“Much is made lately of unrealized gains being a means of tax avoidance, so I propose selling 10% of my Tesla stock,” tweeted Elon. “Do you support this?” asked Musk, Saturday afternoon, providing his 62.5mm Twitter followers a yes/no voting app. “I will abide(n) by the results of this poll, whichever way it goes,” added Elon. “Note, I do not take a cash salary or bonus from anywhere. I only have stock, thus the only way for me to pay taxes personally is to sell stock,” explained the world’s richest man, his auto company’s market cap $1.23trln. Tesla longs voted No. The few remaining solvent shorts voted Yes. And all those young programmers, with bright minds but no code, raced to build bots to vote multiple times.
Overall: “Some have put the global figure between $100 and $150 trillion over the next three decades,” said Janet Yellen in Glasgow, speaking at the COP26, prying opening the Overton Window. “At the same time, addressing climate change is the greatest economic opportunity of our time,” continued America’s Treasury Secretary, and she is undoubtedly right. “These programs are exciting -- but as big as the public sector effort is across all our countries, the $100 trillion plus price tag to address climate change globally is far bigger,” she added. And you see, the cost already appeared rather small. That’s how the Overton Window works. Because “$100 trillion plus” somehow feels quite a bit less than $150 trillion. And once you say $150 trillion a few times, it honestly doesn’t seem so big. Afterall, when you think about it, that cost is spread out over three decades, which leaves it just $5 trillion per year. And that number used to feel utterly out of reach until 2009 when the Global Financial Crisis sparked the first $3 trillion US federal government budget. Of course, the deficit that year was $1.5 trillion, which seemed large at the time, but is just half of today’s $3 trillion deficit. And this year’s deficit is a wafer-thin-mint smaller than last year’s $3.1 trillion number. Besides, it only took the Fed to click a button to create the roughly $6 trillion to purchase nearly all of Janet’s issuance for the past two years, and despite widespread panic about the unsustainability of such an arrangement, 10-year interest rates remain just 1.45% even with inflation running at 5%, house prices up 20% this year, and the S&P 500 at all-time highs (+25% year-to-date). But of course, those returns seem small with Bitcoin up over 100% this year. And such a move used to be large. But Ethereum is up 620% in 2021, which isn’t actually that impressive when compared to its 3,460% jump since Jan 2020. That’s the kind of number that makes $150 trillion seem smallish. And in the end, it might be. But no worries, $300 trillion is just a double.
Week-in-Review (expressed in YoY terms): Mon: Japan’s LDP surprisingly maintain outright majority, EU/US agree to remove tariffs on steel and aluminum for 2y, global covid deaths surpass 5m people, Biden and Erdogan engage in positive interaction, India pledges carbon neutral by 2070, S. Korea impts 37.8% (43%e) / expts 24% (28.5%e), S&P +0.2%; Tue: RBA officially abandons YCC but pushes back on eagerly embarking on tightening cycle, Biden scolds Xi for not showing up at COP26, Republican Youngkin won the VA gov race – potentially foreshadowing a difficulties for the Dems in the midterms, Yahoo to end operations in China, S&P +0.4%; Wed: Fed announces taper ($15b/month) for Nov and Dec and “as appropriate” thereafter / Powell sticks with transitory inflation view, Poland CB hiked 75bps (only 50bps exp), Putin declares that Russia will have hypersonic cruise missiles by 2022, Lagarde confirms that conditions for a rate hike are unlikely to be met by next year, UK house prices 9.9% (9.2%e), Turkey CPI 19.89% (20.35%e) / Core CPI 16.82% (17.9%e) / PPI 46.31% (41.4%e), Italy unemp 9.2% (9.3%e), EU unemp 7.4% as exp, Russia CPI 8.13% (8%e) / core CPI 8.03% (8%e), S&P +0.7%; Thur: BoE shockingly unchanged after the market priced a 15bp hike over the past couple months, Norges bank unch as expected but confirmed likely to hike in Dec, US/Aust/India/China fail to sign pledge to phase out coal by 2050, Biden admin says large companies will be fined beg Jan 4th if employees not vaccinated or tested regularly, OPEC+ maintained plans for 400k bpd production increase (below US calls for 600-800k bpd), German factory orders 9.7% (11.3%e), EU PPI 16% (15.4%e), Brazil IP-3.9% (-4%e), US init claims 269k (275k exp), S&P +0.4%; Fri: US NFP 531k (450k exp) / unemp 4.6% (4.7%e) / AHE 4.9% as exp, study shows that Pfizers antiviral (Paxlovid) cut risk of hospitalization or death from covid by 89%, RBA mins confirm commitment to keeping policy highly supportive, BoE gov Bailey says rates will rise at some point but won’t go back to 4-5%, shares of China developer Kaisa Group suspended after missed coupon payment – Kaisa is second largest offshore borrower after Evergrande in China’s prop sector, Japan household spending -1.9% (-3.5%e), EU ret sales 2.5% (1.5%e), Canada emp change 31.2k (41.6k exp) / unemp 6.7% (6.8%e), US cons credit 29.9b (16b exp), S&P +0.4%; Sat: US Dems pass $1tln infrastructure deal.
