PWA 2025 Year-End Letter, Part 2: Interesting Times!! And A Note On Hedging

We'll begin Part 2 with a few key highlights from our latest internal strategy narrative.

From the Executive Overview:

The PWA Global Macro Core Portfolio is constructed to align with the prevailing macroeconomic setup entering 2026 -- characterized by sustained fiscal expansion, a structurally softer U.S. dollar, stable but elevated inflation, on-the-margin improvement in global manufacturing activity, and shifting geopolitical and supply-chain dynamics. The portfolio emphasizes real-economy exposures, broad-based global equity diversification, and a deliberate mix of inflation-resilient assets, while retaining the flexibility to strategically hedge specific positions or asset classes as conditions warrant.

The portfolio balances four strategic pillars:

• Global Equities for long-term growth
• Fixed Income for income stability and inflation protection
• Commodities / Real Assets for regime hedging and structural scarcity
• Cash & Money Markets for liquidity, optionality, and risk control

This structure positions the portfolio for a late-cycle environment in which investment in infrastructure, industrial capacity, and the real asset complex plays an increasingly central role in driving returns. By design, it limits reliance on financial-asset appreciation driven by leverage and valuation expansion, favoring return sources anchored in physical capital and pricing power.

From the Strategic Allocation Framework section:

The equity sleeve is globally diversified, sector-balanced, and incorporates both cyclical and defensive components.

The fixed income sleeve provides inflation protection (TIPS), sovereign diversification (US treasuries and EM govt bonds), and controlled duration exposure.

The commodities sleeve balances precious metals, miners, uranium, industrial metals, and broad agricultural and energy-linked exposures.

The cash allocation reinforces liquidity and optionality.

Overrides:

Certain structural biases are intentionally embedded:

Industrials: U.S. overweight, reflecting reshoring, infrastructure spending, and defense modernization

Energy: U.S. overweight, driven by U.S. midstream stability, LNG expansion, and superior capital discipline

Technology: Non-U.S. overweight within the sector target, reflecting attractive valuations and diversification relative to U.S. mega-caps

Together, these adjustments maintain sector neutrality while optimizing regional exposures in line with the forward macro setup.

Among other details, I'll spare you the formal, lengthy, sleeve-level and individual position narratives.

On a 0 -10 scoring basis, here's how our updated allocation presently scores within each macro regime:

Scenario Ranking (Highest [10] to Lowest [0] Expected Performance)

 

And here's how we see the macro probabilities going forward: 

Forward-Looking Macro Regime Probability Forecast (12-18 Months).  Based on current global macro signals: fiscal impulse, global PMIs, inflation path, term premium behavior, and EM relative strength.

• Soft Landing → Reacceleration: 35%
• Reflects the big conclusion from our regime modeling: the combination of fiscal impulse + capex + improving PMIs outweighs the deterioration in LEI and some labor series.
• Mild Recession: 15%
• While labor is showing distinct signs of weakness, other anti-recession forces (capex, housing, credit spreads) have proven more persistent of late.
• Goldilocks: 13%
• The current soft-landing setup lends itself to sticky inflation, as opposed to the classic not-too-hot, not-too-cold scenario... I.e., a bit hot, all else equal.
• Commodity/Capex: 12%
• Structural underinvestment + geopolitics + fiscal spending.
• Dollar Weakness: 10%
• Remains a meaningful structural theme, but big relative-rate moves have already happened; the edge is lower than a year ago.
• Risk-On + Falling Term Premium: 5%
• Requires declining term premium + synchronized global growth
• China Stabilization: 5%
• Reflects less tail-risk pricing in China assets vs early ’24, but still uncertain transmission.
• Stagflation: 5%
• A bit higher recognition that sticky inflation + term premium risk is real, but still a minority path.

This outlook departs from consensus in that it does not treat late-cycle conditions as synonymous with imminent recession, nor does it assume a return to a classic Goldilocks regime. Instead, it reflects a regime shaped by fiscal dominance, structural underinvestment, and supply-side constraints, where growth can persist unevenly even as labor softens and term premia remain elevated.

In this environment, traditional leading indicators and rate-cut narratives provide incomplete signals, while returns are increasingly driven by physical investment, pricing power, and policy-supported capex rather than liquidity, leverage, or valuation expansion.

While, as outlined above, late-cycle conditions do not by themselves imply that a recession is imminent, recent employment data are clearly signaling rising cyclical risk heading into next year... At the same time, it remains difficult to envision a full-blown recession in an environment where the federal government is running near-record budget deficits… Typically such fiscal largesse is reserved for deep recession, not late-cycle expansion -- yet, here we are!

