Velardo is an experienced Italian Venture Capitalist and options trader. He is an early Bitcoin and Ethereum adopter and evangelist who has grown his passion and knowledge after pursuing the Blockchain Strategy Programme at Oxford University and a Master’s degree in Digital Currency at Nicosia University.
Velardo manages an 8-figure portfolio of his investment company with a team of analysts; he is a sort of FinTweet mentor, people interact with him online, and he has more than 40,000 followers after his tweets. He has built a fortune in the great tech years and put together a tail strategy during the pandemic that allowed him to take advantage of the market drop. “I did not time the market, and I did not think this was even a black sworn,” he says.
On the side of the financial markets, Velardo has a unique combination. He was a real estate entrepreneur that developed several projects in Tunisia, Miami, Italy, the UK, and many other countries and cities. But he has always been passionate about options trading. Still, contrary to the volatility player and quant trading, he always had a value investing touch in his blood. Antonio studied Value Investing at Buffet’s famous business school at Columbia University. Even though the central concepts of value investing are antagonists to the venture capital pillars, Antonio’s approach tries to bridge elements of both worlds in order to seek alpha. Velardo has learned the importance of spotting pure growth stories and taking advantage of their S-Curve position. This is an essential element of Velardo’s approach as he looks forward to embracing great tech stories at the right time of the adoption cycle. This applies to stocks but also to blockchain projects.
European banking system set to collapse after coronavirus black swan?
European banking system set to collapse after coronavirus black swan?
I’m just looking at Europe in search of potential business opportunities. My radar is always switched on and completely proof of any political issue. I’m on a trip to Europe, and I was deeply impacted by empty airports, empty stores and restaurants, and desolate downtowns, in particular in my native Italy.
Europe is facing, like the rest of the world, an economic recession, probably the worst after II world war with significant pressure on stock markets and a collapse in consumer spending.
The main question I’m asking myself is how all of this is impacting the European banking system and whether there is any business opportunity around. Is it better to invest in the US, in Europe, or any emerging market?
The consensus is pointing at around a 10% decline in the European economy, with Italy probably exceeding 12%. Bad credits are set to explode in Europe because of deteriorating assets.
Is this enough to foresee a credit crunch with a snowball effect implying bank defaults and a financial meltdown with global ramifications?
Honestly, I think there are still some issues that need to be assessed to answer this question. We don’t know how long the coronavirus impact will last and how deep it will jeopardize the real economy.
My guess is that the worst still has to come because European banks and Italian, in particular, still had to recover from the last financial crisis, which began in late 2008 with toxic real estate debt, spread to eurozone sovereign debt, and lasted for more than seven years.
If I look at Deutsche Bank in Frankfurt or Santander in Spain or even the plethora of popular banks in Italy, they are all facing poor profitability, an inefficient scale of operations, and the continuing cost of cleaning up old bad credits. This is crazy to me! If I believe at the potential value disruption for shareholders, I can’t figure out how most of them are still stuck to their junk shares.
Let’s look at some figures, and let’s try to be serious! The European economy relies on the banking system to a much greater extent when compared to the US. European companies are much more exposed to the banking system than US peers. More than 2/3 of European companies’ debt is represented by bank loans, while American firms tend to diversify their source of finance by placing bond. Less than 30% of American firms’ source of funding is represented by bank debt.
All of this means that sooner or later, bad credits will destroy the assets of the banking system despite the efforts of the European Central Bank to continue flooding the financial system with cash.
Someone may argue that a mega-merger trend might save the sector. It worked in the past for other mature industries, but it doesn’t work this way for the banking system. When the entire system has deteriorated, it fails in being the pivot of the economic system. And this is not recoverable by simply merging banks and scaling up dimensionally.
The European Central Bank is called to make all possible efforts to sustain sovereign debts (see Italy) on top of the banking system. I foresee a turmoil future ahead for the European economy, the European banking system, and I would definitely be scared if I had shares of any European bank in my portfolio.
I prefer to remain invested in the US, prefer digital assets, and continue to firmly believe that the US economy will come out of the crisis at a much faster pace than Europe.
About Antonio Velardo
Antonio Velardo is an experienced Italian Venture Capitalist and options trader. He is an early Bitcoin and Ethereum adopter and evangelist who has grown his passion and knowledge after pursuing the Blockchain Strategy Programme at Oxford University and a Master’s degree in Digital Currency at Nicosia University.
Velardo manages an 8-figure portfolio of his investment company with a team of analysts; he is a sort of FinTweet mentor, people interact with him online, and he has more than 40,000 followers after his tweets. He has built a fortune in the great tech years and put together a tail strategy during the pandemic that allowed him to take advantage of the market drop. “I did not time the market, and I did not think this was even a black sworn,” he says.
On the side of the financial markets, Velardo has a unique combination. He was a real estate entrepreneur that developed several projects in Tunisia, Miami, Italy, the UK, and many other countries and cities. But he has always been passionate about options trading. Still, contrary to the volatility player and quant trading, he always had a value investing touch in his blood. Antonio studied Value Investing at Buffet’s famous business school at Columbia University. Even though the central concepts of value investing are antagonists to the venture capital pillars, Antonio’s approach tries to bridge elements of both worlds in order to seek alpha. Velardo has learned the importance of spotting pure growth stories and taking advantage of their S-Curve position. This is an essential element of Velardo’s approach as he looks forward to embracing great tech stories at the right time of the adoption cycle. This applies to stocks but also to blockchain projects.
