“Reflect frequently upon the instability of things, and how very fast the scenes of nature are shifted,” wrote Marcus Aurelius, last of the Five Good Emperors, in 170 AD. I wandered through the Colosseum after dark, Rome’s oppressive heat slowly fading, Goldman’s European Financials Conference approaching. “Matter is in perpetual flux,” wrote Aurelius, an inspired leader, a stoic philosopher. “Change is always and everywhere at work; it strikes through causes and effects, and leaves nothing fixed and permanent.”
Overall: “We have always known how to combat this fragmentation: in 2010, in 2012, in 2020, every time with different instruments,” declared the European Central Bank’s Villeroy. “Nobody should have any doubt, including on markets, over our collective will to prevent fragmentation,” continued the Frenchman, Italian government bond spreads widening. “We have the will, and nobody should doubt we will have the instruments if and when necessary.” But this of course, left those of us who are paid to entertain doubts to wonder what will mark the point where it becomes necessary for Europe’s central bank to intervene in markets, creating euros to then purchase peripheral bonds. “There is no specific levels of yields increase, or lending rates or bond spreads that can unconditionally trigger this or that,” explained Christine Lagarde, ECB President, when asked for details. “We will determine on the basis of circumstances, of countries, how and when that risk is likely to materialize and we will prevent it,” she asserted, hopeful that such ambiguity will discourage speculators from pushing markets to the point where the central bank pledged to act. “But we are committed - committed - to proper transmission of our monetary policy and as a result fragmentation will be avoided to the extent that it would impair that transmission,” said Lagarde, confident. But no two crises are the same. In 2010, 2012, and 2020, European inflation in Europe’s north was virtually non-existent. In 2012, when President Draghi declared the ECB would do “Whatever it takes,” European inflation was 2.35%. In a world of perpetually low inflation, the power of central banks to create money with which to prevent fragmentation – also known as subsidizing cohesion – appears unlimited, costless. But in a world of high and rising inflation, subsidies risk boosting inflation and de-anchoring expectations. Investors must contemplate all outcomes and are left to evaluate the probability northern Europeans are willing to bear such costs on behalf of their southern neighbors now that EU inflation is 8.1%.
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Week-in-Review (expressed in YoY terms): Mon: Beijing continues to ease covid restrictions, Saudi Arabia hikes crude prices for Asia more than expected, UK PM Johnson survives no-confidence vote (smaller margin of victory than expected), Turkish FinMin Nebati signals ultra-loose monetary policy to continue, China Caixin serv PMI 41.4 (46e) / comp PMI 42.2 (37.2p), S&P +0.3%; Tue: RBA hikes 50bp (~33bp exp), Erdogan says CB will continue to cut rates even as inflation rises, Target cut outlook for the 2nd time in 3w as it eases an inventory surge, Brazil govt proposes cutting fuel tax - rekindling fiscal concerns, Kuroda continues to support current monetary easing – USDJPY 20y high, World Bank cut 2022 global growth forecast to 2.9% (3.2%p), Yellen says US infl unacceptable but likely to stay high, Germany factory orders -6.2% (-4.1%e), US cons credit $38b ($35b exp), S&P +1.0%; Wed: Kuroda says BoJ does not target FX rates – allowing USDJPY to press even higher (above 134), Chile CB hiked 75bp, Poland CB hiked 75bp as exp, India CB hiked repo 50bp while keeping the CRR rate unch, Russia / Turkey talks brought no sign of progress on deal to unblock shipments of Ukrainian grain, Chinese tech stocks jump as regulators approve 60 new games, Dalio says stagflation will push CBs to ease in 2024, Yellen says some Chinese tariff cuts may be warranted, US mortgage demand falls to 22y low, Germany IP -2.2% (-2.4%e), Italy ret sales 8.4% (5.6%p), EU 1Q GDP (final) 5.4% (5.1%e), Russia CPI 17.1% (17.35%e) / Core CPI 19.87% (20%e), S&P -1.1%; Thur: ECB announces end of APP July 1 / signals 25bp hike in July and possibly more than 25bp in Sept / no details regarding a peripheral spread widening prevention tool, Shanghai to lockdown district (2.65m people) over the weekend due to six new covid cases, China expts 16.9% (8%e) / impts 4.1% (2.8%e) / trade bal $78.76b ($57.7b exp), Mexico CPI 7.65% (7.64%e) / Core CPI 7.28% (7.26%e), Brazil IPCA infl 11.73% (11.88%e), US Init claims 229k (206k exp), S&P -2.4%; Fri: US CPI 8.6% (8.3%e) / core CPI 6% (5.9%e), rare joint statement from Japanese FSA / MOF/ BOJ noting concerns on the rapid depreciation of the JPY – will take appropriate action if necessary, ECB’s Holzmann confirmed that 25bp hike in July and 50bp hike in Sept likely, US House of Rep begin public Jan 6 hearing, Shanghai will lock down almost entire city this wknd for mass testing, Turkey doubles the reserve requirement ratio for lira denominated commercial loans, Russia CB cut rates 150bp (-100bp exp), Japan PPI 9.1% (10%e), China PPI 6.4% as exp / CPI 2.1% (2.2%e), China agg financing 2.79t CNY (2.03t exp), Turkey unemp 11.3% (11.5%p), Italy IP 4.2% (0.1%e), Mexico IP 7.1% (5%e), Canada emp change 39.8k (27.5k exp) / unemp 5.1% (5.2%e), US UofM 50.2 (58.1e) / 1y infl exp 5.4% (5.3%e) / 5-10y infl exp 3.3% (3%p), S&P -2.9%.
