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Market Commentary

New Money

Lee Adaptive Strategies Update      

Monthly Commentary

May 2021

Equity markets were generally flat in May, with the S&P 500 gaining +0.69%, bringing it to up +12.62% for the first five months of the year.

US Economic indicators released early in the month were concerning. The two most widely watched, unemployment and inflation, both had notably worse than expected results. The market did not have a strongly pessimistic reaction. There were a few bad days, and if you are the kind who expects the market to perpetually march upward you may have been disappointed. But in general, the market seems to have paused for reflection and consolidation rather than exhibiting a substantive worry for the economy.

For both unemployment and inflation, there were explanations in the media of how these readings were a misleading fluke, rather than a fearful auger of the near future. Persistent high unemployment, it is said, is just a temporary problem of readjustment to the end of the pandemic. There is some truth to this, but we are concerned that this period of readjustment may last longer than anticipated.

There was similar hand waving around inflation, explaining away the highest monthly core increase in 29 years as a one-off artifact of recovery from recession. Again, we agree there is some truth in that, but high inflation numbers are also consistent with the bear story that the tidal wave of newly printed money might, after all, have the effects we were taught to expect in economics class.

Of particular concern to us is the so-called breakeven rate, expected inflation as implied by the current pricing of inflation protected Treasuries (TIPS) and their ordinary nominally denominated counterparts. The end of May number for expected inflation over the next ten years was 2.42%, just a bit higher than the actual average rate over the past 25 years of 2.16%. Yes, it is possible that inflation will continue at the rate experienced over the past quarter century. But it is also possible that it might be meaningfully higher and, we think, it is fairly unlikely that it will be much lower. This suggests a complacency in the market, which in turn raises the specter of a sudden shock when reality sets in.

The US Bureau of Labor Statistics will release May unemployment numbers on Friday June 4^th and Consumer Price Index numbers on Thursday the 10^th.

Talk of inflation naturally leads to discussion of hedges. As we will never tire of saying, equities are, in principle, inflation protected in that they are the ownership of real assets. As a practical matter this is complicated by the possibility of economic disruption as a side effect of inflation, which might harm the economy and stock prices.

Fixed income and cash are, obviously, poor places to invest when the value of the currency is falling.  Commodities are real assets, so could be attractive. Fine art and collectibles are best left to experts.

Younger and hipper investors might consider Bitcoin. (And its crypto brethren.) It is most certainly not a real asset in the conventional sense, but it is not denominated in dollars either.

We may be showing our age, but we do not think we are alone in regarding Bitcoin as a new and almost experimental phenomenon. But it is not that new. Wired magazine ran a story entitled “The Rise and Fall of Bitcoin” in November of 2011. According to the article, the first Bitcoin transaction was for two pizzas from Papa Gino’s, purchased for 10,000 BTC, or about $357 million at today’s prices. As the title implies, Wired was fairly pessimistic on Bitcoin ten years ago, particularly in regard to its potential as a currency.

Here in 2021, it is hard to take the idea of Bitcoin as money seriously. It is an untraceable means of payment, which does have practical uses, some of them illegal. And for a few weeks you could buy a Tesla with it. But we think virtually all these transactions work as the Tesla one did: the agreed price was in dollars, with the sum momentarily translated into Bitcoin based on the current market.

The argument that Bitcoin is not a good place to hide wealth from the ravages of dollar inflation can be made by two facts: 1) Bitcoin was down 38% in May and 2) this was not considered especially remarkable. To the great majority of Bitcoin users, it is not a medium of exchange nor a store of value, but a vehicle for speculation.

The most recent rise and fall in the value of Bitcoin was mostly inspired by Tesla and its boss Elon Musk. In February Musk announced that Tesla would take Bitcoin in payment and make a multi-billion dollar investment in it. Then in May he announced that Tesla would no longer accept Bitcoin, citing his apparently recent realization that Bitcoin is not environmentally friendly.

And it is not environmentally friendly. The creation of new Bitcoins, known as mining, uses absurdly massive arrays of specialized computers. Readers who have not seen video of these installations on YouTube or TikTok should go online. Bitcoins may not physically exist, but they are made from large quantities of electricity, which in most places is made from burning fossil fuels.

