Federal Reserve Rate Cuts and Economic Trends

The reason why the Fed cut rates, the only theory I can find for why the Fed is cutting rates and people talking about is that the so-called real interest rate is too high. I mean, you take the nominal interest rate, call it your Fed funds rate, and you less. and that is at a level that is elevated. By the way, we also have these kinds of high real interest rates in the late 90s where you had this productivity boom. So a high real interest rate is not a reflection of the economy being restrictive. It's not. It's a reflection of the economy having a higher return on capital, a higher productivity rate. That's bullish for the economy. I think we are in Goldilocks now. Hey, everyone. This episode is sponsored by Polkadot. Polkadot is the largest community DAO empowering 1.3 million dot holders to shape the future of the network through active participation. With over 500 applications backed by over $6 billion in shared security, Polkadot's adaptable technology powers a diverse ecosystem from DeFi to AI. Join the Polkadot DAO and be part of that transformation. This episode is sponsored by Mantra. The Mantra chain is the purpose-built layer one blockchain designed for tokenized real-world assets and regulated digital assets, offering scalable high-performance architecture. Positioned as the blockchain for tokenized RWAs, Mantra is onboarding traditional financial institutions into Web3. Join the ongoing OM GenDrop campaign to be part of the future of regulated digital assets today. All right, welcome back to another episode of On The Margin. We're recording here live from permissionless, and I'm joined today by Ram Aluwalia of Lumita Wealth. It's great to have you here. How's it going? Good to see you again, Felix. Doing well. Thank you. Yeah, yeah. Good to have you. You were on our roundup a few weeks ago. It was a ton of fun. I saw you were speaking here, and I just had to come. get you in here and chat with you. Always great to meet in person too. Yeah, that as well. Love your hat. I almost wore the same one. Well, you know, this is a top signal for VCs and crypto, obviously. If you see VC with Pat, you're supposed to go max sell. That sounds about right. Ron, for those that don't know you, do you just want to intro yourself, what you focus on and what you do at Lumida? Sure. I lead Lumida Wealth. We're a private wealth management firm. We're reimagining, reinventing wealth management. Most of our clients are founders, exited founders that created wealth as entrepreneurs or in digital assets. And we're cross-asset class investors. So as we invest across... public equities. We invest in distressed commercial real estate through third-party managers. We invest in private credit. We take a thematic approach to investing. Really enjoy what we're doing. We've been having a great two years since we started. That's awesome. Sweet. Well, I want to start our discussion by just looking at some broad macro ideas and what we've been seeing here. I'll just run through a couple of economic data points that we've gotten this week. Yesterday was the inflation print that came out on a month-for-month basis. We saw that come in at 0.3%. which was 10 bps above what was expectations. In the same vein, the headline month over month came in at 0.2, which is also 10 bps above. When you dig a bit more into the granular data, services are actually below expectations, but core goods came in slightly above expectations. We've seen that shelter, which has just been one of the stickiest and largest components of inflation, owners equivalent rent and all of that. After a rebound last month, we actually saw that, you know, downtick lower. Just this morning, we got PPI, which came in On month over month, headline PPI came in at 0%, which was below expectations. And, you know, always good when you see a zero on that one. So, you know, with that context in mind, I would just love to hear what's your broad macro view of the economy and markets today? Overall, you know, we've been consistently of the view that we have got a strong economy that's going through a process of normalization, right? We saw a jobs print of 250,000 on a few weeks, one week ago. And the economy is strong. I think there's been a lot of consternation around weakness in the economy, and people are reading too much negative data on things like rising consumer credit delinquencies. The reality is, number one, corporate earnings are strong. They've exceeded expectations in the last quarter. I think they will do fine this quarter. The reason why that matters is that corporates don't fire, they don't cut workers when they're growing earnings. They want to invest in their businesses. and job losses are necessary to get a recession. So that's one. Two, you've got the Fed that's cutting rates. I believe they're adding fuel to the fire on a relatively robust economy. Three, you've had an influx of immigration that helps to offset labor wage price increases. That's actually bullish for the economy. And at the same time, you're seeing real wages increase. So if you take the kind of nominal wages, less inflation, you're seeing real incomes go up. We've seen several months in a row of retail sales data beats. There have been shifts in consumer spending patterns, less from goods and manufactured products, more to services. I think that's confused people. But overall, that's robust. I expect that we'll see continued strength in retail spending in Q4, starting to pick up some more retailers as a result. The banks are healing also. So, you know, there's an economic side. There's a lot to be excited about on the market side. Markets are now concerned about rising inflation. So after we saw that nonfarm payrolls beat, which was significant, what you've seen is the 10 year rate has gone up. So bond prices are starting to account for higher inflation rates. You've seen the U.S. dollar increase. You've seen expectations of Fed rate cuts diminish from 50 bps to 25 bps. The next time the FOMC meets, that's partially why the dollar is increasing. You're also seeing commodities like natural gas, oil, and uranium roll over somewhat. We're still bullish those kinds of themes for various reasons. But that's what the market is saying. The market is saying, hey, the Fed may have made a mistake here. So you think 50 bips was a mistake? It's not just that long bonds are reflecting that the Fed are getting underneath us aggressively enough. It actually was a mistake. The Fed cut rates. It was a mistake. It was a head fake. And they overreacted. We are seeing significant productivity growth. We haven't seen this kind of productivity growth since the late 90s, when you also had the emergence of technology that led then to the internet era. Productivity growth is important because it allows corporates to grow earnings without laying off workers. And it also allows workers to increase their real wages. So it's the only free lunch in economics. So we are entering a productivity boom that's exciting, that's bullish. And the reason why the Fed cut rates, the only theory I can find for why the Fed is cutting rates and people talking about, is that the so-called real interest rate is too high. I mean, you take the nominal interest rate, call it your Fed funds rate, and you less inflation. And that is at a level that is elevated. By the way, we also have these kinds of high real interest rates. in the late 90s where you had this productivity boom. So a higher real interest rate is not a reflection of the economy being restrictive. It's not. It's a reflection of the economy having a higher return on capital, a higher productivity rate. That's bullish for the economy. Yeah, yeah. It seems like there's a lot of noise right now in a lot of the economic data. So I know when you were on the Roundup a few weeks ago, this was at a time before we got the super hot jobs report, but... At that time, there was a lot of discussion of dynamics like the SOM rule, which got triggered. And interesting enough, after last week's report, it actually reversed the trigger. You look at the yield curve inversions. People have been saying there's going to be a recession imminently for almost two years now because of these inversions. Why do you think these somewhat tried and true signals seem to be misfiring? This time is different, and here's why. Number one, we've had a significant influx in immigration, which... It's influenced the unemployment rates. The denominator, the base of employees has increased. That's actually bullish for the economy because you can think about GDP as the product of labor and labor productivity. So the left-hand side of the equation has gone up. That's one. Number two, consumers refinanced. So consumers have locked in 2.5%, 3%, 30-year fixed-rate mortgages. I told my wife we're not moving where we live for 10, 15 years. So best trades we ever did. Meanwhile, the U.S. dollar depreciated 20% over the last four years. So the other factor is that household balance sheets are still at record levels in that household balance sheet consists of their home, consists of equities, which are at record highs. Real incomes are going up, of course, too. So, you know, the consumer is fine. It doesn't mean that everything's perfect. It's not. It is a K Street recovery. You can see that in weakness in areas and, you know, dollar general, dollar tree, etc. But two-thirds of the economy is actually driven by the top one-third of spenders. It's a key thing that people forget. So I believe that the other factor that's confused people is these leading indicators are off. Because the leading indicators overweight manufacturing data. And the United States has made this remarkable transition from a manufacturing-centric economy to a services-driven economy. People want experiences now. People want more healthcare. Healthcare as a percentage of GDP continues to grow. Yeah, and services as a percentage of GDP is like what, like two-thirds now or something? That's right. That's right. And look at restaurants. People are going out. They want to spend time with each other. So that's where you're actually seeing growth. It's not about goods. You know, the goods trade happened in COVID and people locked up their homes. They went on Amazon. They bought a lot of stuff, got shipped to their homes. So kind of today you're at 2019 levels. Look at the Visa consumer spend data year over year. You got 4% consumer spend growth, probably tracks to where nominal GDP growth is. It's one of my favorite real time indicators. The banks reported this morning, Wells Fargo CEO said the consumer is fine, JP Morgan saying the consumer is fine, of course the consumer is fine. So I think you're going to start to see the word Goldilocks emerge. I already saw last week, there's an article in Barron's about referencing the term Goldilocks was always cast in this era of skepticism. So users were Goldilocks. I said, well, maybe it's not Goldilocks. I think we are in Goldilocks now. The vibes are going to catch up. to the reality of the economic condition in the months and quarters ahead. Yeah. I mean, when you look at household balance sheets, like you're saying, and just the amount of demand for leverage and loans, it almost feels like we're at the beginning of a credit cycle, not at the end. And bank credit growth is increasing. I agree. Consumers can access more credit. The debt to income ratio of the consumer balance sheet, if you take the assets of the consumer at the bottom and you put their incomes on top, or the inverse of that ratio, you can They're fine. So the consumers have access to credit. When the consumers don't have access to credit, that's the time to be worried. Mortgage refinance applications have shot up. Now, they pulled back because mortgage rates started going up. Yeah, yeah. Because the Fed, in lowering the front end of the curve, scared the bond market, who's now concerned about inflation. So the Fed actually accomplished the opposite of what they