Introduction

Hello everyone, and welcome to the second monthly update for I-Dog Capital, the People’s hedge fund!

For those who didn’t read the inaugural issue, my name is Ian, I’m 30 years old, and I work in financial services for a public accounting firm. I originally created I-Dog Capital as the eventual hub for my personal non-retirement investments, but a journey through employment struggle, debt, and the covid volatility led me to want to retool that plan. Now, in 2024, the fund is just getting back to its feet, and who knows what it will turn into. After an initial $2,000 investment in 2022, I look forward to contributing to the fund again, and expanding upon the strategies I currently trade with in my personal portfolio. Since mid-2020, my usual style of index fund holding and value investing has given rise to options trading, and after some refining of strategy, I look forward in time to incorporating that into I-Dog Capital’s performance.

My positions

Since its inception in 2022, I-Dog Capital has traded almost exclusively on the S&P 500. Due to capital constraints, the fund would sell put options on SPLG, the smaller S&P 500 index fund, with expiry in 30 days or more. My preference is to sell options that expire in 7 days or less, but SPLG, due to not being as liquid, did not have a large enough options chain, so monthly contracts have been the norm. As the fund grows, this will all change, and the duration, tickers, and strategies will all become more complex and interesting.

Starting this month, you’ll notice an additional position, that I will touch on later on in this issue.

The fund’s current holdings are as follows:

• ($7.50) in -1 SPLG April 19 57 Put
• $91.80 in 1 share of $BIL
• $1,785.92 in cash reserves

The fund’s total value is $1,870.22

My Performance

The fund’s performance in March was 0.75%. The fund’s performance year-to-date is 3.34%. Since inception, the fund has returned (7.5%). By contrast, the S&P 500 is up 10.77% year-to-date.

• Note that so far in 2024, the fund is being far outpaced by the S&P 500. I do not expect this to change in the near future, as the fund does not have adequate capital to take on riskier trades. With more capital, this will improve.

My Trades

The fund executed two trades in March:

• First, the fund rolled forward its February 56 SPLG Put up and forward. This entailed two separate trades combined as one. The fund bought back the February put for ($3) and simultaneously sold the March 57 put for $23. This netted a profit of $20, less commissions, for the trade.
  • Note that as the market has moved higher, there was not enough premiums on the 56 strike to make the trade for March worthwhile. So, I rolled up to the 57 strike, sacrificing an additional $100 of risk (principal) for a higher premium, and thus a higher payout on the trade. As you can see, however, that additional risk only translated into $20 of premium. So maybe additional strategy is needed.
• Next, the fund initiated a position in $BIL, the SPDR short term (1-3 month) treasury bill ETF. This ETF is a bond fund, or as I like to call it, a bond that acts like a stock. In today’s high interest rate environment, I would like to put the fund’s idle cash to work earning a competitive interest rate, and a highly liquid fund such as BIL is the perfect position to capture short-term yield while also allowing the broker’s 2x margin to keep my trading power as consistent as if I had kept the whole position in cash. I expect to slowly build a position in $BIL that replaces the fund’s cash position.

SPLG currently trades at $61.51, so you can see how far away our previous strike of $56 was, and why I felt the need to move up a strike. Our current put is worth ($7.50), giving us a $15.50 gain. BIL currently trades at $91.80, and we purchased our first share at $91.57, giving us a $0.23 gain. Seems very small, but this will grow over time as we add shares.

The Fund’s March P/L is $15.73, including unrealized gains on securities. Without these gains, the Fund’s March P/L is $15.50.

Insights

So earlier in this issue, I mentioned the start of a new position, in $BIL, the SPDR short-term Treasury Bill ETF. This is part of a larger strategy to capitalize on the current level of interest rates, which are at generational highs around 5.3%. Indeed, the Federal Funds Rate hasn’t been this high since the very early 2000s, when the macroeconomic picture looked very different than it does today.

Why Are Rates So High?

The Interest Rate is the seminal tool in a Central Bank’s toolbox. It is how the central authority manages the ups and downs of an economy, which by the constraints America has set for it, naturally does go up and down. Interest Rates are the policy tool that central bankers use to keep the “ship” floating on the right course. It’s an apt comparison, because the economy is a lot like a ship, with the central bank much like its captain. If the economy runs too cold, much like a ship that hasn’t picked up the wind, the central bank, like the captain, engages in actions to make the ship go faster. In our case, they would cut interest rates. This would, in theory at least, ease affordability by pushing down the cost of borrowing for purchases. All else equal, houses, cars, appliances, etc. would be more affordable, and so consumers would want to buy more. This speeds the economy, and gets us back on track.