Weekly Close: S&P 500 -5.1% and VIX +2.96 at +27.75. Nikkei +0.2%, Shanghai +2.8%, Euro Stoxx -3.9%, Bovespa -5.1%, MSCI World -2.1%, and MSCI Emerging +0.6%. USD rose +4.5% vs Brazil, +4.2% vs Chile, +4.1% vs Turkey, +2.7% vs Yen, +2.6% vs Sweden, +2.1% vs Australia, +2.1% vs Mexico, +2.0% vs South Africa, +1.9% vs Euro, +1.5% vs Ethereum, +1.4% vs Canada, +1.4% vs Sterling, +0.8% vs Indonesia, +0.7% vs China, +0.3% vs India, and +0.2% vs Bitcoin. USD fell -5.6% vs Russia. Gold +1.4%, Silver +0.1%, Oil +1.5%, Copper -4.0%, Iron Ore +5.5%, Corn +4.4%. 5y5y inflation swaps (EU -3bps at 2.23%, US -3bps at 2.74%, JP +7bps at 0.83%, and UK +4bps at 3.91%). 2yr Notes +41bps at 3.07% and 10yr Notes +22bps at 3.16%.
YTD Equity Indexes (high-to-low): Chile +23.6% priced in US dollars (+21.6% priced in pesos), UAE +13.4% priced in US dollars (+13.4% in dirham), Colombia +12.2% in dollars (+8.5% in pesos), Brazil +11.9% (+0.6%), Saudi Arabia +11.8% (+11.7%), Turkey +5.8% (+36.9%), Indonesia +5.1% (+7.7%), Portugal +0.3% (+8.6%), Singapore -1% (+1.9%), Norway -4% (+5.7%), Canada -5.4% (-4.5%), Thailand -5.5% (-1.5%), Venezuela -6.1% (+5.1%), Mexico -6.6% (-9%), HK -7.4% (-6.8%), South Africa -8.3% (-8.5%), Australia -9.8% (-6.9%), UK -9.9% (-0.9%), Malaysia -9.9% (-4.7%), Argentina -10% (+6.8%), Spain -10.5% (-3.7%), Greece -10.8% (-3.4%), India -10.9% (-6.6%), Philippines -11.7% (-8.3%), Israel -12.5% (-5.7%), Czech Republic -13.8% (-7.8%), China -14.5% (-9.8%), Taiwan -15.4% (-9.7%), MSCI World -15.8% in US dollars, Denmark -17% (-10.7%), Japan -17.1% (-3.4%), S&P 500 -18.2%, Korea -18.9% (-12.8%), Belgium -19.2% (-12.5%), Germany -19.5% (-13.4%), Russell -19.8%, France -20.1% (-13.5%), Switzerland -20.4% (-13.9%), New Zealand -20.7% (-14.6%), Netherlands -21.1% (-14.5%), Finland -22.1% (-16.2%), Russia -22.3% (-39.7%), Euro Stoxx 50 -22.7% (-16.3%), Austria -23.3% (-17.5%), Italy -23.4% (-17.5%), Ireland -25.6% (-19.4%), Sweden -25.7% (-17.7%), NASDAQ -27.5%, Poland -27.6% (-21.6%), Hungary -33.8% (-23.2%).
Disorientation: “People who are lost may experience different types of reactions,” writes William Syrotuck in Analysis of Lost Person Behavior. “They may panic, become depressed, or suffer from woods-shock.” The book is a study of 229 people who were lost in the wilderness. “Most go through some of the stages,” he writes. “If they do not totally exhaust or injure themselves during outright panic, they may eventually get a grip and decide on some plan of action. What they decide to do may appear irrational to a calm observer but does not seem so nearly unreasonable to the lost person who is now totally disoriented.”
