“Before investing in a fund that holds bitcoin futures contracts, make sure that you carefully weigh the potential risks and benefits,” warned the SEC via a Thursday evening tweet. Twitter blew up. Digital asset prices surged. Because of course, Biden’s SEC Chairman, who consults with the Treasury Secretary and others on crypto would only approve an ETF if they were going to let the market decide if bitcoin is here to stay. But the new ETFs will provide exposure to bitcoin that is almost as costly and inefficient as could be imagined, including because of the futures-related risks the SEC cites. And relative to the underlying digital asset markets, which trade 24x7x365, these ETFs will trade just 252-days per year on exchanges whose primary trading hours are only 6.5-hours per day. Such a vast chasm between the digital asset markets and our legacy exchanges will drive more investors away from archaic financial intermediaries to the new digital ecosystem. And all the excitement lifted bitcoin to within striking distance of its record weekly close – that is, for the sort of traders who still operate as if markets close.
Overall: “Today’s announcement has the potential to be a game-changer,” said Biden, from the White House steps, directing attention to the Port of Los Angeles and its newly extended hours of operation. “Private sector companies need to step up as well,” pleaded the President, scrambling to grease America’s rusty supply chain. Nearby, the Bureau of Labor Statistics released its consumer price index for September. The CPI rose +5.4% from 2020. And a few blocks away, the Social Security Administration considered the arguments for and against transitory inflation, then hiked next year’s benefits by +5.9%. That’s the largest cost-of-living adjustment in 40 years, and a reminder that the lags in inflation are integrated into public policy. In 2020, the inflation adjustment was just +1.6%. But that was before consumer prices jumped +5.4% – inflation cut 3.8% of purchasing power from seniors living off social security. And they’re not alone. This time last year, investors who sought the safety of risk-free 10yr Treasury notes (+0.74% yield back then) lost -11.19 % when measured on an inflation-adjusted basis. What connects these two stories is that both Social Security commitments and Treasury securities represent government liabilities. And the net present value of those liabilities is impossibly large to meet – in real terms, at least. So the government’s long process of lightening its burden from that real liability has finally begun. If successfully coordinated and executed by the Fed, Treasury, IRS, regulators and elected politicians, inflation rates will be guided to remain well above nominal interest rates for decades. That’s what the inflation-index Treasury market is signaling. By design, the process will destroy vast sums of capital because private-sector assets are the government’s liabilities. And our job as investors is to adapt to this new environment. The starting place is to view it all as neither good nor bad, but rather an inevitable process that simply is – a world of nominal illusion.
Week-in-Review (expressed in YoY terms): Mon: “Polexit” fears continue to swirl following Polish supreme court ruling that the country’s constitution overrides certain EU laws, severe flooding in Shanxi province displace more than 1.75m people / flooding causing 10% of coal mines shut in Shanxi – intensifying energy shortage, Chinese property developer Modern Land asked to defer payment on bond due end of Oct, Austria’s PM steps down amid corruption allegations, WTI futures rally to highest level since 2014, Norway CPI 4.1% (3.9%e), Turkey unemp 12.1% (12.1%p), S&P -0.7%; Tue: BoK unch as exp – slightly hawkish tone, IMF lowers global growth forecast 0.1% (to 5.9%) for 2021, Macron unveiled 30b EUR plan to help decarbonize, Evergrande misses three more interest payment related deadlines, Fed’s Bostic highlights that supply chain disruptions likely to have lasting impacts on inflation – promotes Nov tapering, Fed’s Bullard wants to finish tapering by end of Q1 2022, Fed’s Quarles to no longer chair supervision committee, Japan PPI 6.3% (5.8%e), Sweden unemp 3.7% (3.9%p), UK unemp 4.5% as exp, Turkey IP 13.8% (10.5%e), German ZEW 