Thread by @dampedspring

Damped Spring Framework 101
I believe 4 factors drive major market macro assets.
1. Growth Expectations and their changes
2. Inflation expectations and their changes
3. Changes in Risk premiums which are driven by changes in monetary conditions and expected future portfolio vol

4. Positioning and flow

With this framework I evaluate each asset across the globe. I focus on the DM
1. Equity index
2. Long term bonds
3. Currencies
4. Gold and oil

I will add short term bonds if they ever offer more symmetric returns

This framework is used to generate alpha in an uncorrelated fashion. It is also used to generate a balance portfolio of beta for long term investing. The Bridgewater All Weather fund, Harry Browne's permanent portfolio, 60/30/10 are all versions of this type of beta

To understand the implications of the framework it helps to deal with various assets and how they fit into the framework. Let's start with long term nominal bonds as they are the easiest conceptually.

Nominal government bonds with high enough yields (rare today) respond with high correlation to shifts in the framework. Prices go up when growth and or inflation expectations fall. Prices go up when risk premiums fall. Prices go up when positioning isoffside and buying triggers

Stocks are trickier. Let's start with framework basics. Equities are nominal bonds with uncertain coupons. Those uncertain coupons are discounted with a rate that can be decomposed as a long term risk free rate plus a risk premium over that rate

Increase growth expectations increases the coupons and increases the discount rate. These are opposing forces. The response of the overall equity market is to rally on increases in growth and expectations reliably. But at the sector level this can be more or less responsive

Stocks are a nominal assets as their earnings are nominal. All else equal the revenue and the costs are impacted by inflation the same and the coupons increase along with inflation. Similarly the discount rate increases and in aggregate stocks are assets that go up with inflation

But inflation itself impacts revenues and costs with different timing. In time when pricing power is high and labor conditions are slack margins can expand and stocks do very well with inflation. In other times wages go up without pricing power and stocks fail to respond.

Stocks are impacted by risk premium changes reliably. When money is easy and/or portfolio volatility expectations are falling risk premiums contract stocks rally. Lastly offsides positioning is a similar driver to any other asset

Gold is an important asset it is an alternative to fiat currency and is a store of value. It's price responds to monetary conditions and risk premium shifts. However the correlation to growth and inflation expectations shifts are very low short and medium term

What drives gold. A combination of falling growth and/or rising inflation expectations came result in falling real long term rates. Gold has a very reliable reaction moving up when real rates fall. On top of this my framework adds another driver for gold

Gold contains a call option that pays when CBs lose credibility and the fiat money system collapses. Some believe this is imminent but to me this tail option is far OTM. However shifts in central bank credibility impacts the implied volatility of this tail option and golds price

Oi is a reliable pro growth pro inflation asset with an unreliable risk premium connection for spot contracts. But more reliable for longer term contracts.

Currencies are the most complicated of each of these assets. For one there is no risk premium for DM currencies. (This doesn't apply to EM currencies which are likely to have a risk premium)

Secondly the growth and inflation drivers are all relative between two countries expectations. While the framework can be used effectively regarding changes in relative growth and inflation expectations shifts, flow matter more in currencies than other assets

Flow in currency markets occur due to trade and investment. As trade flows tend to be slow moving and large they tend to set the long term trends. However investment flows tend to be fast moving and also large enough to be impactful. Major pools of save savers shifting savings

Drives most short and medium term levels. Essentially when savers are unable to buy assets in their own country or other countries assets appear to have more attraction on a forward looking basis asset flow and currency moves.