Commentary by AG Capital Management Partners, LP
We ended the year much as we performed all year long – one step forward, and one step back. That’s OK. In a year where our ideas have not come to fruition in a timely fashion, our job is twofold: first to question our fundamental themes and decide if we are wrong and need to adjust; and second, to not lose our patience if the answer is “no”.
Our views and our conviction remain intact, as we believe that we are at the tail-end of an epic, 13+ year bull market in stocks that has ended with a classic bubble, one that will take the better part of the rest of the decade of the 2020s to re-set valuations and expectations to a norm that sets the stage for better equity returns in the 2030s and 2040s.
Our strategy for 2022 remains to be broadly short commodities, short equities, and long Treasury bonds – at least for the first quarter to the first half of the year – as we believe a severe correction is coming in equities and in many commodities. Equity markets have conditioned investors to buy even the smallest of dips, as drops of -3% to -5% have all been (with hindsight) buying opportunities over the last 12 months. We see the strong potential of a severe correction, in the -15% to -25% range, that will set the stage for a substantive low as occurred during March 2020 or December 2018.
The economic growth slowdown we are anticipating should drag inflation down, and as central banks reverse their tightening policies, we will look to reverse our own positioning later in 2022. We plan on going long crude oil on a multi-year basis, due to reduced supply from a lack of capital investment. We also plan on buying other select commodity markets where we see opportunities and buying equities for a trade on the long side after a sell-off.
But for now, we do not see any fundamental or technical reasons to change our current positioning.
A random assortment of thoughts
Instead of a single narrative, we’ll end this letter with our thoughts on a handful of random topics that are top-of-mind for us right now, in no particular order.
Although our idea generation is primarily fundamentally driven, we believe that technical analysis is important. It does not need to be complicated – all we do in our work is visually look for consolidations and ranges that allow us to decide how a market is trading relative to another market. In other cases, it assists us in our risk management, by allowing us to decide where we are ‘wrong’ on a particular trade that we then need to cover.
The key thing we’ve noticed over the years is that the timeframe of technical analysis has needed to be lengthened further and further for it to be meaningful. Your portfolio manager was able to find reliable set-ups on hourly charts in his early years, back in the 2002-2006 timeframe. Over time, as more and more algorithms and high-frequency traders began to disrupt patterns in the charts, we lengthened our timeframes such that by the time we started AG Capital in 2014, we relied on daily data to make decisions. In recent years (2017 and on), we’ve noticed that even daily data is primarily noise, and only weekly and monthly data has informative value for technical analysis. This is of critical importance, as the line between luck/gambling and skill/investing is very, very fine. To make sure you stay on the right side of that divide, you must ensure that you push your use of tools such as technical analysis to a time interval that has information value (or density), instead of randomness.
Developed market central banks have a certain mystique about them. They are independent of political influence. They are staffed by erudite, accomplished, and credentialed economists. These things have been largely true during “good” times – times like the 1950s or the 1990s. But the political independence of central banks tends to fall apart during tough times. When social and economic disruptions challenge the power of society’s elites, the central banker’s unofficial job is to accommodate the political imperative and to shift their orthodoxy to get in line with the times. We have already seen the Fed start to make sure shifts, by factoring the economic plight of underrepresented and minority workers into its framework.
We are also seeing changes in Europe, where, much to our surprise, the hardest money central bank over the past 80 years – the German Bundesbank – has relaxed its opposition to stringent fiscal rules within the eurozone. With everyone’s focus on Covid-19, one of the easiest to miss stories of the year was the announced retirement of Jens Weidmann, Bundesbank president and a long-time critic of the ECB’s easy-money policies who is stepping down for ‘personal reasons.’ Although not the only hawk on the council, this is a notable moment and one that dovetails with our key view that central banks will maintain a straightforward monetary policy this decade and accommodate the social spending that politicians order during every significant dip in economic growth.
The investment implications of climate change politics
We are not climate change deniers. We only note that based on some elementary back-of-a-napkin math, the only way to reduce carbon emissions globally is for China and India to grow out of their use of coal. Since this will not happen for decades, most climate goals for 2030 and 2040 will not be met. In addition, the political shift in the West against the use of fossil fuels has created a situation where not just growth CapEx but ongoing maintenance CapEx for oil, natural gas, and coal assets has been cut to the bone. Since intermittent supplies of energy such as solar and wind cannot replace baseload energy supplies from fossil fuels and nuclear power, the main investment implication is that we will see higher prices for fossil fuels this decade, with rolling bull markets in crude oil, coal, and natural gas – the only energy sources that can realistically power our world for the next few decades (or longer). As a result, we plan on going long crude oil futures later in 2022 on a correction and plan on trading natural gas on the long side from time to time.
Time and performance
Time is the natural enemy of almost every short-term trading strategy, whether discretionary or systematic. Sooner or later, the markets will change so that short-term strategies cannot handle. Although fundamentals can play out over months, they usually work over multi-year timeframes. In line with our thoughts on the technical analysis above, one of the critical things we have done over our history is slowly and continually extending our time horizon for our fundamental views and our supportive technical analysis. If there is one thing we have done that will help ensure our long-term survival, that is it.
A strange industry
The hedge fund business is a strange one. It’s more art than science. In most industries, whether medicine, engineering, plumbing, or beauty/cosmetics, long-term success comes from copying and adopting best practices that competitors introduce; otherwise, you will be left behind, and you will lose market share.
The hedge fund industry works in the opposite way – in investing, if you do what most of your competitors do, you will underperform. Your goal as a hedge fund manager is to adopt operational best practices but to continually ignore chasing the investment “best practice,” whether that happens to be artificial intelligence or growth stocks at the top of a bull market led by them. They say to “buy low; sell high” – we’re going to do just that.
Trading futures involves a substantial risk of loss and is not suitable for all investors. Past performance is not necessarily indicative of future results.