Likewise, cutting interest rates will, at least theoretically, solve the opposite problem. If the ship is running too hot, such as what happened during the Covid crisis in 2020-2022, there was too much demand for too limited a supply. This manifested in a lot of ways, but perhaps most notably featured by the hundreds of cargo ships waiting to dock at the Port of Los Angeles in 2020, as consumer demand for Stuff (of various kinds) was bottlenecked by not enough workers to service transit at the ports. Demand had outstretched Supply, and that led to rising prices; the biggest inflation scare in the history of my generation, the biggest since the 1980s. In these situations, the central bank would raise interest rates, making things less affordable, and hopefully tamping down on the demand that leads to rising prices. With not as many consumers trying to buy things, producers of those things would do things to try and win back their business. Things like special promotions, deals, and eventually, lowering prices. In America, the interest rate policy is set through the Federal Funds Rate, which targets two points.

Since the 1980s, when the Federal Funds Rate peaked at 19%, the policy response to every financial/economic crisis was to lower that rate. In a period that became known as the Great Moderation, our rates lowered gradually, from 19% in 1981, to 8.3% in 1990, to 6% in 2000, to 0.15% in 2010, to 1.5% in 2020, up to 5.3% today. That track does not tell much of the story, but it does paint a picture of rate policy easing downward to rest at around 0% after 2008. The Federal Reserve had to get creative and use some other tools in its toolbox after it could no longer lower interest rates. And many people, myself included, believed that rates would never again, at least in a long term sense, raise above their new level of between 0% and 0.25%. This ZIRP period, of Zero Interest Rate Policy, we believed, was borne out partially due to natural conditions in the economy that made 0% long-term rates the new normal. In economic terms, this is called an R* of Zero.

The R*, the economic variable meaning the real long-term interest rate an economy naturally sets, cannot be quantified, only estimated. It is one of the variables the Fed tries its best to approximate when it sets policy based on its Dual Mandate of Full Employment and Stable Prices. The variable for an economy’s natural long-run rate of unemployment is U*, and similarly cannot be quantified, only approximated. But for the better part of the 21st century, many prominent economists had laid out the conditions for a world with an R* of Zero, and those conditions had, at least partially, borne out. Ben Bernanke and Larry Summers, throughout the 2010s, had arrived at the moniker Secular Stagnation, to describe this period. Here are a few of its tenets:

1. A global savings glut – a mountain of investable capital so huge that traditional economic models broke. Prior to 2008, there was a belief that the global pool of investable capital was limited, and delineated by private vs public sectors, and that excess capital from one side would “crowd out” investment from the other side. When looked at through the lens of loanable capital after 2008, the impetus was on real rates staying low, so there was a worry that too much investment from the public sector would “crowd out” private sector funds, and would cause those private investors to demand a higher return on their capital. This would lead to a rise in interest rates overall, as the govt would have to raise more capital to keep rates lower, leading to the Fed needing to monetize more of that debt. The Crowding Out thesis led to fiscal austerity and a lack of investment, that slowed the 2008 recovery.

2. A wave of globalization – free trade agreements, the collapse of viable economic alternatives leading to a unipolar, capitalism-dominated world, and steady liberalization of developing nations, was thought to be a deflationary trend because the frictions between nations were thought to be slowly eroding and giving way to one, massive, single world marketplace. Some markets, like fossil energy markets, already display this status. But the belief was bolstered by certain macro-events, such as China’s accession into the WTO, the interlinked natures of Real Estate and Sovereign Debt/Currency crises around the world, and established trends of offshoring, so economists believed that these trends would stay.

3. An aging population – this ties with #1, but the focus here is on the developed world and its aging populations. We are seeing results of this in a few East Asian countries already, but this is feared in America as well. A world that has run out of its able-bodied, “workable” population. A world that would either need to import mass waves of immigration, or massively automate, as outsourcing locations became more scarce, to keep up its current levels of growth, and a world so financialized that the only way its growing portion of retired/senior citizens could keep the same standard of living was to keep those current levels of growth. And the resulting population would have the lion’s share of investable capital, primarily from appreciated real estate and security holdings, enough to result in #1 above.

There are other tenets of a world with an R* of Zero, but these are some of the primary ones. This was where all the smartest guys in the room felt the world was heading, after 2008 and into the late 2010s. A world where Public funding was limitless (but needed to be constrained), where humanity eventually became a global monoculture and all inflationary pressures melted away, and where the resulting inequality would permanently hamper long-term interest rates below their expected levels. In short, a world where humans would be less enterprising, less risk-taking, and more defensive of what they already have. A world of falling consumption, of tighter supply, and of lower growth.

