I have frequently described “Project Zimbabwe” as a highly inflationary cycle where both fiscal and monetary stimulus go into insanity mode. While I sincerely hope we don’t go hyperinflationary like Zimbabwe, I certainly think we see an elongated period of substantial and debilitating inflation. When this cycle finally ends, society and our financial system will have been irreparably changed. For those who are aware of where we’re heading, I believe this is going to be the golden age of inflection and Event-Driven investing. For everyone else, I think it will be absolutely miserable.
One point that I made last year, was that “Project Zimbabwe” will be a process. It will not be linear. Look back at old charts of Weimar Germany, they all look like parabolas, however that is quite deceptive—there was actually a whole lot of volatility. There were multiple deep pullbacks that bankrupted speculators who knew what was coming on the inflationary side but got over-levered or overstayed their welcome in the various rolling bubbles of the period. Looking into the weeds and ignoring the parabolas; there were frequent sector rotations, speculative bubbles that crested and collapsed, and multiple 50% or greater pullbacks. As I have said many times, I believe the trick to managing “Project Zimbabwe” is to be as long as possible, without getting taken out during one of these pullbacks—especially as the increased level of stimulus warps the market’s ability to price securities, leading to violent and often arbitrary movements.
Let’s go back a century to Weimar. Most speculators knew that the government had lost control and that the only path forward was to print money. However, occasionally the politicians would try and arrest the inflation—as inflation crushes voters. Sometimes, it was an offhand quote from a government official, sometimes it was concrete action. The market would convulse in panic, only to find that the authorities had zero tolerance for pain. Voters hate inflation, but they hate losing their jobs even worse. I believe that in most societies, the politicians work for the speculators, not the voters—caught in a stall-speed between inflation and depression, politicians will almost always choose inflation. However, there were brief moments where the market believed the politicians—or at least worried that they’d lose control to the downside and things would crash. Once again, I believe the trick to navigating what is coming is to stay as long as possible, while not getting taken out during the inevitable pullbacks. If your timing is good, you can add size at the end of each pullback and potentially increase your returns, especially as the amplitude of each incremental move will usually be greater—besides, as money gets debased, it is imperative to have some financial leverage.
I bring all of this up as the Fed has followed through much as I expected they would. They’ve done a whole lot of talking, but precious little in terms of concrete actions. They got people convinced that they’d go full-Volcker and take rates into the teens, but I think more recent history tells us that they won’t. A pause feels inevitable.
Of course, they will do the bare minimum to try and regain some credibility, but it is all for show. I don’t think these guys actually care about inflation—they care about enriching their buddies in Private Equity while pretending to care about “inclusive economic policy” and other woke-word-salad nonsense. I think they’ll pause on rates at the first sign of real economic pain. The history of the Federal Reserve for the past few decades is that they overstimulate, then try to reign things in; until they break something, leading them to overstimulate again. Once on the hamster wheel, their only choice is to spin it faster. Meanwhile, the fiscal side is already preparing for another trillion in stimulus to supposedly fight inflation—they clearly have even less stomach for a pullback.
Therefore, I find it baffling that so many investors got so bearish back in June and July. Look, we all have PTSD from 2008. It was a miserable experience that I never want to repeat. That said, this isn’t 2008. Anyone who thinks that it is, is asking to get their portfolio debased by “Project Zimbabwe.” The lesson that the Fed learned from blowing up the financial system back then, is that once it starts to unravel, it’s harder to put it all back together again—just look at how extreme their response in March of 2020 was. Even after it was obvious that they had flooded the market with too much liquidity and inflation was spiraling out of control, the Fed wasn’t taking any chances—they kept plowing ahead with QE until the first quarter of 2022.
It is clear to me that they prefer inflation to another lost decade of patching up the financial system like in the 2010’s. Oddly, investors think that the Fed will take rates to a level where it detonates things. JPOW doesn’t want to be the next Arthur Burns, but that is still preferable to being the guy who blew up the Eurozone and Japan. Given the level of debt in the system, tightening too much could very well blow up the US as well. These things cascade fast—markets cannot even get close to stall-speed. All the bluster is for show—these guys know that the Fed is Fuct—they’ll go back to money printing at the first sign of panic.
I go on vacation because it focuses the mind. Vacations ensure that I stop worrying about each data-point and instead focus on the big picture. It is clear to me that we’re in the early innings of “Project Zimbabwe” and we just had our first real shake-out. Plenty of speculators were over-levered, mostly in Ponzis. They got shredded for staying too long in last-cycle’s rolling bubble. They missed their chance to pivot into the next rolling bubble. In my view the only thing that matters during “Project Zimbabwe” is staying as levered long as you can be, while correctly choosing the right rolling bubble. Energy is one of the few asset classes that is still up on the year—it’s giving you a clear message about what’s coming—it sure feels like energy is going to be the next rolling bubble. Miss it at your own peril.
