The Long Painful Process Has Just Begun

The Ferocious Beauty of Truly Free Markets

The Ferocious Beauty of Truly Free Markets
May 23, 2021
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Forward Guidance

Forward Guidance
June 20, 2020
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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: The Long Painful Process Has Just Begun

“People keep telling me investors are maximum bearish,” said Alpha, one of the market’s greatest macro minds. “The foundation for that claim is more or less that investors hold historically high cash balances.” BofA private clients reportedly hold 12% in cash and its Bull & Bear Indicator shows an Extreme Bearishness reading. “But if someone says they hold 12% cash, it means they still hold 88% of their money in risk assets. That’s insane. Given this macro backdrop, maximum bearishness should be more like 88% cash and 12% risk assets,” said Alpha. “That’s what my portfolio has looked like this year. That’s how you should trade maximum bearishness. And it won’t be forever. There’ll be a time to buy. Just not yet.”

Overall: “Everything I am saying is important,” declared the dictator, his credibility fading, dangerously, his hopelessly corrupt nation failing. “And what I just said is no less so: you can't feed anyone with paper – you need food; and you can’t heat anyone’s home with these inflated capitalizations – you need energy,” continued Putin, claiming eastern Ukraine, doubling down. “The United States is practically pushing Europe toward deindustrialization in a bid to get its hands on the entire European market. These European elites understand everything – they do, but they prefer to serve the interests of others,” he said, showing his hand. Putin has few good cards to play of course. The nuclear card is most terrifying, suicidal too. So for now he’s focused on dividing his adversaries, exposing our greatest weaknesses, hypocrisies. We have plenty. The game we’re now playing involves the most fascinating interplay of macroeconomic forces and geopolitics in our lifetimes. Decades of deepening globalization and technological advance produced enormous prosperity that rewarded capital in an outsized way relative to Western labor. We mistook this for a permanent state of the world. But unsatisfied with an abundant present, our financiers pulled prosperity from the future by hyper financializing our economies. In the pursuit of maximum profit, we blindly abandoned redundancy, accepted fragility. We attempted to address climate change without investing in a credible bridge to a sustainable future. Each one of these developments are inextricably linked and have produced the vulnerabilities that Putin and our adversaries now seek to exploit. Britain’s pension system just cracked. The Bank of England vowed to do whatever it takes to save it from excessive leverage and poorly designed financial engineering. The central bank reverted to money-printing and bond-buying to stabilize a system made fragile by money-printing and bond buying. Nord Stream 1 and 2 pipelines were attacked, reminding every nation on the planet that key infrastructure assets built for peaceful times become liabilities in periods of war. The West is now awakening from decades of poor policy. The consequences will appear overwhelming at first. We’ll get through. But that long, painful process has only just begun.

One River Digital’s Deputy CIO, Marcel Kasumovich, published a note on the tightening of financial conditions and its impact on digital assets. Peak tightening in digital financial conditions occurred in June 2022, and digital asset prices have decoupled from traditional forces since then. The digital tightening cycle is unique and was led by credit which has now become the land of opportunity [click here].

