“Limited beauty sleep, and lord knows I need it,” typed Marcel, Deputy CIO of our digital business, on the internal markets chat, sharing his analysis of the nature of the economic downturn now approaching. It was 3:11 AM his time and I was 5hrs ahead, prepping for the Goldman Apex Symposium. “But I feel strongly prepared for today’s discussion,” he added, grinding, ahead of an eagerly awaited lunch with Lindsay and an important investor in NYC. Like all Marcel’s chats, this one was long, full of detail, policy insights, illuminating historical references. “The market is miles too optimistic on the nature of this downturn. The consistent message embedded in the pricing of stocks and bonds is that it’ll be short and sweet.”
Overall: “The North American economy is making choices for the sake of attractiveness, which I respect, but they create a double standard,” said Emmanuel Macron, a nervous sickness rising, his Gallic hope for Liberty, Equality, and Fraternity slipping away. “In addition, they allow state aid going to up to 80% on some sectors while it’s banned here -- you get a double standard,” added France’s President. “It comes down to the sincerity of transatlantic trade.” But of course, trade is neither sincere nor insincere. Trade is trade. Or at least, free trade is free trade. It is an arrangement between two parties to exchange one thing for another at a mutually agreed upon price -- this is how markets clear. Macron called out both the US and Norway for making “the real super-profits” from their energy exports, benefitting from “geopolitical war unearned income.” And no doubt, this is true. In times of rising conflict, nations that control strategically vital assets profit in outsized ways. France controls few. The US controls many. But since the last world war, America’s global security guarantee leveled the playing field to allow nations with few or even no strategically vital assets to nevertheless prosper, participating in ever-deepening globalization, specialization, integration. This period was an historical anomaly, utterly extraordinary. And it is ending. Macron knows this. As does Xi Jinping, with insufficient domestic energy to power his economy, too little home-grown food to feed his people, and now facing new restrictions on strategically vital American technology exports. In fact, every leader on the planet knows this now. Even those who desperately cling to the hope that this is not so, are quietly putting in place contingencies if they are wrong. This new operating environment is entirely foreign to any investor alive today. So, we must unanchor ourselves from a past that is no longer and proceed with open minds.
One River Digital portfolio managers Paul Ebner and Sarah Schroeder wrote a great piece about systematic trend-following strategies in digital asset markets. Trend-following is particularly well-suited for periods of quantum change. And given our expertise in both trend and digital, we built Digital Trend. For a glimpse [click here].
Week-in-Review (expressed in YoY terms): Mon: China keeps 1y MLF unch as exp, UK’s new chancellor Hunt dramatically scales back Truss’s spending plan (32b GBP) in U-turn from recent mini-budget, Germany to extend lifetime of 3 nuclear power plants, China to no longer resell LNG to other countries in retaliation for recent US chip ban, Xi’s opening speech signals no change to Covid-Zero policy, Ukraine continues to be hit by drone attacks, Fed’s Bullard says 75bp in Dec is possible, Singapore non-oil expts 3.1% (6.9%e), Brazil eco activity 4.86% (5.3%e), US empire mfg -9.1 (-4.3e), S&P +2.7%; Tue: Goldman beats, BOE confirms gilt sales to begin Nov 1, NFLX subscriber growth surprises to upside, US prepared to release more from SPR if necessary / will look to reload below $72/barrel, EU gas prices ease on talk of warmer winter / worker strikes at France nuclear plant risks exacerbating energy crisis, Ukraine says Russia has destroyed 30% of power stations since 10/10, BoE’s Cunliffe says LDI funds have raised billions in capital recently, RBA says downshift to 25bp hike was partly due to higher meeting frequency, Kuroda says he has no intention of resigning, NZ 3Q CPI 7.2% (6.5%e), Germany ZEW -59.2 (-66.5e), EU ZEW -59.7 (-60.7p), US IP 0.4% MoM (0.1%e), US NAHB housing mkt index 38 (43e), S&P +1.1%; Wed: TSLA beats earnings est, China keeps loan prime rates unch as exp, UK home secretary resigns, Russia evacuates civilians from Kherson / declares martial law in occupied regions, Fed’s Kashkari says CPI may have peaked but not core, Kuroda says FX stability is important, Ukraine shot down 13 Iranian made drones that were targeting more key infrastructure, UK CPI 10.1% (10%e) / Core CPI 6.5% (6.4%e) / RPI 12.6% (12.4%e), S. Africa CPI 7.5% (7.6%e) / Core CPI 4.7% as exp, EU final CPI 9.9% (10%e) / Core CPI 4.8% as exp, Poland PPI 19.6% (22.4%p), S. Africa ret sales 2% (4.9%e), US housing starts 1.439m (1.461m exp), Canada CPI 6.9% (6.7%e) / Core trimmed mean CPI 5.2% (5.1%e), S&P -0.7%; Thur: UK PM Truss resigns / new leadership vote in 1 week, Indonesia CB hikes 50bp as exp, Turkey CB cuts rates by 150bp (100bp exp), US nat gas futures fall to lowest level since March, US eyes expanding tech ban to AI and quantum computing, USDJPY probes above 150 for first time since 1990, China considers cutting quarantine period for arrivals, Australia unemp 3.5% as exp / emp chg 0.9k (25k exp), Germany PPI 45.8% (45.4%e), France mfg conf 103 (100e), ECB CA -26.3b (-20b prev), US Philly Fed business outlook -8.7 (-5e), US init claims 214k (233k exp), US leading index -0.4% (-0.3%e), S&P -0.8%; Fri: BOJ/MOF intervene in USDJPY, German 10y surpasses 2.5% for first time since 2011, Bannon sentenced to 4m in prison, Meloni picks Giorgetti as fin min, Moody’s cuts UK outlook to negative, UK PM candidates need to be nominated by Monday afternoon (Sunak, Mordaunt, Johnson are the front runners), WSJ’s Timiraos article suggests Fed to begin discussing when to start slowing hikes, Hunt suggested a delay to his fiscal plan date of 10/31, Fed’s Daly cautioned about risks of overtightening / wants Fed to start planning for smaller hikes, UK cons conf -47 (-52e), Japan CPI 3% (2.9%e) / Core CPI 1.8% as exp, UK ret sales -6.9% (-5%e) / core ret sales -6.2% (-4.2%e), UK public sector net borrowing 20b (17.5b exp), Sweden unemp 7% as exp, EU cons conf -27.6 (-30e), S&P +2.4%; Sat: Further strikes on Ukraine infrastructure, Xi has former leader Hu Jintao removed from Communist Party Congress (public humiliation).
