wknd
notes


                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           Examining All Possibilities

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wknd
notes

Each Sunday morning for over a decade, One River’s CIO, Eric Peters, has published “Wknd Notes.” It is an unorthodox take on markets, politics, and policy that’s widely read across our industry and within global policy/political circles. Eric has written for as long as he has traded and the discipline is part of his investment process. Drawing on wide-ranging, multi-disciplinary research, historical study, and discussions with interesting characters throughout the world, Eric collects those things he finds most thought-provoking each week and distills them into a concise letter. At times the ideas and views are consistent with his own, but just as often, they challenge his positions and it is this openness to opposing views that helps him maintain a flexible mind in the search for emerging opportunities and risks. His writing is a reflection of how he thinks, and as such it is as focused on identifying the right questions to ask as it is on seeking answers. The publication of this work is Eric’s way of exchanging ideas/information and developing dialogue with a network grown over his thirty-one-year career.

wknd note: Examining All Possibilities

“Average hourly earnings ran at a +9.2% annualized pace in Friday’s employment report,” said the Oracle. “On a three-month annualized pace, wages grew +7.0%,” he said, alone in the desert. “For those hoping that the US will avoid a wage-price spiral, this report was no Quaalude.” But the past was not what I’d called to explore. Of all my sources, only the Oracle foresaw 7% inflation back in early 2021. And my hope was to glimpse what the future holds. “This year’s path is hazier with the Fed now in play. But it is difficult to see inflation below 7% for this year, and it is within the range of reasonable outcomes to see 10%.”

Overall: “I have tried everything,” declared Senator Manchin. “It’s dead,” said the Democrat from West Virginia, lamenting the passing of Biden’s roughly $2trln Build Back Better program that would have passed but for Manchin and Sinema’s support. Fiscal conservatives cheered, pretending to appear desperate to return the good old days of pre-pandemic austerity. You see, back in 2019, America’s economy grew 4.0%, fueled by a 4.7% federal budget deficit. But then the pandemic thrust the nation into this brave new world. The economy grew 5.7% in 2021, powered by a 12.4% federal budget deficit ($2.8trln). And that followed a monstrous deficit in 2020 to nearly offset that year’s -2.3% GDP decline. These sorts of deficits add up. And sure enough, US national debt hit $30trln this week, up nearly $7trln since late January 2020. It made for a good headline. But of course, the Fed owns $9trln of bonds that it can hold in perpetuity, which means in practice, that federal debt is closer to $20trln. That still sounds like a big number. But nominal GDP grew last year by 12.7% (5.7% real GDP plus 7% inflation). So $20trln isn’t what it used to be. And if nominal GDP ends up growing +10% this year (4% real GDP plus 6% inflation), then $20trln is even less. Do that for a decade, even with a couple recessionary years of -2% real GDP and 6% inflation and we’ll have barely any debt left at all. But of course, you don’t lose passage of a $2trln Build Back Better spending program by a couple votes and end up spending nothing at all. And if you completely slashed the deficit, we’d have a depression anyway. So massive deficit spending will continue, even as its absolute value shrinks relative to the size of the nominal economy. That is what financial repression looks like. The whole time our central bankers will pretend to lean against the inflation. While the politicians pretend to rein in spending. And investors will writhe in pain. But the truth is, at the end of a multi-decade debt super cycle, this is the least painful of a few awful choices.

