Author: Autumn Lane Advisors

I was deep into drafting this letter when the futures market began selling off on Sunday night, forcing me to pause and rethink much of what I had written. The recent market volatility has been truly extraordinary. On the upside, it’s led to my phone buzzing nonstop with calls, emails and texts from concerned friends and clients, a level of engagement that I appreciate. 

On Monday, the Tokyo Stock Exchange Stock Price Index (“TOPIX”) experienced its worst day since 1987, serving as a stark reminder of the fragility of global markets. While we’ve weathered significant global storms such as COVID-19 and the global financial crisis, Monday’s plunge in the TOPIX was the most severe in nearly 40 years. Considering all that has transpired since 1987, it’s remarkable that Monday stands out as the worst day. Naturally, this turmoil spilled over into the U.S. markets, as global sell-offs often become contagious. 

 “Only when the tide goes out do you discover who’s been swimming naked.” — Warren Buffett

The U.S. market was already on shaky ground due to weak economic data, including disappointing labor and manufacturing reports, which stoked fears of a global economic slowdown. Many believe that the surprise rate hike by the Bank of Japan was the catalyst that ignited a broader market sell-off, shocking investors who had expected a continuation of low rates. This triggered a sharp decline in the equities of major Japanese trading firms, leading to turmoil across Asian markets and eventually cascading over globally. The interconnectedness of the global financial system means that events in one region can quickly affect markets worldwide. Specifically, many investors were short Japanese bonds to invest in higher-yielding assets elsewhere, and when a global shock occurs, those trades unwind violently. Of course, many apply copious amounts of leverage to this carry trade to increase returns. It’s a clear reminder that while markets tend to rise slowly, they often fall quickly—much like taking the stairs up and the elevator down. 

When the sell-off begins and volatility spikes, it’s a risk-off scenario across most risk assets. This is largely driven by leveraged positions and risk management practices. In leveraged portfolios, increased volatility translates to increased risk, prompting managers to reduce their exposure. This often leads to the selling of the best-performing stocks or other assets, exacerbating the decline. At one point, the VIX surged over 60% on Monday, marking the highest level since the COVID-19 shutdowns. What happens next? My phone starts to buzz… 

“If you put the federal government in charge of the Sahara Desert, in 5 years there’d be a shortage of sand.” — Milton Friedman

The unemployment rate is currently 4.3% and beginning to rise, but it remains well below the historical average of 5.7% over the past 70 years. The Federal Reserve, with its dual mandate to manage both inflation and unemployment, is now shifting its focus more towards the latter, as inflation appears to be under control at this juncture. 

It’s important to note, however, that the current low unemployment rate might be somewhat misleading. Recent studies have shown that a significant portion of post-COVID job growth has been driven by immigrants. In fact, one study suggests that 75% of employment growth since 2019 has been attributed to this demographic.(1) 

U.S. GDP has shown robust growth, with Q2 coming in at 2.8%, and the Atlanta Fed’s GDPNow currently estimating 2.9% as I write this. This is near the upper end of the healthy 2-3% growth range (see shaded area in the chart below). If this economy doesn’t feel like your typical growth environment, you’re not alone. Many have yet to fully adjust to the previous price increases, which still weigh heavily on consumer sentiment. Government spending has been a significant driver of recent GDP growth, fueled by the passage of the Inflation Reduction Act, the Infrastructure Bill, and the CHIPS Act. As these initiatives continue to roll out, we expect this trend to persist. Over the past six quarters, even if all other economic activity were stagnant, the economy would have still averaged nearly 0.7% GDP growth per quarter solely due to government spending. 

The market is currently pricing in five rate cuts by January 2025, with a 76% probability of a 50 basis point cut in September. Given rising unemployment and the difficult housing situation, I agree the likelihood of at least one rate cut in September is extremely strong. As I’ve highlighted in previous letters, the rate curve used to forecast these probabilities is highly volatile. We’ve witnessed market expectations fluctuate significantly—from anticipating seven cuts, down to just two, and now back to five—reflecting the uncertainty and sensitivity of market sentiment to evolving economic conditions. 

Looking ahead, we have two more CPI and jobs reports scheduled before the next Fed meeting. If these data points align with recent trends, we can expect the much-anticipated Fed cuts to begin in September. 

These rate cuts are particularly significant for smaller businesses. A compelling chart from Torsten Slok of Apollo illustrates the growing divergence between Large Cap (S&P 500) and Small Cap (S&P 600) companies following recent rate hikes. Smaller companies, which are more reliant on floating-rate debt due to limited access to capital, are particularly vulnerable to changes in interest rates. This sensitivity is clearly reflected in the data, highlighting the disproportionate impact that rate increases can have on smaller firms compared to their larger counterparts. 

