“Pre-pandemic a heavy jet cost $7k-9k an hour to charter. Now it costs $18k-$20k,” said the CIO, discussing his private economic indicators. The market remains white hot. No sign of softness. “All these guys worth $100mm got sucked into a portfolio mix with 75% illiquid investments, 25% liquid. Guys like that spend $3mm-$5mm year and make $2mm after tax. They’re slowly bleeding, but even after last year are not yet scared,” he said. “Powell won’t finish tightening the tourniquet until he terrifies these guys,” he said. “They need to feel like their private portfolios won’t come back. They need to see their liquid portfolios lower still. They need to take losses to raise liquidity. It happens every cycle. We’re clearly not there yet.”
Overall: “Since the outbreak of the epidemic, we have always put people first and life first, adhered to scientific and precise prevention and control, optimized and adjusted prevention and control measures according to the time and situation, and maximized the protection of people’s lives and health,” said Xi Jinping, in a New Year’s address to his restive subjects, who had finally had enough and took to the streets, risking revolution. “After arduous efforts, we have overcome unprecedented difficulties and challenges,” added Xi, surely awed by the power of one man atop a vast security apparatus to hold a nation of 1.4bln under lockdown, a testament to the overwhelming power of a modern surveillance state. In the history of humanity, no such thing had ever been attempted. But it occurred in China of course, a nation where every so often a remarkable social/economic experiment takes place on a scale that is incomprehensible to the western mind. Its Great Leap Forward from 1958-62 led to many unexpected outcomes, one of which was the starvation of 40-50mm Chinese. The one-child policy from 1980-2015 was history’s greatest social experiment. No more brothers, no sisters, no aunts, no uncles. A generation of “missing women” has left today’s China with 723mm boys and just 689mm girls. “While it is still a struggle, everyone is working hard with perseverance, and the dawn is ahead,” said President Xi to his nation of lonely, mostly only-children, emerging from the psychological torture of lockdown. How such things manifest is anyone’s guess, the outcome of each grand experiment interweaving, compounding, echoing through generations. Of course, it’s not all for the worse. No nation in history has lifted so many from extreme poverty, even if was in part self-inflicted. And through it all, amongst the key lessons learned, one is that to maintain control, the government must instill fear while delivering economic growth. So having just discovered the limit of its ability to lockdown its people, the time has come to give them economic growth. “Let’s work harder, persistence means victory, and unity means victory,” said Xi Jinping, to his nation, humanity’s remarkable experiment.
I spoke with Magnify before the holidays about inflation, digital assets, FTX, and today’s unique policy environment. Here’s the 30min video [click here].
Week-in-Review (expressed in YoY terms): Mon: New Year’s holiday = quiet markets, Indonesia CPI 5.51% (5.39%e) / Core CPI 3.36% (3.39%e), EU PMI (final) mfg 47.8 as exp, S&P closed; Tue: Ukrainian strike on Russian military facility kills 63, Kevin McCarthy fails to win enough votes to become speaker in first three ballots (first time speaker not elected on first ballot since 1923), AAPL asked suppliers for fewer components due to weakening demand, China’s new foreign minister supports the growth of US relations, China says it will hit back at nations that impose covid restrictions on its travelers for political reasons, ECB’s Kazaks expects next two meetings to