Week-in-Review (expressed in YoY terms): Mon: Erdogan removes the Statistical Office Chairman ahead of upcoming CPI release, Fed’s Bostic suggests a 50bp move could be appropriate but not his preferred approach, Fed’s Daly supports a gradual but consistent tightening path / Fed is NOT behind the curve, Fed’s George says a more aggressive path on balance sheet could lead to shallower rate hikes, Poland CB gov Glapinski reiterates that there is room for more tightening, Tokyo’s population declined for first time in 26y, US/UK to target oligarchs in any Russia related sanctions, Japan IP 2.7% (2.9%e) / ret sales 1.4% (2.8%e), Australia private credit 7.2% (6.9%e), Turkey tourist arrivals 170.6% (111.5%p), Spain CPI 6.1% (5.5%e), EU GDP 4.6% as exp, Italy GDP 6.4% (6.2%e), Mexico GDP 1% (1.5%e), German CPI 5.1% (4.3%e), US Chicago PMI 65.2 (61.5e), S&P +1.9% Tue: RBA announced it would end QE on Feb 10th, S. Africa to drop isolation for asymptomatic covid cases, strong earnings from Google, Japan unemp 2.7% (2.8%e), S. Korea exports 15.2% (15.8%e) / impts 35.5% (29.5%e), Australia ret sales -4.4% MoM (-2%e), German ret sales 0% (3.4%e), UK house prices 11.2% (10.9%e), France CPI 3.3% (2.9%e), German unemp 5.1% (5.2%e), US mfg PMI 58.7 (59e), Italy unemp 9% (9.2%e), EU unemp 7% (7.1%e), US mfg PMI 55.5 (55e), US ISM mfg 57.6 (57.5e) / Prices Paid 76.1 (67e), S&P 0.7%; Wed: RBA gov Lowe reiterated that the end of QE doesn’t mean an immediate rise in rates but a 2022 rate rise is plausible, Putin expressed cautious optimism about reaching agreement with US, OPEC+ agreed to go ahead with 400kbpd increase, BOC’s Macklem says considering allowing bond roll offs once rate hikes begin, BCB hikes 150bps as exp, Biden orders 3k troops to eastern Europe, EU CPI 5.1% (4.4%e) / Core CPI 2.3% (1.9%e), Italy CPI 5.3% (4%e), Brazil IP -5% (-5.9%e), US ADP -301k (180k exp), Russia IP 6.1% (4.5%e), S&P +0.9%; Thur: Meta erases roughly $250b of market cap, Amazon beats in after hours, BoE hikes 25bps as exp / surprisingly 4 (out of 9) votes for 50bps hike, ECB unchanged but significant hawkish pivot in language/guidance, US said Russia has filmed a staged false attack against Russian territory as a pretext to invade Ukraine, Biden says US forces killed al-Quarashi (leader of the Islamic State), 4 of Boris Johnsons aides step down amid “party-gate”, Turkey CPI 48.69% (48%e) / Core CPI 39.45% (38.9%e) / PPI 93.53% (96.78%e), EU PPI 26.2% (26.1%e), US init claims 238k (245k exp), US unit labor cost 0.3% (1%e), US ISM services 59.9 (59.5e), US durable goods orders -0.7% (-0.9%e), S&P -2.4%; Fri: US NFP strong beat: 467k (125k exp and whisper was even lower) / 709k upward 2m revision / unemp 4% (3.9%e) / AHE 5.7% (5.2%e), Russia denies “fake video” accusation / China supports Russia’s demands for binding security guarantees and opposes further Nato expansion, Beijing Olympics kick off, S. Korea CPI 3.6% (3.4%e) / Core CPI 3% (2.8%e), Canada emp change -200.1k (-110k exp) / unemp 6.5% (6.3%e), S&P +0.5%

Manufacturing PMI (high-to-low): Switzerland 63.8 (previous month 64.2), Sweden 62.4 (previous month 62.1), Austria 61.5 (previous 58.7), Netherlands 60.1/58.7, Germany 59.8/57.4, Czech Republic 59/59.1, Italy 58.3/62, Greece 57.9/59, US 57.6/58.8, UK 57.3/57.9, Norway 56.5/57.55, Canada 56.2/56.5, Spain 56.2/56.2, France 55.5/55.6, Japan 55.4/54.3, Taiwan 55.1/55.5, Poland 54.5/56.1, India 54/55.5, Indonesia 53.7/53.5, Vietnam 53.7/52.5, South Korea 52.8/51.9, Russia 51.8/51.6, South Africa 50.9/48.4, Hungary 50.7/65.5, Singapore 50.6/50.7, Turkey 50.5/52.1, China 49.1/50.9, Brazil 47.8/49.8, Mexico 46.1/49.4. Services PMI: Sweden 68.6/67.4, Ireland 56.2/55.4, UK 54.1/53.6, France 53.1/57, Brazil 52.8/53.6, Germany 52.2/48.7, India 51.5/55.5, US 51.2/57.6, Russia 49.8/49.5, Italy 48.5/53, Japan 47.6/52.1, Spain 46.6/55.8.

