Recommended Open And Closed Trades
I have not put out an update since the beginning of the year won my recommended trades so, I thought it was about time. So here goes. I am currently positioning for three themes:
Exponential Rebound in US Economic Growth I am positioning for a robust economic rebound in the second half of the year because of two factors. One factor is the impact on growth from the acceleration of vaccinations, particularly in the customer-facing economy. COVID has had a disproportionate effect on the downside in this sector. Accordingly, I would expect a similar but opposite impact in the recovery. This pattern reflects that the average employee in this sector tends to be younger and paid below the country’s median income. So, that means marginal propensity to consume is greater than one, e.g., the borrow. Consequently, spending drops more than the average as their incomes drop, but they spend more than average as their incomes rise.
The second factor is the impact of government spending. In the near term, this reflects the stimulus checks and the extension of unemployment benefits from the recent $1.9 trillion stimulus package and the one late last year. Keep in mind the key here is not the stimulus money itself but rather the prospects of getting back to work. A large amount of the stimulus checks has been saved given the uncertainty of the job rebound. That means these savings could turn into consumption with the strengthening of the economy. Further, I also believe there were be further spending initiatives later in the year from Biden’s “Build Back Better” program.
I positioned this theme with 8% OTM call on an equally weighted S&P index. I choose this index versus S&P because I believed there would be a partial convergence between this equally weighted index and the market-weighted S&P. S&P’s performance last year reflects, in part, the outperformance of Nasdaq type equities in a low growth environment. of Nasdaq type equities. I recently restruck this trade to a 30 delta after the rally in the underlying index.
Positioning for Inflation I positioned for an upswing in inflation for three reasons. First, inflation was priced too low given historical norms. Second, as I described above, the economic rebound would push implied inflation closer to the 2% historical norm. Third, inflation could move above historical norms if the velocity of money normalized along with the economy and the FED chose to continue QE. This third factor is still very relevant even after the repricing of inflation closer to the 2% area. As I talked about in my recent commentary on inflation, the potential magnitude of FED QE needed to support government deficits is beyond even the extremes during WW2. Consequently, one of two events could unfold with inflation and/or a weaker dollar.
Key Opportunities on The Path To Net-zero I basically spent February focused on this theme. I pretty much went down the rabbit hole to do the necessary deep dive to educate myself on the move toward net-zero. I found it very difficult to come up for air and write anything given the overwhelming amount of data and research on the subject. But I emerged, and hopefully, the effort will be worth it. I believe this theme that will play out over the next year and the years to come. The US, Europe, and China could be spending close to 2% of GDP every year of the next 20 to 30 years. So, think 10s of trillions of dollars.
After the first couple of weeks, it was clear to me that there was one very compelling trade: buy the builders. Not the builders of the blades or the solar panels but rather the builders that will put everything together to create the coming renewable electric grid. Buy the companies that will build the solar and wind utility level plants. Buy the companies that will build the transmission connections to the existing grid. And buy the companies that will build the new macro grid that will link areas of high renewable energy to the rest of the country. Fortunately, all three companies are basically the same: engineering companies. I planned to put out the thesis in three parts, with the first two parts creating the fundamental economic framework of my typical trading strategy. The third part would be the trades themselves. I put out the first two pieces but have been spending even more time on the third piece. However, putting this piece together, I realized that my builder’s basket has already done well. So, I needed to highlight this basket as part of my recommended trades just to flag it. I will put out the third piece soon. Let me know if you want to know the names in the basket. Even with the performances, this theme is very, very early in the cycle.