Week-in-Review (expressed in YoY terms): Mon: right wing alliance wins Italian elections / Giorgia Meloni likely to become next PM, GBPUSD collapses below post Bretton Woods lows following Kwarteng’s hinting that more fiscal spending would be coming/ Gilts above 4% first time since 2010 / BOE says will not intervene until next meeting (Nov 3), Nord Stream pipelines attacked off coast of Denmark, Lagarde signals rate hike to continue over next several meetings as yields spike, Kuroda says FX intervention was appropriate, German IFO 84.3 (87e), HK expts -14.3% (-9.7%e) / impts -16.3% (-10.2%e), US Chicago Fed 0 (0.23e), US Dallas Fed -17.2 (-9e), S&P -1.0%; Tue: estimates of MoF intervention last week ~$25b, BoE’s Pill calls for significant monetary policy response, Hungary CB hikes 125bp (100bp exp) / says ending hiking cycle, Fed speakers are hawkish / Bullard says inflation targeting regime is at risk, Saudi King names MBS as PM, Apple slows iPhone production after demand falters, Japan serv PPI 1.9% (2.4%e), EU M3 6.1% (5.3%e), Mexico unemp 3.53% (3.4%e), Brazil IPCA 7.96% (8.14%e), US Durable goods -0.2% MoM (-0.3%e), US FHFA housing index -0.6% MoM (0%e), US Case Shiller House prices 16.06% (17.05%e), US cons conf 108 (104.6e), US Richmond Fed 0 (-10e), US new home sales 28.8% MoM (-2.2%e), S&P -0.2%; Wed: BOE announces temporary long dated bond purchases due to sharp rise in rates / rumors of pension fund liability issues, Hurricane Ian (cat 4) makes landfall on Florida’s west coast, Turkey’s Erdogan says rates to fall further, EU proposes new package of Russia sanctions, ECB’s Kazaks says next hike must be big – calls for 75bp in Oct, sham “referenda” in Ukraine show strong support to join Russia, Yellen says markets are functioning without liquidity issues, Australia ret sales 15.4% (9.7%p), German cons conf -42.5 (-39e), Sweden ret sales -5.1% (-3.8%p) / Cons conf 49.7 (53e), Italy cons conf 94.8 (95.1e), US Trade balance -87.3b MoM (-89b exp), US pending home sales -22.5% (-24.5%e), Russia IP -0.1% (-0.9%e) / retail sales -8.8% (-8.5%e) / unemp 3.8% (4.1%e), S&P +2.0%; Thur: UK PM Truss says her economic policy is the “right plan” for the UK, PBOC asked banks to be ready to intervene to strengthen the currency, Softbank to cut Vision Fund staff by 30%, US mortgage rate jumps to 6.7% - highest since 2007, Mexico CB hikes 75bp as exp, Meta announces hiring freeze, BOE’s Ramsden says gilt purchases will be unwound in an orderly way, LME considers banning new supplies of Russian base metals to its warehouses, another leak in NS pipelines in the Baltic sea, ECB’s Simkus supports QT talks as soon as possible, Spain CPI 9.3% (10%e), EU eco conf 93.7 (95e), German CPI 10.9% (10.2%e), US final 2Q GDP -0.6% as exp, US initial claims 193k (215k exp), S&P -2.1%; Fri: Putin signs documents to annex occupied Ukrainian territories / continues rhetoric that this conflict is vs the “west” and threatens nuclear actions, Japan confirmed intervention was $19b (lower end of est range), India’s CB hikes 50bp as exp, China asks banks to trade FX closer to fixing, China offers income tax breaks for some home purchases, EU backs package to cut power use, Fed’s Brainard says policy needs to be restrictive for some time and avoid pulling back early, ECB’s Visco says excessive and rapid rate hikes risk a recession, Biden says NS attacks were deliberate act of sabotage, Turkey cut to B from B+ / UK outlook revised to negative by S&P, Micron to slash production after steep plunge in demand, Japan unemp 2.5% as exp / IP 5.1% (1.8%e), China mfg PMI 50.1 (49.7e) / serv 50.6 (52.4e) / comp 50.9 (51.7p), China Caixin mfg PMI 48.1 (49.5e), Australia private credit 9.3% (9%e), UK house prices 9.5% (9.9%e) / UK CA bal -33.8b (-43.6b exp) / UK 2Q final GDP 4.4% (2.9%e), France CPI 6.2% (6.6%e), France cons spending -3.8% (-3.7%e), German unemp 5.5% as exp, Italy unemp 7.8% (7.9%e), EU CPI 10% (9.7%e) / Core CPI 4.8% (4.7%e), Italy CPI 9.5% as exp, Poland CPI 9.8% (9.3%p), S. Africa trade balance 7.2b (23.7b exp), Brazil unemp 8.9% as exp, US personal inc 0.3% MoM as exp / spending 0.4% MoM (0.2%e) / PCE Deflator 6.2% (6%e), US Chicago PMI 45.7 (51.8e), US UofM 58.6 (59.5e) / 1y infl exp 4.7% (4.65e) / 5-10y infl exp 2.7% (2.8%e), S&P -1.5%.

Weekly Close: S&P 500 -2.9% and VIX +1.70 at +31.62. Nikkei -4.5%, Shanghai -2.1%, Euro Stoxx -0.7%, Bovespa -1.5%, MSCI World -1.5%, and MSCI Emerging -3.6%. USD rose +2.9% vs Brazil, +2.0% vs Australia, +1.7% vs Canada, +1.3% vs Indonesia, +1.0% vs Yen, +0.8% vs South Africa, +0.6% vs Turkey, and +0.4% vs India. USD fell -5.4% vs Bitcoin, -4.9% vs Ethereum, -2.8% vs Sterling, -2.0% vs Russia, -1.9% vs Sweden, -1.2% vs Euro, -0.3% vs Mexico, -0.2% vs China, and -0.1% vs Chile. Gold +1.0%, Silver +1.0%, Oil +0.4%, Copper +1.2%, Iron Ore -0.1%, Corn +0.4%. 5y5y inflation swaps (EU -20bps at 2.02%, US -32bps at 2.16%, JP +1bp at 0.89%, and UK +12bps at 3.89%). 2yr Notes +7bps at 4.28% and 10yr Notes +14bps at 3.83%.

Sept Monthly Close: S&P 500 -9.3% and VIX +5.75 at +31.62. Nikkei -7.7%, Shanghai -5.5%, Euro Stoxx -6.6%, Bovespa +0.5%, MSCI World -8.6%, and MSCI Emerging -12.2%. USD rose +17.7% vs Ethereum, +8.1% vs Chile, +6.9% vs Australia, +5.6% vs South Africa, +5.3% vs Canada, +4.4% vs Brazil, +4.2% vs Yen, +4.0% vs Sterling, +4.0% vs Sweden, +3.3% vs China, +2.8% vs Bitcoin, +2.6% vs Indonesia, +2.6% vs Euro, +2.4% vs India, and +1.8% vs Turkey. USD fell -4.7% vs Russia, and flat vs Mexico. Gold -3.2%, Silver +6.4%, Oil -9.8%, Copper -3.5%, Iron Ore -1.9%, Corn +1.0%. 5y5y inflation swaps (EU +3bps at 2.02%, US -38bps at 2.16%, JP -6bps at 0.89%, and UK +9bps at 3.89%). 2yr Notes +79bps at 4.28% and 10yr Notes +64bps at 3.83%.

