Talk of inflation has been swirling for some time amid all the stimulus that’s been pouring into the market and the soaring debt levels in the U.S. The Federal Reserve has said that any inflation that does occur will be temporary, but one hedge fund macro trader says there are plenty of reasons not to trust what the central bank says about inflation.
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Colin Lancaster, who previously worked with Ken Griffin at Citadel and Dmitry Balyasny at Balyasny Asset Management, told ValueWalk in an interview that he doesn’t believe central banks have much credibility when it comes to inflation. He added that it’s really hard to trust central bankers when it comes to inflation because they have “chronically mismodeled inflation and inflation expectations over the last two decades.”
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Many surprised about the pandemic
In his recently released book Fed Up!, Lancaster tells the story of a macro trader working before and during the COVID-19 pandemic. He said he always wanted to write a book and always has books he’s working on. Lancaster admires writers who can “take a really complicated story and turn it into a page turner that people want to continue to read about an incredibly interesting cast of characters.”
During the lead-up to the global economic shutdown, many market watchers seemed surprised at the severity of the virus. Lancaster said he feels one of the most amazing things about the pandemic is how surprised many people were about it when it happened.
He said that thinking about the performance of a lot of macro hedge funds shows who was aware of the virus and who wasn’t. He noted that the market was facing an external shock that would shut down the entire global economy. Lancaster added that a lot of people got the enormity of the shock right, but those who didn’t, “shame on them.”
He noted that the reaction to the pandemic was very delayed, but it was a normal reaction because of the size of the shock.
“If you look at the actual data, the economic data, all these data points, they look like mistakes,” Lancaster said. “We saw this deceleration activity that we’ve never seen before… So again, we just had this shock that shut down the global economy, which is really an amazing thing to have witnessed.”
The markets took off suddenly after the initial shock in February and March, and Lancaster thought it was strange because recoveries from such an event typically take much longer to play out. He believes it was “a direct result of the size of both the fiscal spending, fiscal stimulus, combined with monetary policy and the amount of quantitative easing.”
History of quantitative easing
Lancaster explained that central banks have been working over the last few crises to develop emergency measures. He believes the problem we are seeing right now is the fact that central bankers have flooded the system with liquidity, which will let the economy overheat, which is going to cause more issues.” Lancaster believes the rapid recovery was due to the enormous size of the monetary adjustment and fiscal spending.
“One of the things I also wanted to include in the book was not only a description of this but a description of the role of central banks,” he said. “QE in modern markets. I think it’s a really important thing. I wanted to try to address all of those topics in a more user-friendly manner so people can understand the significance of them while still understanding the story.”
Warning about inflation
Lancaster warned about central banks’ history involving inflation and believes all the fiscal stimulus we have seen over the last year will create a great environment for macro investors. He noted that the dominant theme recently has been that the central banks are recognizing a stronger-than-expected economic rebound.
“The Fed is going to let things run incredibly hot and say, ‘This inflation stuff, don’t worry about it,’ but it’s a really hard thing to trust them on, and it’s going to create an amazing set of conditions as we get closer to the end of this year and early into next year,” Lancaster said. “We’re going to have GDP of 7-8% and inflation well above their 2% target. What are they going to do about it without killing the recovery? So they will be forced to taper their bond-buying activity. The markets will price in additional rate hikes. It’s all going to be fascinating to see as we get closer to the end of this year.”
The new roaring 20s and the “new” New Deal
Lancaster looked at past crises and compared the pandemic to them. He noted that the late 1970s and 1980s saw high inflation and high unemployment. During the pandemic, the Fed focused on QE, and he said in some ways, we are in a period like the 1970s, but for different reasons. He explained that inflation and employment haven’t behaved as expected because they have been too low for too long.
“Central banks decided they needed to find new tools to manage the cycle, and we’re turning back to spending and money supply,” Lancaster said. “So it’s the new roaring 20s, the New Deal combined with incredibly easy monetary policy. This is just an experiment that’s being taken to a new degree or order of magnitude, and it will be fascinating to see how this plays out because I think the outcomes are more uncertain than at any time I’ve seen in my career.”
Currency replacement trades
Lancaster believes macro investors will have a lot of opportunities in the coming months and years. He noted that one trend we are already seeing is what he calls “currency replacement trades.”
“It’s the rise of bitcoin and the cryptocurrencies,” he said. “You’ll see gold perform well in this type of environment because what is happening from a monetary policy perspective is there’s this substantial shift that’s taking place in the markets.”
Lancaster believes bitcoin is here to say and that the cryptocurrency was “started by a band of geeks who were really worried about government-controlled currencies.” However, he’s concerned about cryptocurrencies right now.
“What I worry about, this whole space is part of the speculative excess we’ve seen,” Lancaster said. “There are a lot of these coins, and the meme products are complete scams. They will be zeros, and the kind of pump and dump environment… I really worry about that. I don’t think that’s healthy. Yes, blockchain and bitcoin are here to stay. On the other hand though, fraudsters are coming out of the woodwork and trying to make a quick buck.”
No more debt
He emphasized that the outcome of the current situation is more uncertain than the outcome of any other crisis he has seen in his career. Lancaster believes the U.S. has reached the point where it is maxing out on the level of debt it can run with.
“What I mean by that is that the way we continued to solve our own problems and the world’s problems is by adding new debt into the system,” he said. “There’s a scene from the book where the team is in a limousine driving down the Vegas Strip, and they look at one of the billboards, and it measures the amount of debt.”
Lancaster said before the pandemic, the U.S. stood at about $23 trillion in debt, but it is now about $29 trillion. The nation added $6 trillion in debt in a short amount of time, and he doesn’t believe the debt levels are sustainable, especially in a low growth, low inflation environment. Lancaster believes central banks know they need to find a way to deal with all that debt.
Macro is back
“I think in the book there’s a famous line saying, ‘Macro is back,’ and I do think it really is,” he added. “I think the investment opportunities across the macro landscape, I think the strategy as a whole, is going to outperform other strategies. We’ll have these items I’ve mentioned come together, also the French election, the continued rise of populism… It’s going to be a fascinating period, an amazing set of markets to watch.”
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