Hope all goes well… “The great thing about equities is that they’re not bonds,” bellowed Biggie Too, global chief strategist for one of Wall Street’s too-big-to-fail affairs. “The best thing about US stocks is that they’re not European or Asian or emerging equities,” barked Biggie. “The terrific thing about equities is that they’re nominal,” said Too, repeating the lyrics traders are chanting as stocks rise in defiance of today’s inflationary hiking cycle. “That’s where we’re at right now,” said Biggie. “The market is trading like we gotta suck ’em all in, maybe pop to new all-time highs.” And Biggie closed his eyes, smiling, a golden grin. “Sell new highs, because the story we’re gonna be talking about soon is recession.”
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Overall: “We will continue to walk and chew gum at the same time,” explained Michael Regan, defending Biden’s push to increase oil and gas production while honoring pledges to meet emission reduction targets and wean the US economy from fossil fuels. “I don’t think the goals are mutually exclusive,” continued the head of America’s Environmental Protection Agency. Regan is simultaneously right and wrong. Honest and deceitful. Which means he’s being truthful. Such contradictions reflect the infinite complexity of the real world. One where for every action is a reaction, an endless loop of ever widening possibility. When globalization peaked years ago, for reasons we’d like to pretend we understand but probably never quite will, all sorts of unfamiliar chain reactions started. Slowly at first. America, we now know, began its retreat, accommodating the transition to a multi-polar world order. Somewhere along that path, we could no longer deny our impact on the climate. And having never attempted to cooperate on a global scale to solve an existential crisis, we stumbled into the unknown. To have thought that would have been sensibly executed, required one to ignore the entirety of human history. We set goals that required near perfect and selfless cooperation between nations, and ignored many realities of market economics, game theory, opportunists, adversaries. Then, out of nowhere arrived a pandemic, which exposed every crack in an ageing foundation. The resulting shortages in nearly every commodity (including labor), when paired with unprecedented monetary expansion created an inflation that empowered swing producers, one of whom capitalized on the situation to attack Ukraine. That conflict amplified the growing global shortages, which will now further stress the divisions between rich and poor nations. Their citizens too. And without global cooperation, there is no chance for humanity to address its greatest challenges. Which is why to reduce our environmental impact, we will need to produce more fossil fuel. Fertilizer. Food. Minerals. Metals. While simultaneously setting a recalibrated and realistic course for the great transition to renewables. It is history’s greatest challenge. Humanity’s opportunity.
Week-in-Review (expressed in YoY terms): Mon: BoJ offered to buy unlimited amount of bonds for three straight days to maintain YCC after successive offers earlier in the day failed to lower yields / USDJPY breaches 125 (6.5y high), Ukraine / Russia hold in-person talks today, Zelensky said Ukraine could renounce its ambitions to join NATO in a potential peace deal but stressed sovereignty and territorial integrity are beyond doubt, Biden denied seeking a Russian regime change after his comment that Putin cannot remain in power sparked concern over the weekend, Shanghai begins phased 4-day lockdown, US 5y vs 30y inverts for first time since 2006, Biden to announce minimum tax on those worth more than $100m, S&P +0.7%; Tue: Renewed optimism on Ukraine/Russia peace negotiations, Russia pledges to reduce attack on Kyiv but U.S. warns threat not over, US 2s10s inverts briefly, ECB’s Holtzmann calls for 2x 25bps hikes in 2022, Fed’s Harker does not favor 50bp hike in May but not off the table, Chile CB hikes 150bp (175bp exp), Japan jobless rate 2.7% (2.8%e), Australia ret sales 4.7% (13.9%p), German impt prices 26.3% (27.2%e), German