This is one of those things that would be hard to explain to a space alien or a child. What practical benefit is gained by burning coal to make Bitcoin? It is the sort of thing that future generations might cite as an example of decadence indicating societal decline.

Of course, almost all criticisms of Bitcoin, that it has no intrinsic value, that it has little practical use, that it is neither a useful medium of exchange nor a reliable store of value, that it is only valuable as long as others continue to agree that it is valuable, and that mining it is pointlessly costly and damaging to the environment, can also be said of gold. But gold does not seem new or experimental. It is, as economist Willem Buiter called it, a “six-thousand-year-old bubble.”

The Market Sentiment Framework

We use our Market Sentiment Framework to adapt the mechanics and weightings of our full quantitative models to changing market conditions.

The Sentiment Framework gauges the current state of market psychology on two dimensions. Efficiency measures the crowdedness of the market, the volume of participants seeking investment opportunities. Lower levels of efficiency imply more market mispricing. Optimism measures the willingness of investors to take on risk in exchange for distant and uncertain rewards. Higher levels of optimism imply a better outlook for risky asset classes.

Similar to the market price level, both sentiment measures were largely unchanged in May.

Optimism began the month at 0.35 and ended the month at 0.39.

Efficiency fell slightly, starting the month at 0.69 and ending at 0.66. Efficiency continues to be comparatively low in absolute terms, which suggests a market that is still under stress.

Both measures are higher than where they were pre-COVID. The current positioning of the Sentiment Framework implies a market that is functioning less than ideally, with marginally optimistic but fearful investors. This would imply a positive but challenged outlook for the market as a whole, but possibly an opening for value strategies to find opportunities.

PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS OR PROFITABILITY.

Definitions:

Lee Adaptive Large Cap Sector Composite (“LALCS Composite”).  A capital weighted performance composite of an investment strategy known as the Lee Adaptive Large Cap Sector strategy (the “LALCS Strategy”) that holds some combination of the U.S. large cap sector ETFs and/or cash, as determined by a proprietary quantitative model.   The LALCS Composite performance is based on actual trading profits/losses/expenses net of a management fee of 0.50%.  Actual expenses of operating the LALCS Strategy may vary, depending on the investment structure in which the Strategy is used, which could result in lower returns than those stated for the LALCS Composite. Such expenses may detract materially from the performance of the LALCS Strategy and, consequently, the results shown above may not be fully indicative of the actual performance results of the LALCS Strategy.

THE LALCS COMPOSITE IS BEING SHOWN FOR ILLUSTRATION PURPOSES ONLY AND SHOULD NOT BE RELIED UPON.  NO REPRESENTATION OR ASSURANCE IS MADE THAT ANY INVESTOR WILL OR IS LIKELY TO ACHIEVE RESULTS COMPARABLE TO THOSE SHOWN ABOVE OR WILL MAKE ANY PROFIT OR WILL BE ABLE TO AVOID INCURRING SUBSTANTIAL LOSSES.

PAST PERFORMANCE OF THE STRATEGY AND THE LALCS COMPOSITE ARE NOT INDICATIVE, OR A GUARANTEE, OF FUTURE RESULTS.  IT SHOULD NOT BE EXPECTED THAT THE LALCS STRATEGY’S ACTUAL RETURNS WILL REPLICATE THE RETURNS SHOWN IN THE PERFORMANCE MODEL.

Lee Adaptive Broad Market Composite (“LABMS Composite”).  A capital weighted performance composite of an investment strategy known as the Lee Adaptive Broad Market Strategy (the “LABMS Strategy”) that holds some combination of the U.S. large cap sector ETFs, a small cap ETF and/or cash, as determined by a proprietary quantitative model.   The LABMS Composite performance is based on actual trading profits/losses/expenses net of a management fee of 0.50%.  Actual expenses of operating the LABMS Strategy may vary, depending on the investment structure in which the Strategy is used, which could result in lower returns than those stated for the LAUSE Composite. Such expenses may detract materially from the performance of the LABMS Strategy and, consequently, the results shown above may not be fully indicative of the actual performance results of the LABMS Strategy.

