If the secular regime has transitioned from the Great Moderation of the past few decades to one of fiscal dominance, perhaps the most seismic change to the investing paradigm that most of us grew up in is the changing influence of bonds in a 60/40 portfolio.🧵 During the Great Moderation era (defined as disinflation and low volatility of inflation), the correlation between stocks and bonds was negative. That meant that if there was a shock to the 60 side of the portfolio, the 40 side would offer a counterbalance. /2

If the fiscal picture in the US is deteriorating per the new era of fiscal dominance, and gold is rallying sharply as a result, wouldn’t it make sense for the dollar to be declining? That’s what the chart below suggests.🧵 Why is the dollar holding up so well? I think the answer is the Fed. While fiscal dominance should be pressuring the dollar, the Fed’s restrictive policy is providing a counterbalance. /2

Several unusual things are happening in the markets, which in my view are most likely explained through the lens of fiscal dominance. 🧵 We are all painfully aware of the $11 trillion increase in the Federal debt since the pandemic in 2020, and we also know that the Fed has been shrinking its balance sheet (and therefore stopped being the buyer of first or last resort). /2

What time is it in the cycle? Now that we are 17 months into a bull market cycle, it’s worth asking how much life there is left. How long can this broadening bull continue?🧵 As the chart illustrates, cyclical bull markets can be as modest as 48% (1966-1968) or as grand as 200% or more (1982-1987, 1994-1998). /2

Based on the 1949-1968 and 1982-2000 super-cycles, we might be later in the cycle. Adding some support to that thesis is the CAPE model. The CAPE (or cyclically adjusted P/E) model holds that the prevailing 10-yr P/E ratio is a good predictor of the 10-yr forward annualized return (CAGR).🧵 By that measure, the 10-year CAGR should moderate from its peak of 16.5% in 2019 to a mere 2.6% in 2034. Those returns are not consistent with a secular bull market (quite the opposite) and therefore suggests that we are late in the game. /2

With the market gaining ground at a strong clip, the total return index is back above its 150-year trendline (in both nominal and real terms). This raises the question of what inning we are in with regards to the secular trend. My guess is that we are in the 7thinning.🧵 Where we are along the secular trend remains a guessing game in real time, but so far, the market continues to track the secular bull markets of 1982-2000 and 1949-1968. You can see that the trendlines below are almost identical. /2

With the S&P 500 index having gained six P/E points since its October 2022 low (from 15x fwd EPS to 21x), it’s time for the market to grow into its multiple.🧵 With the economy apparently soft landing and the Fed not pivoting as quickly as was expected just a few months ago, earnings will have to do the heavy lifting from here. If that doesn’t happen, the market cycle will be over its skis. /2

Here is some more detail on the 1966-1970 analog. I indexed the inflation-adjusted S&P 500 to the Oct 2022 and Oct 1966 lows. The similarities are obvious, not only cyclically but also in terms of the secular trend. The bottom panel shows the Fed’s policy rate then and now.🧵 During the 1960’s, the policy focus was on employment more so than inflation, and it was a period of concurrent loose fiscal policy and loose monetary policy. /2

The soft-landing vibes remind me of the 1966-‘68 analog. It was a period of fiscal dominance (guns & butter) and monetary acquiescence, not unlike the COVID days. It was also when the stocks/bonds correlation shifted positive & the secular bull market for equities was maturing.🧵 In 1966 the Fed prematurely pivoted from a tightening policy to an easing policy- this allowed the market cycle to recover and for a recession to be averted, at least until 1970 when the recession did happen. It was a cycle delayed, not canceled. /2

Fed pivot or not, liquidity is on the rise again. Overall liquidity, as defined by the Fed’s balance sheet, less reverse repos (RRP) less the Treasury’s cash balance at the Fed (TGA), has been rising since mid-2023, taking stocks with it. 🧵 As the Fed’s reverse repo program gets closer to being depleted (only $440 billion left), all eyes will be on how much longer the Fed’s Quantitative Tightening (QT) program will continue. /2

With the trailing P/E-multiple now at 23x and the forward P/E at 21x, the implied equity risk premium (iERP) has fallen to 3.5%. The iERP is basically a sentiment indicator and is the residual value in the discounted cash flow model (DCF) at which the price “makes sense.” 🧵 The “realized” ERP is around 5% (going back 100 years), and if we plug that number into the DCF model (assuming 6% EPS growth), we get a fair value of 16.2x. That’s five points less than the current valuation. /2

