February 2025 Update

February, 2025

How are you coping?

A frenetic and for some traumatic start to the Trump Presidency round II. Nonetheless and regardless of your stance on politics, social cohesion, fiscal policy, and stuff such as individual vs government responsibility required, as investors we will have to find 'coping strategies' (to use modern HR jargon) with what appears to be a significant pendulum swing.

Here in bullet point format are some of the new challenges we see. We've probably missed some. Naively perhaps we see a very simple solution to them. We'll reveal at the end of the brief conjecturing.

Central bankers love trotting out they're 'data driven' in setting interest rates but the data on inflation and (un)employment is alarmingly, clearly and more obviously inaccurate. If they don't have accurate data how can they make the correct decisions? - how should investors cope?

As DOGE removes 'wasteful' spending in the US by government agencies, a simple Kalecki calculation means it has to be replaced with a fiscal spend of equal efficacy by one, some or all of, the private sector, the overseas sector or personal sector. If it isn't replaced then nominal GDP will fall, and while interest rates may thus adjust downwards, it's not clear they will, nor that the cost of capital to discount company earnings will fall. Spreads to Treasuries may not contract or widen.

Tariffs can appear and disappear in a moment. A favourite sector or country can be clobbered by a few comments on 'Truth Social' Capital Expenditures from Big 'Tech' have all but been guaranteed to increase. This makes sense since it's what companies should do, but part of the miracle of the US equity market has been a high level of share buy backs and subdued capital investment. This changes the dynamics. Time to buy the picks and shovels companies and not the Gold prospectors?

China won't backdown or be bullied quietly - see an excellent article entitled 'ctrl Altman delete' on Substack by a colleague in Hong Kong, Mark Tinker.

Equity market volatility has been very subdued at below c.15% and, more importantly for active managers, cross sectional volatility has been subdued too. This has manifested itself in the extraordinary returns to the momentum risk factor. However, if a few large companies' share prices rise and rise, then their correlations do too, and the diversification offered to investors falls. We pointed out that $ billions was being invested globally on a single company's eco-system, representing or chewing up over 10% of a passive strategy risk budget. That's more like gambling. You can avoid this by diversification. So, and given the above 'problems' we see developing, we anticipate (finally) the cross-sectional volatility reverting to normal levels and thus offering more opportunity for active managers. If you have skill then the more chances you have to use it, and the greater its effect as the difference between winners and losers widens, (cross-sectional volatility) the bigger your excess return. This means investors should:-

1. Diversify more if they haven't already. More stocks, more countries, more sectors, more variety in size exposures

2. Use a risk control tool to ensure correct sizing and directionality of views, and

3. Be prepared for higher portfolio turnover and to 'suffer' a value bias

We'll see if we're correct!

Delft Partners February 2025