Kevin Smith & Tavi Costa, Crescat Capital

As many of our long-time listeners know, over the years, I've become increasingly protective and selective with the guests that I invite to come on the show. Truth be told, we get pitched weekly for people looking to expand their reach. Sometimes it's just so off the wall and disconnected to trading that I have to laugh. But, this isn't the case with today's guests, which I'm super excited to bring on for an interview.

Kevin Smith and Tavi Costa generously gave their time to join me for an incredible look inside their philosophy and macro models at Crescat Capital, a hedge fund based in Denver, Colorado. This is an episode you won't want to miss. In fact, I encourage you to listen to it at least twice to make sure you pick up on all the little details you might have skipped the first time around.

Kevin is the founder and CIO of Crescat Capital and has 26 years of investment industry experience.
Tavi has been an analyst on Crescat's investment team for more than five years with a focus on global cross-asset research.
Last year, Crescat was the number one performing macro hedge fund by BarclayHedge.
Take a look at Crescat’s Quarterly Research Letters and their Current News and Updates for more perspective and insight.

Crescat's Macro Model

Crescat uses a data-driven approach to discretionary investing. Their 16-factor macro model includes macro indicators, fundamental factors, key valuation factors, and a few other technicals.
The model quantifies several factors that have worked in the past and have a really high correlation with changes in the business cycle.

Flawed Narratives:

There are many flawed narratives surrounding central bank intervention, U.S. stock valuations, and China.
Crescat uses its model and process to create data-supported narratives and profit from global macroeconomic themes.

Yield Curve Inversions

55% of the yield curve in the U.S. is inverted.
Yield curve inversions in the U.S. may take 1-2 years to play out.
As we review the historical record, a lot of times, market peaks have coincided with inversions.

Corporate Debt

We currently have record-high levels of corporate debt.
Companies have been taking on debt to buy back stock in this cycle.
But, many companies don't even have the free cash flow to fund their on-going business operations.
Many of these "disrupter" companies have gone through IPO's without generating positive free cash flow.

Market Sentiment

When sentiment is at either end of the extreme, you get the biggest inflection points that become tradeable events.
When the future expectation starts to fall versus the present situation, it tends to be a very negative sign.
When the spread between the future expectation and the present situation turns negative, and consumer confidence falls, it often leads to a recession.
Consumer confidence tends to be high every time at the peak of a cycle.

The Goldilocks Scenario

At this time, everything in the market is as good as it gets.
Consumer confidence is high, interest rates are low, inflation is low, unemployment is low, and corporate earnings are high--and corporate valuations are high.
This type of perfect setup happened right before the 1929 crash.
So, ultimately, it is not the best time to invest in US equities.

Potential Market Issues

Crescat is constantly looking for what could go wrong or against our views and reviewing what our models are telling us.
The Fed could drop interest rates.
Precious metals have been in a 7-year bear market and would take off if the Fed changes interest rates.
When yield curve inversions happen, it tends to be very positive for gold relative to the S&P 500.
All the signs presently point to tremendous value in precious metals.

Using Options to Express Trades

Because of the low volatility environment for equities and corporate credit, Crescat is using long put options to express their bearish views on those things.
When building a position, they are looking for their views to play out over the next 3 to 6 months, so they will select options within that maturity range with strikes between slightly in the money to slightly out of the money.

Staying Consistent with Investment Views

It is important to provide good research and quality content that supports your thesis and validates if it is right or wrong. Thus, communication with clients that explains our position is important.
Make sure that the models you look at are still supporting your thesis and that your overall ideas are still correct.
Research and validation of your thesis is a continuous, on-going process.
Sticking with your plan (if you have a good plan) is better than panicking and trying to move in the direction of the markets in general.
Stay committed to your fundamental and macro models to keep you positioned.
Use a risk model to contain your exposure and ride through pullbacks.

Conclusion

You can never be right on all your views and should recognize when you are wrong.
It's not about the short-term losses, it's about the long-term view that you take.
The long-term value of the portfolio will play out, but it may take some time.