Warren Pies & Fernando Vidal, 3Fourteen Research - I Think That The Next 40 Years Are Unlikely To Look Like The Last 40 Years | #315

Episode Summary

Executive Summary: In this episode, hosts Matt Baber and co-founders Warren Pies and Fernando Vidal of 314 Research discuss a data-driven approach to investing that combines expert qualitative insights with quantitative discipline. The guests share their firm's origin story, their research process integrating machine learning with technical and fundamental analysis, and their perspectives on current market conditions including inflation, commodities, oil, and Bitcoin. Key themes include the importance of price action, sophisticated trend analysis via 'trend breadth,' model transparency, and the growing role of real assets in portfolios. The conversation offers a nuanced view of inflation as supply-chain driven rather than structural, the neutral outlook for oil despite bullish narratives, and the emerging role of Bitcoin as a diversifier.

Main Topics: Origin Story of 314 Research (Priority: 5/5): Warren Pies and Fernando Vidal met at Ned Davis Research, where they collaborated on quantitative and fundamental research. They launched 314 Research in 2020, leveraging their complementary skills in real assets strategy and machine learning to fill a perceived gap in the market for rigorous, transparent research. Research Process: Combining ML with Technicals and Fundamentals (Priority: 5/5): The firm's process starts with domain expertise to define features, then applies machine learning (e.g., cross-validation, out-of-sample testing) to build robust models. They emphasize avoiding overfitting and using model explainability rather than black boxes. 'Trend breadth'—a proprietary indicator measuring trend strength across multiple timeframes—is a core component. Oil Market Analysis and Neutral Stance (Priority: 4/5): The oil model combines inputs on inventories, technicals, positioning, and physical markets. Despite a strong rally, the model remains neutral due to conflicting signals: inventories are drawing and technicals are positive, but futures positioning is extended and OPEC holds record spare capacity (~10 million barrels), which caps upside. The host jokingly notes the 'only signal you need is buy oil when it's minus $30'. Inflation Debate: Supply-Chain vs. Structural (Priority: 4/5): The guests argue that current inflation is largely a supply-chain issue, not a sign of structural inflation. They cite massive dispersion within CPI (median component correlation turning negative), spare capacity in oil, and slack in employment. The Fed is expected to stay accommodative until breakevens reach 3-4%. Bitcoin as an Emerging Diversifier (Priority: 4/5): Bitcoin is held as an 8% position in their real asset allocation model. They highlight its uncorrelated nature and note the model's resilience during Bitcoin's 80% drawdown in 2018 (portfolio only down 5.5%). The conversation notes a shift from career risk in holding Bitcoin to career risk in not holding it. Gold as an 'Infinite Duration' Asset (Priority: 3/5): Gold is described as a chameleon asset with different drivers across regimes. Currently, it is suppressed by rising nominal interest rates, which act as a powerful force since gold is an infinite duration asset. The model uses components including trend, positioning, real rates, and asset allocation attractiveness. Government Spending and 'Entrenched Interests' (Priority: 3/5): The guests expect structural increases in government spending as a share of GDP. They recommend investing in companies already doing business with the federal government ('entrenched interests'), using both contractor lists and natural language processing of filings to identify such firms.

Key Arguments: The next 40 years are unlikely to look like the last 40; real assets will be a necessary component of diversified portfolios. It's easy to fool yourself with backtests; rigorous out-of-sample testing and cross-validation are essential to avoid overfitting. For cross-sectional analysis across heterogeneous assets, price action (trend) should be heavily weighted over fundamentals; fundamentals work best within a single asset class. Current inflation is supply-chain driven (e.g., lumber, semiconductors, oil) rather than indicative of tight capacity; the Fed is correct to stay accommodative. The oil rally is largely a result of OPEC discipline and spare capacity, not a genuine super-cycle; neutral positioning is warranted. Bitcoin's value as a portfolio diversifier is supported by its low correlation and the performance during its 2018 crash. Gold is an infinite duration asset and currently hampered by rising rates, despite other bullish factors like negative real rates. Trend breadth—measuring trend across dozens of timeframes—provides a more robust signal than traditional 12-month or 6-month momentum alone. Hierarchical risk parity is a superior portfolio optimization technique compared to mean-variance optimization, as it is less sensitive to correlation estimation errors.

Data Points: OPEC spare capacity: ~10 million barrels per day - Cited as the key overhang on oil prices, making a super-cycle call premature. Bitcoin drawdown (2018) vs. model portfolio performance: Bitcoin -80%, portfolio -5.5% - Demonstrates the diversification benefit and the model's ability to scale down risk. Average equity weighting in real asset allocation model: 38% - Historical average, currently reduced from 51% to 43%. Current bond weighting in model portfolio: 23% - Model is still shunning bonds. Energy sector yield vs. utility sector yield: Energy ~100 bps above utilities - Energy became the highest yielding sector in 2019, reflecting its shift to a short-duration equity. CPI median component correlation: Negative for first time since 1950s - Indicates massive dispersion: pockets of inflation alongside deflation. Five-year breakeven inflation rate threshold for Fed concern: 3-4% - Current levels remain ~100 bps below that threshold. Dollar support level: 89.90 - Breaking below would be a significant bearish signal for the dollar.

Pivotal Quotes: "I think that the next 40 years unlikely to look like the last 40 years. And I think that this real asset space is going to be a really necessary component to a broad asset allocation strategy that's going to succeed in this new era going forward." — Warren Pies: Explains the macro rationale for founding 314 Research and focusing on real assets. "You want to build your conviction off fundamentals, but you want to manage risk off of price action and technicals." — Warren Pies: Summarizes the philosophy of combining fundamental and technical analysis in their models. "I do think there was this, we've passed this point of this phenomenon where, you know, it was career risk to consider having Bitcoin exposure. And I do believe we've passed into where we flipped it. So it's now kind of career risk if you don't have Bitcoin exposure." — Warren Pies: On the shifting perception of cryptocurrency among institutional investors.

Implications: Listeners should consider increasing allocations to real assets and diversifiers like Bitcoin, while being wary of inflation narratives that may be overblown. The episode underscores the value of combining domain expertise with rigorous quantitative methods to avoid common pitfalls like overfitting and narrative-driven investing.