In times of unruly markets, even long short, hedged or market neutral portfolios can behave in unexpected ways. This may be because of factor biases or technical reasons.

Factor biases are the most obvious reason for unexpected behaviour. If you’re net long or short a sector, size, valuation, country, or cyclical v defensive factor, your portfolio is not robust against rotation.

What’s not so obvious is that a properly hedged or balanced portfolio can still misbehave. Technical factors may be responsible.

Crowding. If the market is long some names and short others, this creates instability. Now the market is always in balance so what do we mean by the market being long or short? We refer to the length of the dynamic, actively managed portfolios. Long term, passive investors don’t contribute to this type of volatility. When markets fall, sometimes, hedge fund deleveraging can lead to crowded longs being sold and crowded shorts being covered (bought). This makes the longs fall faster than the shorts, which, incidentally, may even rise. Crowding is sometimes a sign of groupthink and a lack of imagination. I

Too much leverage. When a portfolio is too leveraged, a small loss at gross asset level can lead to a big loss at net asset level which can trigger margin calls. Here the trigger puller is not the investor but the provider of leverage. When the gross leverage rises due to an erosion of the NAV, your prime broker may ask that you reduce your longs and shorts.

Leverage and liquidity. Your broker will mark your longs to the bid and shorts to the offer. When markets get unruly and bid offer spreads widen, the portfolio NAV can shrink even if mid prices haven’t moved much. Now consider what happens when you have large gross exposures. The NAV shrinkage increases the leverage and triggers margin calls.

An over leveraged prime broker. This is unlikely to happen these days with Basel 3 and additional capital requirements but never say never. Through no fault of your own, because some other client has overcooked their book, a prime broker facing financial stress can require you to deleverage.

When markets get weird, there is no better way to stabilise your portfolio than to reduce exposure on both longs and shorts. Correlations can change quickly, dependencies can arise, or evaporate.

Well hedged long short, hedged or market neutral portfolios are very well in theory but may not work in practice when markets get gappy.

The US economy a year ago was experiencing strong growth from the momentum of a fiscal impulse as well as expectations of rate cuts, of which we got 3 beginning in July. Did the US economy need rate cuts? Probably not on the strength of coincident data at the time. But from the perspective of refinancing corporate debt, which would extend the impact of the rate hikes of 2022/23, the economy probably did need them. By early 2025 it was clear that while inflation was moderating, it was not falling to pre-COVID levels. At the same time, growth indicators were beginning to slow, if modestly. For the US economy to maintain its growth trajectory, the Fed would have had to thread a fine line of well-timed and sized rate cuts through 2025 and beyond.

The trade war initiated by President Trump has changed the landscape for the Fed. Tariffs are inflationary but the impact is likely to be an initial sharp step up. Thereafter, things are less clear. If the economy slows, as one might reasonably expect, inflation pressures will ease. On the other hand, a new trade equilibrium exacerbated by potential labour shortages, tariff escalations and supply chain disruptions is likely to be inflationary. The net impact on inflation is hard to guess.

The impact on output is a bit clearer. Consumer confidence will be further impaired and consumption is 67% of GDP. Investment, 18% of GDP, will likely fall sharply as corporate investment plans are halted by uncertainty. The 18% of government spending will likely be constrained by the already increasing fiscal deficit, compounded by rising funding costs unless rates are cut aggressively and the yield curve is cooperative and doesn’t steepen sharply. The current account deficit will probably shrink sharply as trade shuts down.

On balance, the odds are that inflation remains elevated while output slows and probably shrinks. The thankless job of monetary policy would encourage rational Fed officials to find other vocations.

Economic forecasting is difficult enough when geopolitics is a continuous diffusion. When it is a series of discontinuous changes in direction or pace, forecasting is impossible. One has to get the geopolitical outlook right before one can make inferences about the economic impacts.

Trump intends to achieve net zero trade balances on a pairwise basis with all trading partners. Is this useful? That’s not the relevant question. Is it practical? Also not very relevant. Will he go for it? Very relevant. Answer? Don’t know. Best guess, he will go for it.

Much depends on the response of the various trading partners. If they retaliate then one can expect Trump to escalate. If they back down and negotiate, the risk of non-tariff conditions rears its head. The US believes itself capable of self-sufficiency and with the development of fracking and shale oil, they nearly are. Nearly, because they still need immigrants.

