Picasso’s Portfolio: Dividends and Destruction

Asset Allocation update Q3 2025: Picasso’s Portfolio: Dividends and Destruction

Asset Allocation update Q3 2025:

Picasso’s Portfolio: Dividends and Destruction

October 2025. by PM

Executive Summary

Creative Churn: Schumpeter’s “creative destruction” frames today’s market turbulence:

Long-standing structures, from bond bull markets to mega-cap dominance, are giving way, potentially creating space for emerging asset classes and new leadership.

We remain in a Quad 2 environment — rising inflation, slowing growth.

Small Caps Ascendant: Microcaps and small caps, long ignored, are outperforming

Historical inflection points — from 1940s yield bottoms to 1980s peaks — align with commodity supercycles, with scarcity today signaling the potential for the next upcycle.

Investors, following a QuadLogic approach may capture transformational opportunities in real assets, while bonds waver.

Capitalisms Most Enduring Metaphor

Joseph Schumpeter, the Austrian economist with a novelist’s ear for drama, gave capitalism its most enduring metaphor: creative destruction. He saw progress not as gentle improvement but as upheaval, with new industries razing the old. This was less pathology than essence — the churn that made capitalism vital. It provides for a proximate lens through which to view today’s disorienting economy.

QuadLogic:

We remain in a Quad 2 environment. That’s rising inflation, and rising growth. After nine months of abstinence, the US Federal Reserve has returned to the easing table, trimming interest rates for the first time since December 2024, following in the footsteps of the UK’s Monetary Policy Committee and the ECB. The quarter-point cut to the fed funds rate was largely anticipated, following Chair Powell’s Jackson Hole address in August, which pivoted the central bank’s priorities toward shoring up the labour market. Weak payrolls data, compounded by substantial downward revisions to previous job figures, provided the pathology for the Fed to resume its rate-cutting cycle.

However, we’re minded to believe that inflationary pressures may yet act as a handbrake on the further cuts that the markets expect. The August retail sales report showed retail sales rising 5% compared to last year, which helped boost the Atlanta Fed’s GDPNow forecast of current quarter annualised GDP growth to 3.3%.

Chart 1: Quad Capture

Source: ARIA

The Market’s Murmur

Markets rarely write revolutionary headlines at the time of passing – it always appears obvious only in retrospect. Shifts in leadership often appear first in difficult to discern details — a relative strength indication here, a monetary rotation there. Today, that silent revolution is turning up the volume: small caps are finding their voice and taking the lead.

For years, microcaps and small caps seemed to be the overlooked cousins of the investing world. Mega-cap tech, the S&P 500 heavyweights and a handful of household names held our collective attention. Yet under the surface, the currents of the market’s muddy waters are changing.

Take the Microcap ETF ($IWC). After years of stagnation and sideways frustration, microcaps have broken free — rising more than 50% from their recent lows. This is not random noise; it is a signal of conviction, a hint that capital is flowing somewhere new. While this may suggest increasing investor interest, it does not guarantee continued momentum. Prices are pushing back toward the 2021–2022 resistance levels, quietly announcing that something more fundamental is afoot.

Chart 2: The pitter patter of tiny feet

Source: ARIA

The Empire Strikes Back

The evidence becomes starker when small caps are measured against their larger cousins. Over the past three months, the Russell 2000 ($RTY) has relatively outperformed every S&P 500 sector. Industrials, tech, financials, consumer discretionary — all are trailing in their wake.

Three-month relative strength, a measure which provides a read of how one investment is performing against another over that time frame, is not a frivolous fancy; it may be viewed as a leading indicator, though its predictive reliability can vary. When a segment seizes momentum over that period, history suggests it keeps running. Markets rotate and at this moment, the rotation points squarely to small caps – among other sectors that outperform within Quad 2 and Quad 3 environments – cyclicals, miners and emerging markets. Investors who may have the misfortune to miss those which have taken on the batten, are not merely missing a trade — they are potentially overlooking the early stages of a regime shift.

For years, small caps were dismissed by some as dead money. But money is always moving somewhere, and all markets move in and out of fashion. They find a floor, they consolidate and when the consensus has abandoned them, the stage may become set for a relatively roaring return. If history is any guide, we could appear to be standing at such a juncture today.

Alpha from Ashes: Creative Destruction

Picasso once said, “Every act of creation is first an act of destruction.” Picasso’s expression and Schumpeter’s economic impression converge on the idea that creation cannot exist in a vacuum. Progress follows pain. For four decades, bonds were seen by some as the Volvo of finance, reliable, unflashy and guaranteed to deliver us from evil. From yields peaking in 1981 to the 2020 collapse, Treasuries, on the other hand, were viewed by some as to offer a nearly frictionless path to profits. Each crisis, each shock, only pushed yields lower and prices higher in past upwards trends. Bonds were not merely instruments; they became the scaffolding of modern portfolio theory.

Yet creation ofter demands destruction. That forty-year bond bull appears to have ended. What follows is a new act of creation. Real assets, gold, commodities, energy have surged while bonds have faltered, challenging the historical role of bonds as defensive assets in some portfolios. The old safe haven could be gone, and capital appears to be seeking a fresh home. The new front emerges precisely because the old is displaced - real assets may be viewed now as the frontier, particularly in periods of rising volatility in inflation.