What does Bear not understand about the market's current situation?
What does Bear not understand about the market's current situation?
The economy seems to be in a deep recession, and the market is almost back where it was a few months ago pre-COVID. Some people are still scratching their heads about it, but I’m not. Actually, I profited from this crisis. My performance and equity line have skyrocketed. Let me explain why it wasn’t that hard to predict the direction of the market and take advantage of it, by limiting the risk with OTM options.
The S&P500 is our reference index in the market, and how the index is currently weighted, big Tech companies are an essential part of its portfolio. Amazon, which is now one of the most significant components of the S&P500, is up almost 50% as I am writing this.
COVID has accelerated the progress of digital society. Cloud firms, digital communication enterprises, and all the companies for which mass adoption of technology would probably have taken many more years have now reached impressive levels due to people staying home during the pandemic.
Technology is sticky; great tech companies have historically had a low churn rate. Still, when people discover and use these technologies, they get attached to them because they fall in love with the benefits. Adoption is the key to the valuation of tech companies. Its compound effect on the network is the hidden secret of those that apparently have a lousy multiple but know that once on a growing path, it can go far.
What does increased adoption mean for the network? Exponential or at least logarithmic growth. If all the assets are “just” a matter of calculating the Net Present Value (well, “just” is a euphemism), then even if there is an apparent disruption of earnings for a couple of quarters, the valuation of the company will be higher.
What else can you have if higher earnings are at the horizon due to adoption increase, and the hurdle rate is going virtually to zero? What else would you expect? Your Net Present Value now will be a result of a more significant number on top and much lower denominator for a higher valuation.
Forget about all that negativity and moaning of the street economy from your friend’s bakery or your cousin’s restaurant. The bankrupt has little or nothing to do with those tech giants with market caps of trillions of dollars that are benefiting from the digital life and their moat in this arena.
Your poor bankrupted friend who lost his job or small business, he has no access to the capital market or the Fed Power, he could probably be in deep trouble, but that has nothing to little to do, at least for now, with the best and most powerful market in the world.
Many of us were fortunate enough to profit from the last crisis in 2009. I made 20 times my money and became wealthier by using the Fed’s Quantitative Easing paradigm to invest in assets that, at the time, nobody wanted. However, a few years later, thanks to the expansive monetary policy, my real estate was available to be bought from the same bankrupted people that could not keep up before because of their credit. The same people that lost their single-family homes ten years ago, which I paid 70k for, are buying back the same property from me at 300k with the bank’s money again.
Equity, and in particular Tech, did even better. Look at Apple, Facebook, and Amazon’s stock price a few years ago and compare it to the current rate. I have some friends who kept gold and were preaching against money printing, evoking inflation and the Financial Armageddon. Gold is now returning at a price similar to that of ten years ago, while my Tech’s stock value is ten times what it was. Those friends that used to hang out with me are now not much better off than a decade ago.
This time it has been even easier to make money. It was not difficult to understand which paradigm we were under and what would happen with such a strong and motivated Fed. Trump and Powell (the Chairman of the Federal Reserve) were the certainties that the USA would do anything to bring the market up. They and their language, speech, and willingness to take care of the market were the assurance that the cheap option premium, which was indeed very cheap, would produce amazing results. OTM option premium in March and April on Tech did 7x to 10x.
It’s funny when people find an excuse not to invest because they worry about the Fed’s balance sheet. I don’t get what they think, like if having cash would help them, what damaging fear can be to even the smartest!
Cash is trash, Ray Dalio mentioned recently. The worse place you can be when there is such accommodating monetary policy is cash. Assets, in particular stocks, are the most efficient protection you can have for inflation. Intuitively people think about gold and real estate. But, the best place to be is quality equity, low debt, big moat, and resiliency to the pandemic. In other words, top tech companies.
On the flip side, I’m not worried about the debasement of the currency, and after keeping Bitcoin for so many years, I believe it currently isn’t an alternative to the dollar, and probably won’t be for the next few years. In another article, I will explain my view of Bitcoin which is, for the short term, at least, only a function of the liquidity on the market.
The US will find a way to deal with inflation, and when it happens, which I am quite sure will be in a few years, taxes will increase and drain the extra inflation away. However, I will be offshore and won’t be touched by it. Bonds and cash will be a dead beat, and your fear will become your worst enemy. If you have some savings, a medium two-to-four year horizon and plan to retire, buy stocks with leaps option, quality stock, or index if you are able to spot the right one. And buy your residency in an incredible lovely tax paradise, I am sure it will work just fine.
All this generosity by the Fed will eventually finish when the dollar is threatened as a reserve currency. Right now, they are doing all it takes to keep the economy up, but fiscal and monetary policy will drain the money away from the economy in the near future.
