Last updated on November 22, 2022
Bob Elliott, chief investment officer of Unlimited Funds, joins the podcast to discuss his views on the Federal Reserve, inflation, the midterm elections, and why stocks have entered a long ‘slog’ for the foreseeable future.
Content Highlights
- Investors have been conditioned for recessions to feature a fast decline in equity markets followed by a rapid recovery. This time around those dynamics are different (3:44);
- There is no chance of a ‘Fed pivot’ coming anytime soon (7:58);
- What about infighting at the Fed and within the FOMC? (11:03);
- Yes, you need unemployment to increase for there to be any progress with inflation. Higher prices are no longer due to supply chain issues (13:57);
- The Fed will raise either 50bps or 75bps at its next meeting and rates could easily go up to 6% (21:22);
- Background on the guest and his ETF, the Unlimited HFND Multi Strategy Return Tracker ETF. Stock ticker: HFND (26:19);
- The growing disconnect between hedge fund positioning and retail investors: Hedge funds are short bonds, long commodities, bullish gold, and are sitting on a bunch of cash… (36:21);
- The Fed’s target rate for inflation is 2%, but that could change. That would bring a myriad of issues… (38:24);
- It’s hard to get bullish about longterm bonds: right now and for the foreseeable future (40:54);
- Investors continue to look for reasons that the economy is slowing and the Fed needs to reverse course. There is virtually no evidence of this happening (42:44);
- The midterm elections are likely to lead to a split government. This brings tail risks that few people are talking about (44:50).
More Information About Bob Elliott
- Website: UnlimitedFunds.com;
- Twitter: @BobEUnlimited;
Quick Video Highlights From Our YouTube Channel
Transcript
Nathaniel E. Baker
here with Bob Elliot, the CIO of unlimited funds. Thank you so much for joining me contrarian investor podcast today.
Bob Elliott
Thanks for having me.
Nathaniel E. Baker
Yeah, thanks for coming on. I’m really excited about this to have you here on the show, because you have a pretty big Twitter following and a pretty big Twitter account, I guess, with a lot of views, and that have been published elsewhere as well, that are very contrarian. And I wanted to jump off here and start with a couple of them here that I’ve gotten from observing, some might say stalking your Twitter account.
Bob Elliott
Reading, I appreciate that you’re reading
Nathaniel E. Baker
It’s the least I can do. But anyway, first off, you say here prepare for a slog in equity markets, no crash, no bottom, just a slog. Tell me about that.
Bob Elliott
I think most investors who are in the market today, their, their formative investing experiences, and certainly the ones that are at the forefront of their minds are basically 2008, if you’ve been around long enough, and 2020. And in both cases, those are pretty unusual cycles, in the sense of there was, you know, a massive decline, a very fast decline in equity markets, the economy, etc. And then there was quite a reflationary impulse from the Fed in particular, along with global central banks in order to help stave off, you know, an unwieldy depression. And the result was all things considered a pretty V shaped dynamic, certainly in the asset markets. You saw from the point in which equity markets started to meaningfully fall, let’s say in 2008, in September 2008, the bottom was in March, and then, you know, equity markets started to take off, that’s much longer, or that’s much shorter, for instance, than we’ve been in this downswing in the equity markets so far this year. So I think that’s really on people’s minds. And then when you look at other macroeconomic cycles, what you see is, frankly, that a more traditional macro economic cycle, which is that you get, you know, economic conditions are relatively tight, you get inflationary pressures emerge, you get a central bank responding to those inflationary pressures, you get a tightening of monetary policy, that that dynamic, which is what we’re in right now, which I sort of call it a very traditional inflationary cycle is not fast. And I think that that is like, your people sort of like have grown. They like get their Amazon deliveries overnight, right? They kind of went through a recession overnight. And the reality is like, no, that’s not how it’s gonna work. Like, the way this is going to work, is it’s going to take a long time, because the function and the tools of monetary policy, necessarily take a long time, which is that first you got to tighten, then you got to slow the deteriorate asset prices, then you got to slow demand, then you got to weaken the earnings profile for companies and then they’ve got to stop, start laying people off, then we just have to fall, then spending asphalt then prices have to fall. That that is a that is a lot of steps along the way, which will take a very long time. And frankly, we’re like just getting started.
Nathaniel E. Baker
Yeah, interesting point. Although one could certainly argue that when we’re asset prices are concerned, at least if we look at equities and bonds, those have been falling off a cliff going back about a year now back to November of oh, one. And aren’t we just one pivot away from the Fed from ramping up again? I guess maybe you could make the argument that the Fed can’t pin it, which may be right?