Weekly Close: S&P 500 +1.5% and VIX -4.44 at +23.22. Nikkei +2.7%, Shanghai +0.0%, Euro Stoxx -0.7%, Bovespa +0.3%, MSCI World +1.9%, and MSCI Emerging +2.5%. USD rose +1.8% vs Chile. USD fell -15.7% vs Ethereum, -5.4% vs Bitcoin, -3.0% vs Sweden, -2.6% vs Euro, -2.6% vs Russia, -1.2% vs Australia, -1.0% vs Brazil, -1.0% vs Sterling, -0.9% vs South Africa, -0.6% vs Mexico, -0.5% vs India, -0.1% vs Canada, -0.1% vs Indonesia, and flat vs Turkey, and flat vs Yen. Gold +1.2%, Silver +0.8%, Oil +6.3%, Copper +4.1%, Iron Ore +0.0%, Corn -2.4%. 5y5y inflation swaps (EU -7bps at 1.75%, US -8bps at 2.40%, JP +3bps at 0.67%, and UK -5bps at 3.95%). 2yr Notes +15bps at 1.31% and 10yr Notes +14bps at 1.91%.

Jan Mthly Close: S&P 500 -5.3% and VIX +7.61 at +24.83. Nikkei -6.2%, Shanghai -7.7%, Euro Stoxx -3.9%, Bovespa +7.0%, MSCI World -5.3%, and MSCI Emerging -1.9%. USD rose +44.7% vs Ethereum, +27.0% vs Bitcoin, +3.6% vs Russia, +3.0% vs Sweden, +2.8% vs Australia, +1.2% vs Euro, +0.9% vs Indonesia, +0.6% vs Sterling, +0.6% vs Canada, +0.5% vs Mexico, +0.4% vs India, +0.1% vs China, flat vs Yen, and flat vs Turkey. USD fell -6.0% vs Chile, -4.8% vs Brazil, and -3.5% vs South Africa. Gold -1.9%, Silver -4.1%, Oil +17.7%, Copper -3.1%, Iron Ore +17.2%, Corn +5.5%. 5y5y inflation swaps (EU -12bps at 1.85%, US -4bps at 2.51%, JP +25bps at 0.69%, and UK +2bps at 3.96%). 2yr Notes +45bps at 1.18% and 10yr Notes +27bps at 1.78%.

YTD Equity Indexes (high-to-low): Brazil +11.8% priced in US dollars (+7.1% priced in reais), Colombia +11.1% priced in US dollars (+7.9% in pesos), Saudi Arabia +7.7% in dollars (+7.6% in riyals), Hungary +7.6% (+2.1%), Singapore +6.8% (+6.7%), Greece +6.4% (+5.8%), Chile +5.8% (+2.7%), South Africa +5.6% (+2.4%), HK +5.1% (+5%), Czech Republic +4.6% (+1.2%), Philippines +4.3% (+4.7%), UAE +2.9% (+2.9%), Argentina +2.6% (+5.3%), Turkey +2.1% (+4.6%), Austria +2.1% (+0.8%), Thailand +2% (+1%), UK +1.8% (+1.8%), Indonesia +1.2% (+2.3%), India +0.8% (+0.9%), Norway +0.5% (+0.2%), Spain -0.2% (-1.4%), Canada -0.7% (+0.2%), Poland -1.3% (-3.1%), Italy -1.5% (-2.7%), France -2.2% (-2.8%), Ireland -3.2% (-3.7%), Taiwan -3.2% (-3%), Israel -3.3% (-0.7%), Malaysia -3.4% (-2.9%), Germany -3.8% (-4.9%), Portugal -4.1% (-4.7%), Euro Stoxx 50 -4.4% (-4.9%), Japan -4.8% (-4.7%), Mexico -4.9% (-3.8%), MSCI World -5.3% (-5.3%), Finland -5.3% (-6.4%), S&P 500 -5.6%, Netherlands -5.8% (-6.4%), Belgium -6.4% (-7%), Switzerland -6.8% (-5.7%), Australia -7.1% (-4.4%), Sweden -7.7% (-6.8%), China -7.7% (-7.6%), Venezuela -8% (-9.1%), Korea -8.3% (-7.6%), New Zealand -9.2% (-5.8%), NASDAQ -9.9%, Russia -10% (-8.4%), Russell -10.8%, Denmark -11.4% (-12.4%).

Trading Size: “A few big hedge funds got blown out of their leveraged curve steepeners last autumn,” said the CIO, high atop his prodigious pile. “Then the Fed started sounding more hawkish, and the BOE messed with markets too,” he said. “The banks didn’t want to extend balance sheet to let any of us leverage up as we headed into year end. So those of us who wanted to put on big shorts couldn’t do it in size,” he said. “Then Omicron hit, and people got nervous, stepped away, rates came off. That was a fade, so we sold as much as the banks would let us.”

