Matter Of Time Bubble Implodes; What The Next Financial Crisis Looks Like | Diego Parrilla

False diversification occurs when a portfolio contains many different assets that move together during stress periods; a portfolio of 20 cryptocurrencies is not diversified because all crypto assets fall simultaneously in a crisis, making the number of holdings irrelevant to actual diversification.

“in some cases they fall into the risk of false diversification which means a very simple idea you're confusing a portfolio with many things with Diversified portfolio portfolio with you know not to make wood of a fullen tree but you know portfolio of 20 cryptocurrencies is not necessarily Diversified okay because in the time of a crisis every single one of them might fall at the same time”

Once inflation expectations escape control (as happened in 2022), central banks are forced to abandon their printing strategy and hike rates, demonstrating that uncontrolled inflation expectations represent a hard constraint that forces policy reversals.

“I think it's only and we saw that in 2022 you know once inflation expectations get out of control That central banks lose control and they're forced to to to hike uh so I think this is already telling you that um the You know despite the restrictive conditions there's other ways in which you know that liquidity is is fited in”

Anti-bubble assets (volatility hedges, tail-risk protection) are critical portfolio components because they provide convexity during stress periods when correlations collapse; they are expensive on average but invaluable during crises, much like insurance.

“the role of anti-bubbles and and tail risk and volatility and other sort of protection it's critical and when you build a portfolio in my opinion there's no crystal bow we don't know what's going to happen I think you need to have you know based on your objectives you need Strikers you fielders you need Defenders and you need those goalkeepers”

Individual experiences of inflation vary significantly by consumption patterns (university fees vs. diapers vs. rent, etc.), making a single inflation number unrepresentative of reality and easily manipulated to create the false impression of controlled inflation while actual purchasing power deteriorates.

“and it can be easily manipulated to to to show uh and and make believe the world that inflation is under control when your pocket and my pocket and what we experience in a day today is very different”

The recent volatility spike and VIX surge on Monday were primarily caused by a dramatic deterioration in system liquidity, as measured by the Bloomberg US Government Liquidity Index reaching its highest level since 2012.

“this index is a measure of prevailing liquidity conditions under stress liquidity conditions dislocations from Fair value result in an increased average yield error what we saw is the highest number since the beginning of this chart which is 2012... lower liquidity in the financial system was partly to blame for the spike in the vix that we saw on Monday yes absolutely um I think it's undeniable that uh liquidity has dramatically distorted the uh dynamics of the markets”

Governments and central banks face a structural incentive to choose inflation and currency devaluation over systemic economic collapse, which has created an addiction to monetary stimulus that forces them to intervene in every crisis 100% of the time.

“governments are going to react they will always 100% of the time choose inflation and devaluations to you know a crisis that is systemic and and the system collapsing so we've created this addiction to the system that effectively forces them to to step in every time”

This moral hazard cycle—where bailouts and central bank rescues reward risky behavior—incentivizes wrong behavior and makes the system increasingly fragile, as market participants have learned they will be saved from consequences.

“it's not like we're lear learning the lesson you know the every time we're being bailed out and you have the central back put and mommy and daddy coming to the rescue it's just incentivizing and uh rewarding the wrong behavior and and this this Bast is getting F and F”

The more artificial suppression of volatility continues (via central bank support and policy intervention), the more vicious and explosive the eventual volatility rebound will be.

“and the more you try to suppress it artificially uh the more it's going to be you know vicious on on on the other way”

Asset allocation and portfolio construction require understanding that sometimes equities are cheap and sometimes expensive, and sometimes volatility is cheap and sometimes expensive, making it a cyclical game requiring constant rebalancing.

“there's no good guy and bad guy in this movie you know sometimes equities are cheap sometimes they're expensive uh sometimes volatility is cheap sometimes it's expensive the beauties that take to do it are exactly the opposite time”

The traditional currency war strategy—devaluing to become more competitive and attract jobs/investment at the cost of domestic inflation—breaks down when inflation becomes the dominant problem; then governments prefer currency strength to avoid importing inflation.

“the traditional game in currency Wars um was to devalue your way out of trouble so effectively if you were uh printed too much money you wanted to dilute your currency you wanted to be more competitive and you were in some ways attracting you know jobs and Investments and factories and whatever at the cost of uh inflation and uh maybe you not going away on holidays and and and other things right um and that's kind of the way the world worked for a long time until suddenly inflation comes in and uh and then the game changes because you know what you want is is pretty much the opposite”

US M2 money supply growth turning positive in April 2024 (after years of negative growth since 2022) signals that the disinflation cycle is ending and inflation will resume as central banks resume monetary expansion to support asset prices.