Bob Elliott
Well, I think that’s I think that’s the basic issue, which is there’s two core issues, which is one with inflation, where it is today, which frankly, like we’re gonna see some numbers the for the next couple of months, at least, it’s almost predetermined, that inflation is nowhere near what their targets are. And so they get those numbers with a lag. And so then they have to respond to those numbers. And that is, by its nature, backward looking style goes. And so what you see is a situation where they’re going to continue their tightening cycle, but the economy is not particularly sensitive to the rate rise. You know, I think if, if you had told people we’re going to have you know, 500 600 basis points of short and dry is, and frankly, everything’s like fine. You know, stocks are down 20%, which is like not that big, you know, from all time highs not that big a deal. I think most people would have been surprised by that. But if you look at the, if you look at the underlying balance sheets of the various sectors, companies, households in the economy, like the the period of 15 years of unbridled monetary stimulation has put them in pretty good shape to withstand these types of conditions, this tightening of monetary policy. So that’s taking even longer, you know, it’s less effective and taking longer than I think most people are expecting. So is there a pivot anytime soon? No way, not close. And if anything we need probably meaningfully more tightening, monetary tightening, before we get anywhere close to when the Fed is going to reverse or start to ease or pivot or whatever the heck you want to call it.
Nathaniel E. Baker
How much more begs the question, we’re at 4% now…
Bob Elliott
we can easily see a few 100 basis points more without, that wouldn’t be that surprising. And if you look at the way that the bond market, like the two year market, has really played this, like the two year mark in the bond market has always been behind has been behind for for 11 months. And so what we keep seeing is these curves, they’re just flat flat, in terms of what the Fed is going to do, and the Fed just keeps tightening. And the reason and if you look at what the Fed is looking at, which is the most important thing, look at what the Feds looking at don’t think how would you want to run monetary policy doesn’t matter. Jay Powell runs monetary policy, don’t look at what you think is likely to transpire six or 12 months in the future. He doesn’t care. He’s looking at the inflation numbers. And when you look at that there is no relief. And if there is no relief, the Fed will not stop. That’s the way it goes.
Nathaniel E. Baker
Right. What about political pressure? What about other things?
Bob Elliott
Any government institution has an influence has some political pressure and some influence, though, I think what you are, by and large, the Fed is reasonably insulated to the pressures, particularly when fighting inflation, because the because inflation is a critical mandate of theirs. And so they are pretty insulated. And I think, I mean, this is a little bit weedy in terms of the the nuances of the Fed. But I thought was particularly interesting, what we saw in this most recent fed announcement, which was the statement basically catered a little bit to the political doves, which is fine, the statement doesn’t really do anything. And then chairman Powell got up there and said the same thing that he’s been saying for months on end, which is we’re going to break the back of inflation. And we’re just going to keep going until we do that. And he even said, the statement is one thing. I’m here to clarify the message. Right? That’s what he said. He’s, and I’m here to clarify the message was very clear about his message. And so that’s, you know, that’s what I would expect he hasn’t changed his message. Since the start.
Nathaniel E. Baker
Yeah, he’s been very consistent. Some of this stuff, by the way, was taken directly from Jackson Hole, the talk about price stability, and all these things have worked for work. And there was word for word.
Bob Elliott
Yeah. And if you look at that speech, it is taken word for word from what, from things that Volker said 40 years ago, right? And so it is clear what he’s doing. Like if you are a student of history, and you read what he says, and you’ve read what Volcker said, particularly what Volcker said, after the fact in terms of the things he was weighing and the trade offs and things like that. It’s almost it’s almost as if you know, Volcker has come to direct the Fed once again, you know, he’s the spirit of Volcker is in Jay Powell
Nathaniel E. Baker
Now coming into this announcement, this Fed meeting we had several articles about how there were other Fed officials that were coming out and speaking about there being a pivot specifically, most specifically fed St. Louis Fed President Mary Daly saying it was time to consider stepping down or whatever it was, that she was saying, Do you think there and the market, by the way, treated that as an excuse to bid up equity prices? But erroneously it turns out, but in do you think there’s any infighting at the Fed about that, and, okay, Jay Powell, but he does have he has a vote on the FOMC. But his vote counts the same as everybody else’s. So is there something there you think or not?
Bob Elliott
I mean, I think there’s there’s the two levels of of that, which is one at some level, what was being said, which is, hey, we’ve been racing 75 clip, maybe we’ll stop raising 75 a clip, maybe we’ll start raising 50, a clip, whatever, which to be clear, 50 is still pretty darn fast, all things considered. It’s not 1200 basis points in the span of four months. The way Volcker did, but still it’s pretty fast. In the modern era, I think those statements the market misinterpreted as, as shift as if like going from 75 to 50 is like a meaningful indication of what’s going on knowing no basically what the Fed was was way behind. And so then they caught up pretty early. aggressively and so then now they’re going to shift to maybe 50s. Or were 20 fives I think the more interesting and impactful question is basically where the terminal radius. And that’s exactly what what Powell said, which is stop looking at exactly if we’re tightening 75 or 50, start looking at where we’re going to bring the terminal, right, because and for how long, that’s the thing that matters. And I think when it comes to that’s the sort of the first level is like, who cares? 5075, it doesn’t really matter, the terminal rate matters, and the overall path that they’re on, I think below the surface in terms of whether or not you know, pal as what vote and things like that. The thing I would say is the Fed has a mandate, the Fed has a reaction function. Basically, everyone who is sitting around that table is what is sort of wed to or focused on that reaction function is committed to that reaction function. And so how they’re going to respond is they’re going to see whatever data comes in, they have the reaction function, which is like, if inflation isn’t close to where it needs to go, then you keep tightening. And then they will keep tightening. And so maybe there’s like a little bit of daylight between the slight doves and the slight hawks or whatever. But I think you could, you could miss the forest for forest for the trees, they’re like the the key thing about the forest is as long as inflation is not moving quickly to their mandate, it’s gonna be tightening all day long. Yeah.
