From Harley Bassman, The Convexity Maven, at Simplify Asset Management, December 14,2021:
(Holiday Stocking Stuffers)
Come this time every year, I publish a list of “Investments” that I think will do well over the intermediate horizon – two to five years. These are NOT meant to be nips to blips RV trades, but rather longer-term notions that capitalize upon either my strongly held themes or the trembling hands of Sharpe Ratio focused portfolio managers.
As always, I will caution that my portfolio construction is not suitable for widows and orphans, despite the fact the last year’s stocking stuffers were all winners. However, this success should be viewed with a gimlet eye as it was recently reported that a trading hamster named Mr. Goxx outperformed Warren Buffett. Before I detail this year’s Model Portfolio; let’s consider the macro-landscape.
To repeat (ad nauseam), since the Great Financial Crisis (GFC) we have had the unresolved problem of too much debt, both public and private. The Federal Reserve Bank (FED) instituted a Zero Interest Rate Policy (ZIRP) for their overnight funding rate and combined it with Quantitative Easing (QE) in the hope of creating inflation to depreciate nominal debt.
Notwithstanding the bleating deflationist crowd, I suppose these policies were effective if one considers asset inflation instead of wage inflation a success. Notice the -mashua line- value of Stocks and Bonds has kept pace with the growth of -salsify line- Western Central Banks assets.
*****What has changed since COVID is the massive fiscal support from the Federal Government that stuffed cash into the hands of people with a propensity to spend, rather than into the wallets of investors.
Consumer Price inflation (CPI) has reached a near forty-year peak as post-COVID demand for goods and services cannot be satisfied. What is now unclear is whether this inflation is transitory and will resolve when the supply chain clears up; or is it more long-lasting as the growing Millennial demographic inflects against the accelerating retirement of the Boomers.
My view is that inflation will remain well above the FEDs 2.0% target for all of 2022, yet they will be reluctant to raise rates. I expect they will accelerate their taper of QE to facilitate a steeper Yield Curve, which as detailed in my “Open Letter to the FED” – July 26, 2021, is good public policy.
We can tally the hospitalization rate as COVID transforms from pandemic to endemic; what is unknown is how it may change our work vs life balance patterns such that those who have left the work force decline to return.Switch into long-dated Equity call options
The logic of being a “contrarian” is that once everyone has bought, there is no one left to buy. This makes more sense than timing with a simple valuation metric since prices can continue to rise as long as more buyers lurk in the weeds....
....MUCH MORE (12 page PDF)
If interested see also:Convexity Maven: Heaven, Hell, The Fed and Inflation
Convexity Maven: "A Cheerful Sisyphus”
Convexity Maven: “The REIT Money Machine”
The Convexity Maven Writes an Open Letter To The Fed
Although I sometimes poke gentle fun at Mr. Bassman for his proprietary product creation and packaging during his time at Mother Merrill—remember all those cutesy acronyms (OPOSSMS et al) in the '80's and '90's? That was him—although I poke fun at that, his knowledge of debt instruments and markets, particularly mortgage-related structured products (pre-2007), is unrivaled....
...Wall Street loves to make convexity sound complex (I suppose it’s so they can charge higher fees?). We speak Greek (calling it “gamma”), employ physics as a metaphor (analogizing to it “acceleration”), and use mathematical definitions (since it is the second derivative of the asset’s price change)."Pish. Posh." is a technical term only used by market professionals for those situations where one has decided to go full Alinsky rule #5*
Pish, posh. An investment is convex if the payoff is unbalanced for equally opposite outcomes. So if there’s the potential to earn a profit of two on a bet versus a maximum loss of one, the bet is positively convex. If you can lose three versus making two, it is negatively convex. That’s it. The rocket scientists are called upon to help (fairly) price the cost (value) of such possible outcomes. This is why the expansion of derivative trading in the 1990’s resulted in a hiring spree of physics PhD’s....
*#5 Ridicule is man’s most potent weapon. It’s hard to counterattack ridicule, and it infuriates the opposition, which then reacts to your advantage...
The Convexity Maven is nothing if not a professional. Here is part of his mini-bio at MacroVoices:
Harley S. Bassman
Harley Bassman created, marketed and traded a wide variety of derivative and structured products during his twenty-six-year career at Merrill Lynch. In 1985 he created the OPOSSMS mortgage options product that facilitated risk transmission between MBS originators and financial institutions. In 1988, he assumed responsibility for trading and marketing IO/PO and other levered prepayment securities. Soon after this, he started purchasing RTC auctioned MBS Servicing rights and repackaged them for the securities market as BIGS - Beneficial Interests in GNMA Servicing. Later, he started a GNMA servicing conduit becoming one of the Top 20 originators in 1992. As managing and hedging prepayment risk became a priority focus for the financial markets, Mr. Bassman created PRESERV, Merrill's trademarked Prepayment Cap product. Merrill was a leader in this product category writing protection that covered the risk on tens of billions of notional mortgage servicing rights. Later, Mr. Bassman managed Merrill's initial venture into off-balance sheet mortgage trading.
In 1994, Mr. Bassman assumed responsibility for OTC bond options.
Within a year, Merrill was the leader in this product sector. A wide variety of products were offered including vanilla and complex options on MBS spreads and the Treasury yield curve.
To help clients more fully appreciate Volatility as a primary risk vector, he created the MOVE Index. Similar in form to the VIX Index, it is now the recognized standard measure of Interest Rate Volatility.And so much more, all those cutesy Merrill acronyms can be blamed on him and his team.
From 1995 to 2000 he focused on creating hedge strategies for MBS servicers and portfolio optimization techniques for Total Return and Index investors.
Mr. Bassman became the manager of North American MBS and Structured Finance trading in 2001. During his tenure, he created SURF, (Specialty Underwriting and Residential Finance), a self-contained Sub-Prime mortgage conduit. He supervised the issuance of Merrill’s first Sub-Prime securities. He also transitioned the structuring business to a new technology platform....