“If you don’t know where you’re going, you might wind up someplace else.” — Yogi Berra 

So, where does this leave equity markets? They remain expensive. The S&P 500 is currently trading at 21.5 times forward earnings, nearly two standard deviations above historical norms. The bifurcation in small-cap performance, as highlighted by Torsten’s analysis, has led to significant underperformance of smaller-cap companies. Since January 2023, the S&P 600 has trailed the S&P 500 by almost 19%, underscoring the stark contrast in market dynamics between large and small-cap equities. While we expect that rate cuts could provide some relief to smaller companies, if we are indeed entering into a recession, the benefits of these cuts may be outweighed by the broader impact of a slowdown in economic activity. 

An interesting trend to watch is the performance of the AI hyperscalers—Amazon, Microsoft, Google, Meta, and Tesla—who are leading the charge in AI development and capital expenditures. Last quarter saw a noticeable shift among investors, who are increasingly focused on when they will see tangible returns on their AI investments and what those returns will be. David Cahn of Sequoia Capital published a thought-provoking article titled “AI’s $600 Billion Question,” which I highly recommend. The key takeaway is that the gap between expected AI revenue and actual returns, given the enormous spending, has raised concerns about the profitability of AI models going forward. This situation has profound implications not only for the hyperscalers but also for the overall performance of the S&P 500. While I’m far from being an AI skeptic, it’s important to note that if the return on invested capital decreases, it logically follows that multiples should adjust downward, ceteris paribus. 

Portfolio Updates 

We’ve made significant and exciting changes in both our Autumn Lane Diversified Strategies and Autumn Lane Alpha Opportunities portfolios. We’ve added some outstanding managers and have been reallocating from others. Due to lock-up provisions, it will take a few quarters to see the full impact of these changes. However, we are excited and confident that our expected risk-adjusted returns should improve materially. We look forward to continuing to enhance the portfolio and generate alpha. 

As always, if anyone has any questions or would like to discuss the markets further, please do not hesitate to reach out. 

Best Regards,
Jim Mooney
Partner and Chief Investment Officer
Autumn Lane

DISCLOSURES
This information is provided, on a confidential basis, for informational purposes only and does not constitute an offer or solicitation to buy or sell an interest in Autumn Lane Partners, LP (the “Fund”) or any other security. It is intended solely for the named recipient, who, by accepting it, agrees to keep this information confidential. An investment in the Fund is speculative and involves substantial risks. Additional information regarding the Fund including fees, expenses and risks of investment, is contained in the offering memorandum and related documents and should be carefully reviewed. An offer or solicitation of an investment in the Fund will only be made to accredited investors pursuant to a private placement memorandum and associated documents. Interests in the Fund can only be purchased by investors meeting all the requirements of the Fund. There can be no guarantee that the Fund will achieve its investment objectives. The information contained in this material does not purport to be complete, is only current as of the date indicated, and may be superseded by subsequent market events or for other reasons. In preparing this document, Autumn Lane Advisors, LLC has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources.

This material may not be reproduced in whole or in part in any form, or referred to in any other publication, without express written permission. Send email requests to info@autumnlanellc.com.

(1) Center for Immigration Studies, June 10, 2024.

The past quarter has flown by fast. Growing up, my stepmother often remarked that time accelerates as you age. At the time, I probably just ignored her warnings and went about my day, but now, I find that no truer words have ever been spoken. 

 “Las Vegas is the only place I know where money really talks — it says, Goodbye.” Frank Sinatra

I recently had the pleasure of attending an annual family office conference in Sarasota. It was a fantastic gathering where I met other CIOs to discuss investment ideas and market trends. Despite differing perspectives, I left with the same impression as when I arrived: there is a prevalent concern among investors regarding the valuation of public markets—and for good reason. 

Looking at the work and data of Nobel Laureate Robert Shiller, we find compelling insights from his CAPE (Cyclically Adjusted Price-to-Earnings) ratio, which has forecasted stock returns over the next decade since 1881. Assuming Shiller’s current math holds true, we might expect a real asset return of only 1.8% annually over the next ten years—a figure that is hardly compelling when compared to historical market returns. 

I keep hearing the argument about the record amount of capital in money markets, just waiting for the right moment to “buy the dip.” While it’s true that money market assets are near historic highs, their buying power, especially compared to all domestic public indexes, is below the average of the past twenty years (see next page). Not surprisingly, this ratio reached its peak during the Global Financial Crisis in 2008, indicating the highest level of ‘dry powder’ available at the time. 