have significant rate increases, Lula sworn in as Brazilian president, US nat gas falls below $4 for first time since Feb 2022 on forecast of warmer weather, Blackstone’s BREIT gets $4b commitment from Cal Regents, China Caixin Mfg PMI 49 (49.1e), Turkey CPI 64.27% (66.7%e) / Core CPI 51.93% (53.6%e), Germany unemp 5.5% (5.6%e), Germany CPI 9.6% (10.2%e), US mfg PMI (final) 46.2 as exp, S&P -0.4%; Wed: FOMC mins caution against unwarranted easing in financial conditions / marginally hawkish, China considering ending ban on importing Australian coal, Ant Group won approval to raise $1.5b for consumer unit, BOJ conducts unscheduled bond buying operation for 4th consecutive day, Fed’s Kashkari pens article articulating case for higher policy rates, Germany impt prices 14.5% (18%e), Swiss CPI 2.8% (3%e) / Core CPI 2% (1.9%e), France CPI 5.9% (6.4%e) / cons conf 82 (84e), H. Kong ret sales -4.2% (4.8%e), EU PMI (final) serv 49.8 (49.1e) / comp 49.3 (48.8e), US ISM mfg 48.4 (48.5e) / prices paid 39.4 (42.9e), US JOLTS job openings 10.458m (10.050m exp), S&P +0.8%; Thu: HK to reopen border with China with cap of 60k people, AMZN to lay off 18k workers, PBOC loosens mortgage rates for cities with declining home prices, Erdogan calls on Putin to call for unilateral cease-fire in Ukraine /Putin subsequently calls for Christmas Holiday (Jan 6/7) ceasefire, amount of neg yielding debt falls to 0 from max of $18.4T in late 2020, Fed’s Bullard says policy will move into sufficiently restrictive zone during 2023, Fed’s George advocates hiking above 5% and staying there for some time, Lula calms market by denying pension reform being reviewed, US/Germany to send armored vehicles to Ukraine = major upgrade, Japan monetary base -6.1% (-6%e), China Caixin PMI serv 48 (46.8e) / comp 48.3 (47p), German trade bal 10.8b (7.5b exp), EU PPI 27.1% (27.5%e), Italy CPI 12.3% as exp, US ADP emp change 235k (150k exp), US init claims 204k (225k exp), US PMI (final) serv 44.7 (44.4e) / comp 45 (44.6p), S&P -1.2%; Fri: US NFP 223k (203k exp) / unemp 3.5% (3.7%e) / AHE 4.6% (5%e), reports indicate China looking to ease stringent ‘three red line’ rules for property developers, BoJ conducts another unscheduled bond buying operation, BOJ reportedly sees little rush to adjust YCC policy, S. Africa’s ANC wants to change SARB mandate, TSLA announces price cuts in China for model 3 and Y, ECB’s Centeno said rates are close to peaking, Japan real earnings -3.8% (-2.8%e), Germany ret sales -5.7% (-5.9%e), Germany factory orders -11% (-5.8%e), France cons spending -5.2% (-5.1%e), EU CPI 9.2% (9.5%e) / Core CPI 5.2% (5.1%e), EU ret sales -2.8% (-3.1%e), EU cons conf -22.2 as exp, Canada emp change 104k (5k exp) / unemp 5% (5.2%e) / hourly wage rate 5.2% (5.4%p), US ISM services 49.6 (55e), US factory orders -1.8% MoM (-1%e), S&P +2.3%; Sat: McCarthy becomes House Speaker on 15th vote after major concessions.
Manufacturing PMI (high-to-low): Hungary 63.1 (previous month 56), India 57.8 (previous 55.7), Switzerland 54.1 (previous 53.9), Russia 53/53.2, Mexico 51.3/50.6, Indonesia 50.9/50.3, South Africa 50.2/50.6, Norway 50.02/51.08, Singapore 49.7/49.8, Hong Kong 49.6/48.7, Canada 49.2/49.6, France 49.2/48.3, China 49/49.4, Japan 48.9/49, Netherlands 48.6/46, Italy 48.5/48.4, US 48.4/49, South Korea 48.2/49, Turkey 48.1/45.7, Austria 47.3/46.6, Greece 47.2/48.4, Germany 47.1/46.2, Spain 46.4/45.7, Vietnam 46.4/47.4, Sweden 45.9/45.9, Poland 45.6/43.4, UK 45.3/46.5, Taiwan 44.6/41.6, Brazil 44.2/44.3, Czech Republic 42.6/41.6. Services PMI: India 58.5/56.4, Sweden 53/54.3, Ireland 52.7/50.8, Spain 51.6/51.2, Japan 51.1/50.3, Brazil 51/51.6, UK 49.9/48.8, Italy 49.9/49.5, France 49.5/49.3, Germany 49.2/46.1, China 48/46.7, Russia 45.9/48.3, US 44.7/46.2.