Continuing on my previous thread, the next chart illustrates what I expect to be diminishing returns from future halvings. On the left I show Bitcoin’s outstanding supply (blue) vs incremental supply (orange), and on the right I show the same for gold.🧵 While it’s fair to say that a Bitcoin halving in 2012 (from 2.7m to 1.3m) or 2016 (from 1.3m to 656k) had a major impact on price, I doubt the same will hold true a few decades from now when the incremental supply goes from 160 coins to 80 to 40. /2

Can we value Bitcoin on supply alone? Bitcoin burst onto the scene in 2008 and its track has been explosive to say the least. Whereas gold and silver have followed a more linear path, Bitcoin is operating in an exponential dimension. Why is that?🧵 I believe it’s partially due to the exponential nature of adoption curves. But why should Bitcoin be exponential if it’s just a commodity-currency? I think the answer lies in the non-linearity of its supply curve, and its non-linearity relative to gold’s supply curve. /2

Bitcoin as exponential gold: In the past I’ve explored Bitcoin mostly from a demand perspective, studying S-curves to generate a demand-driven valuation framework. Today I’m presenting my supply-driven approach, which is a variation on the stock-to-flow (S2F) concept.🧵 Let’s set the table first: this chart goes back to 1700 and shows the price change for gold, silver, and more recently Bitcoin (vertical) against their 12-month volatility (horizontal). Until 1970, gold’s price was fixed under the gold standard and later the Bretton Woods system. /2

If the Fed cuts less than the market expects, that suggests less upside for the bond market (in terms of return, not yield).🧵 At 4.15%, the 10-year is at fair value, given where the Fed and the economy are. For yields to go lower, we will need a recession and more rate cuts than the Fed is signaling. Even so, the risk-reward for owning bonds looks compelling at these levels. /2

My previous post assumes that the earnings cycle has bottomed and that we are not about to get blindsided by that recession that we were all expecting a year ago, but which so far hasn’t materialized. If it does make an appearance in 2024, then earnings could get hit, leaving this market cycle (driven by a 6-point P/E expansion) over its skis. 🧵 The yield curve has been signaling exactly such an outcome, but that signal is notoriously difficult to translate into an actionable playbook. The outcomes, both in terms of magnitude and timing, are all over the place, much like the “last tightening” playbook mentioned earlier. /2

What we don’t know: how much will the Fed ease, and will it be for the wrong reasons?🧵 An easing bias doesn’t tell us when the rate cuts are coming or how many there will be. In my view, the market is a bit delusional in expecting 6 or 7 rate cuts this year, unless we get a recession. But the stock market is priced for a soft landing, which doesn’t reconcile with the bond market’s view on rates. Somebody is wrong, and my guess is that it’s the bond market. /2

What we know: the Fed has gone from a tightening bias to an easing bias. 🧵 Following the December FOMC meeting, it’s clear that the Fed has adopted an easing bias towards monetary policy. With the core-PCE inflation rate easing from its peak of 5.6% to 3.2%, this is the correct approach. Monetary policy is a pendulum that swings from 200-300 bps below the neutral rate (or R-Star) during easing cycles to 200-300 bps above it during tightening cycles. We are there, and now both inflation and economic growth are softening. /2

Well, the moment finally came last week, which is very exciting to say the least. Will this be a new chapter towards Bitcoin’s widespread adoption as a commodity-currency? 🧵 It seems that way, although it could take some time to get there. For now, Bitcoin has made it to the middle of what I consider to be its fair value band, driven by the growth rate of its network and the level of real rates. /2

For US stocks, the valuation question (relative to the rest of the world) comes down to the secular leadership of the big growers in the US stock market. By my count we are now in year 14 of this secular bull market (since March 2009), and it seems to be going strong.🧵 In real terms, the S&P 500 is up 476% from the March 2009 low, which is in line with both the 1949-1968 and 1982-2000 super-cycles. /2

We know that market breadth has been narrow, and one of the big questions for 2024 is whether the market will broaden, and whether that can happen in a rising market (OK, that’s two questions).🧵 The chart below shows that the market has now advanced 37% from the October 2022 low, but that only 26% of the stocks in the S&P 500 are beating the index. That’s a very small pond to fish from. /2