Nathaniel E. Baker
Very interesting. Okay. Then your other some other views here. You mentioned inflation. And we got the reading on Thursday, the CPI. And what the what right now, the survey numbers about 8.2% on the headline year over year 6.6%. On the core, I saw some numbers you put out there which are, frankly, kind of terrifying. On headline 9.5%. Is that right?
Bob Elliott
That’s it. That’s on the month over month, and that’s a month over month annualized number rather, that’s the month over month, annualized rather than the year over a year. I think the the consensus, the Bloomberg consensus that I saw today, or what’s in trading economics in other places, is 7.9. Year over year, the folks at the Cleveland Fed are penciling in 8.1, or maybe a hair higher with their inflation Nowcast which by the way, like every investor should be looking at all the time. Like you want to know what that number is going to look like. Like the Cleveland Fed has nailed it every single month for the last 24 months. So if you want, you could go go ahead and write that down. So I am Yes, yeah, inside trick. If anything, actually they pencil they they’ve been consistently higher than consensus. They’ve been persistently right. And if anything, they’ve actually been a bit low relative to what transpires. So they’re penciling in 8.1 on a year over year basis. And that 9.5 On a month over month annualized basis, I think is important to connect. Because the Feds not just looking at the year over year number. They’re looking at the monthly numbers as they come in. And the problem is that we’ve had this shift from gasoline going from being a big deflationary pressure, big deflationary forces, it went from basically what’s called Five bucks to three bucks depending on where you are. And the problem is, it’s now moved back up to 350. And the indications are that it’s likely to move higher. And so you’ve taken a big disinflationary force out of the market. And that’s what the that month over month number highlights that 9.5% Number highlights this shift from basically headline inflation being below core inflation to moving back to a dynamic, where headline is actually going to be higher than core, at least for a couple of months, given how gasoline prices are, are evolving. And that’s that’s the challenge of this whole thing. Like there is no relief. There is no respite for the Fed. And if they keep seeing numbers like this, they have no choice. It’s just how it works.
Nathaniel E. Baker
Yeah. Hang on, isn’t the month over month. Usually there’s a couple tenths of the basis point?
Bob Elliott
Yeah that’s why I put it an annualized journal, because I think it has more intuition. People have more intuition. About a month over month annualized number, which is different from the year over year.
Nathaniel E. Baker
what are you looking at in terms of the headline year over year?
Bob Elliott
8.1? Maybe? 8.2? Yeah. So in that ballpark, which I think is higher than I mean, he’s higher than what I’m seeing for Bloomberg. consensus. Economists consensus but but look like it could be slightly higher than consensus expectations can be slightly lower consensus expectations. It’s really high. It’s too high. We’re way away from the feds mandate. And frankly, the rest of it is just like squinty noise. We’re not close. And that’s the most important thing is if we’re not close, then you know, it’s going to be it’s a problem.
Nathaniel E. Baker
Yeah. You mentioned employment still running, you know, at full throttle a bunch of other things and consumer spending and such. Do you think that they can get inflation lower without unemployment increasing?
Bob Elliott
No. Okay. And it’s just a I mean, not to be too blunt about it, but it’s not possible. And the reason why it’s not possible is that the primary driver of the inflationary pressures that we’re seeing today, it was supply chains, it was oil. But the problem is that has been permeated into a very wide range of prices, you know, more than 50% of prices, right now are rising, or rising faster than 7%, year over year, right. So the rising 50% are rising faster than and so what that reflects is that there’s a permeation of the inflationary pressures, particularly starting to see in the surfaces side of the economy, which is driven by wages, so you get a price rise, which creates higher a demand for higher wages, which then creates more money for spending, which creates a price rise, right, and that cycle has permeated from the goods. So goods is starting to deflate or has a lot of sectors have deflated. But goods is like 10% 15 20% of the US economy. That’s not the thing that matters, the thing that matters is services. And now that we’ve gotten this dynamic in the services cycle, the only way to break the back of inflation and services is to have a weakening of labor market demand of labor market conditions, which then feeds into weakening the wages. That’s just how it works. And so, so in the same, it’s like, the way that you deal with the supply chain issues, or the way you deal with goods, price inflation is by increasing capacity supply capacity, essentially, in the good sectors. Right, that’s what we’ve had to do, you have to basically do the same thing. The the, the structure, or the or the or the cause effect linkages are the same in the labor market. It’s just how do you create labor supply? Well, the way you create labor supply is by having a much weaker demand and firing it. Right. Like that’s, that’s how that dynamic works. And so there’s no other path. And anyone who thinks that there’s another path is,
Nathaniel E. Baker
okay, well, I did have somebody a couple weeks months ago, I’m not gonna name names, but who said who made that point. And what they pointed to was the fact that in the 90s, you had a ton of growth, but not much inflation. So which I guess is different from bringing inflation down? But anyway,
Bob Elliott
yeah, and I mean, there’s a very, very different dynamics that happened in the 90s, the complimenting us in early 2000s, which is a combination of incredible productivity today, you know, most recently productivity negative, there were, there was basically a massive hiring of emerging market labor. Basically, the emerging markets came into being like, Asia came online, you took people from the farm to the factory, you took literally hundreds of millions of people from the farm to the factory that is behind us, not ahead of us. Plus, you had an era of integration and globalization, which helps streamline supply chains and move production to the lowest cost producer, that also, as we can, obviously see, is starting to shift meaningfully right now. Because, you know, because of geopolitical considerations, whether you think they’re right or wrong, it doesn’t really matter to a macro economist, what matters is that, that it exists, and those supply chains are breaking down. And so now you have chips that can be produced in the US, and you have inputs that have to be produced in the US, and you have onshoring, and all of that, which is just the total difference that what we saw in the 90s. And so we’ve got a secular backdrop, that’s, that’s radically different than the 90s. And then we have a cyclical dynamic, which is we happen to have relatively tight labor markets, we happen to have had stimulus, which has helped fuel nominal demand. And so we happen to be cyclically at a time when we’re at peak inflationary pressures in a in a environment of secular, secular inflationary pressures starting to emerge as well.