cons conf -15.5 (-14.5e), S. Africa unemp 35.3% (35.1%e), US Case Shiller home prices 19.1% (18.6%e), US cons conf 107.2 (107e), S&P +1.2%; Wed: Kremlin says no breakthroughs in talks with Ukraine, Kuroda suggests BOJ will continue with YCC as they increased asset purchases to include longer dated securities, Fed’s Bostic reiterated his call for 6 more hikes in 2022, Fed’s Barkin open to 50bp hike, Poland aims to ban Russian energy imports by the end of the year, Spain CPI 9.8% (8.4%e), Brazil FGV infl 14.77% (14.46%e), Germany CPI 7.6% (6.8%e), US ADP 455k (450k exp), Russia ret sales 5.9% (4.4%e) / unemp 4.1% (4.6%e), S&P -0.6%; Thur: US to release 1mm barrels per day from SPR for 6 months, BOJ announced another increase in JGB purchases, reports that Russia offering to sell oil to India $35/barrel below market, Columbia CB hikes 100bp (50% 125bp / 50% 150bp exp), China mfg PMI 49.5 (49.8e) / serv PMI 48.4 (50.3e) / comp PMI 48.8 (51.2p), Japan housing starts 6.3% (1.2%e), German ret sales 7.1% (6.3%e), UK house px 14.3% (13.4%e), France CPI 5.1% (4.9%e), France cons spending -2.3% (-0.9%e), German unemp 5% as exp, Italy unemp 8.5% (8.7%e), HK ret sales -14.6% (-7.7%e), EU unemp 6.8% (6.7%e), Italy CPI 7% (7.2%e), S. Africa PPI 10.5% (10.2%e), Poland CPI 5.5% (4.4%p) / ret sales 13.9% (10%p), Brazil unemp 11.2% (11.4%e), US init claims 202k (196k exp), US Chicago PMI 62.9 (57e), S&P -1.6%; Fri: US NFP 431k (490k exp / 550k whisper exp) / unemp 3.6% (3.7%e) / AHE 5.6% (5.5%e), EU inflation all time high 7.5% (6.7%e), EU leaders plan to warn China against supporting Russia, Czech CB hikes 50bps as exp, Chinese tech stocks rebounded on optimism China will give US full access to audits of most firms, US 2s30s inverts for first time since 2007, ECB’s Knot suggests lift off as early as Sept, China Caixin mfg PMI 48.1 (49.9e), EU mfg PMI 56.5 (57e), US ISM mfg 57.1 (59e), S&P +0.3%.
Weekly Close: S&P 500 +0.1% and VIX -1.18 at +19.63. Nikkei -1.7%, Shanghai +2.2%, Euro Stoxx +1.1%, Bovespa +2.1%, MSCI World +0.3%, and MSCI Emerging +1.9%. USD rose +0.8% vs South Africa, +0.6% vs Chile, +0.5% vs Sterling, +0.4% vs Yen, +0.4% vs Canada, +0.3% vs Australia, and +0.2% vs Indonesia. USD fell -7.3% vs Ethereum, -2.7% vs Bitcoin, -1.8% vs Brazil, -1.1% vs Turkey, -0.9% vs Mexico, -0.6% vs India, -0.5% vs Sweden, -0.5% vs Euro, -0.1% vs China, and flat vs Russia. Gold -1.8%, Silver -3.8%, Oil -12.8%, Copper -0.2%, Iron Ore +10.0%, Corn -2.5%. 5y5y inflation swaps (EU +6bps at 2.24%, US +4bps at 2.65%, JP -8bps at 0.67%, and UK +3bps at 4.02%). 2yr Notes +19bps at 2.46% and 10yr Notes -9bps at 2.39%.
March Mthly Close: S&P 500 +3.6% and VIX -9.59 at +20.56. Nikkei +4.9%, Shanghai -6.1%, Euro Stoxx +0.6%, Bovespa +6.1%, MSCI World +2.5%, and MSCI Emerging -2.5%. USD rose +21.0% vs Russia, +6.0% vs Turkey, +5.8% vs Yen, +2.1% vs Sterling, +1.4% vs Euro, +0.6% vs India, +0.5% vs China, and flat vs Indonesia. USD fell -16.9% vs Ethereum, -13.2% vs Bitcoin, -8.0% vs Brazil, -5.0% vs South Africa, -2.9% vs Mexico, -2.9% vs Australia, -1.6% vs Chile, -1.3% vs Canada, and -0.8% vs Sweden. Gold +2.6%, Silver +3.1%, Oil +7.3%, Copper +6.7%, Iron Ore +31.7%, Corn +8.4%. 5y5y inflation swaps (EU +34bps at 2.21%, US +9bps at 2.64%, JP -10bps at 0.55%, and UK +6bps at 4.00%). 2yr Notes +90bps at 2.34% and 10yr Notes +51bps at 2.34%.
Rand Returns: Financial markets devalued industrialists and inflated industrial design. Consider Taiwan Semi, an important manufacturer of Apple’s ideas. Markets briefly rewarded industrialists after the March 2020 pandemic swoon. Taiwan Semi’s share price surged. The company responded with a $100bln capital spending plan, equivalent to the previous decade of investment. Apple’s share price is up nearly 40% in the past 12mths, Taiwan Semi is down almost 20%. This is a microcosm of our current macro frictions. Taiwan Semi is charged with the task of making phones faster and more energy efficient, not Apple. And they are not rewarded. The degrading of industrialists misaligns investment incentives, leading to shortages that restore balance through a pernicious vessel - inflation.
