Deconstructing the Powell Pivot

Crescat Capital Research Letter & Performance Update

Season’s Greetings and Happy Holidays from Crescat!

Our overriding Great Rotation theme just received a jumpstart with the Fed’s pivot to easier monetary policy at its December 13 meeting. Jerome Powell and Company signaled lower interest rates in 2024. Since the central bank’s shift, note the outperformance of undervalued junior gold mining stocks, including the exploration-heavy TSX Venture Exchange Index, and small cap stocks in general compared to the crowded and overvalued megacap tech behemoths. We illustrate this strong relative performance in the chart below.

 

 

This unfolding divergence favors the deeply depressed small and microcap metals explorers which are ripe for outperformance as we have been saying in our recent letters. We have remained positioned for this major theme across the firm. As a result, each of our strategies is up significantly month-to-date. We believe there is much more to play out, hopefully in the final week of 2023, but especially in the months, quarters, and years ahead.

Inflation to be the Ultimate Deflator of Financial Asset Bubbles

It is important to note that the Fed’s interest rate hiking campaign, which has now come to an end, achieved nothing significant at all, in our analysis, in alleviating the four major fundamental long-term structural inflationary headwinds that we have highlighted in our prior letters. This is what we have referred to in the past as the four pillars of inflation: (1) deglobalization, (2) resource underinvestment, (3) wage-price spirals, and (4) the ongoing central bank monetization of extreme fiscal debt and deficits.

The Fed helped create many of these embedded inflation problems in the first place due to too many years of ultra-accommodative monetary policy which served primarily to create only bigger and bigger debt and financial asset bubbles. Now, we believe the Fed has little choice but to tolerate long-term rising consumer and wholesale prices as it attempts to manage the deflation of these bubbles.

 

 

The Fed’s toolkit for fighting inflation is limited primarily to short-term (i.e. transitory) demand destruction measures through its aggressive interest rate increases. Historically, such a policy has always triggered a recession, often with a lag, and ultimately coinciding with the bursting of asset bubbles. We expect this time will be no different.

Beware the Soft-Landing Narrative:  Stagflationary Recession More Likely Ahead

Despite abundant recession signals, the highly popular narrative remains that Powell is likely to “stick the soft landing”. Generous soft-landing narratives are historically common immediately ahead of economic contractions. The facts are that soft landings are extremely rare and historically nonexistent in the wake of aggressive rate hikes like those already implemented from March 2022 to July 2023. At Crescat, we remain highly committed to our significant long precious metals exposure as our primary means of navigating the likely pending stagflationary recession.

In our analysis, Powell’s pivot was driven by the abundance of indicators signaling the high probability of an approaching hard landing. We enumerated these warning signs in our November 26 letter. Because the central bank made this policy reversal before achieving its inflation target, it was confirmation for us that it was capitulating to the high risk of recession, especially given the losses and potential further losses in the banking and financial system created by higher rates. It was not giving in because it had conquered inflation.

The risks of a banking and financial system crisis were evident as of late October when 10-year yields hit a recent peak just above 5%. At that point, the banking system had just incurred an incremental $125.5 billion unrealized loss on its securities held and a $90.4 trillion decline in bank deposits in its third quarter. This was the same problem that created the bank failures in the first quarter. In our opinion, the Fed pivoted to help the banking sector, especially after giving recognition to likely broader credit losses in the system that have yet to be officially recognized.

Indeed, credit markets have had an enormous relief rally since 10-year US Treasury yields peaked just north of 5% on October 23 and are now down to 3.9%. Meanwhile, 2-year yields have dropped from 5.3% down to 4.3%. It is important to point out that plunging yields as such are normally associated with Fed easing ahead of and during recessions. We think this time will prove no different. The 10-year vs. 2-year yield spread is still inverted. It has been inverted for 18 months now, which is toward the long end of its historical range for this indicator whereby inversions have historically signaled an impending recession. Yield curves normally un-invert only as the recession unfolds. We expect the economic contraction to kick off in the first half of 2024 coincident with a significant decline in crowded megacap tech stock fundamentals and stock prices.

 

 

Suppressed Commodities Have Room to Run

During the likely coming decline in the real economy, we expect to see the re-emergence of commodity price inflation due to high fiscal deficit spending and cumulative years of critical resource underinvestment combined with a more accommodative Fed making this a stagflationary style of hard landing similar to 1973-74 where commodities and commodity stocks performed spectacularly. The early 2000s was another macro analog where it behooved hedge funds and nimble investors to be long commodity-oriented stocks and short large cap tech stocks, even during the onset of the recession and especially during the bursting of the tech bubble. The technical setup today for commodities is particularly strong after the recent sideways trend for more than a year in the equal-weighted commodities index.

