Hope all goes well… “If I could give you a definitive explanation for the phenomenon, I’d either be in line for a Nobel Prize or I’d be a liar,” he said. It was a good answer. I’d asked the candidate to explain quantum entanglement, it has always fascinated me. He’d spent over a decade studying quantum physics, string theory. “The mathematics that we use to describe our work in the quantum field is magnificent. But the analysis required to address complex puzzles in financial markets is beautiful in its own brute way, too.” He left academia after encountering a “two-body problem”, and I respected the honesty, sincerity. His two bodies are still rather young compared to my four.

Overall: “The younger generation must inherit and carry forward the spirit of self-reliance, and hard work, abandon arrogance, and engrave the passion of youth in the water just like our parents did, on the monument of history,” declared Xi, some time ago. Youth unemployment across China continued its rise this summer. The official number approached 21% before Beijing halted its publication. Unofficial estimates stretched to nearly 50% when one counts the “lying flat”, a term adopted by youth who are choosing to quit the rat race altogether. In previous decades, agitated youth took to the streets. New forms of hyper-surveillance make such rebellion far harder. Instead, the young simply opt out. “The facts of countless successful lives show that in youth, if you choose to endure hardship, you will also choose to gain, and if you choose to contribute, you will also choose to be noble,” said Xi. Parents across the world nodded in violent agreement, because of course, nothing could be truer. “In youth, experiencing more beatings, setbacks, and tests, will help you walk a successful life,” said Xi, a cold terror slowly rising in the leader for life. The national savings rate rose further still, his subjects preparing for harder times. China’s fertility rate collapsed to a stunning new low of 1.09 per woman (from 1.30 in 2020). This symptom of profound pessimism, if not reversed dramatically, will lead to economic and then civilizational collapse. “In the later years of my life, I always reminded myself that hardship is an opportunity. I must persist in learning more and working more and go to difficult places to train myself,” said Xi, searching for a solution to a problem far more challenging than trade wars, chip dependencies, ghost cities, insolvent banks, stranded infrastructure built for a globalized world that is fading, not to mention his nation’s food, energy and water insecurity. All such problems are solvable provided a nation has a growing population of ambitious, optimistic, hardworking youth. But how to lift a nation whose young consider their current circumstances, assess their future, and quietly lie flat?

Week-in-Review: Mon: US holiday / quiet markets, Chevron LNG workers in Australia plan to strike from 14 Sep, ECB’s Centeno sees danger of ‘doing too much’ on rates, Russia/Turkey talks don’t revive grain deal, Turkey CPI 58.94% (55.90%e) / Core 64.85% (61.70%e), Israel CB unch as exp, S&P closed; Tue: RBA unch as exp, China’s Country Garden avoided default by making payments before grace period expired on 2 bonds, Saudi’s and Russia extend production cuts to end of year (1m ext expected), Beijing raising $40b to fund chipmaking/research to reduce dependency on US tech, GS lowers odds of US recession to 15% (20% prev) / consensus prediction remains at 50-60%, N.K.’s Kim Jong Un meets with Putin / US warns that NK may supply Russia with weapons, ECB’s Visco says must be careful on future policy path, Fed’s Waller (hawk) says no need for anything imminent / Mester says more hikes may be needed but not necessarily in Sept, South Korea CPI 3.4% (2.9%e) / 2Q GDP 0.9% as exp, Japan household spending -5% (-2.5%e), EU PPI -7.6% as exp, S. Africa GDP 1.6% (1.2%e), Brazil IP -1.1% (-0.5%e), US Factory Orders -2.1% (-2.5%e) / Durable Goods -5.2% as exp, S&P -0.4%; Wed: Japan’s Kanada verbally intervenes – ‘won’t rule out any options if moves continue’, BoC unch as exp, Poland CB surprised with 75bp cut (25bp exp), Chile CB cuts rates 75bp (83bp priced), ECB’s Knot says mkt underestimating chance of Sept hike / Kazimir said Sept hike is preferable to a later one, China bans gov’t officials from using iPhones, Australia GDP 2.1% (1.8%e), Germany Factory orders -10.5% (-4.5%e), Hungary ret sales -7.6% (-7.4%e), EU ret sales -1% (-1.2%e), US Trade Balance -$65.0b (-$68.0b exp), S&P -0.7%; Thu: BOJ’s Nakagawa sees easy policy as still appropriate, Japan PM Kishida rumored to shuffle cabinet, Fed’s Williams says policy is in a good place, Russian drones continue to damage port city of Odessa, US/EU working on new tariffs to target Chinese steel producers, China extends iPhone band to some SOEs, Poland CB gov Glapinski confirms dovish stance following surprise rate cut, China Exports -8.8% (-9.0%e) / Imports -7.3% (-9.0%e) / Trade Balance $68.36b ($73.90b exp), Japan leading index 107.6 (107.8e), Germany IP -2.1% as exp, EU (final) 2Q GDP 0.5% (0.6%e), Mexico CPI 4.64% (4.62%e) / Core 6.08% (6.12%e), US (final) 2Q unit labor cost 2.2% (1.9%e), US init claims 216k (233k e), S&P -0.3%; Fri: Chevron LNG workers in Australia begin striking, Erdogan provides verbal support for orthodox monetary policy (higher rates), Fed’s Logan says skipping does not mean stopping, Yellen pledges more financial assistance to Ukraine, PBOC’s CNY fix is at 2m high providing some guidance that authorities are okay with some weakness in ccy, US investigating chip advances made by Huawei, Japan real cash earnings -2.5% (-1.4%e), Japan 2Q (final) GDP ann QoQ 4.8% (5.6%e) / Deflator 3.5% (3.4%e), France IP 2.7% (1.4%e), Canada chg in emp 39.9k (20.0k exp) / unemp 5.5% (5.6%e), Russia CPI 5.15% (5.10%e), S&P +0.1%; Sat: China CPI 0.1% as exp / PPI -3% (-2.9%e).

