All great investment opportunities close gaps. In the most basic sense, they narrow the space between where a price is now and where it should be. The biggest ones appear when most of us see one reality, while subterranean forces are creating something quite different. When such gaps exist, markets tend to send subtle signals, behaving in ways that make little sense based on our understanding of current conditions. When such odd movements begin to manifest, most investors grow angry when they should instead redouble efforts to explore and open their minds to widening range of possible futures. I had a lot of fun considering all sorts of gaps and potential futures with Ryan Sean Adams and David Hoffman on the industry’s leading crypto podcast called Bankless: https://shows.banklesshq.com/p/89-institutions-are-bullish-eric
Overall: “Your devices won’t be the focal point of your attention anymore,” said Mark Zuckerberg in his keynote, shuffling through a computer-generated landscape, renaming his firm Meta. “We’re starting to see a lot of these technologies coming together in the next five or 10 years,” he explained, server farms proliferating across the globe, humming, processor speeds advancing inexorably along parabolic curves. “A lot of this is going to be mainstream and a lot of us will be creating and inhabiting worlds that are just as detailed and convincing as this one, on a daily basis,” said the founder/architect, extending the epic journey of a firm first built to rank undergrad women’s appearance to one that now intends to construct humanity’s new reality: the Metaverse. Zuckerberg’s detractors went wild. “Meta as in ‘we are a cancer to democracy metastasizing into a global surveillance and propaganda machine for boosting authoritarian regimes and destroying civil society… for profit!,’” tweeted AOC. Others were less kind. But Meta carried on, making massive capital investments to win an intensifying war for its very existence. You see, Facebook, like every other organization based upon centralized control – which is to say virtually every institution – is threatened with extinction by a growing army of revolutionary entrepreneurs, developing decentralized alternatives. Incumbents across the most vulnerable industries are sending lobbyists to fortify regulatory moats from an assault by these innovators. Zuckerberg can hope for no such DC support. A wildly successful decentralized Metaverse would utterly destroy Facebook. So, before he loses his entire empire, he must build a wall around his existing network, and pray his users do not flee Meta’s centralized Metaverse. Meta’s longer-term odds of success are not high. And for those of us looking for frameworks to understand this emerging reality, the fierce battle between centralized and decentralized power is a focal point. The conflict will affect every industry, institution. And of course, understanding what is likely to become valuable in this new world that few can yet imagine, let alone understand, presents an enormous opportunity.
Week-in-Review (expressed in YoY terms): Mon: Erdogan walks back threat to expel 10 western ambassadors (US, Germany, France included), Saudi energy minister says OPEC must resist pressures to raise output, Hertz orders 100k Teslas sending Tesla valuation over $1T, FB misses rev est but beats on earnings, Mexico economic activity 4.28% (6.4%e), US Chicago Fed -0.13 (0.20e), US Dallas Fed 14.6 (6e), S&P +0.5%; Tue: Chinese developer – Modern Land Co – misses USD coupon payment, China urges Evergrande founder to pay debt with personal wealth, Pfizer vaccine wines backing of FDA panel for 5-11yo, Erdogan official drops demand to expel 10 ambassadors, UN says global temps to rise 2.7deg this century – far surpassing the 2deg goal from the Paris agreement, 150 people across 9 countries arrested in largest “dark web” sting ever, Iran’s nationally issued gas cards suffer from cyber-attack, Spain PPI 23.6% (18%p), Sweden PPI 17.2% (15.8%p), HK expts 16.5% (20.6%e) / imports 23.5% (21.9%e), Brazil IPCA 10.34% (10.11%e), US Case Shiller 19.66% (20%e), US