Nathaniel E. Baker
Yeah, interesting. The so the issues, you talked about services, employment, is what we’re seeing in Silicon Valley right now, news today yesterday about meta slash Facebook laying people off starting this week. Twitter, obviously, already cut 50% of the staff Apparently, some reports last week about stripe, which I thought personally was the most disconcerting one, but whatever, just because of all the small merchants that are connected, etc. Is that the start you think of this services unwind when it comes to the labor market or not yet?
Bob Elliott
Yeah, I think, you know, in many ways, what we’re seeing in any any economic cycle, there are companies that are early in the cycle in terms of early to decline in the cycle and very sensitive to, to the cycle deteriorating, and there are companies that are much later. And so if you look at the, if you look at the dynamics today, I think what we’re learning for the first time, frankly, is that a lot of these mega tech companies, first of all, I’ve never been through a real recession, like I’m talking about like a traditional recession, right? They’ve, they were growing too fast, and oh eight even like be affected by the recession. And so now, what we’re seeing in 2020 was, if anything, an oddball case that was beneficial to them rather than detrimental. So now we’re seeing very boring macroeconomic recession. Where are these companies? Most of these companies are advertising companies. Not stripe necessarily. But But Amazon, you know, huge portion is essentially advertising in terms of its structure. Certainly the fast sensitive stuff. MATA is just an advertised, it’s like a newspaper, right? Twitter is a newspaper, you know, in a in a slightly different form. And so typically, advertising is one of the fastest moving sectors in terms of the earliest to shift to downshift, as the macro economic cycle turns like you’re seeing that combined with the fact that, to be honest with you like these, these companies were the least prudent in terms of their hiring cycle based upon more secular trends. And so yeah, they’re facing, you know, over over employment in many of these companies against a top line that’s starting to fade because they’re early in the cycle. But like, if you look, if you look basically like saying, challenge your job planning, Challenger, job, layoff announcements, what you see is basically other than in New York, and San Francisco, in the tech industry, firing, or layoff announcements are actually down this year, meaningfully than they were last year. Right. And so, we basically have, you know, I think, the tech community, the New York, San Francisco, tech community, like has a lot of intrigue and interest, and people want to look at it. But in the grand scheme, but when if you’re trying to hire somebody to do some manufacturing in the Midwest, can’t find it. If you’re trying to hire somebody who is doing a service jobs, say tourism, or airlines or any of that stuff, can’t find enough people. And so the vast, vast majority of the economy, and the labor market is very, very tight. And these New York and San Francisco tech jobs, you know, they don’t matter that much. And they’re very, very much on the leading edge. And we have a long way to go. Hmm.
Nathaniel E. Baker
All right. Last question on the Fed before I move on to some other things, but just going back here to what do you think the Fed will do at its next meeting? And how much longer do you see them raising rates?
Bob Elliott
Well, the Fed tightened 75 or 50? I hard to know, doesn’t really matter. No one, no one probably will have no one has like a good Alpha opinion on that. It’s kind of a coin flip. And it doesn’t really matter for the macro economy, like where are we going? You know, it’s going to be we haven’t had we haven’t had the deterioration labour market, we haven’t had the slowing of, of incomes. And we certainly are very far away from the slowing of inflation. So I can easily see a circumstance where they keep backing out 50s For a while here, you know, could you get 6% over the you know, let’s say they do four meetings at 50, or, you know, a few meetings a 50. And a couple more meetings to 25. Like that seems totally plausible, reasonable, I think the biggest thing to recognize is like is that as an investor today, this cycle is very different from the cycles that we’ve seen before. And so as an investor, today, you’re you’re best off instead of trying to like pick the pick the terminal rate, you’re better off recognizing you don’t actually know what the terminal rate is. And so you’re better off engaging in momentum, rather than value, so to speak, in terms of where that rate is price, and keep your eyes on the various things that will lead the things that will cause the Fed to shift their policy. So things like you know, initial claims or, or continuing claims are good leading indicators of, or good coincident indicators of job market weakness, or strength, which are good leading indicators of whether incomes will come down, and eventually inflation will come down. And so I’d be much more focused on looking at those indicators and see how they’re playing out at different points in time basically, seeing if they’re starting to deteriorate as my canary in the coal mine, much more than I would try and pick up particular rate, because it’s is it possible they could keep raising 300 basis points? I don’t know. You don’t know. Most investors don’t know. And frankly, the Fed doesn’t. And I think that’s an important thing to think about that they don’t even know how far they need to go. And so we’re much better off trading on the on the momentum.