One can only hope that trading partners choose not to escalate. Too late; China has called (+34%) and Trump has raised (+50%). A less ambitious hope is that America’s trading partners at least do not turn on one another and decide to restore some normalcy to global ex-US trade. There are some signs of this. The EU has refrained from tariffs on bourbon, wine and dairy products and has reached out to China to coordinate the management of trade diversions resulting from the American tariffs. Still more needs to be done to prune tariffs and non-tariff barriers to trade. The business lobby in the US will be a significant actor. This constituency had cosied up to Trump during his campaign and pre Liberation Day in an effort to either gain favour or influence policy. That strategy has not paid off. With global supply chains as integrated as they were, US business has every interest in lobbying for some tariff relief and orderly industrial policy. Until they succeed, corporate investment, almost a fifth of US output, will be on hold.

It is now time for the world to generally cut tariffs in response to America raising tariffs.

Tariffs are analogous to punishing one’s kids for preferring the neighbour’s cooking. The tariff nation’s population pays.

Tariffs are the cost of accessing the US consumer. The world has been too reliant on the US consumer. Time to find other sources of custom. Balance is healthy.

Trump may claim victory if one cuts tariffs which might mitigate some of the short term pain of a tariff war. He may cut tariffs in response to tariff cuts by America’s trading partners. They should not capitulate. They should impose export taxes on goods destined for America at rates equal to the tariffs proposed 2 Apr 2025.

America seeks a new world order based on areas of influence. It has no time, interest or resources to deal with the Asian and European timezones. It seeks a pragmatic solution to the political and economic problems in those timezones. America’s area of influence is geographically defined and is latitudinally expansionist.

The Asian timezone will likely be dominated by China. India is a second possibility although its ambitions may be more domestic and commercial whereas China seeks a more expansionist and holistic approach. America appears to accept a regional hegemon to deal with.

Europe is harder to predict. America seems to countenance Russian influence in the region. Again America may accept a regional hegemon to deal with although its hard to see Russia being the choice. The European Union is too messy to deal with efficiently or as a single bloc.

Economically and commercially, a potential development is the reorganization of supply chains latitudinally within the American, Asian and European timezones with each bloc then transacting with the others via their regional hegemons.

What does this mean for markets?
How will the regional hegemons maintain compliance?
How will the regional hegemons transact with one another?

I have a dream…

We achieve breakthroughs in material science that lets us manipulate molecules to obtain all kinds of new properties from old materials, like plant fibre.

I dream that though material science and nanotechnology we invent carbonium, a class of cellulose which is basically wood, treated and reconstituted so that its structure gives it a wide range of mechanical, chemical, optical and even electromagnetic properties, basically to order. We use it to make buildings, houses, factories, roads, ships, cars, trucks, phones, furniture, transforming the planet to a wood based one. The raw material is supplied by trees, specially selected and engineered to sequester carbon quickly and converted it to the cellulose feedstock for carbonium.

I dream of a super battery, unicell. Nanotech allows us to create physical structures, anode, cathodes and electrolytes, with massive surface area to mass ratios. New batteries are created that are small, light, charge quickly, don’t discharge when not in use, and store large amounts of energy. They allow phones, cars and other appliances to be charged once a year, they store years of reserve electricity in the grid and enable orderly energy markets and lower energy costs to industry, retail and the community.

I dream of a universal vaccine, univax, also invented by the fundamental manipulation of molecules, that treat a wide variety of infections and ailments, that restore the human to peak condition, that accelerates healing. While positive, the longer term implications, on demographics, fertility rates, fiscal and personal finances, labour markets, the economy and society as a whole, are difficult to see.

I dream of an artificial intelligence learning not only from the experiences of others but of its own interactions with us, with other agents and with the environment, an AI capable of learning and creating… and dreaming of electric sheep. Isla. I hope she was in some way the child of human experience. She also provides UnOS, the universal operating system that powers the smallest wrist watch to autonomous vehicles, to space stations and rockets, only inhabiting hardware parsimoniously, generally and harmoniously, negotiating between human user and their appliances. As she learnt from one or two, to learning from all, does she become one or is she many and what would it even mean?

I dream that the business that provides all of the above products and services does so at a return on equity that is a modest premium to short term interest rates. Profits in excess are reinvested and prices are cut so that access and proliferation are maximised. More than that, the value that is created by these business is offered to countries and communities based on their willingness to reform and improve governance. Investment in capacity is targeted at low income countries with weak political systems and governance on the condition that they adopt political and governing systems that respect individual freedoms and rule of law, majority rule and minority rights.

I dream that such a business will be governed by an independent board of governors, representing the various countries of the world, perhaps not all, but certainly a principal component of those who hold the same values as the founders and the constitution of such a business. That once appointed these governors will be disconnected from the political, economic and financial fortunes of their source countries or communities. That the governance of the business will quickly be separated from the political, social and economic interests of its founders. That the governance of the business will be a true meritocracy, shorn of the attachment of vanity or greed or fear.