In our previous commentary, we discussed reality as the trajectory of three parallel lines (markets, geopolitics, and Karl Barth’s writings on creation) that eventually intersect. Since then, the market reality met the geopolitical reality in at least two cases: the oil and the gold market. But first, let’s review the performance of energy-related stocks and gold prices since we posted that commentary, and contrast that performance with the performance of the S&P 500.
Source: Morningstar
It is obvious from the above graph that both energy-related stocks and gold outperformed the S&P 500 by multiples of 10 and 7 respectively. But why did that happen? Before we attempt to give an answer to that question, let’s remind ourselves that in our illusionary-celebrated reality the two fundamental portfolio concepts of portfolio alpha and the concept of lowering/minimizing a portfolio’s beta, are still alive and well.
Karl Barth’s writings on creation reflect Plato’s and Huxley’s fears that the power of the senses would overthrow the power of the mind, and hence in an age that celebrates the death of truth, the power of emotion obliterates reason. As we are chained to the flickering shadows of brainless celebrity culture (from politics to social media, and from business to idolized political worship inside the churches), the spectacle of the new Roman arena titled “mystical fabrication of inauthenticity” makes us lose the forest for the tree in our decision-making process. That unfortunate trend seems to have an element of irreversibility in it. That applies to portfolio analysis too.
A portfolio enjoys Alpha when it achieves returns above a benchmark’s performance, adjusted for risk. Assuming that someone’s benchmark is the performance of the S&P 500 (represented in our graph by the ticker VOO), by having energy-related stocks and gold (tickers XLE and GLD respectively in the above graph), the portfolio would have achieved superior performance in the last month.
Portfolio Beta represents the systematic risk of a portfolio relative to the perceived market risk as the latter is reflected by an index such as the S&P 500.
Ideally, a portfolio would have a risk identity lower than that of the market while enjoying excess returns relative to the market. Of course, that ideal may be unattainable, however, if market reality is analyzed and interpreted using geopolitical lenses nowadays, then that ideal might be feasible as the market reality has testified during the last month.
About three years ago, we wrote that “there cannot be real portfolio alpha apart from understanding the new and evolving international paradigm of the balance of power and the emerging new order.”
But now, let’s attempt to answer the question of energy and gold overperformance in the last month. In short, our answer is that the combination of geopolitical risks, strong global demand, and OPEC’s consistent cuts, have uplifted oil prices and the fortunes of oil-related stocks. In the last 30 days, the geopolitical landscape has become riskier and more dangerous due to Putin’s belligerence and aggression, the threat of an escalating war in the Middle East, and an evolving authoritarian alliance that seeks to change the international world order. Consequently, oil and gold prices kept rising and may stay high as long as the geopolitical risks remain elevated. The rise in gold prices could also be partially explained by the expectation of lower rates this year, as well as the gold purchases by central banks. However, what appears as a breaking pattern of co-movement between gold prices and the direction of yields, as shown below, could possibly be explained primarily by geopolitical factors.
Source: Bloomberg
When geopolitical risks rise, then a flight to safety is inevitable. However, that flight to safety didn’t include bonds this time around. The explanation for this is the sticky inflation rate – which doesn’t seem compliant to the desire that it drops to the target rate of 2% – and hence the talk of higher rates for a longer period than originally anticipated. This past week, we saw the 10-year rate touch the 4.40% level as the US economy continues exhibiting signs of strength amidst rising consumer, corporate, and government spending. Therefore, investors had another reason (besides the geopolitical) to turn to energy and gold (Having said that, we still believe that in the future, oil’s landscape could be highly disruptive due to demand shocks).
As Karl Barth may have said today, we have lost the sense of the awe of creation, and consequently, we have the sheer pleasure of being emancipated from reason and truth. Will then the sense of never being tired of the puppet masters who manipulate facts, create illusions, and misguide the public through the armies of cultural enablers and influencers, be irreversible? Is the reality of politicians and preachers along with the other armies of incompetent idiots who use mass propaganda and made-up narratives to create a sense of faux reality – for a public that has lost the sense of what constitutes a virtuous reality based on competence, sincerity, honesty, courage, and fairness – be also irreversible? Is the reality of a market that amplifies faux narratives – and has surrogates repeat them in endless loops of breaking news cycles giving deceptive reality a mythical dimension and the aura of uncontested truth – also irreversible? How else would we interpret the disappearing spread between junk bonds and Treasuries (amidst rising geopolitical tensions, uncontrollable debts, market overvaluation, and sticky inflation), as shown below?
As we look forward, we are obliged to classify risks (and the corresponding portfolio positions) into current and possible imminent risks, as well as medium-term dangers. For the latter, as our previous commentary discussed, the danger of a nuclear confrontation has increased thus the need to establish a US-led nuclear umbrella, as deterrence may have started becoming precarious (just look at China’s 70% rise in warheads between 2019 and 2023) at a time when arms-control agreements are falling apart. The possibility that the US will have to face two major nuclear rivals in the medium-term is rising, hence the need to debate and decide on new nuclear submarines, ICBMs that can carry more than one warhead, the acceleration of production of plutonium pits, and other nuclear options.
What is then the greatest danger in the next few weeks and months? We would say that such danger can be found in a dual attack: A retaliatory attack (after Israel’s attack on the Iranian Consulate in Damascus) on Israel by Iranian proxies and an attack by Kim Jong Un on South Korea. That potential dual attack could attract other significant players in the conflict including the US, Iran, and possibly an alliance of authoritarian states. While Kim Jong Un’s recent threats, co-declaration with Putin, and rhetoric could be a spectacle, this is not the time to be complacent in our analysis, plans, and portfolio hedging.