Nathaniel E. Baker
Okay, fair enough. All right. And with that, Bob, I’d like to take a quick break and come back. If you’re a premium subscriber, you do not get the break. Don’t go anywhere. Don’t touch the dial. We’ll be right back. In fact, we already are.
Bob Elliott
Welcome back, everybody. Bob Elliot here, CIO of unlimited funds Bob. This is the segment of the show, where we ask our guests to tell us a little bit more about himself or herself and himself in this case, and how they came to the state of their career. And I know there’s a big fund in your background, one up in Westport, Connecticut. I don’t know if I can I can identify them. I guess I could, but whatever, it doesn’t matter, because it’s all in the public domain. But But let you talk about, yeah, how your career has transpired. What got you into investing in the first place? And how it got to be that you started this fund, and you have an ETF to tell us about that.
Bob Elliott
Yeah, I mean, my my career has been basically 20 years as a systematic investor, I got into investing in college. My My training is, my academic training is more in the in the pure sciences. But I found increasingly, like, one of the things that I found very interesting is basically, in the same way you could think about, like a scientific, I studied plants a lot like to think about the plant ecosystem as being like a series of Gods effect drivers, and how does the whole ecosystem you know, it’s a complicated ecosystem that fits together that then determines, like, whether plant grows or not, which is the core of my research many years ago,
Nathaniel E. Baker
You’re talking to a guy who barely passed 10th grade bio
Bob Elliott
And so and so I thought, like, I look around, you know, our lives, our day to day lives. And the thing that kept striking me was how, frankly, like, it seemed like all these macro economic forces are the things that actually drive our day to day lives. It was the 2000s recession, I went to cash early into in the summer of 2000, thought that that was like a great, you know, a great trade was patting myself on the back when I went and pulled all my money out of cash in the summer of 2001. And put it entirely in the stock market, because of course, the stock market was bottoming and ended up losing money for the course of you know, two additional years before it bottomed. And like that whole dynamic I found fascinating as basically like this, this is this wild, like system that’s running everything in our lives, basically, that we’re sort of living in, and it’s running things. And I started getting into investing mainly from that perspective, to sort of understand how the world works and things like that, you know, and I was in Bridgewater for a long time, I increasingly, you know, I was I was there and was really one of the small handful of investors that took it from a niche in investment houses out in the woods of Connecticut to being the institutional incumbent that it is, and built investment strategies across all sorts of different asset classes and such, many of which are in the flagship, your alpha fund. And, and over time, you know, basically wanted to overtime, increasingly recognize that the sort of world of two and 20 is not, it’s like pretty good for the manager, I mean, it’s great for the manager, right charge high fees, you know, you you live a good lifestyle, but it’s pretty bad for investors, because even though the manager generates great returns, they basically take it all away, and fees, and investors are left with nothing, the combination of that, and seeing the biggest, most sophisticated institutions in the world, basically running meaningful parts of their portfolio through diversified hedge fund strategies and other alternatives. And I got to thinking basically, was there a way to sort of bring low cost indexing diversified low cost indexing to the world of two and 20? And that was really the spark the question that started Unlimited, which was, was, could we create low cost index products for two and 20 strategies that could be available to everyone? And, and that was that was really the core of it. Now, of course, to do that, you have to do something very different than what a typical index or does a typical index or looks at what’s in the s&p 500 just buys? It’s not that complicated. You can’t invest directly in these two and 20 products, because most of them will take your money like the Bridgewater is the world won’t take the average person’s money, even if they did they charge it to 20. And then what do you do with that, right, you got to pay yourself something and investors are even worse off than they were before. And so instead, what we worked on was basically a technology that allows us to look over the shoulder of those investors to understand how they’re investing in close to real time and then be able to create a replication we use that understanding to translate that into long and short positions in low cost index ETFs, which we which basically serve as the backing of our index products HFMD ETF, which is seeks to replicate the grocer fees, returns of the hedge fund industry, and then we do it at a much lower fee structure than a typical tune 20 Manager.
Nathaniel E. Baker
Oh, that’s really interesting. So how do you get the data on the Hedge fund positions.
Bob Elliott
Yeah, so most hedge funds report their returns to one of the main return aggregators, so like Bloomberg or Credit Suisse and things like that. And then what we do is we look at that information, we look at the returns information, particularly at the individual sub strategies, like global macro or, or long short equity or managed futures, and we and we compare the returns that we’re seeing to a plausible set of exposures that those that’s fun style could have on or could be driving their returns. And when we do that comparison, you basically infer what positions they have on at at each point in time. And so it’s a little more complicated that we use a variety of machine learning techniques, which are pretty, pretty advanced, weren’t around years ago, to not only solve for today’s portfolio, but also in the context of the returns that are the portfolio that explains the returns to time because returns are time varying or I sorry, are path dependent, time varying and path dependent. And so we use machine learning to do that most effectively. But the gist of it is, we basically look at how their returns are going and we infer what they’re doing from that pattern, which are,
Nathaniel E. Baker
but aren’t most of the these hedge funds much more actively traded than just sitting on various instruments?