Manufacturing PMI (high-to-low): India 58.6/57.7, Indonesia 53.9/53.3, Greece 52.9/53.5, Russia 52.7/52.1, Norway 51.43/56.38, Mexico 51.2/53.2, China 51/49.2, South Africa 51/48.2, Vietnam 50.5/48.7, Brazil 50.1/47.8, Singapore 49.9/49.8, Hong Kong 49.8/49.4, Japan 49.6/49.6, Turkey 49/49.9, South Korea 48.9/49.4, Canada 48/49.6, United States 47.6/46.4, Hungary 46.5/45.9, Spain 46.5/47.8, France 46/45.1, Netherlands 45.9/45.3, Sweden 45.8/48, Italy 45.4/44.5, Taiwan 44.3/44.1, Poland 43.1/43.5, UK 43/45.3, Czech Republic 42.9/41.4, Austria 40.6/38.8, Switzerland 39.9/38.5, Germany 39.1/38.8. Services PMI: India 60.1/62.3, Russia 57.6/54, Ireland 55/56.7, Japan 54.3/53.8, China 51.8/54.1, Brazil 50.6/50.2, US 50.5/52.3, Italy 49.8/51.5, UK 49.5/51.5, Spain 49.3/52.8, Sweden 49/53.4, Australia 47.8/47.9, Germany 47.3/52.3, France 46/47.1.

Weekly Close: S&P 500 -1.3% and VIX +0.75 at +13.84. Nikkei -0.3%, Shanghai -0.5%, Euro Stoxx -0.8%, Bovespa -2.2%, MSCI World -1.4%, and MSCI Emerging -1.2%. USD rose +5.2% vs Chile, +3.0% vs Mexico, +2.3% vs Russia, +1.5% vs South Africa, +1.2% vs Australia, +1.1% vs Yen, +1.1% vs China, +1.0% vs Sterling, +0.7% vs Euro, +0.7% vs Sweden, +0.7% vs Brazil, +0.6% vs Indonesia, +0.4% vs Turkey, +0.4% vs Canada, +0.3% vs Ethereum, and +0.3% vs India. USD fell -0.1% vs Bitcoin. Gold -1.2%, Silver -5.5%, Oil +1.4%, Copper -3.5%, Iron Ore -2.2%, Corn +0.1%. 10yr Breakevens (EU +10bps at 2.41%, US +8bps at 2.34%, JP -1bp at 1.11%, and UK +3bps at 3.81%). 2yr Notes +11bps at 4.99% and 10yr Notes +8bps at 4.26%.

Year-to-Date Equities (high to low): Greece +35.4% priced in US dollars (+35.5% priced in euros), Hungary +34.1% priced in US dollars (+29.8% in forint), Argentina +33.4% in dollars (+163.5% in pesos), NASDAQ +31.5%, Ireland +21.3% (+21.4%), Mexico +20% (+8.3%), Denmark +19.4% (+19.8%), Italy +19% (+19.1%), Poland +17.4% (+15.8%), S&P 500 +16.1%, Spain +13.7% (+13.8%), MSCI World +13.3% in dollars, Germany +13% (+13%), Taiwan +12.4% (+17.2%), France +11.8% (+11.8%), Euro Stoxx 50 +11.6% (+11.7%), Brazil +11.5% (+5.1%), Japan +10.8% (+25%), India +9.1% (+9.5%), Russia +9% (+45.9%), Czech Republic +8.8% (+10%), Korea +7.7% (+13.9%), Saudi Arabia +7.3% (+7%), Netherlands +7.2% (+7.3%), Chile +5.5% (+11.5%), Switzerland +5.4% (+2%), Turkey +5.3% (+51.1%), Russell +5.1%, UK +3.4% (+0.4%), Canada +2.8% (+3.6%), Indonesia +2.2% (+1.1%), Portugal +1.2% (+1.3%), Austria +0.5% (+0.6%), Colombia +0.3% (-16.9%), Sweden -0.3% (+6.5%), Norway -0.9% (+7.8%), Belgium -1.3% (-1.2%), Singapore -3.3% (-1.3%), Venezuela -4.5% (+85.4%), Australia -4.9% (+1.7%), UAE -5.1% (-5.1%), China -5.2% (+0.9%), Israel -6.7% (+2.2%), Philippines -7% (-5.2%), New Zealand -8.4% (-1.1%), Malaysia -8.4% (-2.7%), HK -8.4% (-8%), South Africa -9.6% (+1.6%), Thailand -9.8% (-7.3%), Finland -10.1% (-10%).

