Hope all goes well… “My massive bias is to believe things always work out okay,” said Simplicity, walking Occam’s Razor. “But today somehow feels unique, and when I look at supply and demand in oil, grains, base metals too, there’s an undeniable tail risk here,” he said, having analyzed the fundamentals of such things over a long career. “Without a perfect North American growing season, there will be shortages, perhaps we’ll have them even with perfection, it’s too early to be sure.” And Simplicity paused, sharpened by decades of trading markets that oscillate wildly in times of great uncertainty as producers, consumers and speculators struggle to balance supply and demand. “It’s critical to size your positions small enough so that you don’t discover you’re trading a 3-year perspective with a 3-day stop-loss.”
Overall:“One thing is certain: To be effective, the Fed will have to inflict more losses on stock and bond investors than it has so far,” said Bill Dudley, former Fed President, saying bluntly what his active-duty central bankers barely dare whisper. “Market participants expect higher short-term rates to undermine economic growth and force the Fed to reverse course in 2024 and 2025 - but these very expectations are preventing the tightening of financial conditions that would make such an outcome more likely,” explained Dudley, scratching the surface of the disquieting predicament the Federal Reserve now finds itself in. And because the world’s developed-market central banks adopted US policy in recent decades, the Fed’s quandary is now a global phenomenon. “This would mean hiking the federal funds rate considerably higher than currently anticipated. One way or another, to get inflation under control, the Fed will need to push bond yields high and stock prices lower,” Dudley said. Cooling an over-heated, capacity-constrained, hyper-financialized economy, in a time of deglobalization and war, without first tightening financial conditions is proving rather difficult. Like all complex problems, this one took decades to create. Back when the US economy had less debt and leverage, when financial assets had lower valuations, and when wealth was less concentrated, the ups and downs of the real economy drove financial markets. In such a world, the Fed quite easily used conventional rate policies to influence our behaviors to achieve their objectives. When those became less effective, they introduced unconventional policies, and forward guided their intentions to become highly predictable. The effect was the hyper-financialization of our economy. Now, with such high levels of debt, leverage, valuations, and wealth-concentration, it is financial markets that drive the real economy, not the other way around. We have never experienced a modern economic cycle that looks anything like this. And Dudley may be right in his prescription. But if it is one thing, it is certainly not certain.
One River’s Head of Research, Marcel Kasumovich, published a terrific piece titled, “The Dollar is Dead... Long Live the (Digital) Dollar” [click here].
Week-in-Review (expressed in YoY terms): Mon: Fed’s Daly says the case for a 50bp rate hike in May has increased, Lithuania becomes first EU country to stop Russian gas imports, Elon Musk announces 9% stake in TWTR, Shanghai infections rise by 9k – entire city now under some sort of movement restriction, ECB’s Vasle says neg rates may end by end of year, Turkey CPI 61.14% (61.5%e) / PPI 114.97% (105.01%p), EU investor confidence -18 (-9.4e), Mexico cons conf 43.9 (43.8e), US durable goods -2.1% (-2.2%e), S&P +0.8%; Tue: RBA kept rates unch as exp – hawkish statement by dropping “patience” from forward guidance, US stopped Russian gov’t debt payments in USD to US banks – increasing chance of default, Fed’s Brainard calls for “rapid pace” of B/S reduction, Zelensky addresses UN security council requesting that Russia is dropped, Ukraine holds talks with China for first time since Russian invasion, EU to phaseout Russian coal imports, US imposes sanctions on Russian darknet and crypto exchange, European Commission intends to launch new “rule of law” mechanism against Hungary – would make recovery funds unavailable to Hungary, Kuroda says JPY decline “seems somewhat rapid” but also that “weak JPY is positive for economy overall”, protests in Peru over high inflation turn violent, S&P -1.3%; Wed: Fed minutes show $95b/month of B/S run down once announced with ~3m phase in ($60b treasury / $35b MBS) / one or more 50bp hikes “could be appropriate”, Poland CB hikes 100bp (50-75bp exp), China Caixin PMI declines below 50 on covid lockdowns – Shanghai remains on lockdown for foreseeable future, Macron / Le Pen polls continue to narrow, Canada approves first oil-mega project since 2018, China State Council continues to push for supportive monetary policy, EU PPI 31.4% (31.6%e), Brazil IGP-DI infl 15.57% (15.27%e), S&P -1.0%; Thur: Hawkish March ECB minutes open door to possible 3Q22 hike, EU diplomats agree on new sanctions including banning Russian coal, Ukraine says Russian troops are readying for offensive in east, RUB recovers to preinvasion levels, Fed’s Bullard calls for 3-3.25% rate in 2H22, Chile announces $3.7b economic stimulus plan, Peru CB hikes 50bp as exp, Swiss unemp 2.2% as exp, German IP 3.2% (3.7%e), EU ret sales 5% (4.9%e), Mexico CPI 7.45% (7.38%e), US init claims 166k (200k exp), US cons credit 41.82b (18.1b exp), S&P +0.4%; Fri: Russia central bank cuts rates 300bp during unscheduled meeting, Russia bombs civilians waiting at train station to be evacuated from Donetsk region, US congress votes to support Biden’s oil import ban – making any reversal more logistically difficult, Lavrov says Ukraine’s latest negotiating stance moves away from what was achieved during in-person talks last week, Walmart to pay truck drivers up to $110k/yr (same as 1st year UBS bankers), Ketanji Brown Jackson confirmed to Supreme Court, Japan bankruptcies -6.46% (2.91%p), Hungary CPI 8.5% (8.8%e), Brazil IPCA infl 11.3% (11%e), Canada emp change 72.5k (79.9k exp) / unemp 5.3% (5.4%e), Russia CPI 16.69% (16.9%e), Russia 4Q GDP 5% (4.8%e), S&P -0.3%.