intended to accomplish. They've actually created a tightening. Yeah, I tweeted about this the other week. It was almost like a hawkish 50-bips cut because of what happened to the long bond. So do you think they gave up on the 2% target by cutting 50 bips? Was that the admission? Or do you think they're just misreading the data? The Fed hasn't given up on the 2% target. The Fed knows that despite the talk of being a two-mandate mission, ultimately, the primary mandate is credibility. Because the Fed... Policy effectiveness turns on their credibility with the public. If the Fed has lost credibility in the public, and you can measure that through consumer inflation expectations, which are now creeping up again, then their policy effectiveness diminishes. So I think they take that seriously. And they also see more of the real-time data, which you alluded to around services coming in, the real-time rent data moves faster than the data that the Fed looks at. But they They believe that inflation has been won and they're tilting towards focusing on the labor side of the mandate. Yeah, and like you said, some of those labor signals are noisy and difficult to interpret. So, okay, we got the 50 bps cut. What do you think happens for the next six months here? Do you think they cut in November? Is that even relevant to your framework of what occurs? I think they will cut in November 25 bps. We have to take the data day by day. I don't think they should cut, but I think they will cut. it's quite interesting that there was one lone dissenting voice in the last FOMC meeting, as you can see from the transcripts, who argued that we don't need to cut Governor Bowman, and she was proven correct. It tells you the power of non-consensus thinking. Yeah. And then when you read the minutes, it was a lot more split than they made it seem. That's right. A lot more split. Now, by the way, these minutes are edited, modified nine ways to Sunday before they're released. And maybe there's a preview or signaling. around the approach the Fed will take, which might be a slower path to rate cuts. And this is significant because I do believe that over the last two years or so, the economy has recalibrated to a population of retirees and boomers who are funding their lifestyle off of low-risk treasuries that were paying off five points. It's great. Never been better to be a boomer. Now that you're cutting rates, those boomers have modified their spending behavior and investing behavior. So you're seeing high dividend yield stocks ramp like Philip Morris, up like 20 or 30% in a few months. High dividend yield stocks, they've got to substitute from a risk-free asset before inflation to equities to take on more risk to fund their income. So that's going to have some consequences. The Federal Reserve is now favoring borrowers and creditors. I don't think it's actually the healthiest move. You want to have an economy with a high real interest rate. You want to have an economy that doesn't encourage speculative investing in projects that don't make any sense. And here you are at all-time highs and the Fed is cutting rates. Yeah, yeah, insane. So I mean, with that discussion of, you know, secularly higher rates, one of the big discussions going on, and this is what's trying to, the Fed is trying to figure out is where the new neutral rate is in this new recalibrated economy that you're talking about. So, you know, we're all trying to fill our way around where this is, you know, the Fed funds rate, the terminal rate is roughly, you know, being priced around 3%, roughly, you know, in the recent SEP, they're around 2.9 on neutral. It almost feels like the market is starting to realize that it might even be higher than that. Do you think it's higher than that? And how does that reflect into your overall economic view? There is no neutral rate. It's a flawed academic model. And the reason why is the most significant driver to understand whether policy is easy or tight is called animal spirits. When people are excited, then they go spend. It doesn't matter what the interest rates are or they'll speculate. We saw that when the Fed was raising rates in the last one and a half years of the dot-com cycle. It doesn't matter. Speculation can continue. You saw that in 2006, 2007. You saw that in 9-11. After 9-11, animal spirits dampened. Consumers got on their turtle shells. And former president George Bush said, hey, Americans, get out and shop. So psychology... is the fundamental driver of beta and the Fed doesn't control that. There's a backdrop of these geopolitical risks. There's an election that's creating anxiety. So those are some of the reasons why animal spirits are kind of mixed right now. But there really is no neutral ray. This is what makes Fed policy standing central banking very difficult because let's say Trump gets elected, for example. Yeah. You know, we saw in 2016, there was a massive boost to animal spirits and you saw an incredible stock market rally after the kind of initial dump. Small business confidence increased as well. So if that were to happen, animal spirits would go up. I mean, it's another, you know, lever that's distinct from monetary policy and distinct from fiscal policy. You know, there's reasons why around the holidays you have unusual seasonal tendencies. Thanksgiving, Hanukkah, Christmas, New Year's, Memorial Day. These are generally bullish for markets. So yeah, there is no neutral, right? Yeah, interesting. So I mean, you mentioned there quickly about the election. How do you manage the dichotomy between the two potential outcomes? Does it really matter to you? Does it significantly affect your market views and where the economy headed? Or is it just both are going to be running a significant deficit and it's just about the way that that occurs? There's a short-term and long-term answer to that. In the long-term, it doesn't matter. The long-term driver of asset prices and stock prices, three variables. One is earnings. Two is valuation. Three is interest rates. Corporate earnings aren't influenced by whoever's in power. Markets like gridlock, actually. Markets don't like dramatic shifts in policy. They like stability. They like rule of law. They like clarity. In the short run, however, markets are driven by positioning and news flow. So if there's wrong way positioning, people are offsides and incoming news data suggests that they're offsides. For example, people are short China. Incoming news says China is going to stimulate and you have 30 percent plus short interest in the China indices and you're going to get a significant rally. So. That's what drives pricing in the short-term positioning, sentiment, news flow. So from an investor perspective, if you're in categories like energy, it matters. If you're in offshore drillers, then it matters. If you're in natural gas, it matters. If you're in digital assets, it matters. So the certain categories where it can matter. If you're in financial services, it might matter, although both... 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All right, back to the show. I want to shift gears here and... Talk a bit about how Lumina approaches asset allocation. And I want to start from the top level and then we can drill in deeper. So what's your perspective on just broad asset classes and how you look at them and how you decide how to weight them? It's a great question. So we form capital market expectations based on our assessment of valuation, earnings growth, and interest rates when it comes to stocks. You've got to look at how that trades off with fixed income assets. And we develop a view on where we think we are in the commodity cycle. I'd say the difference with us and others is that we're also trying to understand what is priced in, as opposed to being very static. This is a market that is hyper-accelerated. So you have moves that ordinarily would take two years, and they get done in two or three weeks. So you have to be tactical. High level, we have a bias to value right now. Growth stocks have had an incredible run. The growth to value ratio, if you look at, say, the S&P growth stock index versus the S&P value index, it's been diminishing. You're also seeing that in weakness in, say, software stocks or cloud stocks. So we think growth at a reasonable price or quality value, free cash flow and buybacks, that's the right way to position. There's a lot of analysis we do to arrive at that answer. So there's not like a spreadsheet with a couple of toggles, but we try to unpack the onion. level of time. Certainly you see that globally central banks are cutting. That should benefit commodities, for example, or commodity-linked producers. The geopolitical risk around Russia and Europe and the need that data centers have for energy, we believe, creates strong interest in natural gas. We like that as a theme. So that drives our approach. So it's not just looking at asset prices, valuation, earnings policy, but you have to also say, what What are the themes in the market? Like what's driving demand in the market? The number one theme that's driving markets today is AI, of course. You know, you see that with the poster child NVIDIA that's getting close to all-time highs. It's obviously been one of our picks. And you see that with the supply chain that follows NVIDIA that includes other folks in semiconductor category, other leaders, but also includes data centers. Data center related companies are doing well, both in public markets, private markets like Coreweave, we're also an investor. And then the utility companies, utility stocks have outperformed the S&P 500 dramatically handily, 30% plus. We actually sold our utility stocks. Do you think that was just people thinking there's going to be a recession and they piled in on utilities? Or do you think there's something else there? Say again? Do you think that people just thought there's going to be a recession so they piled in on utilities? Or do you think there's something more there? They see earnings growth. So the independent power producers in utilities, such as the Constellation Energies of the World and the VSTs of the World, they've done really well because they're inking deals with hyperscalers like Microsoft and Amazon that need insatiable amounts of energy to fuel AI. So that's the primary driver, right? You saw the headline, Microsoft inking a deal with Three Mile Island Nuclear Plant, Talon Energy, which is a name that we had to own this year. They had inked a deal with Amazon. So nuclear is back. We love that theme as well, the nuclear renaissance. So, but yeah, utilities have done well. But to your point, at the beginning of the year, I would have said overweight utilities. Now I don't own utilities. So we're more tactical and dynamic. That's because of the nature of markets today. There's this hot ball of liquidity that reprices assets quickly. You have a two or three week move like you saw in China. Then it gives back. Yeah. Two or three week move in small caps. And then it starts to soften. You saw a parabola in digital assets in May. Then that gives back. Yeah. So we're... We're responding to the condition of the market rather than trying to impose our will on how markets should behave. Yeah. I find an interesting example of that is I hear your personal opinions that it sounds like you're a believer in us seeing an AI-induced productivity boom and that it's the real deal. But then I also hear that you're more weighted to the value factor than the growth factor, which is kind of orthogonal to that. It's a very nuanced positioning. It's a great point. So I think the productivity boom today isn't actually driven by AI yet. Right. But The good is yet to come. I think this is driven by other factors. I think certainly founder-led business will be benefiting from that. But I still own growth names like NVIDIA, Meta, Google, App. And I believe they are cheaper than other names. And I don't mind paying for growth if they can deliver. So if you own a growth stock