THE LABMS COMPOSITE IS BEING SHOWN FOR ILLUSTRATION PURPOSES ONLY AND SHOULD NOT BE RELIED UPON.  NO REPRESENTATION OR ASSURANCE IS MADE THAT ANY INVESTOR WILL OR IS LIKELY TO ACHIEVE RESULTS COMPARABLE TO THOSE SHOWN ABOVE OR WILL MAKE ANY PROFIT OR WILL BE ABLE TO AVOID INCURRING SUBSTANTIAL LOSSES.

PAST PERFORMANCE OF THE STRATEGY AND THE LABMS COMPOSITE ARE NOT INDICATIVE, OR A GUARANTEE, OF FUTURE RESULTS.  IT SHOULD NOT BE EXPECTED THAT THE LABMS STRATEGY’S ACTUAL RETURNS WILL REPLICATE THE RETURNS SHOWN IN THE PERFORMANCE MODEL.

Lee Adaptive Global Equity (“LAGES Composite”).  A capital weighted performance composite of the of an investment strategy known as the Lee Adaptive Global Equity strategy (the “LAGES Strategy”).  The LAGES Composite performance is based on actual trading profits/losses/expenses net of a management fee of 0.50%.  Actual expenses of operating the LAGES Strategy may vary, depending on the investment structure in which the LAGES Strategy is used, which could result in lower returns than those stated for the LAGES Composite. Such expenses may detract materially from the performance of the LAGES Strategy and, consequently, the results shown above may not be fully indicative of the actual performance results of the LAGES Strategy.

THE LAGES COMPOSITE IS BEING SHOWN FOR ILLUSTRATION PURPOSES ONLY AND SHOULD NOT BE RELIED UPON.  NO REPRESENTATION OR ASSURANCE IS MADE THAT ANY INVESTOR WILL OR IS LIKELY TO ACHIEVE RESULTS COMPARABLE TO THOSE SHOWN ABOVE OR WILL MAKE ANY PROFIT OR WILL BE ABLE TO AVOID INCURRING SUBSTANTIAL LOSSES.

PAST PERFORMANCE OF THE LAGES STRATEGY AND THE LAGES COMPOSITE ARE NOT INDICATIVE, OR A GUARANTEE, OF FUTURE RESULTS.  IT SHOULD NOT BE EXPECTED THAT THE LAGES STRATEGY’S ACTUAL RETURNS WILL REPLICATE THE RETURNS SHOWN IN THE PERFORMANCE MODEL.

Lee Adaptive China Equity Composite (“LACS Composite”) Performance.  A capital weighted performance composite of the of an investment strategy known as the Lee Adaptive China strategy (the “LACS Strategy”).  The LACS Strategy is currently offered by LCM to certain qualified investors through certain accounts managed by LCM on a discretionary basis (“LACS Managed Accounts”).  The LACS Managed Accounts use the same investment program as the LACS Strategy.  The Composite performance is based on actual trading profits/losses/expenses net of a management fee of 0.35%.  Actual expenses of operating the LACS Strategy may vary, depending on the investment structure in which the LACS Strategy is used, which could result in lower returns than those stated for the LACS Composite. Such expenses may detract materially from the performance of the LACS Strategy and, consequently, the results shown above may not be fully indicative of the actual performance results of the LACS Strategy.

THE LACS COMPOSITE IS BEING SHOWN FOR ILLUSTRATION PURPOSES ONLY AND SHOULD NOT BE RELIED UPON.  NO REPRESENTATION OR ASSURANCE IS MADE THAT ANY INVESTOR WILL OR IS LIKELY TO ACHIEVE RESULTS COMPARABLE TO THOSE SHOWN ABOVE OR WILL MAKE ANY PROFIT OR WILL BE ABLE TO AVOID INCURRING SUBSTANTIAL LOSSES.

PAST PERFORMANCE OF THE LACS STRATEGY AND THE LACS COMPOSITE ARE NOT INDICATIVE, OR A GUARANTEE, OF FUTURE RESULTS.  IT SHOULD NOT BE EXPECTED THAT THE LACS STRATEGY’S ACTUAL RETURNS WILL REPLICATE THE RETURNS SHOWN IN THE PERFORMANCE MODEL.

