Tavi Costa: Finding Value and Asymmetrical trades
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About the guest:
Tavi is a Member and Portfolio Manager at Crescat Capital and has been with the firm since
2013. He is responsible for developing Crescat’s macro models as part of Crescat's thematic investment process.
His research has been featured in financial publications such as Bloomberg, The Wall Street Journal, Reuters, Yahoo Finance, Real Vision, and others.
Question 1: The Current stage of the US economic cycle
Giorgio: you have designed Crescat’s Macro model, with the objective to identify the current stage of the US economic cycle, what’s your model telling you right now? At what stage of the US economic cycle are we in?
Answer Summary:
We are at the peak of the business cycle, while equities peaked last November (markets always precede the real economy as investors price them “looking forward”)
Most leading indicators are signaling a steep recession in the next 6 to 9 months (Housing, confidence, ISM)
The labor market is a lagging indicator and has a long way to decline from the current extremely positive levels.
Valuations are still too high although they have come down in the last 9 months. Equities are more overvalued today when compared to bonds than 9 months ago (as bond yields have soared).
During past bear markets overvaluations were concentrated only in a few asset classes or sectors (Tech bubble of 2000, Real estate Bubble of 2008). Today, however, most sectors and asset classes are overvalued. If we look at the Utilities, the Consumer Discretionary, and the Staples sectors, we see balance sheets with high debt levels and it’s difficult to find undervalued stocks.
If we look at short-term technical indicators, the markets now look oversold (October 3rd, 2022), however, if we look at macro indicators (we can’t see a bottom until we see a clear pivot from the Fed), we can clearly expect more downside in the market. Although we could see some bear market rallies from these oversold levels, the main trend remains “down”.
Question 2: A 1987-style market crash?
Giorgio: In a recent tweet you said:
“I'm starting to think that the next leg down in stocks could look like the 1987 crash. Liquidity is drying up, Nasdaq is about to break support and the Fed is not stepping in (for now)…”
Why do you think we could be heading towards a 1987-style crash and how could investors safeguard their capital?
Answer Summary:
Believing that we are entering in an inflationary decade, one way to play the current markets is to go long commodities and energy, while shorting the overvalued segments of the market (currently mega caps and consumer discretionary stocks)
Creating a long-short portfolio (long commodities, short overvalued tech, and consumer discretionary) allows playing a rebound in the Commodities to Equities ratio which is currently sitting near all-time lows
The reason why cyclical commodities are performing relatively well even against a stronger dollar and higher rates is because of the extremely tight supply. The Capex of commodity producers adjusted for GDP is currently sitting at historical lows.
Question 3: Gold’s role
Giorgio: In my last interview, I had the pleasure of speaking with Michael Howell, perhaps the number one liquidity expert in the world, and he said that Gold is not an inflation hedge but a monetary inflation hedge.
In other words, gold is a hedge against the largesse of central banks, when they print money and expand their balance sheet, gold goes up, and when they shrink their balance sheet gold suffers.
Do you agree with him? And what’s the role of Gold in an investor’s portfolio today?
Answer Summary:
Gold is a hedge against monetary disorder. In the last 40 years, central banks around the world bought US dollars (mostly through US treasuries) to improve their balance sheet and attract capital.
As the US has become more and more indebted, Central Banks around the world may begin to look for alternatives to US treasuries to put on their balance sheets. Gold is the perfect solution in this scenario, as central banks increase their gold reserves and may decide to decrease their US treasury holdings.
The most vulnerable countries in the next decade are the net importers of commodities.
Question 4: Getting exposure to gold
Giorgio: For the average investor, what are the ways to get exposure to gold? And what position size would give a good risk-adjusted return?
Answer Summary:
Gold might very well become the new US treasury when it comes to protecting portfolios. Many investors that are used to holding a 60/40 portfolio (60% stocks, 40% bonds) may decide to replace part of the bond allocation with gold.
We are in a macro environment that could favor gold over treasuries for the next years.
To get more leverage investors could:
Buy silver, which has historically been a levered alternative to gold, especially during precious metals bull markets.
Gold miners.
Royalty and streaming companies (safer business model than gold miners as royalty companies are not exposed to mining costs)
Question 5: The dollar and currencies
Giorgio: Talking about currencies, the dollar is performing incredibly well this year. While a strong dollar may help the US to lower inflation, it may also endanger companies’ earnings.
What’s your current view on the dollar? Do you think it has more room to rise or not?
Answer Summary:
Given this year’s incredible rise in the dollar, it now may be too late to get a good risk-adjusted return by going long the dollar.
Long the dollar against the Chinese Yuan still looks attractive.
We are entering a world in which we could see some major de-pegs of currencies as we saw back in the 1990s.
Long the Brazilian Real against currencies of countries that are net importers of commodities (Japan, China, etc), could be a good trade.
The world has now divided into 3:
Countries that are protecting the cost of debt (by capping yield) at the expense of their currency, like Japan.
Countries that are holding the currency, at the expense of their bond market. Like the United States
Countries that are letting both the bond market and the currency market decline.
Ultimately, most countries will need to follow Japan’s path to hold down the cost of debt as their debt levels are too high.