today, it's like you're hiring LeBron James on a $100 million contract. You need him to post triple doubles every night. If he does not, got to pull the plug. NVIDIA is cheaper than names like ARM. AMD has roughly the same 4 PE valuation as NVIDIA, which makes no sense. And so having exposure to that matters, but picking your spots carefully is important. NVIDIA is pulling away from the rest of the semiconductor category. It is our dominant position in semiconductors. And the earnings are keeping up. I want you to explain this a little bit. Because people will... We'll look at a chart of, I don't know, Cisco in 2000 or something and compare it to NVIDIA and say, oh, look, it's just the same repetition. But to your point, the earnings have actually been keeping up with the stock price. Like the 4B, there was a few times where stock was doubling, but I think the PE was actually going down. Can you explain that dynamic a bit? NVIDIA sells GPUs to the most cash flush organizations in the world, which are called these big tech companies like Microsoft, Amazon, Google, and Meta. who each independently have said, we're going to spend $50 to $100 billion in capital spending on AI. And they have to do it for existential reasons, because if they lose the race for AI, they get disrupted. If Google loses the race for AI, then their market cap in multiple compresses. If Apple loses the race for AI, then meta launches a new form factor. If Microsoft loses the race for AI, then Microsoft Office is irrelevant. I'm not even sure you need Microsoft Windows where we're going three years from now. So how much are you willing to invest to protect your market-dominant position? If your market cap is trillions of dollars, yes, you're going to spend $50 to $100 billion. And it legitimately is the future. I mean, we're using AI at Lumida's investment processes every single morning. I can see the analyst productivity rate of growth. So the point that people have missed is that NVIDIA's got tremendous earnings growth. I'm an investor in... Core, which NVIDIA is also backed, 90% of next year's revenue is fully accounted for. They have a backlog. They're saying, hey, get in line. So the demand is there. You've got Saudi Arabia that wants to build 60 data centers. They're asking the U.S. Department of Commerce for access to NVIDIA chips. NVIDIA and these AI chips are going to refactor how we think about defense. You're going to have more hive drone warfare. Driven by AI technology cyber security is gonna be factored AI You're gonna see a eyes a fraction of the defense budget in videos actually cheaper on a 4 PE basis Then it has been other points in history. Now our last buy was at 105. No our base is a lot lower than it is now So, you know how you enter these names matter, right? So our last buy was when there was concerns about antitrust risk, right? They said the DOJ is gonna the price didn't move for today. It dropped the two days is hanging out there Despite the fact that Nvidia refuted that allegation. Yeah. And so the bad news is there. Yeah. Bought that on discount. So, and then, you know, Google antitrust news, I think that's baked in. If Google's broken up, some of the parts worth more than the whole, it's a win there. If it's not broken up, then the narrative cloud lifts as a win there as well. You've got to have a long-term view. Yeah. Meta has incredible distribution through WhatsApp, Instagram, Facebook. and training data that gives them a competitive edge. So we think that OpenAI is boxed out, right? OpenAI is competing with Microsoft, their parent company, who's going after enterprise. They're competing with Meta, who's going after the consumer app. They're also competing with Google. So they are flanked on all sides, and they're blowing lots of money. on companies like CoreWeave to stay relevant. Yeah. I want to ask you a little bit more about some of the other factors that you look at. And just to give a bit of background for those that aren't in the trenches as much on modern asset allocation, it's largely looked at through a factor lens as opposed to years ago. We originally had the cap and model, which was like the market factor. But we've evolved to this world of having factor loadings, factor weightings that are the one we've been talking about is growth to value. There's also the momentum factor. There's large cap versus small cap. And then there's endless other factors. are deeper than just those big three-factor models. So what's your perspective on the other ones? And how do you reflect that in your asset allocation process? I live in factors. So factor investing is transforming modern investing. The difference I have with how others approach factors and others like Dimensional Fund Advisors, one of their founders got a Nobel Prize for discovering the Fama French model and the three-factor model, which you alluded to, Felix, is that we take views on factors. So some... Sometimes factors get overbought and I don't want to own the factor. So in early July, when you saw record call option buying in these MAG7 names, momentum factor was three standard deviations overbought. That was a time to de-risk. So you have to have views on factors. I like owning value today because with rate cuts, you're going to have value stocks that have more debt on their balance sheets, have the ability to refinance at lower rates, and that's going to drive incremental earnings. So there's an interaction of macro. and factors also. So there's quite a few factors that are out there. You have to study the interaction of these factors with the macro picture and then connect it with the best bottoms-up fundamental expression of the idea. So if momentum is overbought, that might not matter for a stock like Allstate or Arch Capital Group in the insurance category. They have momentum factor. Momentum pullback, they did not pull back. We own those names. I get my momentum factor, I get my value factor, I get my quality factor as well because they've got a moat. Yeah. Yeah. Yeah. And so just to compare how other asset allocation companies or just the broader world looks at factors, I believe it's more so they try to just isolate the specific factor and just basically weight themselves. They do a terrible job at that. They're not really expressing a view. This is what they do. I'm a recovering quant. I used to... A lot of blog posts on quant.stackexchange.com. You can check it out there. So... You know, modern portfolio theory hasn't really changed since Harry Markowitz, who won a Nobel Prize in the 1950s or so. What Harry Markowitz said is this. You develop a correlation matrix of how these securities co-vary with one another with one Zags and one Zigs. And you get expected returns and you solve this math function that minimizes risk and maximizes return per unit of risk. The problem with that is that these correlation matrices are backward looking and correlations change. Yeah. Yeah. Why do they change? Technology can cause correlations to change. Policy can cause correlations to change. The Federal Reserve can cause correlation change. Here's a simple example. In the COVID era of 2020, what happened? Zoom stock, Peloton stock, archetype stocks going up and to the right. The digital economy. Then when these vaccines rolled out, that was the top of the market. And they started collapsing. The factor model would take... a year to catch up would not understand yeah so the way i approach it is i integrate in a synthesis a coherent picture of the world that attempts to start with a top-down macro view what factors do i want to own what are the companies that give me the best expression of the factors you gotta look at the technos as well you wanna you wanna buy low and not chase overbought fomo conditions And then also consider events that can change movements. So geopolitical risk is high right now. That has created a bid for oil, for example. Yeah. I love that we're getting into the weeds here on the Kwon stuff a little bit. I can turn out with you on Kwon all day long. I love it. I love it. So I'm going to ask you one more question on this. And it's something that I've been wondering about as well as we're getting into this idea of these formulas that are the bedrock of modern portfolio management. One of them for me is these math functions you talk about, a lot of them are… built on a bedrock of standard deviation, which is built on a bedrock of normal distribution. What's your thoughts there? This is why quant models give a false seduction of clarity. And I say this as a recovering quant. I used to run the quant reading group in New York City sponsored by Morgan Stanley. We had my friends from Two Sigma and AQR and others there. The reality, as you pointed out, is that the distribution of returns is leptokurtotic. which means you have fat tails, number one. Number two, distributions have skew. So you can have certain assets that are more right-tailed. And you also have investors that have a preference for securities with certain kinds of distributions. I can see this in the data. So stocks that have high Sharpe ratios, investors tend to bid up those stocks. Investors also have the preference for stocks that have high Sharpe ratios. stocks that have a positive trend. Now, any technician could tell you this. Any investor could tell you this. But these normal distributions are not accurate. The statistical term that people use is called heteroscedasticity. You have time varying correlations. So traditional statistical techniques aren't terribly effective at modeling risk. You need like a Bayesian approach to model risk. There's a Nobel Prize won by Fisher Black. I believe Bob Litterman at Goldman, they created this way to develop a portfolio based on your views and introducing kind of like humility into your views so that the models aren't over-indexing to historical data. That's a better approach. But people have fallen in love. The funny thing about Goldman is that and it's kind of well-known, but like the Goldman private wealth group has lagged because of an over-reliance on these factors. Interesting. Right? So they're saying, well, statistically it's worked. And there's always a reason why it didn't work this year. So these factors are a tool. Yeah. They are not the end-all, be-all. They are good. It's a good framework. They're good guideposts to help you think about things. But there's no substitute for critical thinking. Yeah. Okay. So last question in this world. world of taking a look at quant models, do you think there's an over-reliance on risk-adjusted return as a metric? Because on the bedrock of that is Sharpe ratio, which is measured, again, by standard deviation, which, as we talked about, has some issues. Do you think it's just the way it's measured is not great? Or is it that there's just an over-reliance on adjusted return versus just absolute return? So the measurement could be improved, for sure, like Sortino ratio, which looks at the downside risk relative to return. and doesn't penalize upside risk is a better way to measure risk versus sharp ratio. Sharp ratio, for those who are listening, is the expected return divided by the standard deviation return. But do you really care about upside volatility? No. You care about downside volatility. You're excited for that. I'm excited about that. What you care about is drawdown risk because people have loss aversion. Statistically, especially Europeans, have heightened sensitivity to when prices drop versus when prices rise. They feel more pain. relative to the satisfaction when prices increase. I don't believe there's a mistaken focus on risk-adjusted return. In fact, that's exactly what investors should do, as opposed to focusing on total returns. Investors, especially speculative investors and retail traders, and often investors in digital assets, they believe they can get high total returns by focusing on assets that have historical high total returns that also... comes high total volatility. Actually, the better way to compound and