S&P 500 Total Returns Index.  The returns for the S&P 500 index on a total return basis, that is, with dividends included and does not reflect the deduction of fees and expenses.  You cannot invest directly in this index. The returns for the S&P 500 Index are provided for comparison purposes only to show how the LALCS Composite compares to a broad-based index of securities.  The S&P 500 is comprised of a representative sample of 500 large-cap companies.  The index is an unmanaged, float-weighted index with each stock’s weight in the index in proportion to its float, as determined by Standard & Poors.  The index is one of the most widely used benchmarks of U.S. equity performance.  The index is not subject to any of the fees or expenses to which the LALCS Composite is subject.  It is not possible to invest in this index.  The index is used for comparison purposes only.  It should not be assumed that the LALCS Strategy will invest in any specific securities that comprise the index or that the investment program of the LALCS Strategy will track the index.  Consequently, the returns of the LALCS Composite may or may not be highly correlated with those of the index.

Russell 3000 Index. The Russell 3000 Index is a market-capitalization-weighted equity index maintained by FTSE Russell that seeks to be a benchmark of the entire U.S. stock market.  It measures the performance of the 3,000 largest publicly held companies incorporated in America as measured by total market capitalization and represents approximately 98% of the American public equity market. The returns for the Russell 3000 index are provided for comparison purposes only to show how the LABMS Composite compares to a broad-based index of securities.  The index is not subject to any of the fees or expenses to which the LABMS Composite is subject.  It is not possible to invest in this index.  It should not be assumed that the LABMS Strategy will invest in any specific securities that comprise the index or that the investment program of the LABMS Strategy will track the index.  Consequently, the returns of the LABMS Composite may or may not be highly correlated with those of the index.

MSCI All Country World Index. The returns for the MSCI All Country World Index (“ACWI”) on a total return basis, that is, with dividends included and does not reflect the deduction of fees and expenses. The returns for the index are provided for comparison purposes only to show how the above composite returns compare to a broad-based index of securities. The MSCI AC World Index is composed of large and mid-capitalization developed and emerging market equities. The index is one of the most widely used benchmarks for global equity performance. You cannot invest directly in this index. It should not be assumed that the strategies above will invest in any specific securities that comprise the index or that the investment program of the strategies above will track the index. Consequently, the returns of the composites above may or may not be highly correlated with those of the index.

MSCI China Index Net. The returns for the MSCI China Index Net on a total return basis, that is, with net dividend tax withholding and does not reflect the deduction of fees and expenses. The returns for the index are provided for comparison purposes only to show how the above composite returns compare to a broad-based index of securities. The MSCI China Index represents large and mid-capitalization across H shares, B shares, Red chips, P chips and foreign listings (e.g. ADRs). With 495 constituents, the index covers about 85% of this China equity universe. Currently, the index also includes Large Cap A shares represented at 5% of their free float adjusted market capitalization.  It should not be assumed that the LACS strategy will invest in any specific securities that comprise the index or that the investment program of the LACS strategy will track the index. Consequently, the returns of the composite above may or may not be highly correlated with those of the index.

Disclaimer:

PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS OR PROFITABILITY.

The above is the opinion of the author and should not be relied upon as investment advice or a forecast of the future. It is not a recommendation, offer or solicitation to buy or sell any securities or implement any investment strategy. It is for informational purposes only. The above statistics, data, anecdotes, and opinions of others are assumed to be true and accurate however 3D/L Capital Management does not warrant the accuracy of any of these. There is also no assurance that any of the above are all-inclusive or complete.  

3D/L does not approve or otherwise endorse the information contained in links to third-party sources. 3D/L is not affiliated with the providers of third-party information and is not responsible for the accuracy of the information contained therein.

Past performance is no guarantee of future results. None of the services offered by 3D/L Capital Management are insured by the FDIC and the reader is reminded that all investments contain risk. The opinions offered above are as of May 31, 2021 and are subject to change as influencing factors change.

More detail regarding 3D/L Capital Management, its products, services, personnel, fees, and investment methodologies are available in the firm’s Form ADV Part 2 which is available at https://files.adviserinfo.sec.gov/IAPD/Content/Common/crd_iapd_Brochure.aspx?BRCHR_VRSN_ID=669397 or by calling (860) 291-1998, option 2 or emailing sales@3dlfinancial.com or visiting 3D’s website at www.3dlfinancial.com