My Process

Below is the process that I have built and will continue to adapt dynamically over time. The #1 GOAL: preserve capital. You can only grow and compound what you preserve in the first place.

NOTE: this was originally a PowerPoint presentation, so bear with me.

Building Blocks of Approach

Correlation between the rate of change of growth/inflation and asset returns was first discovered by billionaire hedge fund manager Ray Dalio.

◦ “I knew which shifts in the economic environment caused asset classes to move around, and I knew that those relationships had remained essentially the same for hundreds of years. There were

Ray Dalio

only two big forces to worry about: growth and inflation.” - Bridgewater Founder Ray Dalio

◦ "When growth is slower-than-expected, stocks go down. When inflation is higher-than-expected, bonds go down. When inflation is lower-than-expected, bonds go up.” - Dalio

Investment Philosophy

Top-down investment approach using macroeconomic factors to drive investment decisions on a microeconomic level across global equities, sovereign credit, FX, and commodities.

◦ Historically speaking, the main drivers of asset returns have been growth (real GDP growth

Quad Map (Hedgeye)

%) and inflation (Headline CPI %). More specifically, it is the rate of change of both growth and inflation that drive asset returns.

◦ There are 4 possible regimes, or “Quadrants” based upon growth and inflation, with both variables either growing or slowing on a year over year rate of change basis (Perfected IMO by Hedgeye Risk Management, where I get all my forecasting data).

Quad 1

Growth accelerating while inflation is decelerating.

◦ Quad 1 is the best-case scenario for the US economy. In this environment, GDP growth is accelerating while inflation is decelerating, meaning that the economy is growing more rapidly but not overheating.

◦ Thus, the Federal Reserve remains neutral (as their mandate is to curb inflationary pressures) and the “Goldilocks” economy is left to run.

◦ This is good for risky and cyclical assets such as stocks and high yield credit (but not energy because inflation is slowing), and not so good for Treasuries, the US Dollar, and other “safe assets.”

Quad 2

Growth accelerating while inflation is also accelerating

◦ Now, Quad 2 is more likely what occurs when growth begins to accelerate—inflation begins to accelerate as well.

◦ Unlike in Quad 1, the Fed becomes slightly more hawkish and begins to watch inflation much closer. If inflation accelerates too quickly (usually above the Fed’s target inflation rate of 2.0%), then they will look to raise short term lending rates to slow down the economy.

◦ This is good for risky and cyclical assets such as stocks and energy, and bad for safer assets such as treasuries and other safer bonds.

Quad 3

Growth slowing as inflation is accelerating.

◦ With inflation accelerating, would usually be hawkish and looking to curb inflation if it reached above its 2.0% target.

◦ However, the Fed’s hands are tied given that any rise in short-term rates would potentially further dampen growth. So, they typically stay neutral.

◦ This is good for growth stocks, gold, commodities, utilities, and long-duration treasuries, and bad for financials, value stocks, and materials.

Quad 4

Growth slowing while inflation is slowing.

◦ Lastly, we have Quad 4. Quad 4 occurs when growth and inflation are slowing at the same time.

◦ In this environment, the Fed turns dovish and looks to cut interest rates in order to spur growth.

◦ This is good for the safer areas of the stock market—such as consumer staples, utilities, and low beta—as well as treasuries across the curve, and bad for the riskier/more cyclical areas of the stock market—such as tech, energy, and financials—and high yield credit.

Historical Backtest and Returns by Quad

Median and average return based on Quad.

Batting average based on Quad.

Conclusion

I'll be adding more information later to dive deeper into the process, but this is the most important piece to hammer home.