grow wealth is focused on high risk-adjusted returns. So here's an image for you. Imagine inefficient frontiers, which you learn in kind of portfolio finance theory, right? X-axis, you've got volatility. Y-axis, you've got expected return. And you've got this kind of concave down chart. What most people do is they find that kind of return maximizing point, which is paired with a lot of volatility. What I try to do is find that. that tangency asset where I can get high return per unit of risk. By the way, that's what Warren Buffett does. Warren Buffett, he'll own stocks with reliable earnings that have less risk, but then he borrows AAA-rated debt that he can get an expense from. By the way, he just reissued bonds in Japan at a very low cost that's below the rate of inflation. So he's borrowing at a negative real rate. And what he's doing is he's extending the line. You learn this all kind of corporate finance 101, portfolio theory 101. that's actually the right strategy. That's actually the right approach to take. I bought CVS end of May, it's bombed out, bad news priced in. So let me learn about this business. Got a lot of free cashflow. Stock hasn't been this cheap in 10, 15 years. They're protected from insurance. They own Aetna. If they renamed to Aetna, the stock would go up 30% probably in a day. People forgot about that. And that's being the S&P since we bought it for half the time. And the risk adjusted return was higher. Now I don't do this. But for someone that wanted a higher total return that would, quote, unquote, run faster, theoretically, you might buy in the money long dated call options that would allow you to do what Buffett is doing as opposed to trying to find a high volatile asset, which statistically will actually not deliver the expected return you want. This is what document literature is called the low vol anomaly. It led to the rise of risk parity strategies. Right. Lower vol assets. perform higher velocities. Yeah. Okay. So that's a really good primer for the fact that we're actually talking at a crypto conference. So I want to talk about a few things here. The first is this idea of risk-adjusted return. I rant on this quite a bit in terms of the digital asset space because everyone's obsessed with absolute return. And my personal framework sometimes is when I take profit on, I don't know, Bitcoin or something like that, I actually just move it into equities. And sometimes people get confused by that, but it's just, for me, it's... lowering my beta and just kind of securing that. I would love for you to unpack your perspective on digital assets and crypto and also how you manage these dynamics of it's a highly volatile asset. We just talked about this low volatility anomaly and how you can get really high sharps there. But we're talking at a conference that is probably the polar opposite. So how do you navigate that? I'm probably one of the few people that have learned from the Oracle of Omaha. And also see the thesis around digital assets. And I grew up at Merrill Lynch in 2008. So I saw what happens when banks don't trust one another. They don't finance each other overnight. And you have lack of transparency on these subprime securitizations that almost took down the banking system. What I see in digital assets is the promise of transparent settlement that doesn't have a trust requirement on a counterparty. You can put it all on chain. We still don't know where the Pentagon spent a trillion dollars, by the way. Why isn't that all on chain, right? You see corruption in different areas, put it all on chain. So now let me answer your question. So, you know, my framework for thinking about asset classes, inspired by Hyman Minsky, the Minsky hypothesis. I have a little variation on it. So I'll tell you kind of my, he has a three-phase framework. We'll get into that if you want, I have a four-phase framework. But, you know, the time when you want to really leg into digital assets or other asset classes. It's called the when all the bad news is priced in. Phase one, when it's hated. It's hated and it's disgusting to own. And it's shameful to own. You don't tell your friends you want to own it. When I bought CVS, I called up three of my smart buddies, professional investors. So what do you think about CVS? I laid out my thesis. They all hated it. I said, all right, that's the buy trigger. I did mine else, of course, right? So that's phase one. The next phase is you climb a wall of worry. There's skepticism. So that's the next phase. What's happening there is shorts are shorting and they're getting squeezed on the way up. That's actually creating a bid for the security. So then the next phase is when you have kind of this optimism phase that sets in and you got to transition to a momentum market. So momentum market gets going then. And then you want to stay in and hang until you see the parabola. The parabola is when you get euphoria. Before you want to get out, there's a wonderful, wonderful quote by Sir John Templeton. He says, bear markets end in pessimism. They climb a wall of skepticism. They mature on optimism, and they end in euphoria. If I could tattoo that on my long legs, I would absolutely do that. It also brings in the idea of sentiment and the importance of positioning and variant perception. Think about those back to that earlier framework. How do you think about what asset classes to focus on at different times. You know, I bought MUFG Bank in Japan last week. People forgot about Japan. Japan had a big correction off the ZN Carry trade on why I'm in Japan. I wasn't in Japan when people were hyping it over the last year or so. Yeah. Yeah. So how do you-Or China, same thing. We were in China in early Feb before David Tepper was on CNBC. People hated it. Yeah. Now when it's on all the headlines, then you know it's efficiently priced or overvalued and I'd rather sell to them. Yeah. Ben Graham said once, Mr. Market shows up on your door and spits prices at you. You can choose which ball you want to swing at. Sometimes the prices are high. Sometimes they're low. When they're low, I want to buy. You make your money on the buy. Then you wait for Mr. Market to catch up to you. If the prices are high, I'm going to sell. Yeah. So how do you yourself measure your allocations towards digital assets? Do you really focus on the position sizing? Do you really focus on… you know, risk management and getting into these ideas. We're talking about a risk-adjusted return, which also can be kind of difficult because it depends on, you know, how you're measuring as your benchmark. Is it just like Bitcoin as your benchmark? I love for you-Phenomenal questions. Yeah, benchmark. I truly enjoy these. So-Thank you. First off, we start with our client because we have to focus on honoring our client's objectives. We build investment policy statement, identify what their risk tolerance is, return objectives, liquidity needs, unique circumstances, and other considerations. So that's number one, right? Make sure that your clients have safety and can accomplish their important objectives. Then number two, solve for lifestyle. Make sure their lifestyle is not going to be impaired by investment strategy. So you have to deck investment strategies against those first two buckets. And after you've solved for that, then you can have a conversation around aspirational investment strategies. You shouldn't have a high-risk strategy unless you've known that you've defeased or de-risked your... ability to accomplish your safety objectives, save for a house, pay for your kid's tuition, and your lifestyle objectives, enjoy travel and leisure with your spouse. So it varies based on the client. The other consideration... is taxes. I believe we're past mid-cycle on digital assets. That means I believe that if I buy a position today, then I'm going to sell inside 12 months, I'm going to have to pay taxes on that. So where do you put that position, in a taxable or non-taxable account? It's one of the reasons why I'm contemplating launching ETF, because the IRS does not tax in-kind transactions, which is an incredible form of tax alpha. So my approach to digital assets is highly tactical, just given where we are. We were doing the discount to NAV trades like GPTC, and ETHG. We sold those in May of this year, continue to rotate out as our clients get to long-term capital gains. And those were a core position. Now we are tactical, finding tactical opportunities from time to time. The last tactic we did was in June, we bought and then we sold two days before Trump spoke at the Bitcoin conference. Sell the news. Yeah. Yeah. So, you know, just wrapping up, I just want to get your take on where we are in with respect to that cycle that you laid out. You know, are we about to... transition to the momentum phase or are we actually already seeing the parabola and now we're just sort of slowly bleeding lower objectively speaking we have seen a problem we saw a problem in may uh so that's happened now take you know nvidia had a problem in june took a few months to work off now we're back china had a problem in march took a few months now we're back so uh i think a lot's going to turn on the election yeah if trump wins i think think you're going to see an increase in the ETH to BTC ratio that'll be significant. And I think you're going to possibly see year-end euphoria. And actually, you might want to sell that counterintuitively. I'm still working through this, by the way. I might revise my views three ways to whatever two weeks from now. You got to be dynamic, right? So however, if candidate Harris wins, then the question turns on who will be her SEC appointment. One candidate, I'm told, is actually a former... former digital asset founder, which would be actually bullish and not priced in. On the other hand, if it's a Warren nominee, well, that would be terrible and awful. Totally. But the key unlock for digital assets is rational policy. We don't have that right now. No. I wrote an op-ed with the former SEC chair in the Wall Street Journal with Arthur Levitt. He's one of our Lumida investors, critiquing the current SEC for not providing interpretive guidance, clarity of the road, and not enabling... in a creator economy to tokenize intellectual property. We have David Bowie bonds that are helping institutions make money and Marvel Common. That's when I was at Merrill. Merrill securitized Marvel IP, which then created Iron Man, all these movies. And here you've got creators that are trapped using these gatekeepers like Instagram and TikTok as opposed to pushing the economics and the creativity out to the long tail. the next 1,000 Taylor Swifts that can get underwritten by their fan base. I think that's the promise of digital assets and a rational digital asset securities law policy. Yeah. Well said. Cool. Well, look, it's been so fun to do this in person. Always a pleasure, Felix. Thank you. Yeah. And just for the audience, where can they find more about your work? Thank you. Well, you can follow me on Twitter at Ram Alawalia. You can also go to LumidaWealth.com. I have a podcast called Lumida Non-Consensus Investing. also on TikTok. I would encourage you to sign up for our Lumida ledger. I publish it every Sunday at 12 o'clock. We share our macro views. We talk about certain stocks and themes and AI as well. We have a Telegram group. So a lot of ways you can find us. We try to meet the customer wherever they live. Awesome. Well, thanks again. That was great. There's over 500 protocols building on Polkadot, and one of them is called Polymech. Polymech is a decentralized community-driven funding protocol on Polkadot, enabling... regulatory compliant and transparent fundraising a web3 polymech ensures compliance with a novel kyc aml process facilitating a trustless and automated funding process from fundraising to token distribution by removing intermediaries polymech offers accessible inclusive and transparent funding opportunities for all participants powered by polka dot polymech