 Alpha: “It requires that you think holistically about your portfolio,” said the CIO of a sovereign wealth fund, somewhere in Asia Pacific. “It’s the way you’d think in my seat. You’d look at the overall risk, netted off across all the portfolio positions,” he said. “It’s similar to running a multi-strat fund with a comprehensive risk management structure and a center book, the difference being that we are by design long the market rather than market neutral.” We were talking about a Total Portfolio approach to investment management. Of the largest pools of investment capital in the world, several of the leading performers are run in such a way.

Alpha II: “Typical large investment funds have asset class teams, and each will try to optimize its own portfolio, its own allocation,” continued the same CIO. “Whereas we try to optimize across the whole portfolio, every asset class, all opportunities, at least conceptually,” he said. “If you go down the route of having asset class teams, you somehow need to find how to compare the returns of capital across asset classes and manage a competition for capital so that you allocate to the best investment. There’s always a conflict between bottom up and top down.”

Alpha III: “We organized ourselves in a different way,” he said. “We have a whole team of generalists and hopefully they can do anything,” he said. “But the reality is that you naturally get market segmentation. And expertise on certain asset classes and sectors is very important.” So, he’s been trying to increase the degree of specialization across the investment team without losing the whole of portfolio approach. “And it gets harder at the size we’re running at,” he admitted.

Alpha IV: “One of our key advantages is that we have a very long-term horizon,” he explained. “It allows us to have quite a high risk appetite.” They take substantial active risk around their reference portfolio, accepting the volatility required to generate alpha. “We think about where we have structural advantages, where and why we may have a better chance of making money than others in such a competitive marketplace.” They don’t require short term cash flows. “We can really look through situations, events, dislocations, see across the chasms.”

Alpha V: “Perhaps our biggest advantage is governance,” he explained. “You can only really think long-term if you have real buy in from your investors,” he said. “We have only one investor, a clear mission, and strong buy in.” As a sovereign wealth fund, they have access to unique investment opportunities, managers, and certain reputational advantages too. “We’ve been able to stick with our strategy because people have bought into it. And of course, if there were ever a few years of negative returns, that could be tested. But the philosophy has worked well.”

Anecdote: “Conceptually it’s very easy,” said the CIO. “Practically it’s very hard,” he continued. A lovely winter day in August, the world upside down. We were discussing dynamic asset allocation, which for them consists of adjusting one’s portfolio to lean against powerful market trends. “It is the part of our investment program that our peers are most interested in discussing.” He leads a sovereign wealth fund with the world’s top performance for the past decade. To outperform requires investors do those things others generally do not. Defying the crowd at such scale is high art. “We base our dynamic asset allocation decisions mostly on relative valuations. It is a mean reversion process that capitalizes on volatility harvesting. And at times we will underperform, even have substantial drawdowns, but in the long run it has produced tremendous alpha.” In 2021-22 the approach helped contribute to the portfolio outperforming its 80/20 equity/bond benchmark by 700bps. “If you’re entering a high-volatility trending environment, the strategy is not very good. But if you’re entering a high-volatility non-trending environment, it is quite a good approach,” he said. “The periods that are both most challenging and ultimately rewarding are when you’ve had markets selling off a lot and your long position gets bigger and bigger, your liquidity is drawing down. You need to have the right limits at those times, and our limits are bigger than others because of our long horizon,” he said.  “When that happens, like it did during Covid, when the collapse was faster and deeper than we thought it should be, it made us wonder, do we understand the underlying distribution?” Such periods torture those who risk defying the crowd, because of course, no one can outperform without paying a steep price, emotionally, mentally, physically. “It made us consider, if something is at an extreme, do we feel more confident that it will revert? Or less confident, because perhaps we don’t understand the underlying system?”

Good luck out there,

Eric Peters
Chief Investment Officer
One River Asset Management

Disclaimer: All characters and events contained herein are entirely fictional. Even those things that appear based on real people and actual events are products of the author’s imagination. Any similarity is merely coincidental. The numbers are unreliable. The statistics too. Consequently, this message does not contain any investment recommendation, advice, or solicitation of any sort for any product, fund or service. The views expressed are strictly those of the author, even if often times they are not actually views held by the author, or directly contradict those views genuinely held by the author. And the views may certainly differ from those of any firm or person that the author may advise, converse with, or otherwise be associated with. Lastly, any inappropriate language, innuendo or dark humor contained herein is not specifically intended to offend the reader. And besides, nothing could possibly be more offensive than the real-life actions of the inept policy makers, corrupt elected leaders and short, paranoid dictators who infest our little planet. Yet we suffer their indignities every day. Oh yeah, past performance is not indicative of future returns.