The wealth gap will be huge, much bigger than now. All of us that have benefited from the asset bubble towards which we are flying will be 100 times richer than those with no savings. And will, eventually, live another paradigm in which the wealthy would ultimately be hit. However, my retirement will be offshore, and my money safe from taxes.
Now please be careful, I am only advocating to go long on the top class companies in the USA. Your hedge should be being short on the countries and companies that don’t have the benefit of having a reserve currency.
I think you can be an Alpha creator if you can pick not only the winners but also the losers of the market. This market created an enormous differentiation, and now it hasn’t been effective in discriminating, so here it comes the new strategy to hedge your position.
To be more precise, the current crisis is different than the boom and bust cycle that usually leads to a financial crisis. In a typical economic cycle, the interest gets pushed up when things are going great to avoid inflation. Economic contraction starts to happen, the debt crisis will show up, and then again, monetary policy will start the expansion period to accommodate the economy.
The normal debt cycle, the way we know it, will result in credit falling, monetary policy tightening, and only after, the income will be hit before a new accommodating monetary policy kick in. However, because of the virus, we had income falling before, in a scenario where the interest rate was already zero. Credit expansion now cannot be exercised by merely cutting interest rates, so the Fed needs to adopt other policies to be effective.
Once that happens, the way out has been Quantitative Easing, but that weapon has also been used. So now the Fed is moving to something that has never happened before. More and more economies are embracing Modern Monetary Theory or MMT.
MMT has different layers and approaches, but basically it is the idea that a country could and should always run at a constant deficit. Instead of going deeper into theory, let’s focus on the paradigm’s consequences and how to structure your strategy.
Economies that have reserve currencies like the USD will be able to “print their way out” without creating hyperinflation, at least for the next few years. But all those countries that don’t have that ability will face more significant issues and a hyperinflation scenario.
Fiscal policy will be used in combination with monetary policy to send money to support the economy. Now “support the economy” does not mean the market goes up, it means that the Fed will do all it takes to promote full employment, and that is their mandate.
At a certain point, all those companies affected by COVID will eventually be picked up, to generate jobs. I would not be surprised if, in the next few months, the affected sectors receive an extra stimulus. At the end of the day, the Fed knows that the only way to reach full employment is to send money and support the old economy businesses. To incentivize jobs to the less skilled people, who are the ones suffering, that necessarily needs to be done with fiscal stimulus.
The difference between the countries without this ability, like the emerging markets in Latin America and the USA or Europe, will be enormous. The gap will increase with time, and if not dealt with, conflicts and riots will be a daily issue in those countries. Shorting Latin America, their banks, and debts would be your hedge while long on the USA market.
What will happen in the long term? Well, I recall a lesson at university in which when studying MMT, my professor was speaking about the colonies, and how they were operating their monetary policy.
Dutch colonies; for example, were printing to pay their local workers (the slaves). Printing paper currency and plenty of it, with the queen or king’s head on it, to pay to the slaves. Where was this leading? You would be thinking “inflation,” well, those colonies were obligated to pay a lot of taxes. And do you know what the Dutch army was doing with it? They were burning piles of money to drain the inflation. That was a way to get the useless paper out of the system and, at the same time, to make it less worthless.
So, we are moving into a scenario in which we will see asset pricing inflating. Those who have access to credit and assets will become more prosperous, while others will be much poorer. One day, far in the future, this large gap will have a repercussion in politics. Taxes will be the way for the poor to take back some wealth, and it will be the only way for the governments to avoid the debasement of the whole system.
If the strategy is not clear: long USA equity and short emerging markets, especially South America. Look for assets and businesses that target the rich, not the poor. Start to look for a place to run to when taxes hit hard, escaping from taxes could be an issue if you don’t prepare for it, and take all your money back. Becoming wealthy will be that easy.
About Antonio Velardo
Antonio Velardo is an experienced Italian Venture Capitalist and options trader. He is an early Bitcoin and Ethereum adopter and evangelist who has grown his passion and knowledge after pursuing the Blockchain Strategy Programme at Oxford University and a Master’s degree in Digital Currency at Nicosia University.
Antonio manages an 8-figure portfolio of his investment company with a team of analysts; he is a sort of FinTweet mentor, people interact with him online, and he has more than 40,000 followers after his tweets. He has built a fortune in the great tech years and put together a tail strategy during the pandemic that allowed him to take advantage of the market drop. “I did not time the market, and I did not think this was even a black sworn,” he says.
On the side of the financial markets, Velardo has a unique combination. He was a real estate entrepreneur that developed several projects in Tunisia, Miami, Italy, the UK, and many other countries and cities. But he has always been passionate about options trading. Still, contrary to the volatility player and quant trading, he always had a value investing touch in his blood. Antonio studied Value Investing at Buffet’s famous business school at Columbia University. Even though the central concepts of value investing are antagonists to the venture capital pillars, Antonio’s approach tries to bridge elements of both worlds in order to seek alpha. Velardo has learned the importance of spotting pure growth stories and taking advantage of their S-Curve position. This is an essential element of Velardo’s approach as he looks forward to embracing great tech stories at the right time of the adoption cycle. This applies to stocks but also to blockchain projects.