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My tentative playbook/recommendations for this scenario:

 Long homebuilders (ETFs: ITB, XHB; pair against short SPY if you want to be beta-neutral)
Long gold/gold miners (ETFs: GLD, GDX, GDXJ....)

This is a super difficult question. I'd be hesitant to immediately jump to long vol or flight-to-safety trades as offering the best reward-to-risk here.

 Another March-style liquidity crisis seems much less likely, given we have a better understanding of COVID as a medical condition, of the nature of its economic impacts, and--perhaps most importantly--how policymakers are prone to respond.

Basically the recommended trades could do very well in an environment in which there is pressure for real interest rates to decline coupled with a Fed that is game to move to a more accommodative stance on the margin.

COVID is fundamentally a real shock and not a sharp monetary disequilibrium. People (rationally) want to defer consumption. Housing is already quite hot, as it is minimally impacted by COVID and, as the archetypal long-lived durable asset, is actually a great vehicle for people to defer consumption. If the Fed is with the market (as it would likely be), homebuilders could continue to outperform if a greater-than-expected COVID resurgence drives more on the margin to seek to defer consumption and increase real housing demand.

To first-order, gold benefits from real-interest rates declining.  Fundamentally, when there is high demand to defer consumption (i.e. to save) and low-demand for investment, long-term real interest rates could (somehow) decline even futher and continue the favorable environment for gold. Yes, it has rallied quite strongly since 2019, so we'd have to be wary of chasing here. But just eyeballing the charts for this, I think there are attractive levels to add this risk on slight dip from current levels (e.g. 1820-1840ish in spot gold.

Also, the broader monetary policy reaction function is always critical to consider in my opinion. The FOMC would be more likely to extend the weighted-maturity of their asset purchases if it looks like COVID is resurging in an unexpected way. Bigger picture, they may look to make more credible commitments to overshooting 2% inflation post-COVID in order to hit their new average inflation target objective.

Obviously, a main risk I see to these trades is that these are just a continuation of COVID trades from this year (no real special view here) and we could potentially just be chasing after already-crowded trades which are prone to squeeze against us if we're wrong.


Good point and indeed indexing played a prominent role in the late 90s tech boom; it was a broad market phenomenon, in contrast to the idea that it was a micro-speculative frenzy contained to things like zero-revenue IPOs.

However, here I’ll expand on the meta-contrarian “bubble” point and offer that the dot com boom was not a case of markets gone haywire. I think we had a case for real technological prospects coupled with a market buying into the expectation that the Greenspan Fed was capable of providing nominal stability over the long-term.

It perhaps serves as a positive case study as to why some economists bang the drum so strongly for nominal GDP-level targeting. With expectations of nominal stability, the hurdle to invest in high-risk, long time-horizon projects, is greatly reduced. This can effectively yoink away much of the equity risk premium and could justify the high valuations and low expected forward returns to equity that marked the 1999-2000 period.

I’ll caveat by saying that this is currently just my working model of the late-90s, but it perhaps offers the deliciously contrarian view that managers just blindly dumping money into tech indices were actually not ‘uniformed flow’, even if they weren’t fully cognizant of the incentives they were responding to at the time

tl;dr: YES. But it also depends what you mean by 'good investment'

First, we can look at the claim that passive investing is a 'bubble.' Among those calling "Bubble!", I see two separate groups making two slightly separate claims.

One group claims that incessant inflows of passive money are inflating prices of the largest stocks (AAPL, MSFT, GOOG etc.) which make up the largest part of cap-weighted indices such that they trade substantially away from an equilibrium fair value. 

I think these claims are quite dubious. Prices are set by the marginal trade, and although I know little of micro-structure/market-making, markets are likely quite robust even to large amounts of so-called 'uniformed flow'.  To claim that the presence of such flow--even if it may have grown quite substantially--is distorting prices of some of the most liquid and scrutinized securities in the world for years on-end, requires substantial evidence. For now I mostly see handwaving and pointing to all sorts of valuation metrics from this crowd, with relatively little to show for it beyond that. (Disclaimer: the meta-contrarian in me is also broadly skeptical of 'bubbles' as a general concept. I'm partial to ideas that posit that both the dot-com boom and housing boom of the late-90s/early 2000s were far from bubbles qua bubbles, but that's a separate discussion.)

The second type of claim is more along the lines of  'passive flow has disrupted normal market functioning, particularly at a microstructure-level'. Here the claims are certainly both more speculative and more abstract. Claims here often appeal to complex-systems ideas, namely that certain feedback mechanisms will either cause a spectacular financial blow-up one day (killing passive by fire), or will drive markets to a permanent new equilibrium in which the Market Is Strictly Passive (killing active by ice). I'm not willing to entirely discount these ideas; however, the idea that active managers will be there to exploit potential passive-driven inefficiencies and bring markets back toward an equilibrium seems to be the more plausible base-case against which these more speculative theories have the burden to demonstrate superiority.

Here is where I will take a speculative turn myself and appeal to a macro-explanation of the passive phenomenon. Indeed, as others have pointed out, the last 10 years have been exceptionally strong for big tech stocks. Being long FAAMNG bettered just about every other macro trade out there in any asset class (save perhaps for being leveraged-and-perma-long German Bunds). 

Coming out of the 2008 crisis, we had extremely high equity risk premiums, coupled with central banks not quite sure how to deal with the ZLB, and indeed there is compelling evidence that monetary policy perennially leaned too tight in many developed economies for most of the post-08 period. What results is a low inflation, low nominal growth, low interest rate environment, with broad corporate balance-sheet de-leveraging, which is particularly favorable for such near-monopolies like FAAMG, with their stable & moderately growing cash flows of extended duration.

Now in terms of maxing out favorable risk/reward per unit time spent deciding an allocation, it still looks quite difficult to top passive. But that doesn't always mean a passive allocation to large-cap equities, 60/40 stocks/bonds, etc. will always be there to deliver.

My own (very speculative and tentative) view is that the next 5-10 years will not be nearly as strong for real equity returns as the last 5-10. For example, we have an FOMC that is taking active steps to commit to a more expansionary objective, at least attempting to make-up for undershoots in their 2% symmetric inflation target. However, the (current) level of discretion the FOMC appears to be favoring in terms of their reaction function has already lead some macro-historians to draw parallels to the 'stop-go' era of policy in the 1970s, which was a poor environment for financial assets of almost all types.

Intermediate-term, I think it's likely that the post-COVID macro environment will be characterized by high, but relatively unstable expectations of nominal growth, which would reverse many of the macro-tailwinds that benefitted FAANMG so greatly this past decade. Of course, this is LW, so if there also appears to be mounting evidence that we're about to transition to a new AI-driven mode of economic growth, a lot of this playbook gets tossed out the window :)