Trading Size II: “So everyone came into January wanting to put their shorts on,” said the same CIO. “Omicron news from South Africa looked better, the banks were open for trading, and then the Fed got more hawkish,” he said. “That all produced the real-rates shock.” The most exposed assets got killed. “But look, C&I loans in the US are growing 35% annualized, broad money growth is ripping. Real-rates can firm up as long as the economy is growing. People worried the Fed would be hiking into a slowdown. But I’m not so sure that’s what comes next.”

Trading Size III: “Jan is probably a taste of what will happen later this year, in the teeth of QT, but we’re not there yet,” explained the CIO. “Cynics say the market won’t be able to stomach the path, and that the fear of higher rates and QT will be enough to crack stocks and credit, and make the Fed blink,” he said. “But I think economic strength may surprise on the upside. Then there are two wildcards: China’s zero covid policy will fail with Omicron. But there’s talk Beijing will release a new mRNA vaccine post-Olympics. If that allows them to reopen faster than expected, it’s bullish. The bear tail is that Russia crosses into Ukraine, and China has their back.”

Ageing Models: “Here’s what’s going on -- Strong report any way that you slice it. We will start to see old ‘buffer stock models’ of goods and labor markets dusted off,” wrote Marcel Kasumovich, our Head of Research, messaging the team in real-time, analyzing Friday’s non-farm payroll report. “January is a month of massive firing. For instance, unadjusted payrolls were down 2,824k in the month, but the adjusted number was up 467k. So there was less firing than usual, which obviously translates to a big payroll gain. Why less firing?”

Ageing Models II: “In a labor market projected to be super-tight, you keep redundancy in your staff,” continued Marcel. “Hours worked were down, a telling sign of this dynamic. It is precisely what is meant by inflation behavior. Inflation isn’t some daft equation with a linear linkage between massaged data. The behavior comes through things like hoarding. A few extra employees. More copper in the barn. Order a few extra widgets. Excess inventory is profitable in an inflationary mindset. The US has already crossed the Rubicon.”

Ageing Models III: “The bond market has a very simple read - more front-loaded tightening, no risk of persistent inflation,” added Marcel. “2023 rate expectations +10-15bp. 2028 +2bp. 5y5y inflation expectations near the lows for the year.” 5yr/5yr inflation swaps closed the week -8bps at 2.40%. “And qualitatively, the inflation dynamics should be most felt in digital asset prices which should be supported by signs of self-sustaining inflationary dynamics taking hold.” Bitcoin is inexplicably +10% since the jobs report, even as 10yr bond yields jumped 10bps.

Anecdote: I had written something intentionally provocative. About a theory most traditional economists despise, yet few understand. Modern Monetary Theory. And took great care to capture its essence, succinctly, stripped of my bias. Easier said than done. To examine a matter, requires that we observe it from many angles. But to properly examine a thing, we must also consider the observer. The former is simpler than the latter. So, without realizing it, we generally spend our lives studying new things, while devoting far too little time exploring ourselves, our biases, beliefs. There was a time, not so terribly long ago, when Ptolemy taught us that heavenly bodies revolved around the earth in perfectly circular orbits. The theory faced challenges. Planets occasionally appeared to move backwards. So, Ptolemy separated the sky into 88 independent domes and theorized that each planet moved in small epicycles around a fixed dot in its larger orbit. The smartest humans on earth believed this. But with the discovery of each new object in the sky, the complexity required to hold this theory together grew exponentially. In 1543, Copernicus published a book, On the Revolutions of the Heavenly Spheres. It took 200 years and bitter struggles with the Catholic Church for his heliocentric model to entirely replace Ptolemy’s absurd theories. This is not a unique occurrence in human history; it is a pebble on the beach. With such humbling lessons, it is a wonder we still cling to any beliefs. Some theories we accept as being unambiguously true will someday be seen as the absurdities of antiquity. We just don’t yet know which ones. They live undetected in our minds, influencing, undermining. Which leads back to today’s economic models, which fail in material ways to explain reality. It may even be that there is no economic model to explain this unique time in human history. And to prepare for the investment opportunities that unfold when large numbers of people hold onto a crumbling orthodoxy, even as the evidence of its failure mounts, we must examine all sorts of alternatives. Just as we must explore ourselves.

Good luck out there,

Eric Peters

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.

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