Weekly Close: S&P 500 +1.4% and VIX -0.54 at +21.13. Nikkei -0.5%, Shanghai +2.2%, Euro Stoxx +4.6%, Bovespa -0.7%, MSCI World -0.3%, and MSCI Emerging +2.9%. USD rose +0.9% vs Sweden, +0.7% vs Yen, +0.6% vs Euro, +0.5% vs Russia, +0.4% vs South Africa, +0.4% vs Indonesia, and flat vs Turkey. USD fell -4.9% vs Ethereum, -1.8% vs Mexico, -1.7% vs Bitcoin, -1.1% vs Brazil, -1.0% vs China, -1.0% vs Chile, -0.9% vs Australia, -0.8% vs Canada, -0.1% vs Sterling, and flat vs India. Gold +2.2%, Silver -0.8%, Oil -8.4%, Copper +2.7%, Iron Ore -1.6%, Corn -3.7%. 10yr Inflation Breakevens (EU -14bps at 2.13%, US -9bps at 2.21%, JP -10bps at 0.75%, and UK -21bps at 3.42%). 2yr Notes -18bps at 4.25% and 10yr Notes -32bps at 3.56%.
2023 Year-to-Date Equity Indexes (high-to-low): Mexico +8.6% priced in US dollars (+6.7% priced in pesos, Ireland +6.7% priced in US dollars (+7.5% in euros), HK +6% in US dollars (+6.1% in HK dollars), Italy +5.5% in dollars (+6.2% in euros), France +5.3% (+6%), Euro Stoxx 50 +5.2% (+5.9%), Spain +5% (+5.7%), South Africa +5% (+5.8%), Argentina +4.5% (+5.8%), Netherlands +4.4% (+5.1%), Germany +4.2% (+4.9%), Austria +4% (+4.7%), Czech Republic +3.9% (+4%), Hungary +3.8% (+3.7%), China +3.2% (+2.2%), Thailand +3.2% (+0.3%), Belgium +3.2% (+3.9%), UK +3.2% (+3.3%), Switzerland +3.2% (+3.9%), Korea +3.1% (+2.4%), Colombia +3.1% (+3.2%), Canada +2.9% (+2.2%), Poland +2.3% (+4.2%), Philippines +2.2% (+1.5%), Sweden +1.8% (+4.6%), Russell +1.8%, Australia +1.7% (+1%), Taiwan +1.7% (+1.7%), S&P 500 +1.4%, Denmark +1.3% (+2.1%), Portugal +1.2% (+1.9%), Russia +1.1% (+0.1%), Finland +1.1% (+2.8%), New Zealand +1.1% (+1.3%), Singapore +1% (+0.8%), NASDAQ +1%, Greece +0.6% (+2.3%), Saudi Arabia +0.6% (+0.5%), Brazil 0% (-0.7%), UAE -0.1% (-0.1%), MSCI World -0.3% priced in US dollars, India -0.9% (-1.4%), Malaysia -1% (-1%), Israel -1.2% (-0.3%), Japan -1.3% (-0.5%), Chile -1.5% (-2.4%), Norway -2.2% (-0.1%), Indonesia -2.8% (-2.4%), Turkey -3.2% (-3%), and Venezuela -8% (-5.2%).
Clouded: “I am afraid that you will be disappointed,” said The Oracle, the two of us seated, sipping water. I had travelled far, to the remote cave, to glimpse the future through his eyes. “I am a man of great conviction,” he said. It is true. It’s why I made the journey. No seer has been more accurate on forecasting inflation in the post-pandemic world. “But the outlook is clouded at the moment, and I will need two months before I give you a definitive answer,” he said. And he was right, I was disappointed. “Well show me what you see in the clouds,” I said.
Clouded II: “There is one possible future which resembles many past periods,” said The Oracle, closing his eyes. “Commodity and goods price inflation leads to wage inflation. Then the former remains high as the latter catches up. The Fed hikes until unemployment goes up 1-2%. Wages then come down, and inflation follows,” he said, explaining so many previous cycles. “But our times are unique, which is why consensus has been so wrong for a couple years,” said The Oracle, relaxed, seated on his rock. “And in another possible future, China comes roaring back.”