22.3 (23.5e), Mexico IP 5.5% (4.1%e), India CPI 4.35% (4.5%e) / IP 11.9% (11.6%e), US NFIB 99.1 (99.5e), S&P -0.2%; Wed: US CPI 5.4% (5.3%e) / Core CPI 4% as exp, FOMC minutes confirm Fed is making plans for Nov taper, Apple revises down iPhone production amidst chip shortage, European commission proposes “energy toolbox” to help manage energy crisis, Chilean president declares state of emergency amidst uprising from indigenous people demanding their land returned, Korea unemp 3% as exp, Australia cons conf 104.6 (106.2e), Japan machine orders 17% (13.9%e), China imports 17.6% (20.9%e) / expts 28.1% (21.5%e), China agg financing 2.9T CNY (3.05T exp), China M2 8.3% (8.2%e), UK IP 3.7% (3.3%e), EU IP 5.1% (4.7%e), S. Africa ret sales 4.9% (9.5%e), S&P +0.3%; Thur: LinkedIn to be the last US social media company to shut Chinese operations, Turkish PM Erdogan fired 3 (traditionally hawkish) members of CB’s MPC, Chile CB hikes 125bps (100bps exp), Singapore CB tightened policy unexpectedly by raising the slope of its policy band, far right candidate Eric Zemmur surpasses Marine Le Pen in most recent French election poll, Singapore 3Q GDP 6.5% (6.6%e), Australia emp change -138k (-110k exp) / unemp 4.6% (4.8%e), China CPI 0.7% (0.8%e) / PPI 10.7% (10.5%e), US init claims 293k (320k exp), US PPI 8.6% (8.7%e) / Core 6.8% (7.1%e), S&P +1.7%; Fri: Sir David Ames – a senior conservative MP – was stabbed to death, ISIS-K claim responsibility for mosque bombing that killed 37 in Kandahar, China’s XI not to attend COP26 climate conference, GS caps off stellar week of earnings for US financial institutions, PBOC says risks to the financial system due to Evergrande are controllable and unlikely to spread, Biden signs bill extending debt limit until 12/3, US announces that starting 11/8 travel bans from over 30 countries will be lifted for those vaccinated against covid, Brexit / Northern Ireland saga heats up as Johnson vows to tear up existing N. Ireland protocol, Argentina CPI 52.5% (51.7%e), Turkey exp infl 13.91% (12.94%p), Israel CPI 2.5% as exp, Brazil economic activity 4.74% (4.9%e), US ret sales control group 0.8% MoM (0.5%e), US imprt prices 9.2% (9.4%e), US UofM sentiment 71.4 (73.1e) / 1y infl 4.8% (4.7%e) / 5-10y infl 2.8% (3%p), S&P +0.8%.
Weekly Close: S&P 500 +1.8% and VIX -2.47 at +16.30. Nikkei +3.6%, Shanghai -0.6%, Euro Stoxx +2.6%, Bovespa +1.6%, MSCI World +2.2%, and MSCI Emerging +2.1%. USD rose +3.2% vs Turkey, +1.8% vs Yen, and +0.4% vs India. USD fell -9.2% vs Bitcoin, -4.9% vs Ethereum, -2.2% vs South Africa, -1.8% vs Mexico, -1.5% vs Australia, -1.4% vs Sweden, -1.1% vs Russia, -1.0% vs Indonesia, -1.0% vs Sterling, -0.9% vs Brazil, -0.8% vs Canada, -0.3% vs Euro, -0.2% vs Chile, and -0.1% vs China. Gold +0.6%, Silver +2.9%, Oil +3.9%, Copper +10.3%, Iron Ore +7.0%, Corn -0.6%. 5y5y inflation swaps (EU +5bps at 1.86%, US +2bps at 2.59%, JP +1bp at 0.36%, and UK flat at 3.93%). 2yr Notes +8bps at 0.40% and 10yr Notes -4bps at 1.57%.
YTD Equity Indexes (high-to-low): UAE +54.8% priced in US dollars (+54.8% priced in dirham), Russia +36% priced in US dollars (+29.6% in rubles), Argentina +35.8% in dollars (+60.1% in pesos), Saudi Arabia +34.7% (+34.6%), Czech Republic +29.3% (+32.6%), Austria +28.3% (+36%), India +27.7% (+31.2%), Norway +26.1% (+23.8%), Hungary +24.8% (+30.2%), Canada +23.7% (+20%), Poland +23.5% (+30.5%), Netherlands +21.5% (+28.1%), Israel +21.5% (+21.8%), S&P 500 +19%, Sweden +17.5% (+23.5%), Mexico +17.2% (+19.8%), Venezuela +16% (+320.7%), MSCI World +15.6% (+15.6%), NASDAQ +15.6%, France +14.9% (+21.2%), Russell +14.7%, Taiwan +14.3% (+13.9%), Denmark +13.5% (+20.3%), UK +12.9% (+12%), Italy +12.4% (+19.1%), Euro Stoxx 50 +11.7% (+17.7%), South Africa +11.6% (+11.2%), Indonesia +10.8% (+10.9%), Finland +10.5% (+17.1%), Belgium +10.1% (+16.1%), Ireland +9.9% (+15.9%), Singapore +9.3% (+11.6%), Australia +7.7% (+11.8%), Germany +7.2% (+10.8%), Switzerland +6.8% (+9.9%), Spain +5.7% (+11.4%), Greece +4.9% (+10.6%), Portugal +4.6% (+10.3%), China +4.3% (+2.9%), Thailand +1.4% (+13%), New Zealand -2.3% (-0.6%), Korea -3.4% (+4.9%), Japan -4.3% (+5.9%), Philippines -4.3% (+1%), Malaysia -5.1% (-1.8%), HK -7.3% (-7%), Brazil -8.5% (-3.7%), Colombia -10% (-0.8%), Chile -17.7% (-4.7%), and Turkey -23.1% (-4.5%).