“Inflation is like toothpaste. Once it’s out, you can hardly get it back in again.” Dr. Karl Otto Pohl 

Over the last past months, the Consumer Price Index (CPI) has started to rise again, presenting a bearish outlook for long-duration bonds and valuations overall. The primary driver behind this uptick has been the services sector, which traditionally shows less sensitivity to interest rate changes compared to goods. Alternatively, the services sector tends to be more influenced by wage levels and employment rates, both of which have remained robust—at least for the moment. 

In my previous update, I mentioned that the market was anticipating six rate cuts by January 2025. However, as I write this letter, expectations have adjusted significantly downward to fewer than two cuts, with the precise figure being 1.66. If we take the Federal Reserve’s statements regarding their data-dependent approach at face value, it seems unlikely they will cut rates in the near future unless there is material change in the inflation data. 

“No government ever voluntarily reduces itself in size. Government programs, once launched, never disappear. Actually, a government bureau is the nearest thing to eternal life we’ll ever see on this earth!” Ronald Reagan

The Gipper was spot-on with his quote. One of the most alarming charts I’ve seen recently is from the Congressional Budget Office, projecting the US national debt to GDP ratio. I remember a time when at least one political party cared about deficits, but it seems the Tea Party movement has long faded. Meanwhile, proponents of Modern Monetary Theory argue that excess government spending or deficits don’t matter, often citing Japan as an example. Well, Japan is looking like it finally crossed the Rubicon. Since 2023, the yen has depreciated over 20% against the dollar, and the decline shows no signs of abating. In my experience, these economic shifts occur just as Hemingway famously described: gradually, then suddenly. Japan looks like they have moved on to the ‘suddenly’ phase, which I hope serves as a wake-up call for our Congress.

“That’s it, man. Game over, man! Game over! What are we gonna do now? What are we gonna do?” Private Hudson in Aliens

Given the current S&P 500 valuation coupled with concerns about persistently high interest rates, adopting a prudent stance is, in my opinion, important. In the near term, we are concerned about the valuations of longer-duration assets, such as bonds and corporate real estate. 

We have been strategically “weatherproofing” our ALDS and ALAO portfolios by increasing exposure to investments that will benefit from a higher for longer yield curve environment such as funds with exposure to floating rates. Furthermore, we are allocating resources to market-neutral funds with proven track records of profitability in various market conditions—whether rising, falling, or remaining flat. 

The present setup does not necessarily mean that equities cannot go higher; however, the path to achieving these gains becomes more challenging. To echo my earlier reference to Frank Sinatra, the cards are stacked against you. 

If anyone wishes to discuss markets at any time, please do not hesitate to reach out. I am always eager to assist. 

Best Regards,
Jim Mooney
Partner and Chief Investment Officer
Autumn Lane

DISCLOSURES
This information is provided, on a confidential basis, for informational purposes only and does not constitute an offer or solicitation to buy or sell an interest in Autumn Lane Partners, LP (the “Fund”) or any other security. It is intended solely for the named recipient, who, by accepting it, agrees to keep this information confidential. An investment in the Fund is speculative and involves substantial risks. Additional information regarding the Fund including fees, expenses and risks of investment, is contained in the offering memorandum and related documents and should be carefully reviewed. An offer or solicitation of an investment in the Fund will only be made to accredited investors pursuant to a private placement memorandum and associated documents. Interests in the Fund can only be purchased by investors meeting all the requirements of the Fund. There can be no guarantee that the Fund will achieve its investment objectives. The information contained in this material does not purport to be complete, is only current as of the date indicated, and may be superseded by subsequent market events or for other reasons. In preparing this document, Autumn Lane Advisors, LLC has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources.

This material may not be reproduced in whole or in part in any form, or referred to in any other publication, without express written permission. Send email requests to info@autumnlanellc.com.

I am thrilled to introduce myself as the newly appointed Partner and Chief Investment Officer at Autumn Lane, effective last Friday. It has been a pleasure meeting many of you, and I eagerly anticipate connecting with everyone else. Before delving into a few market insights, allow me to share a bit about my background.

With 18 of the last 20 years dedicated to principal investment roles at Millennium Management, Carlson Capital, and most recently, Everpoint Asset Management (Point 72), my focus spans global public equities, bond portfolios, and private equity investments.