No Capacity I: The global economy faces capacity constraints. Everywhere. Every industry covered in the ISM survey described the lack of capacity to meet demand last month. The “supply chain is still unstable” in primary metals. There is “no letup yet in supply chain challenges” in electronics. The “supply situation getting worse” in general manufacturing. The resulting macro picture is wholly unfamiliar. Demand is weakening sharply with inflation running hot; new orders plunged in March while inventory, supplier delivery times, and prices were near record highs. The resulting rises in industrial profits lead to stronger fixed investment. But given the disregard toward industrialists, it may take a much longer period or political support for industrialists to become convinced. Just ask Taiwan Semi.
No Capacity II: How do economies respond to capacity constraints? They recess by force, by necessity, by math. Monetary policy is a footnote here. Physical constraints to production are cleared with higher prices rationing demand. The Fed is unknowingly being dragged into the new reality, having greatly reduced its real GDP estimates for 2022 with higher inflation and virtually no change to nominal GDP projections. This means a larger share of the income pie is migrating to a narrow group of goods producers. The signs are everywhere – planes, trains, automobiles. Global light vehicle production was 81mm units last year, only 5% higher than 2020 and still 10% lower than 2019. S&P Global Mobility just slashed production estimates for 2022 to be roughly unchanged from last year because of supply constraints. It is all about supply.
No Capacity III: Details matter. Palladium is used almost exclusively for cars with 85% of supplies being the key input to converters that limit pollutants from exhaust. The world’s largest producer, Norilsk, is in Russia, and its enterprise value has vaporized. Palladium production stagnated for the decade leading into the war – the conflict is exposing globalization’s fault-lines. Ukrainian wire-harnesses are a key automotive input – disrupted. China produces 85% of global magnesium – it’s in a production deficit and impairing aluminum output. Supply-constrained inputs go to the highest bidder. It is a supply-side hot potato – capacity limitations push the burden to the most vulnerable, the economy’s weakest players. The shortages in vehicle production are symptomatic of a broader supply challenge, from food to frisbees.
No Capacity IV: Awkward outcomes follow. Higher prices and less demand. It’s already clear in US car sales. New vehicle consumer prices surged to an annual inflation rate of 18%. Since 1955, vehicle inflation has never been above 8%. Today’s situation is beyond an outlier. It’s a new order, and requires fresh thinking, alternative analyses. And total vehicle sales have slumped severely to an annualized rate of 14.5mm units. That was the volume of sales in three of the past four recessions – the exception being the 2001 downturn when sales were substantially stronger than now.
Rand's Cure: There’s no doubt in the power of market forces to adjust incentives to solve these problems. Equally, consumers and governments will be forced into harsh changes in behavior. Austerity may not be welcomed any longer in elite policy circles. But orthodoxy is being imposed nevertheless, by market forces.
Anecdote: No one rang the bell. No one ever does. So, we’ll never know precisely when globalization peaked, in part because it’s not exactly clear what that even means. But global trade volume as a percentage of global GDP rose inexorably throughout our lifetimes, and then topped out around 60% in 2008. We have yet to reclaim those heights. Perhaps that was the high. So much has happened in the fourteen years since, and it’s probably safe to assume that the extraordinary policies put in place during this time were part of a natural process to sustain an infinitely complex global system that was shifting from one macro megatrend to its opposite. So now that globalization has turned to de-globalization, we are left to wonder what it will lead to. It is a hard thing to do. We’ve spent our lifetimes in a world dominated by the former, so it is difficult to envision the latter. Many things we assume to be permanent features of how the world operates are, more likely, the result of increasing integration, globalization. More cycle than science. For my whole life, as wages rose in the US, CEOs raced to scour the planet for cheaper labor. From one cycle to the next, higher real wages therefore led to downward wage pressure. Mean reversion. If food prices rose, Brazilians cleared more rainforest, Russians mined more potash, farmers bought more fertilizer, and shippers built more ships to move inputs and outputs from producers to consumers. Mean reversion. But should we assume this is how the world works in a period of de-globalization? In a world where nations prioritize redundancy over efficiency, what if higher wages lead to stronger bargaining power of labor? Higher unionization? And what if shortages of food and fertilizer lead nations to hoard these vital inputs at a rate that exceeds the ability of capacity-constrained private companies to make more? What then becomes the political reaction function? Such dynamics appear to be taking hold. Now map this across the entire global economy. Consider the vast political repercussions. We may soon discover that de-globalization produces the opposite of mean reversion.
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.