Clouded III: “The world has changed,” said The Oracle. “The Fed Put has been replaced by the Covid Put,” he said. It used to be that investors knew that when stock markets fell, the Fed would cut rates and save them. The extraordinarily massive pandemic stimulus may have convinced consumers that any real economic shock will result in stimulus checks, monetized by the Fed. “In the past, weak growth led to buffer stock saving. Consumers would cut expenditure to save for a rainy day. But that may no longer be true and if so, the old models will not work.”
Clouded IV: “In recent months, prices have fallen far faster than monetary policy can possibly explain,” said The Oracle. “It might be that supply disruption contributed more to inflation. Easing supply chains can lead to further sharp inflation declines,” he said. “The next two months will tell us whether this is a bizarre blip or something real. But I see problems for stocks either way,” he soberly continued. “If inflation stays high, the Fed will hike to 6%. And if inflation falls quickly, margins narrow as wages stay high, and again stocks come under pressure.”
Quadrants: “The transition from low inflation to high inflation is tough for investors, but at least you know you can be short bonds and long vol,” said the CIO, another strong year under his belt. “That’s in the past. This year we are transitioning to slowing growth and a move to softer inflation,” he said. “So, we’re entering the stagflation quadrant.” That’s an even more difficult environment for investors. “It’s a quadrant where you need to look for idiosyncratic alpha, relative value trading, cross market kinds of opportunities. It’s tough.”
Quadrants II: “Everyone was short bonds, but they’re out now,” continued the same CIO. “No one wants to be long bonds. There aren’t big positions out there now. There’s not a lot of convexity to be had. Maybe short the dollar, but the Yen has already increased a lot. Oil probably has the most upside of anything out there. Possibly Chinese equities on the re-opening trade. But no one trusts Xi and that regime,” he said. “So the big money probably won’t be made again until we exit this quadrant and inflation and growth start to really slow hard.”
Quadrants III: “All of that is the linear way of thinking,” added the CIO. “People are nervous about Ukraine, but markets are awful at pricing risks like war,” he said. “It is fine to think about quadrants in the absence of a true geopolitical event.” Last year, the real risk that manifested in markets was not Ukraine specifically, but rather the persistence of inflation relative to expectations. “People who think there are linearities in war are wrong. Wars take abrupt turns. Taiwan or a significant escalation in Ukraine. A tactical nuke. Those are this year’s big risks.”
Anecdote: “The Fed rightly or wrongly has a lot of confidence that they can easily open the spigot and turn the economy back on at any moment,” said the CIO. “They’re like 15 out of 10 confident. They’re like, let’s just have a recession. And that should make investors nervous,” he continued. “They’re so confident, because of how they’ve controlled the economy for the last 15yrs and then particularly after Covid. If they could handle a pandemic, they think they can handle anything,” he said. “So they’re happy to err on the side of causing a recession and push it as far as they need to achieve their objectives.” To soften the labor market and dampen inflation. “The market is mostly priced for a soft landing, and sure, anything is possible. But in a such a highly leveraged economy, you’re either drowning and sinking, or you’re confidently swimming. What you’re not doing is floating still in the water with your nose just slightly above the surface,” he said. “They have to create a reduction in demand and that is a reflexive process.” And because they’re not worried about recession, investors are likely to have to endure one. “The recessionistas are out saying the Fed has already gone too far, that they’ve made a policy error. They say that average hourly earnings over the past few months are already below 3%. They point to mortgage rates, housing inverted yield curves,” he said. “But the recessionistas don’t yet get that the Fed isn’t worried about overtightening. They’re looking around, and they see that there’s still too much wealth. People with money are still pressing. People at the bottom all have jobs. And if they leave for another position, they get paid more. So even though they don’t have great balance sheets, workers will remain confident until they start actually losing jobs.”
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, converse 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.