“us M2 money supply growth is currently at positive almost 1% now remember it was at negative growth ever since 2022 just turned positive earlier this year as of April does that mean then that um uh the disinflation that we saw throughout 2022 uh is over meaning that since money supply is now growing once again”

Velocity of money (how quickly currency circulates and converts into economic activity) is a critical metric because rapid velocity transforms printed money into actual inflation, whereas low velocity can allow printing without visible inflation but signals economic weakness and lack of demand.

“as a central bank you want your money to do the job you want it to run you want it to convert into into Mon monetary activity and so I think the velocity of which things are uh that money is is is acting effectively is helping your case the opposite would be I'm printing money and that money is being just left in the bank account and everyone's too scared to do something”

All fiat currencies are guilty of monetary abuse and eventually will depreciate; the dollar is not exempt, merely in slightly better health to execute devaluation than its peers, making gold and real assets superior long-term stores of value regardless of which currency depreciates.

“let's not fool ourselves the US dollar is as guilty as everybody else on the monetary abuse it's just you know has more room and and it's in Better Health to to do that I think places like Japan or China are very very very limited in their ability to to respond and therefore uh I think there all the currencies all the Fiat currencies are in trouble uh the dollar is in you know slightly better shape”

Monetary and fiscal stimulus solves nothing; it only delays, transfers, transforms, and enlarges problems, masking structural imbalances through temporary liquidity injections.

“this monetary fiscal abuse is not really solving problems it's really just delaying transferring transforming and enlarging them”

The US dollar appreciated throughout 2022 despite high inflation, which is unusual—currencies typically depreciate during inflation—reflecting that other major currencies (Yen, Yuan, Euro) were in worse condition, making the dollar relatively strong on a comparative basis rather than absolutely.

“you know usually when we think about inflation we think about the dollar losing value um but Visa other currencies it hasn't”

Inflation is fundamentally a monetary phenomenon—the result of declining currency value rather than rising prices of goods—meaning real inflation is approximately twice the official headline inflation figures and will remain structurally high regardless of what official CPI prints show.

“inflation at the end of the day is a monetary phenomenon is uh is is more about the you know is not that your house goes up or down the value of your dollar H goes down so I think in that sense ER I believe that real inflation which is at least twice the official inflation it's uh it's going to remain high”

Economic recessions can be healthy and cyclical, but modern central bank policies treat negative growth as an enemy to be avoided at all costs, leading to excessive monetary/fiscal stimulus that prevents necessary adjustment.

“I think we've we've been um been raised and accustomed to this idea that uh negative growth is is the enemy um and and in some ways this addiction to to growth leads us to a number of decisions monetary and fiscal that sort of uh we will'll do whatever it takes to try to avoid them even if they're often healthy and and uh and and cyclical and natural”

George Soros's definition of a bubble is an asset that is artificially expensive based on a misconception that may be true but is distorted, creating valuations that will inevitably implode when the misconception corrects.

“I like to borrow George soros's definition of a bubble he talks about Bubbles as assets that are artificially expensive based on a belief that happens to be full what he calls a misconception so from Sor perspective bubbles are artificial set up it's a matter of time it's a matter of when not if that that valuation will implode”

Portfolio construction should follow a sports team model: maintain strikers (growth assets like equities and credit for capital gains), defenders (hedging assets), and goalkeepers (tail-risk protection), balanced based on investment objectives, rather than traditional 60/40 portfolios that lack adequate downside protection.

“I always use the analogy that uh portfolios and asset allocation is like building a sports team uh I'm Spanish so I use soccer or football right uh but we could use any team and I think you need Strikers you need attackers you need assets like equities or credit that will effectively make money in terms of capital gains and income through the benign conditions but you also need Defenders and goalkeepers”

The market is currently pricing in an aggressive Fed cutting cycle (100% probability of at least one 25bp cut in September, 50% probability of 50bp cut, and further cuts through 2025) primarily because of anticipated economic deterioration rather than successful disinflation, representing a shift from benign to adverse economic scenarios.

“as of Friday August 9th the CMA fa Watch 2 was pricing in a 48 or 49% chance of a 25 basis point cut in September and a 50% chance of a 50 basis point cut in September basically a 100% chance of a Fed pivot but 50% chance of 50 basis point cuts and in November we're getting another cut according to CME watch tool in December another cut so on and so forth January uh 2025”

Quadriga Asset Managers' strategy is to run mandates that deliver reliable, reactive convexity (protection that pays off during stress) both standalone and in combination with long equities.

“what we do as as as the [28:43] goalkeeper of the team we run mandates that try to re effectively deliver reliable reactive convexity and we do that on a standalone basis as well as uh combined with uh with long equities”

Perea's book 'Empty Bubbles' presents the concept of anti-bubbles, which are mirror images of bubbles—assets that are artificially cheap and provide hedging protection against bubble deflation.

“my second book the empti bubbles I I presented this concept of the of the anti-bubble um whereby you know we're looking at assets that are kind of of mirror images of of bubbles you know we're talking about assets that are artificially cheap that they give you a hedge”