Chart 3: Inflation Volatility versus Bonds and Inflation

Source: ARIA

The Big Four ‘O’

Cycles are the investor’s constant companion. Commodity markets are no exception — fear at the bottom, greed at the top. Scarcity breeds opportunity. When investment dries up and supply contracts, the seeds of the next bull market are sown.

If we cast our minds back two decades, crude oil traded at under $20, miners were bankrupt, and mention of rare earths was just that. Those structural deficits set the stage for the 2000s supercycle. Contrast 1980: inflation at its peak, peak bullish commodity sentiment, supply abundant, preceding a bear market that lasted two decades. Today, conditions may suggest an inflection point, where destruction lays the groundwork for rebirth.

The four-decade cycle of bonds in many respects is the obverse. Yields bottomed in the 1940s, peaked in the 1980s, before bottoming again in 2020. Each turning point aligns with a shift in the commodity cycle: post-1940s yields fuelled a commodity bull from the 1950s to 1970s; the 1980s top ushered in decades of decline; Some analysts view the 2020 lows as a potential beginning of a new commodity upcycle. . Liquidity, another pillar of our QuadLogic investment process, (which describes the relative availability of credit or money to borrow), is heavily influenced too by bond cycles, which also impact commodity flows.

Chart 4: The Trend is Your Friend Until It Ends

Source: ARIA

New Order and the World in Motion

Those who are familiar with the ‘Fourth Turning’, an idea originally conceived in 1997 by William Strauss and Neil Howe in the book of the same name, understand how this work of generational theory posits that history unfolds in recurring cycles, each roughly 80–100 years long. Such cycles are termed “saecula.” Each saeculum is divided into four phases (or “turnings”). The fourth turning involves major societal upheaval (war, revolution, depression) which forces society to rebuild institutions and reset national priorities. There is ample evidence to suggest that developed nations may be sitting in front of, or if not in the hailstorm of, a potential fourth turning — a period of rolling crises, both monetary and geo-political, which we should expect to shake existing institutions and demand renewal. The invasion of the Ukraine, Trump’s demands for others to chip into Nato’s defense bill and Germany’s reforming its debt brake this year for example, are not unconnected. Friedrich Merz has announced greater public spending including of course defence and simply put this could well have far reaching consequences, well beyond driving the Dax to all-time highs.

Strauss and Howe’s book is often referenced by policymakers, investors and cultural commentators to frame political and economic turbulence as part of a deeper historical rhythm. One relevance to our QuadLogic approach is recognising that central banks, previously anchored to a 2% inflation target, realise the need to loosen the grip of such an inflation target, which would leave us all to expect continued underperformance of long term bonds - as interest rates remain higher for longer – even if we have just witnessed a spray of interest rates cuts in the UK, Europe and this past week, the US.

Bold with Gold

A decade ago, the idea that foreign central banks would hold more gold than U.S. Treasuries would have seemed almost conspiratorial. Yet the data indicates that: for the first time since 1996, gold as a share of global reserves has overtaken Treasuries, just as Crescat Capital have recently drawn attention too.

Chart 5: Foreign Central Banks Bet on Gold not Bonds

Source: Crescat Capital, ARIA

Commodities move not just on supply and demand, but on liquidity. Strong-dollar cycles crush them; weak-dollar cycles fuel them. Today, liquidity is expanding, the dollar softening and the bond trade evaporating. Capital is on the move — and it is finding its way into real assets.

Picasso’s Query and Schumpeter’s Theory

Picasso didn’t have markets in mind per se, but his quip readily converges with Schumpeter’s economic treatise. For Picasso, every artistic breakthrough requires tearing down old forms or conventions; for Schumpeter, every wave of innovation disrupts established industries, rendering previous technologies or business models obsolete. The destruction of the bond bull market has created the conditions for something new.

Commodities are back in play. Emerging markets are leading growth. The historical role of bonds as a defensive asset may face challenges in today’s environment. Maintaining our gaze on the middle distance, to be forwards looking, recognises every act of creation in markets — every cycle, every regime shift, every opportunity — is first an act of destruction.

Schumpeter’s theory is not uniformly pessimistic. Crises also reset the stage for growth, rebuilding and innovation — much as the post-WWII boom followed years of wartime austerity. For investors who can withstand volatility, these periods have historically presented new entry points into transformational themes: new technologies, renewed infrastructure, or reshaped social contracts. The lesson is not simply to brace for turmoil, but to prepare for the potential opportunities that emerge when old systems give way to new.

For those paying close attention, asset prices are reflecting this fourth saecula – policy intervention is more aggressive, governments run ever larger deficits and at the margin investors are seemingly beginning to question the sustainability of public debts. By way of consequence, there are question marks over established institutional norms such as government bonds being finance’s safe havens. As Picasso saw in art and Schumpeter in economics, creation and destruction are inseparable — and for investors willing to embrace the disruption, today’s turmoil may be the canvas on which tomorrow’s opportunities are painted.

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Asset Allocation update Q3 2025: Picasso’s Portfolio: Dividends and Destruction

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