Manufacturing PMI (high-to-low): Switzerland 65.4 (previous month 68.1), Sweden 64.4 (prev mth 64.7), Netherlands 62.5 (prev mth 62), Italy 61.1/59.7, US 60.8/61.1, Austria 60.6/62.8, Greece 58.9/58.4, Norway 58.54/59.03, UK 57.8/57.1, Germany 57.8/58.4, Canada 57.7/57, Spain 57.4/58.1, Indonesia 57.2/52.2, India 55.9/53.7, Taiwan 55.2/54.7, Czech Republic 55.1/58, Poland 53.8/53.4, France 53.6/55, Japan 53.2/51.5, Hungary 53.1/52, Vietnam 52.1/40.2, Brazil 51.7/54.4, Russia 51.6/49.8, Turkey 51.2/52.5, Singapore 50.8/50.8, Hong Kong 50.8/51.7, China 50.6/50, South Korea 50.2/52.4, Mexico 49.3/48.6, South Africa 48.6/50.7. Services PMI: Sweden 68/69.6, Ireland 63.4/63.7, UK 59.1/55.4, US 58.7/54.9, India 58.4/55.2, Spain 56.6/56.9, France 56.6/56.2, Brazil 54.9/54.6, China 53.8/53.4, Germany 52.4/56.2, Italy 52.4/55.5, Japan 50.7/47.8, Russia 48.8/50.5, Australia 47.6/45.7.
Weekly Close: S&P 500 +2.0% and VIX +0.22 at +16.48. Nikkei +2.5%, Shanghai -1.6%, Euro Stoxx +1.7%, Bovespa +1.3%, MSCI World +1.8%, and MSCI Emerging -0.1%. USD rose +1.6% vs Australia, +1.4% vs Sterling, +1.2% vs Indonesia, +0.9% vs Turkey, +0.6% vs Russia, +0.6% vs Canada, and +0.2% vs Bitcoin. USD fell -2.8% vs Ethereum, -1.7% vs Brazil, -1.2% vs South Africa, -1.1% vs Mexico, -0.6% vs India, -0.5% vs Yen, -0.4% vs Chile, -0.2% vs Sweden, -0.1% vs China, and -0.1% vs Euro. Gold +2.0%, Silver +1.2%, Oil -2.5%, Copper -0.7%, Iron Ore -6.0%, Corn -2.9%. 5y5y inflation swaps (EU -3bps at 1.92%, US -4bps at 2.44%, JP -11bps at 0.35%, and UK +12bps at 3.88%). 2yr Notes -10bps at 0.40% and 10yr Notes -10bps at 1.45%.
