KP
Software Engineer and Finance Blogger
"An investment in knowledge pays the best interest." - Benjamin Franklin

The astute reader might wonder why the Mexican Coat of Arms is the cover image for this article. This article is not about Mexico, even though the country will do extraordinarily well in the coming decades. Instead, it's about what's depicted in the Coat of Arms: a Hawk and a Serpent. These two creatures are age-old symbols forming an allegory for the eternal conflict of opposites: the Hawk represents enlightenment while the Serpent represents the primordial mind.

For Harry Potter fans, the only antidote to Basilisk venom is Phoenix tears. A Phoenix also kills in the Basilisk in the Chamber of Secrets.

Hedge fund manager Chris Cole uses this allegory to describe generational trends of markets as a reflection of society. The Serpent represents a market that once experienced real growth but is now anemic and greed-driven. To continue asset price appreciation despite declining fundamentals, people turn to fiat devaluation and debt expansion. This creates boom and bust cycles with consistently growing debt, much like a "a Serpent devouring its tail into oblivion". The Hawk represents forces of secular change that end this corrupted growth cycle. For example, one such force is aging demographics which leads to deflation and debt defaults. Governments then respond with aggressive inflationary policies causing significant currency debasement and a large wealth gap. Social unrest, conflict, and even restructuring typically ensues. When the dust settles, a new Serpent period starts with a period of secular growth.

Put succinctly, the phases of the Serpent-Hawk cycle are: growth, stagnation, corruption, revolution, and regeneration.

Chris Cole uses this allegory to present ideas for a 100-Year portfolio that can profit in all the phases of the Serpent-Hawk cycle. I choose a narrower scope and present a portfolio focused on just the next 20 years as the current Serpent era ends and a Hawk era begins.

End of the Serpent, start of the Hawk

Although it's hard to articulate the unease, everyone can feel its omnipresence. Society is in a period of significant change. The opioid epidemic, widespread race conflicts, the election of President Donald Trump, out-of-control money printing and deficit spending, and the relentless inflation of the stock market are all symptoms of a society struggling to adapt. Although discussing the root causes of these symptoms is beyond this article's scope, one only needs to look at the inverting population pyramids of most developed countries as well as the rapid progress of automation technology to intuitively understand what's going on and why.

The COVID-19 pandemic greatly accelerated this Serpentine trend with the destruction of the traditional economy and a focus of resources on the high tech economy. Both the Federal Reserve balance sheet and US Government debt saw exponential growth and are at all time highs. The US is more financially fragile than its ever been in recent history and the winds of change are only expected to pick up in the foreseeable future.

The 20-Year Portfolio

Unlike Chris Cole's 100-Year Portfolio, this article presents a portfolio focused only on the next 20 years as the we transition from an era of the Serpent to an era of the Hawk.

To build a portfolio that can survive and thrive in a turbulent world, one needs to have a point of view on how markets will behave as central banks struggle to temporarily fend off financial instability. In such conditions, the claim is that equities will experience stable but slow growth with high volatility periods increasing in frequency.

Why?

Because central banks will do whatever they can to prop up markets and avoid social unrest. For example, consider the aggressive inflationary policies used in both the Great Financial Crisis and COVID-19 that bailed out the economy and restored the equity bull market. In addition, short term volatility is reduced by the large and increasing share of passive investing driven in part by the 401(k) system (almost 50% market share!). Passively managed funds are notorious for following a simple algorithm: buy if you give me money and sell if you ask for money. Money in these funds are thus locked away from active market participation which suppresses short term volatility while introducing bias for upside. Finally, more long term volatility is expected as fundamentals worsen and central banks find it progressively more difficult to fend off financial instability.

So how do you sell short term volatility and buy long term volatility?

The easiest and most accessible way for retail investors to sell short term volatility is to sell covered calls or cash-secured puts on a safe ETF or stock(s) of your choosing. Because the price of an option contains a premium for expected volatility, selling options is considered selling volatility. Done intelligently, selling options can be a reliable and safe income stream.

Buying long term volatility is trickier. Volatility products like the VIX ETF are better for day trading than holding since these funds tend to lose money during low volatility. I believe the best way to buy long term volatility is to buy Cryptocurrencies (Bitcoin, Ethereum) or Gold. Even though you're not technically owning volatility, owning hard-money assets approximates owning volatility since they appreciate after periods of high volatility when central banks and governments print money and expand debt to temporarily stave off financial tragedy. Between Cryptocurrencies and Gold, recent market movements suggest that the former is preferred. Although Cryptocurrencies aren't physical, they have significantly better characteristics such as improved portability, ownability, and transferability. An asset's physicality is less important in a world permeated by the Internet.


So there you have it, one idea to construct a portfolio designed to navigate the turbulent decades ahead. The idea is simple: sell short term volatility while buying long term volatility. Simplicity might seem like a weakness given how complex markets are but as Leonardo da Vinci once said, "Simplicity is the ultimate sophistication".