Cullen Roche – CIO of Discipline Funds
-Merrill Lynch asset management
-2008 financial crisis transformed his view of world – how macro can dominate everything, while micro doesn’t really matter
–Japan had been going through a similar transformation for 20 years – learned a lot from it
-Japan’s financial system modeled after Fed, US – Japan’s lessons taught him that what would happen would be the opposite of MSM narrative
-Beat the drum that post GFC would be sluggish dis-inflation
-At Discipline – hyper focused on financial planning as foundation for portfolio (more bottoms-up); “more Vanguard than Cathy Woods”
Doesn’t believe now will be like 70s style stagflation, more like 2008
Structural trends – globalization, technology, demographics – all long-term disinflationary anchors
Big lesson of Covid – fiscal policy can cause big inflation, it’s the Treasury not Fed that has the bazooka
Cyclical trends – short term inflation bump due to that fiscal policy; will come down if government doesn’t splurge
Debt cycle not consistent with high inflation environment
High inflation can only come from private sector (consumer / corporate borrowing), or public sector (government spending)
Low likelihood of big fiscal spending
In 3-4 years, we’ll realize inflation was transitory
Fed outlook
-they’ve been more aggressive than he expected
-“Fed’s kinda screwed” – look bad coming off 2021 inflation
-should have moved earlier in 2021 – eg, a modified Taylor rule
-too much focus on lagging indicators – eg, employment
–Fed is old school monetarists / Keynesians – don’t wanna live thru 1970s again
He believes today looks more like 2008, not 1970s
Big worry of real housing market downturn
Monetary policy will function through housing market and mortgage rates
As rates > 5%, “something’s gotta give” – not enough housing demand at that level
Last 10 years was one cycle, a blowoff / FOMO effect
Economy now digesting this excess, the bust component
Housing is slow moving animal
Concerned Fed will create more downside than we expect
If in 2023, inflation ticks steadily lower, housing falls fast, unemployment rises faster than expected – Fed will walk a lot back, have a mini 2008
Could be 2008 credit style disinflation rather than runaway inflation of 70s
Nik: hyper focused on housing sector, outsized impact on US economy, 3 months of home price declines
10% decline in home prices is like a flesh wound – only takes us back to middle 2021
If home prices are volatile, balance sheets become volatile
Housing has become an important economic asset – more than previous generations
We don’t understand knock on effects – like 2008
Outlier risk of housing prices falling 25%, risks lurking in shadows
“2008 humbled me a lot” – thought he had a bullet proof macro framework
More analysts now forecasting larger price drops in housing – more expected volatility in 2023, 2024
Argument that covid boom was sorta fake – driven by government spending
If housing falls 25%, causes a lot more collateral damage than anyone expects
Nik: in 2007-2008, analysts argued we’ve never seen national housing price declines YoY, only regional declines – surprised everyone
This isn’t like 1987 crash – it’s not a single event
It’s a structural event – because housing is long drawn-out process, and so core to US economy
Construction still in boom period – lots of supply coming online, but don’t have demand or new construction
We’re probably in 4th inning of housing market downturn – still relatively early
Fed sorta oblivious to it, they don’t realize damage that 6-7% mortgage rates do to housing market
No idea what stocks will do in next 6-12 months
His duration framework for investment assets:
-Cash / Treasuries are Zero duration
-Bonds are 5 year duration instruments
-Stock market is 18 year instrument
–Bitcoin is 100 year duration instrument (gold is 40 year)
Stock market riskier today – valuations high, less attractive relative to other instruments, still high levels of irrational exuberance
Multiples need to come in / move sideways for longer period
High multiples —> Lower risk adjusted returns
Do you want stocks at 30 P/E with high volatility or 4.5% treasury bill with no volatility?
Stocks in 18-24 months – would be shocked if up significantly
Scenario: housing prices slowly grind down 10-20%, no real credit event —> would have stagnant stock market, and maybe 2025 it takes off
Risk is a real credit event – more like 2008 than 1970s – if Fed reverses, would be because real deterioration in balance sheets and economic environment
Fed will likely slowly walk rates back, ease off language, but rates will remain high and cause demand destruction – maybe late 2023 – likely to be behind curve again
At that point, credit has deteriorated, stock markets fallen 40%
Lots of starts and stops until then
Higher probability of hard landing outcome than Fed finding a soft landing
Bitcoin is a technology – more like VC than equity
Public markets are boring 18 year instruments, companies are more stable boring value
VC is much younger, standard deviations larger, thus much longer duration
Bitcoin is weird blend of digital gold + VC + payment system
Bet is it becomes alternative payment system – will take very long time to come to fruition
Will work in parallel with traditional fiat / credit system
Takes time for people to adopt the new mindset
He works with people who have already made good money, closer to retirement, more conservative
Results in shorter duration instruments (eg, Treasuries, equities)
Bitcoin, like VC, has too much potential downside for them
For a true efficient market theorist – maybe 0.5-1% bitcoin allocation (eg, if you put 1% in bitcoin in 2015, could be 20% of portfolio today)
Big advocate of re-balancing in counter-cyclical manner to reduce skew – reduce outsized risk in any single instrument
Don’t want golden handcuffs that you can’t sell, too much capital gains, help control your behavior, don’t wanna become a forced seller
Loved Nik’s book Layered Money and its hierarchical thinking approach