David Grinberg
December 19, 2023
Annual Letter 2023
Strength Through Adversity
It has been such a thrilling year, and I can already tell that 2024 will be a grand adventure! Every year shows us a trial that will either propel us to our next level of excellence or will keep us imprisoned until we truly resolve our problems. That is what I love about markets. I am constantly given a problem with dynamic constraints. It forces you to stay hungry, never allowing you to rest on your laurels for too long.
The great Brazilian Jiu-Jitsu Champion Roger Gracie said on a Lex Fridman podcast, "I think we are measured not when we are at our strongest, but when we are at our weakest. That's when we truly measure ourselves, and our character. Who we are not when we are in a position of power but in a position of weakness." I think the world is experiencing this position of weakness, but it does not mean we are at a point of no return.
Global Turbulence and Market Dissonance
We entered a tumultuous period of significant and rapid rate hikes. Several bank collapses and mergers, countless court trials ranging from the FTX Fraud to antitrust suits against big tech coupled with big oil. And, unfortunately, natural disasters in Turkey and Syria alongside horrific acts of violence in Israel by the terrorist group Hamas. We have a stalemate between Russia and Ukraine with senseless killing on both sides with no end in sight.
The AI arms race is heating up in a period where technology is becoming far more expensive, intensifying the divide between 1st and 3rd world countries. America heads into one of the decade's most essential yet sleepiest election years, with the inflation rate slowly decreasing.
Present-Focused Analysis in Uncertain Times
Most people cannot figure out where we are today, let alone tomorrow. I see myself as a disciple of Howard Marks, and I try very hard to focus on the present instead of guessing the future. There are no certainties, and this game is a mental exercise in weighing the probabilities of outcomes. The past three years have created a cognitive dissonance in traditional economic theory on market cycles.
Yet, ironically, as I write this, the Volatility Index (VIX) is at an all-time low, and selling premiums in the derivatives market and activity in hedge fund leverage of the overnight repo market in the treasuries trade is at an all-time high. Carry trades such as the JPY/USD are incredibly popular, all signs of a continuous irrational exuberance despite signs to air caution. I am even more cautious after discussing current markets with an Uber driver and my dentist on the same day!
Inflation Dynamics and Economic Positioning
So, where are we today? The near-term future troubles me because it is hard to identify a momentum factor in the economy besides AI, despite its implicit power. Anything supported by a single factor is destined to fail. This environment combines a 1970s macroeconomic scenario and an inflationary dot-com-style bubble. If we consider the most pressing inflationary factors, they would be Shelter, Services, Food, and Medical Care costs.
These indexes are moving conservatively at 5% (TTM), whereas their prepandemic averages were roughly 2.5-3% (TTM). Fortunately, food costs have decreased despite their massive jump between 2021 and 2022. The most critical variable inflationary driver is energy costs associated with Oil and Natural Gas, which are currently down about 5% (TTM). If the current CPI stands at 3.1% (TTM), there is little room to force inflation further down unless shelter or medical costs decrease.
Housing Market Complexities
This forces us to consider the housing market and private sector as the key indicators for determining the outcome of core inflation going into 2024. About 70% of Americans' net worth is tied to real estate. Considering the compounded annual rate of change in homeownership from Q4FY19 to Q2FY20, we saw a 15x increase in homeownership rate where household net worth only doubled! This is where most of the Fed's emergency QE policy went at the pandemic's start, increasing the class divide between the rich and poor.
To make matters worse, most homeowners refinanced their homes at a 3-3.5% average interest rate for a fixed 30-year mortgage. Whereas right now, a 30-year mortgage is going for 7.5%. Inventory is also low because homebuilders do not want to commit to building.
Hard Landing Probabilities
Housing prices can come down in several scenarios. Interest rates could drop, incentivizing people to lock in mortgages at relatively lower rates, which is unlikely due to its naturally inflationary effect. Government policy, commodity price drops, or interest rates can incentivize homebuilders to add more homes. People could make more money to afford the new cost of these homes. That is unlikely, as delinquency rates on credit cards and HELOCs have spiked since the second half of 2022.
Ultimately, the nation's overall debt-to-income ratio is troubling, with the silver lining being that the average debt service payments are well distributed across the economy. We see these two factors working together to negatively impact the nation's GDP and put us in the more probable outcome of a hard landing. We do not see interest rates below 4% as the factors contributing to inflation are generally inelastic. As a result, policymakers will be the crucial body to spread out the losses the economy will likely soon endure.
Institutional Positioning and Market Opportunities
Since 2008, banks and semi-nationalized institutions have had far stricter lending practices, decreasing the risk of a systemic event that can harm the well-distributed average. Fundamentally, America's emergence out of these troubling times will depend on its ability to maintain a positive GDP. With a weak balance sheet, rising unemployment, and many economic bottlenecks, the best-case scenario for 2024 is a stable stagflation-like environment.
Many governments will begin pegging their weak currencies to Gold, Commodities, Bitcoin, and Foreign Exchange pairs. As we see in the REPO market trade, many institutional investors will begin to crowd systemically essential institutions to avoid the upcoming volatility. However, Green Mountain Advisers welcomes this economic change as more opportunities will start to appear on the market. After a decade of investor fuss about market valuations and the death of capitalism, free markets will finally give them a chance to prove their investing prowess.
Gratitude and Forward Vision
We are blessed to participate in this grand experiment of free markets and capitalism. Taking our moment in history for granted is a mistake, and we intend to avoid that mistake at all costs. Green Mountain Advisers is constantly expanding in its investing environment, research, and business models.
Despite the unstable picture of 2024, we pray for peace and collaboration worldwide. From Green Mountain Advisers to you, we wish you a happy, healthy, and abundant New Year!