Manufacturing PMI (high-to-low): Switzerland 64 (previous month 62.6), Norway 59.57 (previous mth 56.31), Austria 59.3 (previous 58.4), Canada 58.9/56.6, Netherlands 58.4/60.6, Hungary 57.6/53.8, Sweden 57.3/58.6, US 57.1/58.6, Germany 56.9/58.4, Italy 55.8/58.3, UK 55.2/58, Czech Republic 54.7/56.5, France 54.7/57.2, Greece 54.6/57.8, Spain 54.2/56.9, Taiwan 54.1/54.3, Japan 54.1/52.7, India 54/54.9, Poland 52.7/54.7, Brazil 52.3/49.6, Vietnam 51.7/54.3, South Africa 51.4/50.9, Indonesia 51.3/51.2, South Korea 51.2/53.8, Singapore 50.1/50.2, Turkey 49.4/50.4, Mexico 49.2/48, China 48.1/50.4, Russia 44.1/48.6, Hong Kong 42/42.9. Services PMI: Sweden 65.3/67.7, Ireland 63.4/61.8, UK 62.6/60.5, Brazil 58.1/54.7, US 58/56.5, France 57.4/55.5, Australia 56.2/60, Germany 56.1/55.8, India 53.6/51.8, Spain 53.4/56.6, Italy 52.1/52.8, Japan 49.4/44.2, China 42/50.2, Russia 38.1/52.1.
Weekly Close: S&P 500 -1.3% and VIX +1.53 at +21.16. Nikkei -2.5%, Shanghai -0.9%, Euro Stoxx +0.6%, Bovespa -2.7%, MSCI World -1.5%, and MSCI Emerging -1.6%. USD rose +5.3% vs Bitcoin, +4.1% vs Chile, +3.6% vs Ethereum, +1.5% vs Euro, +1.5% vs Yen, +1.0% vs Mexico, +0.9% vs Sweden, +0.8% vs Brazil, +0.7% vs Sterling, +0.5% vs Australia, +0.4% vs Turkey, +0.4% vs Canada, +0.2% vs India, and flat vs China. USD fell -0.1% vs South Africa, flat vs Indonesia, and flat vs Russia. Gold +1.1%, Silver +0.7%, Oil -1.0%, Copper +0.8%, Iron Ore +1.4%, Corn +5.4%. 5y5y inflation swaps (EU +10bps at 2.34%, US +8bps at 2.73%, JP flat at 0.67%, and UK +1bp at 4.03%). 2yr Notes +6bps at 2.52% and 10yr Notes +32bps at 2.71%.
YTD Equity Indexes (high-to-low): Brazil +32.3% priced in US dollars (+12.9% priced in reais), Colombia +24.6% priced in dollars (+15.2% in pesos), Chile +20.6% in dollars (+15.3% in pesos), UAE +18.9% (+18.9%), Saudi Arabia +18.2% (+18%), Turkey +15.5% (+28.8%), South Africa +10% (+1%), Norway +9.8% (+8.4%), Indonesia +8.7% (+9.6%), Singapore +7.1% (+8.3%), Mexico +4.5% (+2.7%), Canada +3.6% (+3.1%), Australia +3% (+0.4%), Portugal +2.7% (+7.6%), Argentina +1% (+10.3%), Thailand +1% (+1.7%), Malaysia +0.8% (+2.5%), India +0.5% (+2.5%), UK 0% (+3.9%), Israel -0.9% (+3%), Philippines -2.5% (-1.5%), Greece -3.1% (+1.4%), Venezuela -4% (-7.6%), Switzerland -4.9% (-2.9%), Spain -5.1% (-1.2%), S&P 500 -5.8%, Denmark -6% (-2.1%), Belgium -6.5% (-2.1%), Czech Republic -6.6% (-4.4%), MSCI World -6.8%, HK -7% (-6.5%), New Zealand -7.4% (-7.4%), Taiwan -9.2% (-5.1%), China -10.8% (-10.7%), Russell -11.2%, Korea -12.2% (-9.3%), NASDAQ -12.4%, Poland -12.6% (-8%), France -12.6% (-8.5%), Italy -12.8% (-9.2%), Japan -13.2% (-6.3%), Netherlands -13.3% (-9.2%), Germany -13.6% (-10.1%), Euro Stoxx 50 -14.3% (-10.2%), Finland -15.4% (-11.9%), Sweden -15.5% (-11.9%), Austria -19.6% (-16.3%), Ireland -19.9% (-16.2%), Hungary -22% (-16.8%), and Russia -36.2% (-31.5%).
