I hope everyone had a great weekend!

I had coffee with a friend of mine this morning. He is an analyst covering Tech & Media for a family office and he had a great quote.

“I think one of the last sources of alpha is duration of ownership. By the time you see a headline, some algorithm has already analyzed it and traded on it. You can’t be faster. Where you can outperform, is when you own a quality business through cycles and allow your investment to compound. Doing nothing is not easy emotionally or professionally but it’s really is a source of outperformance.”

By Charles Ruff, CFA

AQR: Stock & Bond Correlation

Alternative Thinking | Q2 2022 | The Stock/Bond Correlation Drivers and Implications

As we are all painfully aware, start of 2022 has been one of the worst years on record for a 60/40 portfolio with both bonds and stocks down significantly.

Negative correlation between stocks and bonds is one of the key tenets of traditional asset allocation strategies. But as we’ve seen in 2022, sometimes bonds and stocks are positively correlated.

Historically speaking, negative correlations are the exception, not the rule!

Exhibit 1: Rolling 10-Year

AQR’s findings can be summarized as:

  • During periods when there is uncertainty around economic growth (as in the past two decades) we are likely to see negative stock-bond correlations
  • During periods when there is uncertainty around inflation (like right now) we are likely to see rising stock-bond correlations.

As solutions to this problem, AQR puts fourth several alternative asset classes that can help provide diversification when stocks and bonds are moving in lock-step.

  • Commodities- exhibit low correlation with stocks and bonds and tend to perform well during periods of high inflation uncertainty
  • Long/Short Equity and Multi-Asset Alts- When constructed in a market-neutral manner, the performance of these strategies is unrelated to the macro environment which helps provide diversification.
  • Trend & Macro Strategies- These can be highly correlated in the short-term but these type of strategies have a low correlation to stocks and bonds over the long term.

Klarna and Buy-Now-Pay-Later Nonsense

In the June 6th Weekend Reading, we had some fun with Klarna’s “business model” and “profit projections”

Klarna was valued at $45 billion last summer and we (not so) boldly predicted that its valuation would fall dramatically.

On Friday July 1st the news emerged that Klarna was looking to raise additional capital at a $6.5 billion valuation. A nice, smooth 85% decline from June 2021.

  • As an aside, companies LOVE to drop horrible news on days when they think no one is paying attention, like a Friday before the Fourth of July. This is the corporate equivalent of a kid hiding a failed math test and I think it’s incredibly pathetic that ivy-league MBAs think this is the best way to handle bad news.

Wolf-Warrior Diplomacy

Dubbed ‘Wolf-Warrior’ diplomacy after a popular Rambo-style film, Chinas’ diplomatic style recently became much more aggressive.. Previously, China’s rise, although it generated some uncertainty, was generally celebrated. China’s rise generated untold amounts of wealth and pulled hundreds of millions of people out of poverty. The West was hopeful that China would evolve from a centrally-planned and authoritarian regime into a capitalistic economy with a more representative government. Economically intertwined with the West, a stronger China would assume its role as a world leader in a non-belligerent manner.

As Xi Jinping seeks his third term, these hopes are being dashed. China’s economic rise is stalling and the Communist Party is doubling down on commanding and controlling its population. Externally, China’s aggressive wolf-warrior diplomacy is winning few friends.

Excerpt from Joanna Chiu’s China Unbound:

“China’s boundaries have expanded and contracted for millennia, as shown by the earliest written records from the Shang dynasty, which, in the second millennium BCE, ruled a region around the Yellow River, an area that is only a small portion of China’s extent today. Over thousands of years, successive emperors and warlords expanded their kingdom’s borders through successful military campaigns and defended them from invaders, quite often being forced to retreat and give up swaths of land.

“This was par for the course for major empires throughout history. But the loss of Hong Kong in 1842 to the British during a period of Western imperialism against the Qing dynasty, the last to rule in China, was a humiliation that cut deeply. Its repercussions continue to this day, with the uprisings in Hong Kong stoking modern Chinese leaders’ anger over a time when their ancestors were too weak to defend themselves against technologically advanced allied Western forces.

“Beijing’s concern over the restoration of its perceived traditional territories didn’t start with President Xi. In 1950, one of the first acts of the Red Army after its civil war victory was to invade and annex Tibet, which for centuries had alternated between independence and rule by the Mongolians and Chinese dynasties. Today, Chinese leaders generally take a broad and sweeping view of the country’s traditional territories to include areas that were at any time part of imperial Chinese territory, even if those lands were claimed for centuries by other nations and peoples. And a recent shift in China’s global relations strategy that observers dubbed ‘wolf warrior diplomacy,’ after a Rambo-style Chinese nationalistic action film, has meant that Beijing is now asserting its claims without worrying about what the international community might think.

“In the aftermath of the Tiananmen massacre and the run-up to the 2008 Summer Olympics, Chinese diplomats had been cautious in their interactions with other countries, especially the United States. ‘The idea was to win trust and persuade the world that China’s rise wasn’t a threat,’ says Peter Martin, a former Beijing-based foreign correspondent and author of China’s Civilian Army: The Making of Wolf Warrior Diplomacy.

“That former approach to diplomacy initially proved highly effective, Martin told me, but it frustrated a lot of Chinese citizens who felt that their diplomats were too deferential to their foreign counterparts. As China grew more powerful, many thought their country should assert its interests more forcefully, Martin found in his research, which drew on the memoirs of more than one hundred retired diplomats.

“‘Starting in 2008 [the year China hosted the Summer Olympics], and with increasing intensity after Xi Jinping came to power in 2012, the behaviour of Chinese diplomats became outright aggressive. The long-standing touchiness and insecurity of Chinese leaders was paired with a new sense of strength and entitlement,’ Martin said. ‘The outcome was wolf warrior diplomacy.’

“Liu Xiaoming, who served as China’s ambassador co the U.K. for eleven years, is among a group of diplomats who have taken aggressive stances on social media platforms to champion Beijing’s interests. ‘As I see it, there are so-called “wolf warriors” because there are “wolfs” in the world and you need warriors to fight them,’ Liu tweeted in February 2021. His hundreds of posts, including one that claims ‘people in Xinjiang live a happy life in a stable environment,’ are amplified by an army of fake Twitter accounts that have retweeted Chinese diplomats and state media tens of thousands of times, according to a 2021 investigation by the Associated Press and the Oxford Internet Institute. Many of these accounts impersonate U.K. citizens.”

China’s aggressive posture, in addition to this recent joint statement from MI5 and the FBI is a reminder of how high the stakes are. Politically, the US is focusing on domestic issues right now. When will China reemerge as an election issue?

The Los Angeles Angels Are Embarrassing

Despite having Mike Trout and Shohei Ohtani and the Halos got swept by the Orioles in a four-game series. Two of the best players in a generation and they can’t get above .500. Everyone in that front office should be fired. Perhaps this is good for Disney (DIS) because it leaves the door open for another Angels in the Outfield remake.
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