 

 

Crescat Precious Metals Fund

We encourage qualified investors to consider our Precious Metals Fund which has substantially outperformed its peers and benchmarks in the more than three years since its inception. We accomplished this ultra-high alpha in a bear market for precious metals mining stocks staying fully invested in them on the long side the entire time in accordance with our activist exploration strategy. The bulk of the credit goes to our Geologic and Technical Director, Quinton T. Hennigh, PhD for his ability to identify and help create major early-stage discoveries. What we remain most excited about is to show what we believe we can do in the likely coming precious metals bull market.

 

Performance data represents past performance, and past performance does not guarantee future results. Performance data is subject to revision following each monthly reconciliation and/or annual audit. Historical net returns reflect the performance of an investor who invested from inception and is eligible to participate in new issues. Net returns reflect the reinvestment of dividends and earnings and the deduction of all fees and expenses (including a management fee and incentive allocation, where applicable). Individual performance may be lower or higher than the performance data presented. The performance of Crescat’s private funds may not be directly comparable to the performance of other private or registered funds. The currency used to express performance is U.S. dollars. Investors may obtain the most current performance data and private offering memorandum for Crescat’s private funds by emailing a request to info@crescat.net.

 

Crescat Global Macro and Long/Short

For those looking for an even more comprehensive way of attempting to capitalize on the unfolding macro environment, we encourage you to consider our Global Macro and Long/Short funds. There we remain committed to our short positions in megacap tech stocks today in addition to our activist long precious metals and other commodity long exposures combined with a variety of other macro themes.

 

 

Nasdaq 100 Double Top

Our mega-cap tech short positions worked for us in 2022 when they first peaked but held us back in 2023 during what we believe is a bearish double-top retest now poised to fail. Imagine it is late 2021, and you have the chance to short mega-cap tech all over again from the top, this time just ahead of a likely recession. Our Global Macro and Long/Short investors have this opportunity now.

 

 

Performance of Crescat Strategies Since Inception

We believe our Great Rotation theme is getting ready to play out in full force. We are confident there is much more still to capitalize on in favor of our dedicated long-term clients for whom we are extremely grateful. As we are about to enter a contentious presidential election year, we sometimes hear the idea that election years are historically good for the S&P 500. That had been the case on average only a few decades ago. But then came 2000 and 2008, so we would be careful with such assumptions.

 

Performance data represents past performance, and past performance does not guarantee future results. Performance data is subject to revision following each monthly reconciliation and/or annual audit. Historical net returns reflect the performance of an investor who invested from inception and is eligible to participate in new issues. Net returns reflect the reinvestment of dividends and earnings and the deduction of all fees and expenses (including a management fee and incentive allocation, where applicable). Individual performance may be lower or higher than the performance data presented. The performance of Crescat’s private funds may not be directly comparable to the performance of other private or registered funds. The currency used to express performance is U.S. dollars. Investors may obtain the most current performance data and private offering memorandum for Crescat’s private funds by emailing a request to info@crescat.net.

 

We encourage you to reach out to any of us listed below if you would like to learn more about how our vehicles might fit with your individual needs and objectives.

 

Download PDF Version

 

Sincerely,

 

Kevin C. Smith, CFA

Founding Member & Chief Investment Officer

 

Tavi Costa

Member & Macro Strategist

 

Quinton T. Hennigh, PhD

Member & Geologic and Technical Director

 

For more information including how to invest, please contact:

 

Marek Iwahashi

Investor Relations Coordinator

miwahashi@crescat.net

(720) 323-2995

 

Linda Carleu Smith, CPA

Co-Founding Member & Chief Operating Officer

lsmith@crescat.net

(303) 228-7371

 

© 2023 Crescat Capital LLC

 

Important Disclosures

Performance data represents past performance, and past performance does not guarantee future results. An individual investor’s results may vary due to the timing of capital transactions. Performance for all strategies is expressed in U.S. dollars. Cash returns are included in the total account and are not detailed separately. Investment results shown are for taxable and tax-exempt clients and include the reinvestment of dividends, interest, capital gains, and other earnings. Any possible tax liabilities incurred by the taxable accounts have not been reflected in the net performance. Performance is compared to an index, however, the volatility of an index varies greatly and investments cannot be made directly in an index. Market conditions vary from year to year and can result in a decline in market value due to material market or economic conditions. There should be no expectation that any strategy will be profitable or provide a specified return. Case studies are included for informational purposes only and are provided as a general overview of our general investment process, and not as indicative of any investment experience. There is no guarantee that the case studies discussed here are completely representative of our strategies or of the entirety of our investments, and we reserve the right to use or modify some or all of the methodologies mentioned herein.

