#writing --- **May 19, 2025** Since Trump de-escalated the trade war with China on April 22nd, we have seen the risk markets rebound significantly and volatility recede in a Pavlovian reversal of the risk off wave that had been coursing through the markets since "Liberation Day." As many had hoped, the policy choice was changed as the financial pain became too much to bear. As some pundits have put it, the Trump put is still there, but the strike price is just lower than anyone had thought. ![[Pasted image 20250518200334.png]] The problem with this line of reasoning is that it is recursive, meaning that the next time Trump does something the markets don't like they will drop stocks by ~20% and bonds by 75bps, the supposed strike price, in hopes of forcing his hand. However, Trump, of all people, will not be easily manipulated so he will change tactics to keep everyone off guard. Trump's negotiating strategy focuses on shock and awe to keep his opponents off balance. In other words, we should expect higher realized volatility under Trump. The risk off wave that we just experienced was characterized by stocks, crude, bitcoin, and the dollar all falling together. Bitcoin had been a laggard prior to Liberation Day but has recently been keeping pace with stocks and leading the recovery higher while crude and the dollar have lagged on a relative basis. Crude being the worst performer of the risk on names reflects the market’s view of an increased probability of a recession. ![[Pasted image 20250518225141.png]] Gold performed the best during the crisis while long-term treasuries declined as the yield curve steepened on expectations for Fed easing (due to recession). The Yen and the Euro both moved higher to their respective range highs but have so far failed to break out higher. ![[Pasted image 20250518224430.png]] ![[Pasted image 20250518224822.png]] ![[Pasted image 20250518224949.png]] We can observe a few different themes emerging from this recent market cycle. First, the odds of a recession have increased as the impact of tariffs is widely expected to be growth negative. However, there are lingering worries about inflation from the Fed and some investors which are keeping Fed rate cut expectations to only two cuts this year. ![[Pasted image 20250518230029.png]] These concerns can be traced back to the inflationary experience of the 1970s which saw the CPI rise from under 2% in the late 1960s to over 6% by year-end 1970 only to fall back to 2.5% by 1972 and stay there until bursting higher to over 10% by 1975. While tariffs have proven to be deflationary in the short-term and a recession may further dampen price pressures, the inflationary mindset that was born from the experience of shortages during COVID could be reinvigorated if we experience shortages during a global transition in trading patterns. Second, the dollar has become a risk on asset. While the dollar and stocks rallied together around the election on the US supremacy theme, it wasn't until the start of the year when the correlation between the dollar and stocks started to trend higher. This occurred at the same time that gold really started moving higher which reflects a monetary concern rather than a growth or inflation concern as [Bob Elliott pointed out](https://x.com/BobEUnlimited/status/1924409944805163211). This demonetization movement is another force weighing on bonds pressuring bond yields higher globally and supporting cryptocurrencies. ![[Pasted image 20250519095827.png]] This movement towards demonetization can also be seen in the correlation between gold and US Treasuries. While this pair has tended to demonstrate an inverse relationship as lower rates were supportive of gold and vice versa, recently the two have completely decoupled showing a breakage of this causal monetary linkage. Third, tech stocks have led during the recovery, which is mostly explained by their higher beta, however there is a potential causal linkage with the demonetization theme. Tech companies benefited from the era of low interest rates because they are long-duration investments. However, they have not suffered commensurately as rates have risen, which is evidence that other forces may be at work. Low rates, while supportive of the economy and monetary system in the short run, can also drive demonetization as the higher debt burdens that necessitate low rates weaken confidence in the monetary system. Traditionally, demonetization favors physical over financial assets, however, as we have seen with cryptocurrencies, tech, especially AI, may be a new quasi-physical asset. The ranks of the rich and famous are increasingly made up of creators of intellectual property instead of builders of physical property. We can see evidence of this trend in industries as far off as college sports and the legal system with a flood of money into NIL-deals and litigation finance. These themes all co-exist and operate at different wavelengths and drive the market pricing we see in real time. Market prices are a crude conglomeration of all these different forces at work at any given moment and the primary forces setting marginal prices change as the different waves operating under the surface change. Sometimes we can observe particular waves at work that provide evidence of a change in a longer wave. A good example of this is the secular bond market wave that continues to show qualitative and quantitative evidence of turning higher. ![[Pasted image 20250519102445.png]] The inflation wave that we experienced in the wake of the pandemic caused the upside breakout from the 40-year secular down trend channel. The inflation wave primarily operates in line with the economic cycle; however, the demonetization theme provides a potential wildcard for the inflation wave. Cyclical inflation can usually be countered by tighter monetary and fiscal policies, however if faith in the currency weakens it can lead to hyper-inflation which is what Weimar Germany experienced. We are a long way from that today; however, it is an interesting dynamic to keep an eye on. Knowing these waves are operating is helpful, but ultimately not very useful if we don't know their wavelengths or where we are within them. We try to accumulate evidence that can help us have an approximate idea of the wavelength and where we might be positioned on a particular wave, but these approximations are the furthest thing from an exact science. The idea that cycles or waves exist and are driven by and impact the human actors in the systems they operate within is well accepted. However, the techniques for analyzing them range from exact science to practices resembling witchcraft. ![[Pasted image 20250518201013.png]] Our aim is neither as it is easy to be too exacting or too dismissive of this sort of analysis and we strive only to acknowledge the existence of these forces so that we are not run over by them. In our opinion successful investing is a blend of art and science and it is here that we depart from the lab to walk through the gallery. ![[Pasted image 20250519104827.png]] This is our best guess as to the wavelength and position of some of the primary waves setting prices in the markets today. Knowing roughly where we are is vital to understand where we might be headed. There are many other waves of infinite complexity at work in the markets today and if we tried to include them all in the picture it would be a jumbled mess. Foreign stocks versus US stocks is another long wave that may be in the process of changing but has many confusing dynamics such as the interplay between US tech dominance, the dollar, and interest rates. Getting just a few of these right can greatly increase your batting average in the markets and avoiding the ones that are too difficult to figure out can help avoid losses. The setup pictured above could be positive for US stocks in the short run with inflation falling, rates range bound, and risk sentiment on the upturn. But for now, the markets have come into a trading range, and we won't know if things like demonetization or a recession will hurt stocks or not until the market starts testing the limits of the range. ![[Pasted image 20250519105717.png]]