cons conf 113.8 (108e), US Richmond Fed 12 (5e), S&P +0.2%; Wed: BoC keeps rates unch / announces end of QE (unexp) / brought forward projected timing for the first hike to Q2 2022 (from 2H 2022), Brazil CB hikes 150bps as exp, US bans China Telecom from operating in US, Dems drop “Billionaire Tax” from infrastructure plan, Norges bank indicated it could cut QE purchases, Iran and the EU agreed to restart negotiations on the revival of the 2015 nuclear deal by end of next month, UK defied expectations for fiscal restraint with add’l 75b GBP of stimulus, Australia CPI 3% (3.1%e) / trimmed mean 2.1% (1.8%e), China industrial profits 16.3% (10.1%p), German impt prices 17.7% (17.9%e), German cons conf 0.9 (-0.5e), Brazil unemp 13.2% (13.4%e), US durable goods orders -0.4% MoM (-1.1%e), US cap goods orders 0.8% MoM (0.5%e), S&P -0.5%; Thur: RBA decides not to defend yield curve control levels as front end rates explode higher, ECB unch as exp / Lagarde reaffirms transitory inflation thesis but suggests the inflation overshoot could last longer than they thought before due to supply disruptions / firmest guidance that PEPP would finish in March, BoJ unch as exp, Dems unveil $1.75T social spending bill rework, CB of Turkey raises 2021 inflation expectation to 18.4% (14.1%p), Apple and Amazon miss estimates due to supply chain issues, Russia will start refilling its European gas storage facilities, extreme volatility in G10 yield curves dominate the day / US 20y vs 30y inverts for first time, French detain British fishing ship for fishing in French waters, Spain CPI 5.5% (4.6%e), Sweden 3Q GDP 4.7% (3%e), German unemp 5.4% as exp, Turkey tourist arrivals 59.5% (119.4%p), Germany CPI 4.6% (4.5%e), US init claims 281k (288k exp), US 3Q GDP 2% (2.6%e) / core PCE 4.5% as exp, US pending homes sales -7.2% (-3.1%e), S&P +1.0%; Fri: RBA again decides not to defend YCC – 2y yields go from 0.15% on Weds to 0.78% by Fri, US progressive caucus slows the newly unveiled $1.75T package, Evergrande makes another last minute coupon payment before expiry of 30d grace period, France 3Q GDP 3.3% (2.4%e) / CPI 3.2% (3.1%e), Spain 3Q GDP 2.7% (3.9%e) / ret sales -0.1% (0%e), German 3Q GDP 2.5% as exp, Italy 3Q GDP 3.8% (3%e), UK cons credit -1.8% (-2.4%p), Poland CPI 1.8% (1.3%p) / 3Q GDP 4.2% (16.1%p), EU CPI 4.1% (3.7%e) / Core CPI 2.1% (1.9%e), EU 3Q GDP 3.7% (3.5%e), Mexico 3Q GDP 4.6% (6%e), US personal income -1% (-0.3%e) / spending 0.6% as exp, US PCE Deflator 4.4% as exp / Core PCE Deflator 3.6% (3.7%e), Chicago PMI 68.4 (63.7e), US UofM 71.7 (71.4e) / 1y infl 4.8% as exp / 5-10y infl 2.9% (2.8%p), S&P +0.2%
Weekly Close: Weekly Close: S&P 500 +1.3% and VIX +0.83 at +16.26. Nikkei +0.3%, Shanghai -1.0%, Euro Stoxx +0.8%, Bovespa -2.6%, MSCI World +0.9%, and MSCI Emerging -1.3%. USD rose +2.8% vs South Africa, +1.9% vs Mexico, +0.9% vs Bitcoin, +0.7% vs Euro, +0.5% vs Sterling, +0.4% vs Russia, +0.4% vs Yen, +0.3% vs China, +0.3% vs Indonesia, +0.2% vs Sweden, and +0.2% vs Canada. USD fell -7.5% vs Ethereum, -0.7% vs Australia, -0.2% vs Brazil, -0.2% vs Chile, flat vs India, and flat vs Turkey. Gold -0.5%, Silver -1.7%, Oil -0.9%, Copper -2.8%, Iron Ore -7.6%, Corn +5.7%. 5y5y inflation swaps (EU -6bps at 1.95%, US -16bps at 2.47%, JP -1bps at 0.45%, and UK -24bps at 3.76%). 2yr Notes +4bps at 0.50% and 10yr Notes -8bps at 1.56%.
Oct Mthly Close: S&P 500 +6.9% and VIX -6.88 at +16.26. Nikkei -1.9%, Shanghai -0.6%, Euro Stoxx +4.6%, Bovespa -6.7%, MSCI World +5.7%, and MSCI Emerging +1.8%. USD rose +8.0% vs Turkey, +3.6% vs Brazil, +2.4% vs Yen, +1.1% vs South Africa, +0.9% vs India, +0.5% vs Chile, and +0.2% vs Euro. USD fell -31.6% vs Ethereum, -29.6% vs Bitcoin, -3.9% vs Australia, -2.6% vs Russia, -2.3% vs Canada, -1.9% vs Sweden, -1.5% vs Sterling, -1.0% vs Indonesia, -0.6% vs China, and -0.4% vs Mexico. Gold +1.6%, Silver +8.1%, Oil +11.3%, Copper +6.5%, Iron Ore -11.2%, Corn +5.9%. 5y5y inflation swaps (EU +11bps at 1.95%, US +4bps at 2.47%, JP +21bps at 0.45%, and UK -4bps at 3.76%). 2yr Notes +22bps at 0.50% and 10yr Notes +7bps at 1.56%.