It's not. It's a reflection of the economy having a higher return on capital, a higher productivity rate. That's bullish for the economy. I think we are in Goldilocks now. Hey, everyone.

This episode is sponsored by Polkadot. Polkadot is the largest community DAO empowering 1.3 million dot holders to shape the future of the network through active participation. With over 500 applications backed by over $6 billion in shared security, Polkadot's adaptable technology powers a diverse ecosystem from DeFi to AI. Join the Polkadot DAO and be part of that transformation. This episode is sponsored by Mantra.

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It's great to have you here. How's it going? Good to see you again, Felix.

Doing well. Thank you. Yeah, yeah.

Good to have you. You were on our roundup a few weeks ago. It was a ton of fun.

I saw you were speaking here, and I just had to come. get you in here and chat with you. Always great to meet in person too.

Yeah, that as well. Love your hat. I almost wore the same one. Well, you know, this is a top signal for VCs and crypto, obviously. If you see VC with Pat, you're supposed to go max sell.

That sounds about right. Ron, for those that don't know you, do you just want to intro yourself, what you focus on and what you do at Lumida? Sure.

I lead Lumida Wealth. We're a private wealth management firm. We're reimagining, reinventing wealth management. Most of our clients are founders, exited founders that created wealth as entrepreneurs or in digital assets.

And we're cross-asset class investors. So as we invest across... public equities.

We invest in distressed commercial real estate through third-party managers. We invest in private credit. We take a thematic approach to investing. Really enjoy what we're doing. We've been having a great two years since we started.

That's awesome. Sweet. Well, I want to start our discussion by just looking at some broad macro ideas and what we've been seeing here. I'll just run through a couple of economic data points that we've gotten this week. Yesterday was the inflation print that came out on a month-for-month basis.

We saw that come in at 0.3%. which was 10 bps above what was expectations. In the same vein, the headline month over month came in at 0.2, which is also 10 bps above.

When you dig a bit more into the granular data, services are actually below expectations, but core goods came in slightly above expectations. We've seen that shelter, which has just been one of the stickiest and largest components of inflation, owners equivalent rent and all of that. After a rebound last month, we actually saw that, you know, downtick lower.

Just this morning, we got PPI, which came in On month over month, headline PPI came in at 0%, which was below expectations. And, you know, always good when you see a zero on that one. So, you know, with that context in mind, I would just love to hear what's your broad macro view of the economy and markets today? Overall, you know, we've been consistently of the view that we have got a strong economy that's going through a process of normalization, right?

We saw a jobs print of 250,000 on a few weeks, one week ago. And the economy is strong. I think there's been a lot of consternation around weakness in the economy, and people are reading too much negative data on things like rising consumer credit delinquencies. The reality is, number one, corporate earnings are strong. They've exceeded expectations in the last quarter.

I think they will do fine this quarter. The reason why that matters is that corporates don't fire, they don't cut workers when they're growing earnings. They want to invest in their businesses.

and job losses are necessary to get a recession. So that's one. Two, you've got the Fed that's cutting rates. I believe they're adding fuel to the fire on a relatively robust economy. Three, you've had an influx of immigration that helps to offset labor wage price increases.

That's actually bullish for the economy. And at the same time, you're seeing real wages increase. So if you take the kind of nominal wages, less inflation, you're seeing real incomes go up.

We've seen several months in a row of retail sales data beats. There have been shifts in consumer spending patterns, less from goods and manufactured products, more to services. I think that's confused people. But overall, that's robust. I expect that we'll see continued strength in retail spending in Q4, starting to pick up some more retailers as a result.

The banks are healing also. So, you know, there's an economic side. There's a lot to be excited about on the market side. Markets are now concerned about rising inflation. So after we saw that nonfarm payrolls beat, which was significant, what you've seen is the 10 year rate has gone up.

So bond prices are starting to account for higher inflation rates. You've seen the U.S. dollar increase. You've seen expectations of Fed rate cuts diminish from 50 bps to 25 bps.

The next time the FOMC meets, that's partially why the dollar is increasing. You're also seeing commodities like natural gas, oil, and uranium roll over somewhat. We're still bullish those kinds of themes for various reasons. But that's what the market is saying.

The market is saying, hey, the Fed may have made a mistake here. So you think 50 bips was a mistake? It's not just that long bonds are reflecting that the Fed are getting underneath us aggressively enough. It actually was a mistake. The Fed cut rates.

It was a mistake. It was a head fake. And they overreacted. We are seeing significant productivity growth. We haven't seen this kind of productivity growth since the late 90s, when you also had the emergence of technology that led then to the internet era.

Productivity growth is important because it allows corporates to grow earnings without laying off workers. And it also allows workers to increase their real wages. So it's the only free lunch in economics. So we are entering a productivity boom that's exciting, that's bullish.

And the reason why the Fed cut rates, the only theory I can find for why the Fed is cutting rates and people talking about, is that the so-called real interest rate is too high. I mean, you take the nominal interest rate, call it your Fed funds rate, and you less inflation. And that is at a level that is elevated.

By the way, we also have these kinds of high real interest rates. in the late 90s where you had this productivity boom. So a higher real interest rate is not a reflection of the economy being restrictive. It's not. It's a reflection of the economy having a higher return on capital, a higher productivity rate.

That's bullish for the economy. Yeah, yeah. It seems like there's a lot of noise right now in a lot of the economic data.

So I know when you were on the Roundup a few weeks ago, this was at a time before we got the super hot jobs report, but... At that time, there was a lot of discussion of dynamics like the SOM rule, which got triggered. And interesting enough, after last week's report, it actually reversed the trigger.

You look at the yield curve inversions. People have been saying there's going to be a recession imminently for almost two years now because of these inversions. Why do you think these somewhat tried and true signals seem to be misfiring?

This time is different, and here's why. Number one, we've had a significant influx in immigration, which... It's influenced the unemployment rates. The denominator, the base of employees has increased.

That's actually bullish for the economy because you can think about GDP as the product of labor and labor productivity. So the left-hand side of the equation has gone up. That's one.

Number two, consumers refinanced. So consumers have locked in 2.5%, 3%, 30-year fixed-rate mortgages. I told my wife we're not moving where we live for 10, 15 years.

So best trades we ever did. Meanwhile, the U.S. dollar depreciated 20% over the last four years. So the other factor is that household balance sheets are still at record levels in that household balance sheet consists of their home, consists of equities, which are at record highs.

Real incomes are going up, of course, too. So, you know, the consumer is fine. It doesn't mean that everything's perfect.

It's not. It is a K Street recovery. You can see that in weakness in areas and, you know, dollar general, dollar tree, etc.

But two-thirds of the economy is actually driven by the top one-third of spenders. It's a key thing that people forget. So I believe that the other factor that's confused people is these leading indicators are off.

Because the leading indicators overweight manufacturing data. And the United States has made this remarkable transition from a manufacturing-centric economy to a services-driven economy. People want experiences now. People want more healthcare.

Healthcare as a percentage of GDP continues to grow. Yeah, and services as a percentage of GDP is like what, like two-thirds now or something? That's right.

That's right. And look at restaurants. People are going out.

They want to spend time with each other. So that's where you're actually seeing growth. It's not about goods. You know, the goods trade happened in COVID and people locked up their homes.

They went on Amazon. They bought a lot of stuff, got shipped to their homes. So kind of today you're at 2019 levels.

Look at the Visa consumer spend data year over year. You got 4% consumer spend growth, probably tracks to where nominal GDP growth is. It's one of my favorite real time indicators.

The banks reported this morning, Wells Fargo CEO said the consumer is fine, JP Morgan saying the consumer is fine, of course the consumer is fine. So I think you're going to start to see the word Goldilocks emerge. I already saw last week, there's an article in Barron's about referencing the term Goldilocks was always cast in this era of skepticism.

So users were Goldilocks. I said, well, maybe it's not Goldilocks. I think we are in Goldilocks now. The vibes are going to catch up. to the reality of the economic condition in the months and quarters ahead.

Yeah. I mean, when you look at household balance sheets, like you're saying, and just the amount of demand for leverage and loans, it almost feels like we're at the beginning of a credit cycle, not at the end. And bank credit growth is increasing. I agree.

Consumers can access more credit. The debt to income ratio of the consumer balance sheet, if you take the assets of the consumer at the bottom and you put their incomes on top, or the inverse of that ratio, you can They're fine. So the consumers have access to credit.

When the consumers don't have access to credit, that's the time to be worried. Mortgage refinance applications have shot up. Now, they pulled back because mortgage rates started going up.

Yeah, yeah. Because the Fed, in lowering the front end of the curve, scared the bond market, who's now concerned about inflation. So the Fed actually accomplished the opposite of what they intended to accomplish.

They've actually created a tightening. Yeah, I tweeted about this the other week. It was almost like a hawkish 50-bips cut because of what happened to the long bond. So do you think they gave up on the 2% target by cutting 50 bips? Was that the admission?

Or do you think they're just misreading the data? The Fed hasn't given up on the 2% target. The Fed knows that despite the talk of being a two-mandate mission, ultimately, the primary mandate is credibility. Because the Fed...