Bob Elliott
not not really, I mean, many, many of these funds, particularly the biggest, most sophisticated ones, they you can’t really move money that fast is a short story, because you start to move the markets around. And so typically, what we what we see is that can take months for positions to come on or come off. And certainly when you go a level up, and we’re sort of looking at a call, sort of the wisdom of the hedge fund community is kind of what we’re trying to draw on. So the sort of average insight across a bunch of different managers, that wisdom of the crowd, it takes time to evolve. You know, like most equity long short managers were long growth in tech, you know, in mid 2020. And then they entered this year or 2022, much more conservatively positioned. It’s like an 18 month transition. That’s very similar to what we see what we see with other styles and managers. And so even though we’re not we’re a little bit behind, right, we get the information, and then we analyze it and put it put on the trades. It’s not it’s not so bad relative to how fast we see these things moving through time.
Nathaniel E. Baker
Yeah. And then the other concern or question there would be, I mean, hedge funds look, so I’ve studied this at some length, the number of hedge funds that have outperformed the market over the last 30 years. And you can kind of name on one hand.
Bob Elliott
but that’s because of the fees.
Nathaniel E. Baker
Wait isn’t that net of fees? Oh, right
Bob Elliott
I say that’s because of the issues.
Nathaniel E. Baker
Yeah. Okay.
Bob Elliott
that’s the problem. The problem is not the strategies, the strategies are darn good. The problem is the managers take all the money. And they take, they take all the alpha that they’re generating into their own pocket, leaving investors not much better off than they were. And so that’s why I emphasize that what we’re doing is we’re, we’re targeting tracking the gross of fees returns the pre, before fees, returns of the hedge fund industry, because that before fee return as an example, over the last 20 plus years, is 100. A little over 100 basis points better than the s&p 500 with half the volatility, well, that’s a return stream that anyone would and not 100% correlated by any stretch to modestly correlated to the market. That’s a return stream that anyone would want in their portfolio. The problem is the fees. The problem is not the strategy.
Nathaniel E. Baker
Interesting. Okay. That’s an interesting take. And the and that was This is this isn’t just equities, is it? What other instruments?
Bob Elliott
We use basically positions long and short positions in the 50 largest liquid markets in the world. So you know, you’re talking sectors, equity sectors, equity factors, equity, other geographies, major bond, credit, currency, and commodity markets as well. So we put that all together that sort of 50 our universe, our selection universe is about 50 plausible long and short positions. At any one point in time, we might have some subset of that on, depending on exactly the composition of the positioning, from the managers that we’re seeing.
Nathaniel E. Baker
This, of course, begs the question what you’re seeing right now, and what kind of traits these are traits to the extent that you can talk about that?
Bob Elliott
Yeah, well, I mean, of course, if people want to see the positions, the interesting thing is they’re available every day on an unlimited etfs.com. You can, you know, just like any other ETF, you can see the positions that were holding, which is a reflection of that technology, that understanding. I think the thing when you look at the positions today, it’s very interesting is we’re seeing basically the biggest divergence between hedge fund positioning and the sort of common retail investor than we Have you ever seen in 25 years? Yeah, just we’ve never seen such a such a divergence. And the main things that we’re seeing are that hedge funds risk taking is basically as low as it’s been in 20 years, because of the uncertainty of this market environment. And frankly, because the attractiveness of cash relative to positioning and assets, we also see those managers when it comes to their equity positions, basically, extremely conservatively positioned into value oriented sectors and net short growth oriented sectors. We see them short bonds are net, which is obviously very different from what we see many investors, many investors are holding long bond positions and have been burned by it. Hedge funds have been short bonds all year, which has been a big important component of their of their outperformance of index returns. And then finally, we see them holding positions in commodities and gold, long positions, commodities and gold, which are the largest positions that we’ve seen them hold and 25 years reflective of a inflationary dynamic. And so most common investors basically hold no commodities or gold, you know, golden commodities are a bit of an odd ball thing for them. And so, I think it’s really telling when you think about what is going on in the world, seeing where sophisticated asset managers are positioned relative to where the common investor is positioned. And frankly, how, how unprepared the common investor is for this inflationary cycle?
Nathaniel E. Baker
Hmm. Yeah, well, I mean, that’s interesting. Have you got short bonds? Long commodities? Okay. And long gold? Yeah.
Bob Elliott
And value versus growth sectors? So I mean, really, and, and, and, and very low leverage. So like, you know, 60% in cash?
Nathaniel E. Baker
All right, back to the macro picture here. We talk here about the Fed, and the Feds target rate when it comes to inflation. 2%. You’ve tweeted a little bit about that. How you say that there’s not much of a chance of that. And you said, this is one of the big, big issues for next year? Is the Fed potentially moving away from this 2%? Target? What can you tell me about that?