This presentation is not an offer to sell securities of any investment fund or a solicitation of offers to buy any such securities. Securities of a fund managed by Crescat may be offered to selected qualified investors only by means of a complete offering memorandum and related subscription materials which contain significant additional information about the terms of an investment in the Fund and which supersedes information herein in its entirety. Any decision to invest must be based solely upon the information set forth in the Offering Documents, regardless of any information investors may have been otherwise furnished, and should be made after reviewing such Offering Documents, conducting such investigations as the investor deems necessary and consulting the investor’s own investment, legal, accounting and tax advisors in order to make an independent determination of the suitability and consequences of an investment in the Fund.

Risks of Investment Securities: Diversity in holdings is an important aspect of risk management, and CPM works to maintain a variety of themes and equity types to capitalize on trends and abate risk. CPM invests in a wide range of securities depending on its strategies, as described above, including but not limited to long equities, short equities, mutual funds, ETFs, commodities, commodity futures contracts, currency futures contracts, fixed income futures contracts, private placements, precious metals, and options on equities, bonds and futures contracts. The investment portfolios advised or sub-advised by CPM are not guaranteed by any agency or program of the U.S. or any foreign government or by any other person or entity. The types of securities CPM buys and sells for clients could lose money over any timeframe. CPM’s investment strategies are intended primarily for long-term investors who hold their investments for substantial periods of time. Prospective clients and investors should consider their investment goals, time horizon, and risk tolerance before investing in CPM’s strategies and should not rely on CPM’s strategies as a complete investment program for all of their investable assets. Of note, in cases where CPM pursues an activist investment strategy by way of control or ownership, there may be additional restrictions on resale including, for example, volume limitations on shares sold. When CPM’s private investment funds or SMA strategies invest in the precious metals mining industry, there are particular risks related to changes in the price of gold, silver and platinum group metals. In addition, changing inflation expectations, currency fluctuations, speculation, and industrial, government and global consumer demand; disruptions in the supply chain; rising product and regulatory compliance costs; adverse effects from government and environmental regulation; world events and economic conditions; market, economic and political risks of the countries where precious metals companies are located or do business; thin capitalization and limited product lines, markets, financial resources or personnel; and the possible illiquidity of certain of the securities; each may adversely affect companies engaged in precious metals mining related businesses. Depending on market conditions, precious metals mining companies may dramatically outperform or underperform more traditional equity investments. In addition, as many of CPM’s positions in the precious metals mining industry are made through offshore private placements in reliance on exemption from SEC registration, there may be U.S. and foreign resale restrictions applicable to such securities, including but not limited to, minimum holding periods, which can result in discounts being applied to the valuation of such securities. In addition, the fair value of CPM’s positions in private placements cannot always be determined using readily observable inputs such as market prices, and therefore may require the use of unobservable inputs which can pose unique valuation risks. Furthermore, CPM’s private investment funds and SMA strategies may invest in stocks of companies with smaller market capitalizations. Small- and medium-capitalization companies may be of a less seasoned nature or have securities that may be traded in the over-the-counter market. These “secondary” securities 12 often involve significantly greater risks than the securities of larger, better-known companies. In addition to being subject to the general market risk that stock prices may decline over short or even extended periods, such companies may not be well-known to the investing public, may not have significant institutional ownership and may have cyclical, static or only moderate growth prospects. Additionally, stocks of such companies may be more volatile in price and have lower trading volumes than larger capitalized companies, which results in greater sensitivity of the market price to individual transactions. CPM has broad discretion to alter any of the SMA or private investment fund’s investment strategies without prior approval by, or notice to, CPM clients or fund investors, provided such changes are not material.

Benchmarks

HFRX GLOBAL HEDGE FUND INDEX. The HFRX Global Hedge Fund Index represents a broad universe of hedge funds with the capability to trade a range of asset classes and investment strategies across the global securities markets. The index is weighted based on the distribution of assets in the global hedge fund industry. It is a tradeable index of actual hedge funds. It is a suitable benchmark for the Crescat Global Macro private fund which has also traded in multiple asset classes and applied a multi-disciplinary investment process since inception.

