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Charles Gave Warns Of Possible Paradigm Shift Ahead

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The following is a summary of a recent Financial Sense Newshour podcast, “Charles Gave: Possible Paradigm Shift Ahead.”

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Charles Gave, 74, is a Founding Partner and Chairman of GaveKal-Dragonomics Research since 2001. Before this, in 1986, Gave stepped away from pure research to move into tactical asset allocation, an active management portfolio strategy that plays off of momentum. He co-founded Cursitor-Eaton Asset Management where he was chief investment officer, managing over $10 billion of institutional investor’s money. Cursitor was sold in the mid-1990s to Alliance Capital and Gave remained with Alliance Capital until 1999. After the Dotcom crash, he reverted to his first love: research and tactical asset allocation. He left Alliance Capital to create Gavekal where he is the chairman today.

During the FS Insider interview, Gave describes on what could happen to bonds, stocks, and, most importantly, investors’ portfolios when the 30-year downtrend in inflation completes an unfair low and reverses…

Gave discusses his overall macro outlook, investment risks surrounding the stock-bond correlations during previous inflation cycles, and of course, how specific asset correlations which have been operating for decades — could soon hit a brick wall.

In the last three decades, Gave suggests that many investors have built a portfolio around a deflationary period, which means that some sort of risk parity strategy was adopted (50% long bonds, 50% long stocks).  In other words, stocks and bonds have had a negative correlation — thus the strategy was the ideal for generating and preserving wealth.

Bloomberg provides an easy explanation of what is risk-parity:

“In its simplest form risk-parity involves holding two different assets, stock and bonds for example, and periodically changing the portion of each asset owned to keep the overall risk constant. On Wall Street, risk equals volatility. When the volatility of stocks jumped last week, in this example, risk-parity traders would have exchanged some of their stock holdings for bonds. Likewise, if bond market volatility increased these traders would switch assets back, bonds to stocks. Many small investors follow the risk-parity strategy without even knowing it. For instance, their investment portfolio may hold 60% stocks and 40% bonds, which they periodically rebalance to get back to those percentages.”

Nevertheless, Gave firmly believes the economic tides are shifting from a deflationary environment to an inflationary cycle, which he hints that stocks and bonds could soon develop a positive correlation. Essentially, both asset classes would sell in tandem — producing losses that would be severe for the mainstream investor.

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There is an estimated $2 trillion lurking in the risk parity world, and the three-decade party could be soon coming to an end, as Gave is now actively warning clients the strategy “is about to stop working.”

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