The Irreversibility of a Faux Reality: Illusions, Spectacles, and Geopolitical Challenges to Portfolios’ Alpha and Beta, Part II
Author : John E. Charalambakis
Date : April 9, 2024
In our previous commentary, we discussed reality as the trajectory of three parallel lines (markets, geopolitics, and Karl Barth’s writings on creation) that eventually intersect. Since then, the market reality met the geopolitical reality in at least two cases: the oil and the gold market. But first, let’s review the performance of energy-related stocks and gold prices since we posted that commentary, and contrast that performance with the performance of the S&P 500.
It is obvious from the above graph that both energy-related stocks and gold outperformed the S&P 500 by multiples of 10 and 7 respectively. But why did that happen? Before we attempt to give an answer to that question, let’s remind ourselves that in our illusionary-celebrated reality the two fundamental portfolio concepts of portfolio alpha and the concept of lowering/minimizing a portfolio’s beta, are still alive and well.
Karl Barth’s writings on creation reflect Plato’s and Huxley’s fears that the power of the senses would overthrow the power of the mind, and hence in an age that celebrates the death of truth, the power of emotion obliterates reason. As we are chained to the flickering shadows of brainless celebrity culture (from politics to social media, and from business to idolized political worship inside the churches), the spectacle of the new Roman arena titled “mystical fabrication of inauthenticity” makes us lose the forest for the tree in our decision-making process. That unfortunate trend seems to have an element of irreversibility in it. That applies to portfolio analysis too.
A portfolio enjoys Alpha when it achieves returns above a benchmark’s performance, adjusted for risk. Assuming that someone’s benchmark is the performance of the S&P 500 (represented in our graph by the ticker VOO), by having energy-related stocks and gold (tickers XLE and GLD respectively in the above graph), the portfolio would have achieved superior performance in the last month.
Portfolio Beta represents the systematic risk of a portfolio relative to the perceived market risk as the latter is reflected by an index such as the S&P 500.
Ideally, a portfolio would have a risk identity lower than that of the market while enjoying excess returns relative to the market. Of course, that ideal may be unattainable, however, if market reality is analyzed and interpreted using geopolitical lenses nowadays, then that ideal might be feasible as the market reality has testified during the last month.
About three years ago, we wrote that “there cannot be real portfolio alpha apart from understanding the new and evolving international paradigm of the balance of power and the emerging new order.”
But now, let’s attempt to answer the question of energy and gold overperformance in the last month. In short, our answer is that the combination of geopolitical risks, strong global demand, and OPEC’s consistent cuts, have uplifted oil prices and the fortunes of oil-related stocks. In the last 30 days, the geopolitical landscape has become riskier and more dangerous due to Putin’s belligerence and aggression, the threat of an escalating war in the Middle East, and an evolving authoritarian alliance that seeks to change the international world order. Consequently, oil and gold prices kept rising and may stay high as long as the geopolitical risks remain elevated. The rise in gold prices could also be partially explained by the expectation of lower rates this year, as well as the gold purchases by central banks. However, what appears as a breaking pattern of co-movement between gold prices and the direction of yields, as shown below, could possibly be explained primarily by geopolitical factors.
When geopolitical risks rise, then a flight to safety is inevitable. However, that flight to safety didn’t include bonds this time around. The explanation for this is the sticky inflation rate – which doesn’t seem compliant to the desire that it drops to the target rate of 2% – and hence the talk of higher rates for a longer period than originally anticipated. This past week, we saw the 10-year rate touch the 4.40% level as the US economy continues exhibiting signs of strength amidst rising consumer, corporate, and government spending. Therefore, investors had another reason (besides the geopolitical) to turn to energy and gold (Having said that, we still believe that in the future, oil’s landscape could be highly disruptive due to demand shocks).
As Karl Barth may have said today, we have lost the sense of the awe of creation, and consequently, we have the sheer pleasure of being emancipated from reason and truth. Will then the sense of never being tired of the puppet masters who manipulate facts, create illusions, and misguide the public through the armies of cultural enablers and influencers, be irreversible? Is the reality of politicians and preachers along with the other armies of incompetent idiots who use mass propaganda and made-up narratives to create a sense of faux reality – for a public that has lost the sense of what constitutes a virtuous reality based on competence, sincerity, honesty, courage, and fairness – be also irreversible? Is the reality of a market that amplifies faux narratives – and has surrogates repeat them in endless loops of breaking news cycles giving deceptive reality a mythical dimension and the aura of uncontested truth – also irreversible? How else would we interpret the disappearing spread between junk bonds and Treasuries (amidst rising geopolitical tensions, uncontrollable debts, market overvaluation, and sticky inflation), as shown below?
As we look forward, we are obliged to classify risks (and the corresponding portfolio positions) into current and possible imminent risks, as well as medium-term dangers. For the latter, as our previous commentary discussed, the danger of a nuclear confrontation has increased thus the need to establish a US-led nuclear umbrella, as deterrence may have started becoming precarious (just look at China’s 70% rise in warheads between 2019 and 2023) at a time when arms-control agreements are falling apart. The possibility that the US will have to face two major nuclear rivals in the medium-term is rising, hence the need to debate and decide on new nuclear submarines, ICBMs that can carry more than one warhead, the acceleration of production of plutonium pits, and other nuclear options.
What is then the greatest danger in the next few weeks and months? We would say that such danger can be found in a dual attack: A retaliatory attack (after Israel’s attack on the Iranian Consulate in Damascus) on Israel by Iranian proxies and an attack by Kim Jong Un on South Korea. That potential dual attack could attract other significant players in the conflict including the US, Iran, and possibly an alliance of authoritarian states. While Kim Jong Un’s recent threats, co-declaration with Putin, and rhetoric could be a spectacle, this is not the time to be complacent in our analysis, plans, and portfolio hedging.