Policy effectiveness turns on their credibility with the public. If the Fed has lost credibility in the public, and you can measure that through consumer inflation expectations, which are now creeping up again, then their policy effectiveness diminishes. So I think they take that seriously.

And they also see more of the real-time data, which you alluded to around services coming in, the real-time rent data moves faster than the data that the Fed looks at. But they They believe that inflation has been won and they're tilting towards focusing on the labor side of the mandate. Yeah, and like you said, some of those labor signals are noisy and difficult to interpret.

So, okay, we got the 50 bps cut. What do you think happens for the next six months here? Do you think they cut in November? Is that even relevant to your framework of what occurs? I think they will cut in November 25 bps.

We have to take the data day by day. I don't think they should cut, but I think they will cut. it's quite interesting that there was one lone dissenting voice in the last FOMC meeting, as you can see from the transcripts, who argued that we don't need to cut Governor Bowman, and she was proven correct. It tells you the power of non-consensus thinking. Yeah.

And then when you read the minutes, it was a lot more split than they made it seem. That's right. A lot more split. Now, by the way, these minutes are edited, modified nine ways to Sunday before they're released. And maybe there's a preview or signaling.

around the approach the Fed will take, which might be a slower path to rate cuts. And this is significant because I do believe that over the last two years or so, the economy has recalibrated to a population of retirees and boomers who are funding their lifestyle off of low-risk treasuries that were paying off five points. It's great.

Never been better to be a boomer. Now that you're cutting rates, those boomers have modified their spending behavior and investing behavior. So you're seeing high dividend yield stocks ramp like Philip Morris, up like 20 or 30% in a few months.

High dividend yield stocks, they've got to substitute from a risk-free asset before inflation to equities to take on more risk to fund their income. So that's going to have some consequences. The Federal Reserve is now favoring borrowers and creditors.

I don't think it's actually the healthiest move. You want to have an economy with a high real interest rate. You want to have an economy that doesn't encourage speculative investing in projects that don't make any sense. And here you are at all-time highs and the Fed is cutting rates. Yeah, yeah, insane.

So I mean, with that discussion of, you know, secularly higher rates, one of the big discussions going on, and this is what's trying to, the Fed is trying to figure out is where the new neutral rate is in this new recalibrated economy that you're talking about. So, you know, we're all trying to fill our way around where this is, you know, the Fed funds rate, the terminal rate is roughly, you know, being priced around 3%, roughly, you know, in the recent SEP, they're around 2.9 on neutral. It almost feels like the market is starting to realize that it might even be higher than that. Do you think it's higher than that?

And how does that reflect into your overall economic view? There is no neutral rate. It's a flawed academic model. And the reason why is the most significant driver to understand whether policy is easy or tight is called animal spirits.

When people are excited, then they go spend. It doesn't matter what the interest rates are or they'll speculate. We saw that when the Fed was raising rates in the last one and a half years of the dot-com cycle. It doesn't matter. Speculation can continue.

You saw that in 2006, 2007. You saw that in 9-11. After 9-11, animal spirits dampened. Consumers got on their turtle shells.

And former president George Bush said, hey, Americans, get out and shop. So psychology... is the fundamental driver of beta and the Fed doesn't control that. There's a backdrop of these geopolitical risks. There's an election that's creating anxiety.

So those are some of the reasons why animal spirits are kind of mixed right now. But there really is no neutral ray. This is what makes Fed policy standing central banking very difficult because let's say Trump gets elected, for example. Yeah.

You know, we saw in 2016, there was a massive boost to animal spirits and you saw an incredible stock market rally after the kind of initial dump. Small business confidence increased as well. So if that were to happen, animal spirits would go up.

I mean, it's another, you know, lever that's distinct from monetary policy and distinct from fiscal policy. You know, there's reasons why around the holidays you have unusual seasonal tendencies. Thanksgiving, Hanukkah, Christmas, New Year's, Memorial Day. These are generally bullish for markets. So yeah, there is no neutral, right?

Yeah, interesting. So I mean, you mentioned there quickly about the election. How do you manage the dichotomy between the two potential outcomes?

Does it really matter to you? Does it significantly affect your market views and where the economy headed? Or is it just both are going to be running a significant deficit and it's just about the way that that occurs?

There's a short-term and long-term answer to that. In the long-term, it doesn't matter. The long-term driver of asset prices and stock prices, three variables. One is earnings. Two is valuation.

Three is interest rates. Corporate earnings aren't influenced by whoever's in power. Markets like gridlock, actually. Markets don't like dramatic shifts in policy. They like stability.

They like rule of law. They like clarity. In the short run, however, markets are driven by positioning and news flow.

So if there's wrong way positioning, people are offsides and incoming news data suggests that they're offsides. For example, people are short China. Incoming news says China is going to stimulate and you have 30 percent plus short interest in the China indices and you're going to get a significant rally. So.

That's what drives pricing in the short-term positioning, sentiment, news flow. So from an investor perspective, if you're in categories like energy, it matters. If you're in offshore drillers, then it matters.

If you're in natural gas, it matters. If you're in digital assets, it matters. So the certain categories where it can matter. If you're in financial services, it might matter, although both... Parties seem to be relaxing capital rules for banks Powered by Polkadot, OriginTrail enhances the discoverability of crucial knowledge and secures information in the AI era.

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All right, back to the show. I want to shift gears here and... Talk a bit about how Lumina approaches asset allocation. And I want to start from the top level and then we can drill in deeper. So what's your perspective on just broad asset classes and how you look at them and how you decide how to weight them?

It's a great question. So we form capital market expectations based on our assessment of valuation, earnings growth, and interest rates when it comes to stocks. You've got to look at how that trades off with fixed income assets.

And we develop a view on where we think we are in the commodity cycle. I'd say the difference with us and others is that we're also trying to understand what is priced in, as opposed to being very static. This is a market that is hyper-accelerated. So you have moves that ordinarily would take two years, and they get done in two or three weeks.

So you have to be tactical. High level, we have a bias to value right now. Growth stocks have had an incredible run.

The growth to value ratio, if you look at, say, the S&P growth stock index versus the S&P value index, it's been diminishing. You're also seeing that in weakness in, say, software stocks or cloud stocks. So we think growth at a reasonable price or quality value, free cash flow and buybacks, that's the right way to position.

There's a lot of analysis we do to arrive at that answer. So there's not like a spreadsheet with a couple of toggles, but we try to unpack the onion. level of time. Certainly you see that globally central banks are cutting. That should benefit commodities, for example, or commodity-linked producers.

The geopolitical risk around Russia and Europe and the need that data centers have for energy, we believe, creates strong interest in natural gas. We like that as a theme. So that drives our approach.

So it's not just looking at asset prices, valuation, earnings policy, but you have to also say, what What are the themes in the market? Like what's driving demand in the market? The number one theme that's driving markets today is AI, of course. You know, you see that with the poster child NVIDIA that's getting close to all-time highs. It's obviously been one of our picks.

And you see that with the supply chain that follows NVIDIA that includes other folks in semiconductor category, other leaders, but also includes data centers. Data center related companies are doing well, both in public markets, private markets like Coreweave, we're also an investor. And then the utility companies, utility stocks have outperformed the S&P 500 dramatically handily, 30% plus. We actually sold our utility stocks.

Do you think that was just people thinking there's going to be a recession and they piled in on utilities? Or do you think there's something else there? Say again?

Do you think that people just thought there's going to be a recession so they piled in on utilities? Or do you think there's something more there? They see earnings growth.

So the independent power producers in utilities, such as the Constellation Energies of the World and the VSTs of the World, they've done really well because they're inking deals with hyperscalers like Microsoft and Amazon that need insatiable amounts of energy to fuel AI. So that's the primary driver, right? You saw the headline, Microsoft inking a deal with Three Mile Island Nuclear Plant, Talon Energy, which is a name that we had to own this year.

They had inked a deal with Amazon. So nuclear is back. We love that theme as well, the nuclear renaissance. So, but yeah, utilities have done well. But to your point, at the beginning of the year, I would have said overweight utilities.

Now I don't own utilities. So we're more tactical and dynamic. That's because of the nature of markets today. There's this hot ball of liquidity that reprices assets quickly.

You have a two or three week move like you saw in China. Then it gives back. Yeah.

Two or three week move in small caps. And then it starts to soften. You saw a parabola in digital assets in May. Then that gives back. Yeah.

So we're... We're responding to the condition of the market rather than trying to impose our will on how markets should behave. Yeah. I find an interesting example of that is I hear your personal opinions that it sounds like you're a believer in us seeing an AI-induced productivity boom and that it's the real deal. But then I also hear that you're more weighted to the value factor than the growth factor, which is kind of orthogonal to that.

It's a very nuanced positioning. It's a great point. So I think the productivity boom today isn't actually driven by AI yet. Right.

But The good is yet to come. I think this is driven by other factors. I think certainly founder-led business will be benefiting from that. But I still own growth names like NVIDIA, Meta, Google, App.

And I believe they are cheaper than other names. And I don't mind paying for growth if they can deliver. So if you own a growth stock today, it's like you're hiring LeBron James on a $100 million contract. You need him to post triple doubles every night.