Remember, in a highly inflationary environment, you need to not only be long to keep up, but highly levered long to actually get ahead—especially when taxes get factored in. Think back to Weimar; those who didn’t max it out, those who guessed the cycles wrong and overstayed the prior rolling bubbles, they all ended up broke. Sure, they were Weimar billionaires, but everyone was a Weimar billionaire at the end. Weimar completely upended society and when it all concluded only the shrewdest speculators were on top—everyone else lost everything, despite becoming a Weimar billionaire in the process. Making money in nominal terms was not enough, you needed to create value in real terms. Therefore, the main risk that I see, is not losing money, as everyone makes money during inflation. Rather, the risk is not making enough and essentially falling behind the inflation. When the next bubble heats up, I intend to be maxed out—especially as each subsequent rolling bubble will likely be larger and sillier than the prior one.
Meanwhile, JPOW hasn’t started The Pause yet. In fact, he may be forced to keep going until something breaks. As I learned during this June and July, even next cycle’s rolling bubble can experience sharp pullbacks. Timing The Pause and maxing it out is critical. It’s dangerous to get too exposed before The Pause, but at the same time, you CANNOT miss The Pause. Therefore, timing The Pause is everything here. EVERYTHING.
I naturally struggle to square my view that I need to be maxed out long, with my view that prices may swoon on the day before JPOW finally cries uncle. I also know that by the time he publicly pauses, all his buddies will have been buying for weeks. The violence of the up-move after The Pause will stun those who do not understand “Project Zimbabwe.” Everyone will need to chase and then keep chasing. Once the chase starts, I don’t think equities will stop, especially as levered players will continue to lever up as we rampage higher.
I need to be maxed-out before The Pause, but not too far before. At the same time, imagine missing the next up-move in Weimar and having all your liquidity turn to dust?? Too early and I get taken out, too late and I fall behind. This is the dilemma that I’ve struggled with ever since last fall when I realized that the Fed would temporarily pull back on the liquidity. I’m up this year, but not up enough and it is this dilemma that has held me back from large gains, but also from losses. Now, as we’re nearing the end of this cycle in terms of duration, but potentially not price, the only thing that matters is timing The Pause. When this turns, you cannot miss it.
I thought we were close to The Pause in June. Now I’m less convinced. All great bubbles have an echo-rally. Tech is having its echo rally now. It is giving JPOW the message that he needs to keep pushing on rates. I think he gives it a few more whacks and finally succeeds in breaking something. I also worry that we cannot have a real bottom to the first real pullback in “Project Zimbabwe” without a flush. This pullback never got particularly scary. I got rather long at the end of June because the selling felt cathartic. I’m now reducing my non-energy exposure on this bounce and booking some sizable gains from the lows in June. I am thinking I get another chance to max it all out.
I can afford to play a bit more aggressive here, due to my massive energy call option position—I believe it is the perfect hedge. Of course, I define aggressive quite differently than most. To me, being aggressive is tantamount to having reduced exposure, as I think all the real risk in the market will be right-tailed during this decade. Underperformance will equate to not having enough leverage, which will equate to trailing inflation and destroying capital—even if your stocks go up in Dollar terms. My thinking is increasingly that we get one last test before The Pause. As a result, all vacation long, I’ve been taking my exposure down, as I need to have room to plow into cheap assets when it is obvious that The Pause is imminent. My massive call position fortunately gives me the flexibility to focus on the timing in other sectors. This equity market bounce seems anemic and weak-willed—it likely collapses when oil bottoms—which may have already happened. As oil gets going again to the upside, we’ll get a proper test of the equity speculators before seeing the real bottom. I want capital to deploy into that moment.
In conclusion, my thinking from a six-week vacation, is that we’re progressing along in “Project Zimbabwe” roughly as I expected things to progress. The risk is missing it. The only question is how to get more upside exposure, while not getting taken out. In my opinion, long-dated call options are far too cheap. This is where I need to be pressing it and with far more capital on this pullback. These options give me cheap exposure to what I think is about to happen. The skew is all wrong. When JPOW declares that The Pause is in effect, the market will positively explode to the upside and the IV will spike as the skew shifts. The next up-surge will make the last cycle’s trading in monkey JPEGs look tame—except this time I expect it will be an energy bubble. Every time I think about it, I realize that I need more long-dated upside exposure before the dealers realize just how badly offsides they are. The turn, when it comes, will stun people.
The Pause feels like it is coming, but first we need some real pain to get inflicted by energy on the speculators. The Energy Vigilantes took the summer off. This fall, I think they’re going to re-assert their control of the narrative…