Bob Elliott
Yeah, well, I think there’s a real question on many investors minds about whether the federal either do what’s necessary to bring inflation down to 2% or more will accept structurally higher inflation in order to basically bring inflation down maybe a little bit, and kind of call it a W and accept that there’s higher structural inflation, I think you’re the thing that’s very interesting is that there’s pretty big, pretty big camps on both sides, meaning like, there’s lots of sophisticated professional investors as well as retail investors that are holding both sides of that view. And that what that creates is actually a pretty big dispersion, or could create relatively large moves in the markets, depending on which path that they take. So you know, they, they could, they could take the path of accepting higher inflation, and that’s got a set of dynamics in the markets, and then they or they could not, and then all those people who were basically positioned for them to be easier than expected are going to be burned by that. So you’re that’s that’s kind of like where that settles out, I think is a really interesting question that might lead to some non obvious solutions, particularly if they choose to hold a higher inflation rate, or they choose to accept a higher inflation rate, because we may well see long end, the long end of the bond market really sell off credit, a bit steepening if that’s where they end up. And that that could actually be net detrimental for equities. Even though on the surface easier, money seems better for stocks, but we can have as you could basically have, what is traditional bond vigilante ism, in the sense of, you could have a lot of selling on the long end, the Fed holding the short end down, but a bunch of selling on the long end, which creates a big curve steepening, which is actually quite terrible for equities, if you have that risk, premium expansion in dollar assets. And so that dynamic is it’s not it’s not certain by any stretch, even if they accept higher inflation, that that’s actually going to be good for the equity market. On that.
Nathaniel E. Baker
Wow. So you know, one thing that one common theme here is that the long end of the curve of a bond long term bonds do not sound like they have any potential upside here. Looking forward. I mean, I’m sure there might be some around the edges, but yeah, it certainly
Bob Elliott
it certainly doesn’t look the types of conditions that are that would align with a bond rally. We’re not there yet. We’re not seeing duration and economic conditions or a weakening of inflation pressures. And, and so part of what you know if anything, the bond market has been really lagging in this whole cycle, which is the short rate market keeps It keeps dragging up and up and up. And the bond market just kind of keeps getting brought along. And until, you know, the Fed is in a position to start to ease they don’t necessarily have to start easing, but we you know, the market etcetera has to look at the the conditions and say, Oh, it makes sense for the Fed to stop tightening or start to bring easier monetary policy to the to the market. Until that really happens. The bond markets not looking great. Yeah.
Nathaniel E. Baker
Yeah, no question. Last question. We’ve had a couple of days now, hope hopium, the hope for the Fed pivot. We’ve had at least to write this last before this last meeting. And then heading into Jackson Hole. Both times Jay Powell came out and killed any hopes for the Fed pivot. The first time at least, and there may have been some time earlier in the year. Can you remember? But do you think that the have investors learned their lesson? And are we done here with hopium? At least when it comes to the Fed pivot? Or is it like the boy that cried wolf, will they go there again, before the next meeting, or at some future point?
Bob Elliott
I think if you if you take the pulse of the market, what you hear and what you see is that the investors who were basically steeped in you know, by the depth fed response to flagging growth conditions fed immediate response defying growth conditions, you’re there. It is, it is incredible, actually, how many times a day i i interact with someone who’s basically trying to find a reason why, you know, the macro economy is a disaster and the Fed needs themes in order to support the equity market, like ever, it’s constant, where someone’s trying to find a thing that will help support the notion that the Fed needs to ease or stop tightening or will use very shortly or things like that. And like it, it’s become a bit of a side hustle is disavowing people of the fact that the macro economy is a disaster. It’s not, it’s growing fine. It’s fine. It’s it’s, it’s growing modestly at very elevated levels, or disavowing people, the fact that the labor market is a total disaster, like wage growth is basically never been better. You know, claims are at secular lows. You know, there’s lots of good indications why the labor markets fine. And this is when we get to the we sort of start with the beginning of this conversation. You know, what is a slog, a slog is a boring, slow shift of economic conditions from being elevated to being weaker, and one that takes a long time to play out. And that, frankly, that is the tension is that there’s a bunch of people walking around saying, the economy is going into the can, it’s happening in three months, people are saying there’s gonna be 5% unemployment in three months. Like it’s basically impossible. Right? And I think and that’s all born out of that COVID Oh, eight financial crisis mindset. And it’s wrong. It’s like, very, very wrong relative to how macroeconomic cycles play out through time. And instead, frankly, like, if you and I get on this podcast a year from now, I think what we’ll be seeing is like, oh, unemployment ticked up a bit, growth has slowed a little bit, you know, interest rates are higher than they were, you know, and in a way that is like, frankly, pretty, pretty boring. And that is, that’s a slog, you know, it’s not, it’s not very exciting as an investor, and requires immense patience to navigate, just in the same way. The 2000 cycle required investors to have immense patience, to wait to see all the different parts of the economic cycle play out to finally achieve that durable bottom to finally achieve the reacceleration or the the improvement in the markets. That took three years. Right. Just keep that in mind three years in 2000. And that is not that unusual in terms of a cycle. And that’s probably you know, is it two years, is it three years is a four years, I don’t really know, I’m not gonna pick that. But is it a lot longer than now? Yes, it’s going to be a lot longer than the now.