Lines: After decades of coordinated government policy that prevented widespread capital destruction in each and every recession, we unsurprisingly find ourselves with an overabundance of it. Interest rates remain so low not simply because the Fed set rates at zero and buys $120bln of bonds per month. When there is too much of any commodity, its price declines. And until the supply of capital shrinks meaningfully, or demand for it rises materially, the interest rate that borrowers are prepared to pay for something so abundant will remain low.
Lines II: Of the many lines that divide our fractured world, the darkest separates young and old. For decades, Baby Boomers advocated for an economic and entitlement structure that favored the old relative to the young. The ageing now overwhelmingly control societal wealth and have granted themselves entitlements that claim an outsized portion of future economic output. The young are expected to produce this for them. Baby Boomers also saddled their offspring with a climate crisis. And the young are no longer willing to tolerate the status quo.
Lines III: Much of the tension we see today emanates from competing interests between young and old. This gets obscured by those with an interest to divert attention. But economics doesn’t lie for long. And systems that swing too far from balance are usually drawn back toward center. So the pressures to deprive the old of the wealth they accumulated and the entitlements they granted themselves has begun. The path this process takes will define markets for decades. The fight will be wicked. Agonizing. It has started by haircutting the wealth of those who own bonds.
Lines IV: The worst possible investment environment for wealthy old people is a high inflation environment with (1) very low yields on risk-free bonds, and (2) extremely high valuations for risky assets. Low yields deprive old people of a way to mitigate their loss of buying power. So they grow poorer unless they take market risk. But when asset valuations are historically high and increasingly disconnected from economic reality, old people who buy them run the risk that prices crash. Without income to recover from such losses, such a situation is rightly terrifying.
Lines V: US inflation over the past year was +5.4%. Old people who own risk-free 10-year Treasury notes to secure their retirement lost -11.19% of their real purchasing power in that period (bond prices fell and inflation rose). Those who owned investment grade corporate bonds lost -4.8% of their real purchasing power. In a great irony that foreshadows the generational stresses ahead, old people who own gold to hedge inflation lost -12.8% of their real purchasing power in the past year (prices fell -7.4% and inflation rose +5.4%).
Lines VI: The people who maintained their real wealth in the past year did so because they owned risk assets. The S&P 500 return including dividends was +30.3%. After discounting that by the +5.4% rise in the consumer price index, the real return was +24.9%. House prices rose +19.7%, and on a real basis were +14.3%. Food price indexes jumped +30% over the past year, gasoline and copper prices leapt +50%, oil doubled, and natural gas surged +150% in the US. But few old people own such things. They consume them. And the one thing old people are unwilling to risk their money on is digital assets. Bitcoin surged 441%. Ethereum soared 920%.
Anecdote: There are two good things about being young and broke. The best part of course, is that you are not old. But you also have little to lose. And that is liberating for a person with decades to recover from taking risk in ventures that might fail. Having a large group of such youth is an invaluable asset for the older citizens supported by their innovations and output. But powerful forces, if improperly managed, create havoc. So all successful societies strike a healthy balance between the competing desires of old and young. Nations that favor the former to the detriment of the latter suffer upheaval. This is roughly where we are now - nor are such dynamics limited to the US. And they are amplified by a world with a rising proportion of unproductive elderly. Our youth, in a system they increasingly recognize as profoundly unfair and biased against their interests, are doing as they should: advocating for vast spending programs to build a green infrastructure and social system that reflects their priorities, unconcerned by the resulting inflation that will erode the wealth of their elders. With powerful new blockchain technologies, many are building businesses to bankrupt their parent’s incumbent industries whose lobbyists calcify what our youth see as an unjust status quo. They are fleeing high tax states with bankrupt entitlement systems, for cities like Austin which they then remake in their image. As elderly gold owners writhe in portfolio pain, confused why the price of yellow metal is falling with inflation rising, our young people look to the digital future, buying bitcoin, ether, solana. NFTs. And as investors, our job is to recognize such trends, capitalizing on the opportunities they create, mitigating the risks such periods of upheaval produce. And in this new world, transitioning from old to young, unsettling inversions emerge. The strategies we previously turned to for safety have become risky. While unfamiliar investments that at first appear risky, provide safety.
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.