My connection with David Andrew dates to our time at Lehman in the early 2000s. I became an early client of Autumn Lane in 2017, and our enduring friendship has only strengthened over the years. I am excited about the opportunity to collaborate with David and the exceptional team he has assembled at Autumn Lane.

In the second week of January, I had the privilege of attending a summit in Jackson Hole alongside impressive C-level executives from the Energy, Power, and Renewables sectors, as well as some of the largest global asset managers. It proved to be an enriching conference.

A key takeaway from other institutional investors was the macro impact on the market post-COVID era. I find myself closely following Fed meetings, a habit I didn’t have pre-COVID or even during the great financial crisis.

This week, the market’s attention is on the Richmond Fed Index (Tuesday), Purchasing Managers’ Index (PMIs) (Wednesday), Personal Consumption Expenditures and Durable Goods Orders, Initial Job Claims, New Home Sales (all Thursday), and Personal Consumption Deflator (Friday). While constructing portfolios throughout my career, I seldom focused on these high frequency data points, with the exception of PMI data as a leading indicator for commodity demand. The market eagerly awaits the next data point to gauge when the Fed might cut rates, with the current market pricing in six cuts by Q1 of 2025 (see below).

Why does this matter? The market seeks an anchor for the risk-free rate, in our case, the 10-year treasury bond. A lower 10-year rate historically correlates with a higher market valuation. As the risk-free rate contracts, justifying higher multiples becomes easier. However, the equity risk premium is currently the narrowest since 2002, emphasizing the need for accelerating earnings growth or higher market liquidity.

Empirically, equity performance (orange line) post the first rate cut has not been favorable. The market tends to peak into the first rate cut, forgetting that rate cuts (blue line) historically coincide with slowing economic growth and recession risk (grey bars).

In my perspective, the majority of the fixed income pundits are fixated on a post-Global Financial Crisis (GFC) world, deeming anything surpassing a 3% 10-year as excessive. However, let’s not lose sight of the broader picture – over the past 60 years, the 10-year has averaged approximately 5.9%. When we strip away core inflation as measured by the Consumer Price Index (CPI excluding food and energy), this yields a 2.1% real rate over the last six decades.

Perusing the chart below underscores that post the GFC, real yields reached multi-decade lows. Nevertheless, it doesn’t strike me as unreasonable for the market to anticipate a 2.1% real yield, excluding the financial effects of Quantitative Easing. So, where does this position us on a nominal basis? Assuming a 2.5% inflation going forward, a 2.1% real yield, and some term premium (let’s say 100 bps), a back-of-the-envelope calculation brings us to 5.6% for the 10-year UST. While adjustments to these inputs are prudent and necessary, it appears evident that anything below 4% seems overly ambitious, unless investors are positioning defensively for a significant downturn (aka the hard landing).

Where does this leave us? Concerned about both equity and debt markets. The 10-year and major US indexes do not seem to offer good value in our opinion. Nevertheless, companies with high-quality businesses, strong barriers to entry, and excellent returns on invested capital are poised to continue to outperform. Where could we be wrong? If data indicates a potential plunge into a severe recession, bonds are likely to witness a rally (price up, yields down), following a playbook observed for generations. The abundance of risk-free assets, stemming from government deficit spending, may not hold immediate significance. On the equities front, the influence of animal spirits could persist, propelling valuations even higher.

As we review and make recommendations for our existing portfolios at Autumn Lane, we are identifying compelling niches in the global markets that appear promising, and I look forward to sharing more details in my next update.

Best Regards,
Jim Mooney
Partner and Chief Investment Officer
Autumn Lane

DISCLOSURES
This information is provided, on a confidential basis, for informational purposes only and does not constitute an offer or solicitation to buy or sell an interest in Autumn Lane Partners, LP (the “Fund”) or any other security. It is intended solely for the named recipient, who, by accepting it, agrees to keep this information confidential. An investment in the Fund is speculative and involves substantial risks. Additional information regarding the Fund including fees, expenses and risks of investment, is contained in the offering memorandum and related documents and should be carefully reviewed. An offer or solicitation of an investment in the Fund will only be made to accredited investors pursuant to a private placement memorandum and associated documents. Interests in the Fund can only be purchased by investors meeting all the requirements of the Fund. There can be no guarantee that the Fund will achieve its investment objectives. The information contained in this material does not purport to be complete, is only current as of the date indicated, and may be superseded by subsequent market events or for other reasons. In preparing this document, Autumn Lane Advisors, LLC has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources.

This material may not be reproduced in whole or in part in any form, or referred to in any other publication, without express written permission. Send email requests to info@autumnlanellc.com.