YTD Equity Indexes (high-to-low): UAE +58.9% priced in US dollars (+58.9% priced in dirham), Argentina +52.7% priced in dollars (+81.3% in pesos), Saudi Arabia +35.3% in dollars (+35.2% in riyals), Russia +32.8% (+26.9%), Austria +31.3% (+39.6%), Czech Republic +30.9% (+33.9%), Israel +29.7% (+25.7%), Norway +28% (+27.7%), Canada +26.2% (+23.1%), India +25.7% (+28.1%), Hungary +25.5% (+31%), S&P 500 +25.1%, Netherlands +24.1% (+31.2%), NASDAQ +23.9%, Russell +23.4%, Poland +22.8% (+31.2%), MSCI World +20.2% (+20.2%), France +19.9% (+26.8%), Sweden +18.6% (+24%), Denmark +18.5% (+26%), Taiwan +18.3% (+17.4%), Italy +17.6% (+25%), Euro Stoxx 50 +16.1% (+22.8%), Mexico +15.5% (+18%), Venezuela +15.3% (+339.6%), Belgium +14.5% (+21.1%), UK +11.7% (+13.1%), Singapore +11.6% (+14%), Switzerland +11.5% (+15.1%), Finland +10.9% (+17.9%), Germany +10.1% (+17%), South Africa +9.4% (+12.4%), Ireland +9.3% (+15.6%), Australia +8.9% (+13.2%), Indonesia +7.9% (+10.1%), Spain +6.9% (+13.1%), Greece +6% (+12.1%), Portugal +4.8% (+10.8%), China +2.5% (+0.5%), Thailand +1.3% (+12.2%), New Zealand -1.1% (-0.1%), Philippines -1.7% (+2.8%), Japan -1.7% (+7.9%), Korea -4.9% (+3.3%), Chile -8% (+5.1%), HK -9% (-8.7%), Malaysia -9.2% (-5.9%), Colombia -14.6% (-3.4%), Brazil -17.5% (-11.9%), Turkey -17.9% (+7.2%).
Standing Ovation: The President’s Working Group (PWG) guidance on the future of stablecoin was published. It was a philosophical leap that makes the endgame crystal clear – a pathway led by US policy that invites private innovation into the existing financial regulatory architecture. ‘Wildcat banking’ issues will not exist under the PWG guidelines. US dollar stablecoin will reside inside the insured banking system under the purview of the Federal Reserve. The central bank can play the role as lender of last resort against the collateral held by stablecoin liabilities. Financial stability risks vanish. The private sector, not a central bank, is going to lead the evolution to a digitalized US dollar. America’s government/system deserves a standing ovation.
Standing Ovation II: The PWG guidance also punctuates the philosophical divide between the US and China. The US is embracing private stablecoin as the scalable solution for the digital economy. The technology is working. Under the right regulatory framework, it can rapidly flourish. And it will. China has taken the angle of centralized control. Its private sector captured digital payments initially, and that is being outlawed in favor of a central bank digital currency. There are now 140 million individuals with e-yuan accounts, and transaction volume of nearly $10 billion. But there is no e-yuan appetite in the global digital economy, where the US dollar dominates and is now poised to rapidly expand. It is now nearly certain that China will lose this race for digital dominance, but in such an important matter, the US must press its new advantage.
Puzzles: “Are we closer to the end than the beginning?” asked the CIO. “The is the first of two important questions,” he said. “When there are no investment losses of consequence in virtually any portfolio, you know the answer.” We are closer to the end of cycle. “And sure, some guys just got killed in leveraged bets on short-term interest rates, but that’s the only material loss and it means nothing,” he said. “Capitalism allows for periods of widespread investment gains for a time, but such environments cannot sustain. Inflation is the lever that derails the cycle.”
Puzzles II: “And this leads to the second question,” said the same CIO. “Will this inflation be transitory?” he asked. “If you knew, you’d also have the answer to the first question,” he said. “Everyone thinks this is how we should solve the current market puzzle.” If inflation is transitory, then the bull market can continue. If inflation persists, the next bear market looms. “But this is a very unusual cycle and I think we will discover that the answer to this puzzle does not run backward from inflation to the market, but rather, from the market to inflation.”