YTD Equity Indexes (high-to-low): UAE +56% priced in US dollars (+56% priced in dirham), Argentina +37.6% priced in dollars (+63.1% priced in pesos), Saudi Arabia +35.4% in dollars (+35.3% in riyal), Russia +32.5% (+26.2%), Austria +25.7% (+33.8%), Norway +24.8% (+23%), Israel +24.4% (+22.5%), Canada +24.3% (+20.7%), Czech Republic +23.9% (+29.1%), India +23.1% (+26.4%), Hungary +22.7% (+28.9%), S&P 500 +22.6%, Netherlands +22.5% (+29.8%), NASDAQ +20.3%, Poland +20.3% (+29%), Denmark +18.3% (+26%), MSCI World +18.2% (+18.2%), Taiwan +16.5% (+15.3%), Sweden +16.4% (+22.2%), Russell +16.3%, France +16.1% (+23%), Italy +13.5% (+20.9%), Euro Stoxx 50 +12.9% (+19.6%), Mexico +12.6% (+16.4%), UK +12.2% (+12%), Belgium +11.5% (+18.1%), Singapore +10.1% (+12.5%), Ireland +9.4% (+15.9%), Venezuela +9% (+315.3%), Switzerland +9% (+13.1%), Indonesia +8.7% (+10.2%), Finland +8.6% (+15.6%), Australia +8.5% (+11.2%), Portugal +7.6% (+14%), Germany +7.4% (+14.4%), South Africa +7.3% (+11.8%), Spain +5.9% (+12.2%), Greece +4.8% (+11%), China +4.1% (+2.1%), Thailand +0.6% (+12%), New Zealand -0.4% (+0.1%), Korea -4.2% (+3.4%), Japan -4.7% (+5.3%), Philippines -6.1% (-1.2%), Malaysia -6.7% (-4%), HK -7.1% (-6.8%), Colombia -12% (-3%), Chile -14.5% (-2%), Turkey -19.6% (+3.1%), Brazil -20.4% (-13%).
Does Anyone Care: “Every policy-type person is asking – what is the cost of hiking interest rates early?” said Marcel, our head of research, updating us on the state of such chatter. “Historically, an extrapolation of rate hike expectations leads to a material jump in terminal real rates and an undue tightening in credit conditions,” he explained. “The most obvious recent analog branded in policy minds is the 2013 taper tantrum. 5y5y real OIS jumped from -0.75% in 2012 to +1.50% in 2013 with ~75% of that move happening on Bernanke’s misstep. A lot of factors contributed to the reversal – 5y5y real OIS returned to –0.75% in 2016.”
Does Anyone Care II: “The bond market is giving policy makers a free pass, at least for now,” continued Marcel. “Bloomberg headlines about bond market carnage are true for some micro, leveraged funds but not accurate for the broader asset class. Treasury total return indices were up on the week (+0.5%) and virtually unchanged for the month (-0.07%). If you told the market in August that the Fed might be preparing to hike in early 2022, most traders would have anticipated a harsh outcome for the broader bond market.”
Does Anyone Care III: “The re-pricing of the front-end is very narrowly defined. It is also clear in Australia where the 2024 bond with a 0.1% yield target now trades at 0.8% despite central bank attempts to hold it down. That kind of move amounts to a 1.5% price decline for unleveraged bond owners. So does anyone care?” asked Marcel. “The only players who do are those with leveraged longs. And these were hedge funds that wanted to be short bonds but tried to reduce the negative carry. They bought lots of leveraged short term bonds (sold vol too) and then shorted longer-dated bonds. That trade stung. But it’s a small group of players.”
Does Anyone Care IV: “The UK short-sterling strip tells an important tale of what is to come,” explained Marcel. “It says short-term rates will peak in 2023 and decline thereafter. The terminal real rate remains steeply negative. The bond market is saying financial repression is a permanent part of the financial architecture. It says that if you pull forward hikes to show you’re responding to inflation, there’s no possibility to achieve sustained, positive real short-term rates. There is too much capital in the world, and it needs to be destroyed. Financial repression is the most painful destruction tool as it provides no quick recovery, it instead stretches losses over a generation.”
Anecdote: “Web 1.0 was flat, static,” said the visionary, unseating the slow-moving incumbents. “Web 2.0 arrived and was dynamic, interactive -- it is what we mostly experience today,” added the founder/CEO, lifting his phone from the table, looking at the screen, placing it gently down. “Web 3.0 will be immersive. And we will spend an increasing amount of our lives within the new worlds that it will open.” I’d zipped into the city for our meeting, on autopilot, handsfree, crazy stop-and-go traffic along the Hudson, software navigating the chaos at 60mph. “In these new worlds, our experiences will be virtual, the currencies we use will naturally be native to those worlds, the assets will be digital.” And he paused, thoughtful, entirely at ease. “When I started this company, I saw a future where early digital currencies would become increasingly popular, more valuable. And I expected these technologies would eventually prove useful and solve real world problems,” he said. “Even I am surprised by how quickly the latter has come.” Venture capital is cascading into blockchain companies that are racing to replace the things incumbent institutions presently do; only faster, cheaper, more securely. Some protocols are built to do things we previously considered impossible. Still others do things not previously imagined. These revolutionary pioneers see a world very different from what has been. They have a broadening view of what is possible. “As this future manifests, all assets will be tokenized -- the virtual assets we already see today, the financial assets we have always traded, and many real assets we never even considered tokenizing, exchanging, trading.” While we will split our time between the virtual and the real, all our possessions will gravitate to the blockchain, tokenized, fractionalized. “And we will supply the most trusted custodial wallets to secure digital assets for everyone in that future.”
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.