If he does not, got to pull the plug. NVIDIA is cheaper than names like ARM. AMD has roughly the same 4 PE valuation as NVIDIA, which makes no sense. And so having exposure to that matters, but picking your spots carefully is important. NVIDIA is pulling away from the rest of the semiconductor category.

It is our dominant position in semiconductors. And the earnings are keeping up. I want you to explain this a little bit. Because people will...

We'll look at a chart of, I don't know, Cisco in 2000 or something and compare it to NVIDIA and say, oh, look, it's just the same repetition. But to your point, the earnings have actually been keeping up with the stock price. Like the 4B, there was a few times where stock was doubling, but I think the PE was actually going down. Can you explain that dynamic a bit? NVIDIA sells GPUs to the most cash flush organizations in the world, which are called these big tech companies like Microsoft, Amazon, Google, and Meta.

who each independently have said, we're going to spend $50 to $100 billion in capital spending on AI. And they have to do it for existential reasons, because if they lose the race for AI, they get disrupted. If Google loses the race for AI, then their market cap in multiple compresses. If Apple loses the race for AI, then meta launches a new form factor. If Microsoft loses the race for AI, then Microsoft Office is irrelevant.

I'm not even sure you need Microsoft Windows where we're going three years from now. So how much are you willing to invest to protect your market-dominant position? If your market cap is trillions of dollars, yes, you're going to spend $50 to $100 billion. And it legitimately is the future.

I mean, we're using AI at Lumida's investment processes every single morning. I can see the analyst productivity rate of growth. So the point that people have missed is that NVIDIA's got tremendous earnings growth. I'm an investor in... Core, which NVIDIA is also backed, 90% of next year's revenue is fully accounted for.

They have a backlog. They're saying, hey, get in line. So the demand is there. You've got Saudi Arabia that wants to build 60 data centers.

They're asking the U.S. Department of Commerce for access to NVIDIA chips. NVIDIA and these AI chips are going to refactor how we think about defense.

You're going to have more hive drone warfare. Driven by AI technology cyber security is gonna be factored AI You're gonna see a eyes a fraction of the defense budget in videos actually cheaper on a 4 PE basis Then it has been other points in history. Now our last buy was at 105. No our base is a lot lower than it is now So, you know how you enter these names matter, right? So our last buy was when there was concerns about antitrust risk, right? They said the DOJ is gonna the price didn't move for today.

It dropped the two days is hanging out there Despite the fact that Nvidia refuted that allegation. Yeah. And so the bad news is there. Yeah. Bought that on discount.

So, and then, you know, Google antitrust news, I think that's baked in. If Google's broken up, some of the parts worth more than the whole, it's a win there. If it's not broken up, then the narrative cloud lifts as a win there as well. You've got to have a long-term view.

Yeah. Meta has incredible distribution through WhatsApp, Instagram, Facebook. and training data that gives them a competitive edge. So we think that OpenAI is boxed out, right?

OpenAI is competing with Microsoft, their parent company, who's going after enterprise. They're competing with Meta, who's going after the consumer app. They're also competing with Google.

So they are flanked on all sides, and they're blowing lots of money. on companies like CoreWeave to stay relevant. Yeah.

I want to ask you a little bit more about some of the other factors that you look at. And just to give a bit of background for those that aren't in the trenches as much on modern asset allocation, it's largely looked at through a factor lens as opposed to years ago. We originally had the cap and model, which was like the market factor. But we've evolved to this world of having factor loadings, factor weightings that are the one we've been talking about is growth to value. There's also the momentum factor.

There's large cap versus small cap. And then there's endless other factors. are deeper than just those big three-factor models.

So what's your perspective on the other ones? And how do you reflect that in your asset allocation process? I live in factors. So factor investing is transforming modern investing.

The difference I have with how others approach factors and others like Dimensional Fund Advisors, one of their founders got a Nobel Prize for discovering the Fama French model and the three-factor model, which you alluded to, Felix, is that we take views on factors. So some... Sometimes factors get overbought and I don't want to own the factor.

So in early July, when you saw record call option buying in these MAG7 names, momentum factor was three standard deviations overbought. That was a time to de-risk. So you have to have views on factors.

I like owning value today because with rate cuts, you're going to have value stocks that have more debt on their balance sheets, have the ability to refinance at lower rates, and that's going to drive incremental earnings. So there's an interaction of macro. and factors also. So there's quite a few factors that are out there.

You have to study the interaction of these factors with the macro picture and then connect it with the best bottoms-up fundamental expression of the idea. So if momentum is overbought, that might not matter for a stock like Allstate or Arch Capital Group in the insurance category. They have momentum factor. Momentum pullback, they did not pull back.

We own those names. I get my momentum factor, I get my value factor, I get my quality factor as well because they've got a moat. Yeah.

Yeah. Yeah. And so just to compare how other asset allocation companies or just the broader world looks at factors, I believe it's more so they try to just isolate the specific factor and just basically weight themselves. They do a terrible job at that. They're not really expressing a view.

This is what they do. I'm a recovering quant. I used to...

A lot of blog posts on quant.stackexchange.com. You can check it out there. So... You know, modern portfolio theory hasn't really changed since Harry Markowitz, who won a Nobel Prize in the 1950s or so.

What Harry Markowitz said is this. You develop a correlation matrix of how these securities co-vary with one another with one Zags and one Zigs. And you get expected returns and you solve this math function that minimizes risk and maximizes return per unit of risk.

The problem with that is that these correlation matrices are backward looking and correlations change. Yeah. Yeah. Why do they change?

Technology can cause correlations to change. Policy can cause correlations to change. The Federal Reserve can cause correlation change.

Here's a simple example. In the COVID era of 2020, what happened? Zoom stock, Peloton stock, archetype stocks going up and to the right. The digital economy.

Then when these vaccines rolled out, that was the top of the market. And they started collapsing. The factor model would take... a year to catch up would not understand yeah so the way i approach it is i integrate in a synthesis a coherent picture of the world that attempts to start with a top-down macro view what factors do i want to own what are the companies that give me the best expression of the factors you gotta look at the technos as well you wanna you wanna buy low and not chase overbought fomo conditions And then also consider events that can change movements. So geopolitical risk is high right now.

That has created a bid for oil, for example. Yeah. I love that we're getting into the weeds here on the Kwon stuff a little bit. I can turn out with you on Kwon all day long.

I love it. I love it. So I'm going to ask you one more question on this. And it's something that I've been wondering about as well as we're getting into this idea of these formulas that are the bedrock of modern portfolio management. One of them for me is these math functions you talk about, a lot of them are… built on a bedrock of standard deviation, which is built on a bedrock of normal distribution.

What's your thoughts there? This is why quant models give a false seduction of clarity. And I say this as a recovering quant.

I used to run the quant reading group in New York City sponsored by Morgan Stanley. We had my friends from Two Sigma and AQR and others there. The reality, as you pointed out, is that the distribution of returns is leptokurtotic. which means you have fat tails, number one.

Number two, distributions have skew. So you can have certain assets that are more right-tailed. And you also have investors that have a preference for securities with certain kinds of distributions. I can see this in the data.

So stocks that have high Sharpe ratios, investors tend to bid up those stocks. Investors also have the preference for stocks that have high Sharpe ratios. stocks that have a positive trend.

Now, any technician could tell you this. Any investor could tell you this. But these normal distributions are not accurate. The statistical term that people use is called heteroscedasticity.

You have time varying correlations. So traditional statistical techniques aren't terribly effective at modeling risk. You need like a Bayesian approach to model risk.

There's a Nobel Prize won by Fisher Black. I believe Bob Litterman at Goldman, they created this way to develop a portfolio based on your views and introducing kind of like humility into your views so that the models aren't over-indexing to historical data. That's a better approach. But people have fallen in love. The funny thing about Goldman is that and it's kind of well-known, but like the Goldman private wealth group has lagged because of an over-reliance on these factors.

Interesting. Right? So they're saying, well, statistically it's worked.

And there's always a reason why it didn't work this year. So these factors are a tool. Yeah.

They are not the end-all, be-all. They are good. It's a good framework.

They're good guideposts to help you think about things. But there's no substitute for critical thinking. Yeah. Okay.

So last question in this world. world of taking a look at quant models, do you think there's an over-reliance on risk-adjusted return as a metric? Because on the bedrock of that is Sharpe ratio, which is measured, again, by standard deviation, which, as we talked about, has some issues.

Do you think it's just the way it's measured is not great? Or is it that there's just an over-reliance on adjusted return versus just absolute return? So the measurement could be improved, for sure, like Sortino ratio, which looks at the downside risk relative to return.

and doesn't penalize upside risk is a better way to measure risk versus sharp ratio. Sharp ratio, for those who are listening, is the expected return divided by the standard deviation return. But do you really care about upside volatility?

No. You care about downside volatility. You're excited for that. I'm excited about that.

What you care about is drawdown risk because people have loss aversion. Statistically, especially Europeans, have heightened sensitivity to when prices drop versus when prices rise. They feel more pain.

relative to the satisfaction when prices increase. I don't believe there's a mistaken focus on risk-adjusted return. In fact, that's exactly what investors should do, as opposed to focusing on total returns. Investors, especially speculative investors and retail traders, and often investors in digital assets, they believe they can get high total returns by focusing on assets that have historical high total returns that also...

comes high total volatility. Actually, the better way to compound and grow wealth is focused on high risk-adjusted returns. So here's an image for you.