HFRX EQUITY HEDGE INDEX. The HFRX Equity Hedge Index represents an investable index of hedge funds that trade both long and short in global equity securities. Managers of funds in the index employ a wide variety of investment processes. They may be broadly diversified or narrowly focused on specific sectors and can range broadly in terms of levels of net exposure, leverage employed, holding periods, concentrations of market capitalizations and valuation ranges of typical portfolios. It is a suitable benchmark for the Crescat Long/Short private fund, which has also been predominantly composed of long and short global equities since inception.

PHILADELPHIA STOCK EXCHANGE GOLD AND SILVER INDEX. The Philadelphia Stock Exchange Gold and Silver Index is the longest running index of global precious metals mining stocks. It is a diversified, capitalization-weighted index of the leading companies involved in gold and silver mining. It is a suitable benchmark for the Crescat Precious Metals private fund and the Crescat Precious Metals SMA strategy, which have also been predominately composed of precious metals mining companies involved in gold and silver mining since inception.

RUSSELL 1000 INDEX. The Russell 1000 Index is a market-cap weighted index of the 1,000 largest companies in US equity markets. It represents a broad scope of companies across all sectors of the economy. It is a commonly followed index among institutions. This index contains many of the same securities as the S&P 500 but is broader and includes some mid-cap companies. It is a suitable benchmark for the Crescat Large Cap SMA strategy, which has predominantly held and traded similar securities since inception.

S&P 500 INDEX. The S&P 500 Index is perhaps the most followed stock market index. It is considered representative of the U.S. stock market at large. It is a market cap-weighted index of the 500 largest and most liquid companies listed on the NYSE and NASDAQ exchanges. While the companies are U.S. based, most of them have broad global operations. Therefore, the index is representative of the broad global economy. It is a suitable benchmark for the Crescat Global Macro and Crescat Long/Short private funds, and the Large Cap and Precious Metals SMA strategies, which have also traded extensively in large, highly liquid global equities through U.S.-listed securities, and in companies Crescat believes are on track to achieve that status. The S&P 500 Index is also used as a supplemental benchmark for the Crescat Precious Metals private fund and Precious Metals SMA strategy because one of the long-term goals of the precious metals strategy is low correlation to the S&P 500.

References to indices, benchmarks or other measures of relative market performance over a specified period of time are provided for your information only. Reference to an index does not imply that the fund or separately managed account will achieve returns, volatility or other results similar to that index. The composition of an index may not reflect the manner in which a portfolio is constructed in relation to expected or achieved returns, portfolio guidelines, restrictions, sectors, correlations, concentrations, volatility or tracking.

Separately Managed Account (SMA) disclosures: The Crescat Large Cap Composite and Crescat Precious Metals Composite include all accounts that are managed according to those respective strategies over which the manager has full discretion. SMA composite performance results are time-weighted net of all investment management fees and trading costs including commissions and non-recoverable withholding taxes. Investment management fees are described in Crescat’s Form ADV 2A. The manager for the Crescat Large Cap strategy invests predominantly in equities of the top 1,000 U.S. listed stocks weighted by market capitalization.  The manager for the Crescat Precious Metals strategy invests predominantly in a global all-cap universe of precious metals mining stocks.

Hedge Fund disclosures: Only accredited investors and qualified clients will be admitted as limited partners to a Crescat hedge fund. For natural persons, investors must meet SEC requirements including minimum annual income or net worth thresholds. Crescat’s hedge funds are being offered in reliance on an exemption from the registration requirements of the Securities Act of 1933 and are not required to comply with specific disclosure requirements that apply to registration under the Securities Act. The SEC has not passed upon the merits of or given its approval to Crescat’s hedge funds, the terms of the offering, or the accuracy or completeness of any offering materials. A registration statement has not been filed for any Crescat hedge fund with the SEC. Limited partner interests in the Crescat hedge funds are subject to legal restrictions on transfer and resale. Investors should not assume they will be able to resell their securities. Investing in securities involves risk. Investors should be able to bear the loss of their investment. Investments in Crescat’s hedge funds are not subject to the protections of the Investment Company Act of 1940. Performance data is subject to revision following each monthly reconciliation and annual audit. Current performance may be lower or higher than the performance data presented. The performance of Crescat’s hedge funds may not be directly comparable to the performance of other private or registered funds. Hedge funds may involve complex tax strategies and there may be delays in distribution tax information to investors.

Investors may obtain the most current performance data, private offering memoranda for Crescat’s hedge funds, and information on Crescat’s SMA strategies, including Form ADV Part II, by contacting Linda Smith at (303) 271-9997 or by sending a request via email to lsmith@crescat.net. See the private offering memorandum for each Crescat hedge fund for complete information and risk factors.