And then Covid happened, and everything that economists predicted would turn out to be wrong. In fact, in many cases, the clear opposite seems to have happened!

1. Globalization seems to have flatlined, or even gone backward. Most notably through China, with its tri-pronged worries of never fully recovering from covid, a crisis of foreign direct investment disappearing, and of its domestic wealth sectors crashing (real estate). China is the biggest example, but across the globe, since 2020, the trend seems to have permanently changed. Instead of one seamless world market, with multinational corporations operating in every nation, the new trend seems to be to dance a line between onshoring and offshoring. American and European corporates seem to be “Nearshoring”, of investing more in one’s neighbors than in half a world away, perhaps to assuage security concerns or to enact political reprisal, but at any rate, accepting a higher inflation risk as a result. No longer are the balance of multinational supply chains simply going to where it is cheapest to go. There is now more geopolitical risk, currency risk, and default risk to consider.

2. Fiscal policy in America came through in a big way – much bigger than during previous recessions. Compared with 2008, America opened the floodgates during its 2020-2021 covid policy response. Stimulus checks mailed directly to individuals, forgivable loans essentially bailing out small businesses, and trillions of dollars of additional public policy – through Federal and State governments alike. Against a backdrop even pre-covid of rising State minimum wage laws, coalescing toward a new level of $15/hour (an effort successfully achieved in 22 states, and set to become the norm in 7 more states by 2026), gave consumers much more purchasing power compared with previous crisis. It seems the Fed and the Government took the opposite end of the recovery trade-off this time, and traded a bout of inflation not seen in 2008 for a recovery in employment that happened about 6 times faster than 2008. Much more will be written about the dynamic between the two recoveries, but for now, you be the judge of what worked better.

3. Humanity decided it needs to spend a lot more. I identify two specific drivers, the Fight Against Climate Change, and the 2020s Geopolitical Crises (including ones yet to come) as heralds of this new thinking. We may be finally coming around, and realizing that we can no longer afford to skate idly by, kicking cans down the road, the more we fully understand the risks of not acting. The example of Climate Change will require building out entirely new energy grid sources, replacing the ways we build cement, change the way we think about plastics, air travel, the food we eat, and has the potential to reshape the entire global economy. It’s an understatement to say that an adequate riposte against the Earth’s climate models would run us a few trillion dollars. That, plus the need to be ready, equipped, and capable to combat threats posed by Russia, Iran, and other maligned actors, will necessarily increase public expenditure, which would drive up borrowing.

So, as you can see, many of the deflationary trends previously predicted turned out to not just be wrong, but the opposite of what actually happened. This new world we live in inspires us to think boldly, to act boldly, and to accept a moderately higher level of inflation as a result. A world in which we live in a multipolar system, united by threats and culture, but separate and focused on regional alliances, a world where wages rise faster, where the velocity of money is faster, where deficits are higher, and where growth is higher. This is a world with an R* Higher Than Zero. This is the world our parents and their parents grew up in. And ladies and gentlemen, as I write this to you now, I believe that world has indeed returned. The ZIRP world, where there is no alternative to equity markets, where the world is risk-averse, where things happen slowly, that world gave us a greaty many things, but it is in the past. A bold new world awaits us. And I encourage everyone to take full advantage of what it provides.

But Ian, what does this have to do with $BIL and your portfolio? Well, this is exactly what $BIL is designed to take advantage of. A short-term treasury bond ETF, that owns a basket of treasury bonds with terms of 3 months or less, should be a close-to-risk-free way to earn a passive return in line with the Federal Funds Rate. I believe that rates at their current level are here to stay, at least for a little while, as the economy further adjusts and the Fed works to find the new R*. But for now, we are still growing at a 3.4% pace, with interest rates at 5.25%-5.5%. Clearly the economy can withstand these rates, at least until something snaps, like what happened in March 2023, and the Fed learns even more. For the time being, if you’re not earning at least 4.5% on your money, you’re doing it wrong, and this is the surest way for I-Dog Capital to get it.

Conclusion

In summary, some small gains this month, but the birth of a strategy for the fund. Starting in April, I will finally be out of “bad” debt, and will start to contribute capital to the fund. I’m very excited to share what comes next! I hope you enjoyed this issue, and check out the next issue in a month.

Categories: I-Dog Capital

Tags: Economics, financial, markets, Stock Market