Imagine inefficient frontiers, which you learn in kind of portfolio finance theory, right? X-axis, you've got volatility. Y-axis, you've got expected return.

And you've got this kind of concave down chart. What most people do is they find that kind of return maximizing point, which is paired with a lot of volatility. What I try to do is find that.

that tangency asset where I can get high return per unit of risk. By the way, that's what Warren Buffett does. Warren Buffett, he'll own stocks with reliable earnings that have less risk, but then he borrows AAA-rated debt that he can get an expense from.

By the way, he just reissued bonds in Japan at a very low cost that's below the rate of inflation. So he's borrowing at a negative real rate. And what he's doing is he's extending the line. You learn this all kind of corporate finance 101, portfolio theory 101. that's actually the right strategy. That's actually the right approach to take.

I bought CVS end of May, it's bombed out, bad news priced in. So let me learn about this business. Got a lot of free cashflow.

Stock hasn't been this cheap in 10, 15 years. They're protected from insurance. They own Aetna.

If they renamed to Aetna, the stock would go up 30% probably in a day. People forgot about that. And that's being the S&P since we bought it for half the time. And the risk adjusted return was higher.

Now I don't do this. But for someone that wanted a higher total return that would, quote, unquote, run faster, theoretically, you might buy in the money long dated call options that would allow you to do what Buffett is doing as opposed to trying to find a high volatile asset, which statistically will actually not deliver the expected return you want. This is what document literature is called the low vol anomaly.

It led to the rise of risk parity strategies. Right. Lower vol assets. perform higher velocities. Yeah.

Okay. So that's a really good primer for the fact that we're actually talking at a crypto conference. So I want to talk about a few things here. The first is this idea of risk-adjusted return. I rant on this quite a bit in terms of the digital asset space because everyone's obsessed with absolute return.

And my personal framework sometimes is when I take profit on, I don't know, Bitcoin or something like that, I actually just move it into equities. And sometimes people get confused by that, but it's just, for me, it's... lowering my beta and just kind of securing that. I would love for you to unpack your perspective on digital assets and crypto and also how you manage these dynamics of it's a highly volatile asset.

We just talked about this low volatility anomaly and how you can get really high sharps there. But we're talking at a conference that is probably the polar opposite. So how do you navigate that? I'm probably one of the few people that have learned from the Oracle of Omaha. And also see the thesis around digital assets.

And I grew up at Merrill Lynch in 2008. So I saw what happens when banks don't trust one another. They don't finance each other overnight. And you have lack of transparency on these subprime securitizations that almost took down the banking system. What I see in digital assets is the promise of transparent settlement that doesn't have a trust requirement on a counterparty. You can put it all on chain.

We still don't know where the Pentagon spent a trillion dollars, by the way. Why isn't that all on chain, right? You see corruption in different areas, put it all on chain. So now let me answer your question. So, you know, my framework for thinking about asset classes, inspired by Hyman Minsky, the Minsky hypothesis.

I have a little variation on it. So I'll tell you kind of my, he has a three-phase framework. We'll get into that if you want, I have a four-phase framework.

But, you know, the time when you want to really leg into digital assets or other asset classes. It's called the when all the bad news is priced in. Phase one, when it's hated. It's hated and it's disgusting to own. And it's shameful to own.

You don't tell your friends you want to own it. When I bought CVS, I called up three of my smart buddies, professional investors. So what do you think about CVS? I laid out my thesis.

They all hated it. I said, all right, that's the buy trigger. I did mine else, of course, right?

So that's phase one. The next phase is you climb a wall of worry. There's skepticism. So that's the next phase. What's happening there is shorts are shorting and they're getting squeezed on the way up.

That's actually creating a bid for the security. So then the next phase is when you have kind of this optimism phase that sets in and you got to transition to a momentum market. So momentum market gets going then.

And then you want to stay in and hang until you see the parabola. The parabola is when you get euphoria. Before you want to get out, there's a wonderful, wonderful quote by Sir John Templeton.

He says, bear markets end in pessimism. They climb a wall of skepticism. They mature on optimism, and they end in euphoria.

If I could tattoo that on my long legs, I would absolutely do that. It also brings in the idea of sentiment and the importance of positioning and variant perception. Think about those back to that earlier framework.

How do you think about what asset classes to focus on at different times. You know, I bought MUFG Bank in Japan last week. People forgot about Japan. Japan had a big correction off the ZN Carry trade on why I'm in Japan. I wasn't in Japan when people were hyping it over the last year or so.

Yeah. Yeah. So how do you-Or China, same thing. We were in China in early Feb before David Tepper was on CNBC. People hated it.

Yeah. Now when it's on all the headlines, then you know it's efficiently priced or overvalued and I'd rather sell to them. Yeah. Ben Graham said once, Mr. Market shows up on your door and spits prices at you.

You can choose which ball you want to swing at. Sometimes the prices are high. Sometimes they're low. When they're low, I want to buy.

You make your money on the buy. Then you wait for Mr. Market to catch up to you. If the prices are high, I'm going to sell.

Yeah. So how do you yourself measure your allocations towards digital assets? Do you really focus on the position sizing?

Do you really focus on… you know, risk management and getting into these ideas. We're talking about a risk-adjusted return, which also can be kind of difficult because it depends on, you know, how you're measuring as your benchmark. Is it just like Bitcoin as your benchmark? I love for you-Phenomenal questions.

Yeah, benchmark. I truly enjoy these. So-Thank you. First off, we start with our client because we have to focus on honoring our client's objectives. We build investment policy statement, identify what their risk tolerance is, return objectives, liquidity needs, unique circumstances, and other considerations.

So that's number one, right? Make sure that your clients have safety and can accomplish their important objectives. Then number two, solve for lifestyle.

Make sure their lifestyle is not going to be impaired by investment strategy. So you have to deck investment strategies against those first two buckets. And after you've solved for that, then you can have a conversation around aspirational investment strategies. You shouldn't have a high-risk strategy unless you've known that you've defeased or de-risked your...

ability to accomplish your safety objectives, save for a house, pay for your kid's tuition, and your lifestyle objectives, enjoy travel and leisure with your spouse. So it varies based on the client. The other consideration...

is taxes. I believe we're past mid-cycle on digital assets. That means I believe that if I buy a position today, then I'm going to sell inside 12 months, I'm going to have to pay taxes on that.

So where do you put that position, in a taxable or non-taxable account? It's one of the reasons why I'm contemplating launching ETF, because the IRS does not tax in-kind transactions, which is an incredible form of tax alpha. So my approach to digital assets is highly tactical, just given where we are.

We were doing the discount to NAV trades like GPTC, and ETHG. We sold those in May of this year, continue to rotate out as our clients get to long-term capital gains. And those were a core position. Now we are tactical, finding tactical opportunities from time to time. The last tactic we did was in June, we bought and then we sold two days before Trump spoke at the Bitcoin conference.

Sell the news. Yeah. Yeah. So, you know, just wrapping up, I just want to get your take on where we are in with respect to that cycle that you laid out.

You know, are we about to... transition to the momentum phase or are we actually already seeing the parabola and now we're just sort of slowly bleeding lower objectively speaking we have seen a problem we saw a problem in may uh so that's happened now take you know nvidia had a problem in june took a few months to work off now we're back china had a problem in march took a few months now we're back so uh i think a lot's going to turn on the election yeah if trump wins i think think you're going to see an increase in the ETH to BTC ratio that'll be significant. And I think you're going to possibly see year-end euphoria. And actually, you might want to sell that counterintuitively.

I'm still working through this, by the way. I might revise my views three ways to whatever two weeks from now. You got to be dynamic, right? So however, if candidate Harris wins, then the question turns on who will be her SEC appointment.

One candidate, I'm told, is actually a former... former digital asset founder, which would be actually bullish and not priced in. On the other hand, if it's a Warren nominee, well, that would be terrible and awful.

Totally. But the key unlock for digital assets is rational policy. We don't have that right now.

No. I wrote an op-ed with the former SEC chair in the Wall Street Journal with Arthur Levitt. He's one of our Lumida investors, critiquing the current SEC for not providing interpretive guidance, clarity of the road, and not enabling...

in a creator economy to tokenize intellectual property. We have David Bowie bonds that are helping institutions make money and Marvel Common. That's when I was at Merrill.

Merrill securitized Marvel IP, which then created Iron Man, all these movies. And here you've got creators that are trapped using these gatekeepers like Instagram and TikTok as opposed to pushing the economics and the creativity out to the long tail. the next 1,000 Taylor Swifts that can get underwritten by their fan base.

I think that's the promise of digital assets and a rational digital asset securities law policy. Yeah. Well said. Cool. Well, look, it's been so fun to do this in person.

Always a pleasure, Felix. Thank you. Yeah. And just for the audience, where can they find more about your work?

Thank you. Well, you can follow me on Twitter at Ram Alawalia. You can also go to LumidaWealth.com.

I have a podcast called Lumida Non-Consensus Investing. also on TikTok. I would encourage you to sign up for our Lumida ledger. I publish it every Sunday at 12 o'clock.

We share our macro views. We talk about certain stocks and themes and AI as well. We have a Telegram group.

So a lot of ways you can find us. We try to meet the customer wherever they live. Awesome. Well, thanks again.

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Transcript for:Federal Reserve Rate Cuts and Economic Trends

Transcript for:
Federal Reserve Rate Cuts and Economic Trends