Rate of Change: “Looking back on the 1970s, you find 3 distinct inflationary cycles,” said the CIO. “Inflation first peaked in 1970 at just over 6%, then backed off,” he continued. “It peaked again in 1975 at around 12%, declined, then made a final push to nearly 15% in 1980.” That was it. “In the first two cycles, equities fell when inflation rose, and rose when inflation fell,” he said. “Then in the third cycle, inflation went up and for some reason equities did too. I don’t know why. But maybe it’s not only about inflation, but also the rate of change of inflation.”
Autarky:“What’s the really fancy word for it?” asked the CIO, annoyed that he couldn’t recall it. I simply shrugged, quite happy to keep it simple. “Anyhow, screw it, it’s some word that refers to nations which strive to become self-sufficient, economically independent,” he said. “There will be a move toward that for the years, decades probably. What the hell is that word?” he asked, sighed. “But the thing is, not every country can become self-sufficient so as much as everyone will want to if they need to, hardly anyone can, and that’ll slow the whole process.”
Autarky II: “This is really driving me nuts,” said the CIO. “But I’m not going to Google it, I’ll remember the word, it’s right there, I can just about touch it,” he said. I had already found it but didn’t want to rob him of the pleasure. “What’s more likely to happen will be a shift toward trade blocks, unions of like-minded nations, partners, allies.” I was tempted to suggest such a world would be bifurcated, but that word is a bit much for me, and besides, I was pretty sure that meant two-worlds, when in fact there could be three or more. “This word is driving me crazy.”
Domo Arigato: “The age of optimization and maximization is over,” said the CIO. “It will be replaced by a resurgence of manufacturing, and Japan is filled with such companies,” he said. “Japanese equities have been penalized for years because they employed inadequate financial engineering.” Now they’re comparatively cheap. “With the weakening Yen, Japan’s minimum wage priced in US dollars is the cheapest in the G-7,” he said. “The percent of Japan’s workforce near the minimum wage is high. And the real exchange rate is back to where it was in 1975.”
The Grind: “Neither side is talking, negotiating, they’re participating in a television event,” said the CIO from London. “The US and UK appear to be supplying enough weaponry to ensure that in the end, there will be few Ukrainians left,” he said. “And Ukraine’s only viable strategy is to provoke a war between the West and Russia, which is the one way for them to ensure Russia’s destruction,” he said. “And Russia believes that if it can drag this out, acute global food and energy shortages will fracture national alliances that might appear durable today.”
Anecdote:“The hope is that these cracks will turn into chasms,” said Dr. Mitesh Patel of Imperial College, Faculty of Natural Sciences, Department of Physics. “And eventually we will see some spectacular signature that not only confirms that the Standard Model has broken down as a description of nature, but also give us a new direction to help us understand what we are seeing and what the new physics theory looks like.” He’d just announced the results of a series of particle collisions that reveal the sub-atomic W Boson is heavier than predicted. “If the results are verified by other experiments, the world is going to look different,” he said. “There has to be a paradigm shift. The hope is that maybe this result is going to be the one that breaks the dam.” Despite our magnificent scientific advances, we still barely know how the universe operates. We will all live and die, having existed within a reality we hardly comprehend, or perhaps entirely misunderstand. It is as exciting as it is humbling. And then there is the role that chance plays in the complexity of human interactions. In a game of chess - a two-dimensional board game with just 32 pieces and 64 squares - there are 288bln different possible positions after 4 moves each. There are more possible chess games than atoms in the observable universe. Human relations have many more dimensions than a board game. With 8bln players and 195 nations interacting with a chaotic climate and ever-advancing technology, the range of outcomes is infinite. We develop standard models to make sense of economics, politics, society. But unlike physics, such models are not constrained by set rules, immutable physical laws - just probabilities, tendencies, nothing more. And right now, the probability of extreme outcomes is rising. Inflation, economics, geopolitics. The tendency toward paradigm shifts is evident, underway. Deglobalization, multi-polarity. New models will emerge, they always do. And the risks and opportunities in the transition will be unlike those we’ve observed in many decades.
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.