Andy Constan on Macro-Driven Investing, Inflation and the 3Ds of De-Globalization (E148)

Andy Constan, founder, CEO and Chief Investment Officer of Damped Spring, joins DoubleLine’s Jeffrey Sherman and Samuel Lau to discuss his approach to macroeconomics-driven investing. They also discuss, among other timely topics, Mr. Constan’s outlook for persistent inflation above the Federal Reserve’s 2% target. Damped Spring is a full-service macroeconomic research firm. This episode of the Sherman Show was recorded Nov. 20, 2023.

DoubleLine Deputy Chief Investment Officer Jeffrey Sherman opens the conversation (0:38), asking Mr. Constan to describe his 35 years in the financial markets, a career that began at Solomon Brothers in 1986 and spans roles at such notable names as Bridgewater Associates and Brevan Howard before the launch of Damped Spring. Then the discussion turns to Mr. Constan’s macroeconomic approach to investment decision making (4:45). Mr. Constan operates with a four-pillar framework. First, he focuses on how growth occurs in an economy and how inflation works on an economy. From those two starting points, he seeks to understand “the risk premium that assets contain and how policymakers and market participants can influence the risk premium, which is the return you get on assets.” Once those three factors come into focus, Mr. Constan overlays a fourth pillar his framework: positioning. “When those three other things are moving, it still matters how people are positioned, what's priced into markets and what's going to cause investors to change their positioning.”

Mr. Constan warns against decision-making based on taking risk premiums as objective levels for trade exit or entry (7:18). “There's no level that is the correct level.” Attempting to buy or sell based on perceived whether a term premium is too high or too low can land investors “in a lot of trouble – just as most investors get themselves in a lot of trouble” buying and selling simply because assets are priced above estimates of fair value. “Markets overshoot all the time. It's very difficult to be an investor to base your investment thesis just on the level of valuation. And so the level of risk premium is not that important to me because nobody knows what it is. The only way you can interpret risk premium is through a model. All models have assumptions. All models require assumptions of forward-looking information which is unavailable.”

Instead of focusing on estimated risk premium levels, Mr. Constan’s framework “just focuses on what could change term premiums because that's what you need to know to be an investor. If you think term premiums are going to fall, you want to own assets. If you think term premiums are going to expand, you want to sell assets. And so my framework just focuses on the factors that would cause term premium to change” (8:50). He then describes variables that can change risk premiums. These include changes in the supply of an asset vs. demand for it as well as changes in credit availability and monetary conditions.

Jeffrey Sherman then asks Andy Constan for his thoughts on inflation (12:32), noting “perhaps people have not been thinking about the inflation component for, let's call it, over a decade. What are your thoughts about inflation today? What are your thoughts about how investors should incorporate some of this into estimates that raise premiums and hence thinking through the allocation process?” Mr. Constan starts with the fact of falling inflation, under the twin drivers of correcting supply chains and “less easy” monetary policy. A naïve extrapolation of those trends forward would point to inflation soon falling to the Fed’s 2% target or even undershooting it. Mr. Constan, however, expects inflation to a plateau well above 2%. Factors driving resilient above-target inflation, he says, are “a still-very-strong job market,” ample residual reserves “that will keep liquidity high and support demand” and “the three Ds” of de-globalization.

“Nationalistic de-globalization,” as Mr. Constan calls it (17:14), is underway, but he doubts it will bring about the deflationary promises of its promoters. His three Ds of de-globalization are: (1) North America and Europe building supply chains in nearby, allied countries, duplicating already-existing supply chains based in China; (2) countries throughout the globe building domestic energy infrastructures; (3) onshoring, a conspicuous example Washington’s determination repatriate the building of domestic integrated chip manufacturer. “We'll have a significant amount of capacity and waste created when you have duplicate supply chains. There are no efficiencies created from that. And so with respect to a deflationary payoff, it is not clear to me that it will come down the pike in a number of years. At the moment, it’s very inflationary.”

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