Disorientation II: “Even people who while lost appeared to use good judgement with no suggestion of overt panic, exhibit woods-shock,” explains Syrotcuk. Of the 229 in his study, 11% died, nearly all in the first 48 hours, mostly attributed to panic and the cascade of catastrophic decisions that follow and compound. “Many persons found mobile and well will seem to converse in a completely normal manner. Only upon close questioning does it become evident that they are unable to remember where they spent the first night, whether they had any water to drink or whether they crossed the river yesterday, or maybe the day before.”
Disorientation III: Italian Premier Draghi reminded his former colleagues, moments before this week’s ECB meeting of “signs that there is still spare capacity in the economy.” North-South inflation tension leave the ECB in treacherous territory, searching for a path out. Central bankers told markets that they know precisely how to tame inflation should it arrive. For years, policy was calibrated guard too strongly against deflation. Now Germany’s inflation challenge is more extreme than the 1970s. The tools to tame it are known. The force required is clear. Action is postponed, as the ECB hopes for a rescue.
Disorientation IV: Climate change is an urgent priority. But policies around ESG were introduced before economies and consumers were provided a sufficiently wide off-ramp away from fossil fuels. Policy is discouraging oil production. US output is well below its highs and oil and gas rig counts, which would normally be in the 1000s at current prices, are sitting at 733. A timely alternative has not been provided. Panicked policies can worsen the disorientation - price caps, soliciting foreign production, and taxing profits of oil producers reduce investment capital, compounding the emergency.
Disorientation V: Revolutions are rarely fought on full stomachs. The fear of food shortages is leading to national hoarding policies with hopes of preventing domestic social unrest. The cascading impact on other countries does the exact opposite of its intent, encouraging other nations to close borders and hold larger inventories of agriculture commodities. The solution is found in the problem – more investment and more trade, not less. This is unfamiliar terrain for every living politician. Self-injury is a common consequence of disorientation – food policies embody it.
Disorientation VI: In the decades since the last great inflation, investors came to rely on an inexorable trend toward rising equity and bond prices. In times of economic stress, the two tended to move in opposite directions, and this rewarded portfolios that were leveraged long. Amplifying this dynamic was a mega macro trend toward globalization, which encouraged investors to structure businesses and portfolios to optimize for higher returns. But all choices incur costs, and the price was an increase in economic and market fragility. It now appears that these mega macro trends are reversing. This is utterly unfamiliar territory.
Disorientation VII: “The object of life is not to be on the side of the majority,” wrote Marcus Aurelius in 170 AD. I stood on the rebuilt floor of the Colosseum, looking up at the emperor’s podium, now a crumbled mass of travertine, white gulls darting above in the Roman night, as they have through the ages. “…but to escape finding oneself in the ranks of the insane.”
Anecdote: “Everyone who dies out there dies of confusion,” wrote Laurence Gonzales in Deep Survival: Who Lives, Who Dies, and Why. The book explores what separates survivors from the others. Those who die when lost in the wilderness often do so spontaneously, for no clear medical reason. Disorientation is psychologically devastating for those unable to adjust rapidly. Children are often better suited than adults. “If things don’t go according to plan, revising a robust mental model may be difficult. In an environment that has high objective hazards, the longer it takes to dislodge the imagined world in favor of the real one, the greater the risk,” explains Gonzales. I’ve always found survival stories more useful than economic textbooks and central banker memoirs. It is not that the latter are useless, it’s rather that in markets and business those who fail to steel themselves for extreme adverse events are unlikely to survive them. Studying survival stories, examining the psychological journeys they reveal, can help us prepare and better position ourselves and teams to endure. My favorite and most terrifying is Into the Land of White Death, by Valerian Albanov. Shackleton’s story of The Endurance is required reading. Into Thin Air by Krakauer is terrific for us climbers. So is The Climb, by Anatoli Boukreev, lead guide on Krakauer’s tragic Everest expedition. Reading those two in succession reveals how people often experience the same events so differently, particularly in times of crisis, and this can destroy cooperation when it is most needed. I include Moby Dick in the survival genre. Melville’s genius helps us to understand ourselves, our wild ambitions, our undoing. In bull markets, it is easy to forget that this game is ultimately won by the living. When you’re dead, nothing good can happen. Death is forever. “The world won’t adapt to me. I must adapt to it,” wrote Gonzales, explaining the critical mindset found in survivors. “To experience humility is the true survivor’s correct response to catastrophe. A survival emergency is a Rorschach test. It will quickly tell you who you are.”
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.