I.e., it’s this push/pull -- between softening labor signals and unusually aggressive fiscal support -- that makes the current environment so atypical, and demands that we prepare for multiple late-cycle outcomes rather than a single, consensus path.

Suffice to say, we live in interesting times!

In fact, these "interesting times" embody a sea change which occurs roughly every 4 to 5 decades.

You see, as we've explored herein over the past few years, policy regimes run through long cycles that grow into, then shift away from, what I like to call "capital-friendly" and "labor friendly (populist)" regimes.

The former of which tend to spawn under the weight of what becomes untenably-stubborn inflation and the lack of productivity that characterize the then-failing labor-friendly regime (as the economy's spoils were, for decades, largely shared by working folk, at the cost of constraining corporate tax and regulatory policies, alongside generally-high labor costs... I.e., at the cost of productivity). 

Then the ensuing capital-friendly regime (the last of which began with Thatcher and Reagan, and officially ended with Covid) succumbs to politically-untenable wealth and income inequality -- as corporate America and capital-wielders have effectively captured the lion's share of said economic spoils for decades -- culminating in intense anger among the populace, and thus ushering in the next labor-friendly regime... Which, make no mistake, is where we sit today.

Oh, and by the way, labor-friendly dynamics are very investible, if, that is, you understand them, and if you're willing -- at the onset -- to consider that the future is about to look very different than has your own life experience over the past several decades.

Key to successful investing during labor friendly regimes (or any regime for that matter) is understanding the US dollar's role.

Here's the go-forward base case I laid out back in June.

"The setup for the US dollar, for the next several years, lends very high odds to a declining trend.

Our view stems from the fact that despite the US’s historically-high national debt (as a % of GDP), the federal government will continue to run a budget deficit as far as the eye can see -- thus, further bolstering structural inflation forces that are to-no-small-extent the product of populist regimes (which embody the present and go-forward global zeitgeist).

Ultimately, we see the US resorting to what amounts to the post-WWII strategy of what is essentially "debt monetization" via yield curve control (YCC).

Back then – beginning during the war (in 1942) and ending in March 1951 – the Fed bought up sufficient treasury issuance to keep the long-end of the curve at 2.5%; allowing the government to refinance its maturing debt pile at accommodatingly low rates – all the while allowing inflation to run notably hotter.

Essentially, the US inflated its way out of its debt burden by intentionally refinancing it with de-valued dollars.

The average annual inflation rate from the end of WWII (1945) to the end of the YCC strategy (1951) was 5.5%... Thus, the average real yield on treasury bonds was -3%, with the dollar declining by roughly 25% during that stretch.

Allowing the economy to run “hot” while capping the rate on treasury debt worked (as intended) to reduce the US debt to GDP ratio from 119% in 1946, to a very manageable 73% in 1951.

We’re presently at 124%."

*In Part 3 we'll drill down on the current economic setup — but first, a note on hedging:

While hedging (holding positions designed to mitigate [when hedging downside risk] a directional move, either in an asset, or a portfolio overall) can be accomplished in a number of ways; we do it via diversification, by using options, and, at times, through direct currency exposure(s).

The use of options are arguably the purest hedging play. 

For example, when we buy, say, a put option on the S&P 500 to hedge the downside risk of our overall equity exposure, what we are essentially doing is buying what you might call catastrophe insurance... In fact, "premium" is the word used for the money invested into options contracts.

And just like any other insurance policy you purchase, options, when used for downside hedging, are not there to make money -- except for those times when you're losing markedly on certain portfolio positions... I.e., when conditions warrant, we spend money (we budget for it) to allow us to hold positions where we have long-term conviction, but that are subject to, at times, the kind of wild fluctuations that tend to have most investors abandoning long-term logic due to short-term panic... That (succumbing to crowd mentality) being the proverbial plague of the individual investor.

Conversely, we will, on occasion, implement what we consider to be upside hedging strategies... Meaning, when our overall allocation is, as it is presently, designed (diversified) to provide relative downside support over the foreseeable future -- while sufficiently capturing the potential upside inherent in our macro thesis --  but we feel that the immediate setup favors a significant near-term positive move in a given asset class, we'll allocate some "premium" to ensure that we are in a position to capture a portion of that potential move... While making sure that the premium committed is reasonable (under prevailing circumstances) relative to the size of the overall portfolio.