Nathaniel E. Baker
Yeah. And the fact that people still have hope may be an indication that it’s not due to ending when people talk about it being range bound permanently, and there being no hope that’s when maybe you can start, at least going back to the early 2000s. And I do remember it. Okay, last question. Sorry. I just have one. No, no, you can go at the midterms tomorrow. Yes. Tell me about what you’re expecting there.
Bob Elliott
I’m not into the politics side of things. I have no particular end In your opinion about it, I look at, you know, data driven analysis of political outcomes like 538, or are a number of different equivalent type analyses, they suggest that there’s a pretty high probability that the Republicans will take at least one of the House or the Senate, and most likely both. That creates a an interesting dynamic, which is, you know, a split government, which typically creates much less legislation being passed. And, and frankly, like, the idea that there’s going to be big, stimulative legislation in an environment of divided government going into a general election, like seems, seems like a pretty low probability. And so on the margin, that split government will be beneficial for the Fed, because there’s just this less stimulus versus, you know, dealing with the inflation Reduction Act, which was a bit inflationary, and, and the, the student loan relief, and all of those different things, they’re not the Feds not gonna have to deal with that expansionary fiscal stimulus while they’re trying to tighten monetary policy. The thing that it adds is a level of tail risk to the market that I think, you know, people often don’t discuss in these circumstances, if you go back through time, you’ve got a couple of I call core functioning elements of the government, which is they got to pass a budget, in order to keep the government open, they also will probably have to pass a debt ceiling rise, both of those things are critical functioning. Typically, through time, they are non events, like the common person on the street doesn’t even think about them, they just started happen. But in a politically charged environment with a clearly, let’s say, there’s a clearly divided government structure, you can easily see certain you can easily see, frankly, one side or the other, I know, no particular opinion on one side or the other. But one side, either the Republicans or the Democrats could hold up passing such legislation in order to extract you know, politically desirable outcomes. And frankly, those could have meaningful tail risks. Like if the government shuts down like that has a direct hit to economic activity, which could be quite detrimental for the economy. It also, you know, not raising the debt ceiling, like the US government might technically default on its debt, it doesn’t really matter in that sense of that. I won’t get into the details so that I could bore you to tears about it. But the US government is not defaulting on its debt. But anything that creates, frankly, noise about the idea of holding treasuries is just going to make things worse in terms of, you know, the general spine demand for bonds, and raise interest rates for the rest of the economy. And so those things can easily play out, it could be a lot of friction, it could be a lot of bumpiness and then in the name of political expediency, and that’s probably underpriced or typically is underpriced relative to what’s in the market, given that, that most people just don’t even have it on their radar, they haven’t lived through, you know, through a debt ceiling fighter, or they might not be acutely aware of a debt ceiling fight in the past or are really acutely aware of the consequences of a government shutdown.
Nathaniel E. Baker
I was gonna say in early, when was the Trump that they had, there was a brief shutdown of the government, I want to say really 2019?
Bob Elliott
yeah, there’s been a few, there’s been a few of those brief shutdowns on the order of days, which haven’t mattered that much in the grants in the grand scheme of things, they don’t matter that much, you know, shutting down 10% of the government, because it’s only non essential, shutting up 50% of the government, because it’s only non essential that shuts down, which is only, you know, 12% of the economy or something like that. It’s not that big a deal for economic activity. But if you had a circumstance where you had an extended shutdown, and and I think, you know, that’s certainly I’m not saying that’s a probable outcome, but it certainly would be a plausible outcome, given the type of conflict that exists in the political arena, like, could you have a government shutdown for three months or six months? certainly seems like plausible, and we are totally unprepared for that. Very few people are talking about it or the debt ceiling. I mean, one of the consequences of the debt ceiling not raising the debt ceiling is it would limit the amount of outlays that the government could do and create a fiscal contraction of force fiscal contraction. That’s another example. Probably not in people’s minds not really thought about, but these are the sorts of tail risks that rise when you have a divided government circumstance that, you know, probably aren’t really getting talked about too much, and probably, as I say, are probably underpriced. The risk of them are probably under priced in the market.
Nathaniel E. Baker
Interesting. Yes. Interesting. Points. All right, Bob. Elliot, thank you so much for coming on the contrarian investor podcast today. Fascinating discussion. Really enjoyed it. In closing, maybe you can tell our listeners how they can find out more value. I’ll put these in the show notes. as well,
Bob Elliott
yeah, great. Well, you can follow me at Bobby unlimited on Twitter where, where much of the course of this conversation was inspired by I’m very regularly going through my various macro economic thoughts. Unlimited itself in our initial product, the H fnd. ETF is investable on all the main discount platforms and brokerages. So you can find it listed on New York Stock Exchange H, F and D. And you can learn more about the fund itself and the prospectus and all the nitty gritty information you might want to see, including our positioning at unlimited etfs.com.
Nathaniel E. Baker
Cool, awesome. Thank you, Bob. Thank you all for listening. And we look forward to speaking to you again next time.
Bob Elliott
Great. Thanks for having me.