Weekly Close: S&P 500 +4.7% and VIX -2.33 at +29.69. Nikkei -0.7%, Shanghai -1.1%, Euro Stoxx +1.3%, Bovespa +7.0%, MSCI World +2.2%, and MSCI Emerging +0.2%. USD rose +2.9% vs Ethereum, +2.3% vs Bitcoin, +1.3% vs Indonesia, +1.0% vs Chile, +0.5% vs Turkey, +0.5% vs China, and +0.4% vs India. USD fell -3.1% vs Brazil, -2.8% vs Australia, -2.3% vs Russia, -1.8% vs Canada, -1.5% vs South Africa, -1.4% vs Euro, -1.2% vs Sweden, -1.2% vs Sterling, -0.7% vs Mexico, and -0.7% vs Yen. Gold +0.7%, Silver +6.6%, Oil +0.7%, Copper +2.2%, Iron Ore +1.4%, Corn -1.0%. 5y5y inflation swaps (EU +11bps at 2.35%, US +16bps at 2.66%, JP -1bp at 0.92%, and UK +31bps at 3.62%). 2yr Notes -2bps at 4.48% and 10yr Notes +20bps at 4.22%.
YTD Equity Indexes (high-to-low): Turkey +50.7% priced in US dollars (+111.8% priced in lira), Brazil +22.8% priced in US dollars (+14.4% priced in reais), UAE +19.1% priced in dollars (+19.1% in dirham), Argentina +11.1% in dollars (+66.4% in pesos), Saudi Arabia +6% (+6%), Chile +4.9% (+19.5%), Indonesia -2.1% (+6.6%), India -8.7% (+1.3%), Mexico -9.3% (-11.5%), Singapore -9.6% (-4.9%), Portugal -13.9% (-0.3%), Thailand -16.1% (-4%), Venezuela -16.8% (+49.4%), Greece -17.3% (-4.3%), Canada -17.7% (-11.1%), Israel -18.2% (-6.8%), Norway -18.3% (-2.3%), Malaysia -19% (-7.7%), S&P 500 -21.3%, UK -21.5% (-5.6%), Australia -21.6% (-10.3%), Russell -22.4%, South Africa -22.6% (-11.9%), Spain -24.7% (-13.4%), MSCI World -24.8% priced in dollars, Switzerland -26% (-19.1%), Denmark -26.5% (-15.4%), China -26.6% (-16.5%), Japan -26.9% (-6.6%), Philippines -27% (-16%), France -27.1% (-15.6%), Colombia -27.6% (-12.7%), Czech Republic -27.9% (-18.4%), Netherlands -29.3% (-18.2%), Euro Stoxx 50 -30.1% (-19.1%), Germany -30.3% (-19.9%), NASDAQ -30.6%, New Zealand -30.7% (-17.3%), Finland -30.7% (-20.3%), Belgium -30.9% (-20%), HK -31.2% (-30.7%), Italy -31.4% (-21.1%), Ireland -32.2% (-21.5%), Russia -34.7% (-46%), Sweden -36.7% (-21.4%), Austria -37.5% (-28.1%), Hungary -37.5% (-20.3%), Korea -38.1% (-25.7%), Taiwan -39.5% (-29.6%), and Poland -43.5% (-32.5%).
Big Foot: “Investors are beginning to come to terms with the fact that many things they believed to be true are myths,” said Sasquatch, his already enormous market footprint having deepened markedly post-pandemic. “They assumed the 60/40 portfolio was robust, and sometimes it is, but other times it is not,” he said, winding our way through the streets of London, crooked, cracked cobblestones in his footsteps. “They assumed inflation would remain low forever, expectations too. That TIPS hedge inflation. Tech outperforms. It turns out these things are not always true.”