Puzzles III: “For the past few cycles, the Fed has served as the plunge protection team,” added the CIO, no stranger to buying into market declines once the Fed has panicked. “No one thinks the Fed will intervene aggressively to cap asset prices.” For decades, asset prices have been an input to the Fed’s models but only when they decline. Like all dynamic systems, the economy and stock market adjusted to the central bank’s reaction function, the former becoming financialized, the latter becoming leveraged. “Investors now expect to be bailed out - always.”
Puzzles IV: “There is an overabundance of liquidity and savings in the system now,” he said. “The liquidity isn’t just a function of the Fed, it is also personal wealth, and even for those without assets, their labor is in such high demand that they are swimming in forward liquidity.” When plumbers, roofers and electricians consider a big purchase today, they feel completely confident in their ability to pay for it tomorrow. “So yes, persistent inflation could push the Fed to tighten, sparking a bear market. But strongly rising asset prices could be the catalyst for inflation.”
Puzzles V: “If the S&P 500 doubles in the next 18mths, it would create not only a massive financial stability risk, but it would create an economic engineering issue too,” continued the CIO. “We’re at that point where there is quite obviously too much liquidity, wealth, savings, and if asset markets continue to rise at this pace, the feedback loop into the real economy will accelerate. The process has the potential to be highly reflexive.” Strong asset prices amplify wealth effects, this lifts spending, which boosts the economy, and inflation. “This is what forces the Fed to drop the hammer.”
Anecdote: “A capitalistic economy is definitionally a Ponzi scheme,” explained the CIO, a student of economic and market history, his fortune built by staying a step ahead, timing cycles, anticipating what comes next. “If it stops expanding it collapses. If the economy stops moving it suffocates, like a shark. That is why the Fed behaves as it does, intervening so aggressively, to stop this from happening,” he explained. “Even still it typically fails. The Fed proved unable to prevent the 2002-03 bear market which lasted for 3yrs. It failed to stop the Global Financial Crisis which endured for years in various forms,” he said. “But it did prevent the Covid crisis from manifesting fully, and that was for a simple reason – it was politically unacceptable to do nothing. There was a political consensus that no one was at fault. There were no villains – so we tried to ensure no one got hurt.” We name our crises for their villains. The 1980s Saving and Loan Crisis. 1994 Tequila Crisis. 1997 Asian Crisis. 1998 Russian Default. 1998 LTCM Crisis. 2000 Dot Com Crash. 2008 Global Financial Crisis. 2011 European Debt Crisis. In each, the villain was savaged, collateral damage spread far and wide. “The absence of a villain allowed for a policy response unlike any other, and this will make it difficult for most investors to appreciate the uniqueness of how this cycle plays out,” he said. “We will need far more tightening than anyone can appreciate. There is just too much liquidity and savings in the system.” Having tried and failed to normalize policy for years, the Fed is now planning a timid exit with the loosest financial conditions in decades. “Would it surprise me to see Tesla trade at a $2.5trln market cap? Nope. But assets are already ridiculously overpriced. And the end-of-cycle predicates are here: portfolios where no one loses, people think prices only go up, obscene amounts of wealth being created,” he said. “However, we don’t yet have material tightening. It’s coming. It could still be 12mths, maybe 24. And by that time there will be many villains.”
Good luck out there,
Chief Investment Officer
One River Asset Management
Disclaimer: All characters and events contained herein are entirely fictional. Even those things that appear based on real people and actual events are products of the author’s imagination. Any similarity is merely coincidental. The numbers are unreliable. The statistics too. Consequently, this message does not contain any investment recommendation, advice, or solicitation of any sort for any product, fund or service. The views expressed are strictly those of the author, even if often times they are not actually views held by the author, or directly contradict those views genuinely held by the author. And the views may certainly differ from those of any firm or person that the author may advise, drink with, or otherwise be associated with. Lastly, any inappropriate language, innuendo or dark humor contained herein is not specifically intended to offend the reader. And besides, nothing could possibly be more offensive than the real-life actions of the inept policy makers, corrupt elected leaders and short, paranoid dictators who infest our little planet. Yet we suffer their indignities every day. Oh yeah, past performance is not indicative of future returns.