Big Foot II: “Real estate, it turns out, is not always a hedge for inflation. Nor is gold. And before this cycle is over, investors will discover things they believed to be true about infrastructure, private equity, and a variety of illiquid investments are also just assumptions,” continued Sasquatch, CEO of one of the world’s largest investment firms, his returns surging. “The portfolio adjustments required are dramatic, and clients need help solving such problems, so it’s unsurprising that our solutions business, like yours, is seeing strong inflows.”
The Only Thing: “Well it’s obvious isn’t it,” he asked, answering rhetorically, dismissive of my question, almost irritated, which made me laugh. We’d spent a couple hours together and had finally gotten onto markets. “Well, isn’t it?” he repeated, louder. I’d asked what he thinks is the most important thing to focus on. He’s one of the greatest CIOs of our generation, and keeps his macro trades liquid, his risk management tight. “There is too much debt in the world, so they must inflate it away, which they can do. They will. That’s the only thing you need to know.”
Longboats: “Well, we have gotten the inflation we last discussed,” said the Viking, leading tactical asset allocation for one of the mighty Scandinavian pools of assets. I had last visited pre-pandemic, when we had agreed that whenever the next recession arrived, it would spark an aggressive fiscal stimulus, and catapult us into a new inflationary regime. “But the firms that believed their commercial real estate investments would insulate them from this, have not done too well with that I think,” he continued, a beautiful turn of Swedish understatement.
Longboats II: “If you look at listed commercial real estate companies here on our stock exchange - which is overall down 35% - you find that these names are down 60-80%,” said the same Viking. “Still, you must also consider that inflation has risen by 10% which is a real loss, and the kronor is down 20% against the dollar too.” Stockholm itself was as magnificent as ever, cold but clear, leaves turning. But invisible, its highly leveraged financial architecture sagged, groaned, like everywhere. “And we have not yet seen the private markets marked lower really.”
Smiling: “We are 200% funded,” said the chief risk officer for one of the largest private pension plans. “What does that mean?” I asked. “We have twice as many assets as liabilities,” he said, patiently. “Ah, apologies. I am just used to US pensions which in some cases are just 40% funded. I haven’t ever heard of 200%. How are you so well-funded?” I asked. “Good investing, I think, perhaps some good luck too,” he said, smiling. “And so you are well-positioned for the coming distressed selling, by your poorly funded and leveraged peers?” I asked. He smiled.
Vice Versa: “How do we invest for this new environment?” asked a CIO in Stockholm. “I don’t yet know what you currently own, so that’s hard to answer,” I said. “But in general, I think we should all re-underwrite what has worked for the past couple decades of low inflation, low interest rates, financialization, mean-reversion, leverage, globalization, and peace. Ask how such strategies will perform as these dynamics reverse. Ask how your strategies will fare in a long period of financial repression, where central banks inflate away government debt.”
Vice Versa II: “Re-underwriting is hard, because we are all anchored to what has been, and the future will look very different,” I continued. “To capitalize on new opportunities and insulate yourself from risks, you’ll need to be quite open-minded. My all-in commitment to digital assets reflects this embrace of change. And systematic trend-following strategies are a highly effective way to capitalize on quantum change in traditional markets. That change has only just started. We combine trend-following with volatility trading. These were unloved strategies for the past decade. I think strategies that struggled then will now work well for years. And vice versa.”
Anecdote: When hunting for opportunities, look for things that make little sense. Pull on those threads, see where they lead. Europe grew utterly dependent on Russia for energy. America grew strategically dependent on Taiwan for semiconductors. Each is grossly negligent and should never have happened. But they did. Which makes no sense on the surface and can’t be solely attributed to corruption. These things occurred because society was broadly willing to exchange our most essential strategic interests for optimized economic efficiency and its corresponding profits. We grew sufficiently confident in enduring peace and uninterrupted globalization, that our politicians (not leaders of course), businesspeople, and voters collectively agreed to this nonsensical exchange. There was no hedge in place. And as investors, having now observed this, we are paid to pull the threads. A society that willingly traded away its ability to operate independently from its adversaries and fiercest competitors in the vital areas of energy and semiconductors must surely have committed countless less visible Faustian bargains. And just as society has now begun the long painful process of unentangling itself from these unacceptable dependencies, we will also correct other errors in judgement. The UK pension fiasco is one such example, and only just a hint at the tumult to come in our retirement systems. These plans grew dependent on leverage to match their assets and liabilities at negative long-term real interest rates, which guaranteed pensioners a loss of purchasing power in the best-case scenario. It made absolutely no sense to anyone other than an excel spreadsheet. Such gross negligence happens in systems that have become so highly financialized, engineered, and indexed that investors cannot help but leverage their way to insanity, often without even realizing it. Before this cycle ends in five or ten years, we will discover countless other such dynamics. Because the societal mindset that brought us Russian energy and Taiwanese chip dependencies embedded itself in every facet of our companies, economies, markets, politics, geopolitics. And the trading opportunities will be in discovering these mistakes, and positioning accordingly, before others realize what must radically change.
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.