Q3 Quarterly Close: S&P 500 -5.3% and VIX +2.91 at +31.62. Nikkei -1.7%, Shanghai -11.0%, Euro Stoxx -4.8%, Bovespa +11.7%, MSCI World -5.7%, and MSCI Emerging -12.7%. USD rose +11.1% vs South Africa, +11.0% vs Turkey, +9.3% vs Russia, +9.0% vs Sterling, +8.5% vs Sweden, +7.9% vs Australia, +7.4% vs Canada, +7.0% vs Euro, +6.6% vs Yen, +6.2% vs China, +5.5% vs Chile, +3.0% vs India, +3.0% vs Brazil, +2.2% vs Indonesia, and +0.1% vs Mexico. USD fell -24.5% vs Ethereum, and -3.7% vs Bitcoin. Gold -8.7%, Silver -6.7%, Oil -18.6%, Copper -8.2%, Iron Ore -13.3%, Corn +8.8%. 5y5y inflation swaps (EU -4bps at 2.02%, US -26bps at 2.16%, JP +7bps at 0.89%, and UK +17bps at 3.89%). 2yr Notes +132bps at 4.28% and 10yr Notes +82bps at 3.83%.

Year-to-Date Close: S&P 500 -24.8% and VIX +14.40 at +31.62. Nikkei -9.9%, Shanghai -16.9%, Euro Stoxx -20.5%, Bovespa +5.0%, MSCI World -25.7%, and MSCI Emerging -29.1%. USD rose +181.7% vs Ethereum, +143.6% vs Bitcoin, +39.3% vs Turkey, +25.8% vs Yen, +22.5% vs Sweden, +21.1% vs Sterling, +16.0% vs Euro, +13.7% vs Chile, +13.5% vs Australia, +13.5% vs South Africa, +12.0% vs China, +9.4% vs Canada, +9.4% vs India, and +6.8% vs Indonesia. USD fell -23.1% vs Russia, -2.8% vs Brazil, and -1.9% vs Mexico. Gold -9.4%, Silver -19.2%, Oil +12.8%, Copper -23.1%, Iron Ore +19.7%, Corn +24.0%. 5y5y inflation swaps (EU +5bps at 2.02%, US -40bps at 2.16%, JP +45bps at 0.89%, and UK -5bps at 3.89%). 2yr Notes +355bps at 4.28% and 10yr Notes +232bps at 3.83%.

YTD Equity Indexes (high-to-low): Turkey +22.3% priced in US dollars (+71.2% priced in lira), Argentina +16.2% priced in US dollars (+66.6% priced in pesos), UAE +14.9% priced in dollars (+14.9% in dirham), Brazil +7.9% in dollars (+5% in reais), Chile +4.7% (+18.7%), Saudi Arabia +1.1% (+1.1%), Indonesia +0.1% (+7%), Singapore -5.9% (+0.2%), India -9.8% (-1.5%), Portugal -14.5% (-0.6%), Mexico -14.8% (-16.2%), Thailand -15.5% (-4.1%), Venezuela -17.4% (+46.7%), Israel -19.9% (-8.4%), Malaysia -20.2% (-11%), Canada -20.3% (-13.1%), Norway -22.3% (-4.1%), Australia -23.2% (-13%), UK -23.2% (-6.6%), Greece -23.7% (-11.2%), South Africa -24.5% (-14.4%), S&P 500 -24.8%, MSCI World -25.7% priced in dollars, China -25.8% (-16.9%), Russell -25.9%, Switzerland -25.9% (-20.3%), Spain -26.9% (-15.5%), HK -26.9% (-26.4%), Japan -28.3% (-9.9%), Denmark -29.1% (-18.1%), Colombia -29.3% (-20%), Philippines -29.9% (-19.4%), New Zealand -30.2% (-15.1%), France -30.7% (-19.4%), Netherlands -31% (-19.7%), Czech Republic -31.1% (-21.2%), NASDAQ -32.4%, Belgium -32.8% (-21.8%), Finland -33.2% (-22.8%), Euro Stoxx 50 -33.6% (-22.8%), Germany -34% (-23.7%), Italy -34.7% (-24.5%), Ireland -35.7% (-25.3%), Taiwan -35.8% (-26.3%), Russia -35.9% (-48.3%), Sweden -38.4% (-24.4%), Austria -39.7% (-30.3%), Korea -40% (-27.6%), Hungary -43.7% (-25.4%), Poland -45.8% (-33.7%).

Desk-mates: “What will it take for the Fed to pause?” I asked, early morning, screens aglow, the smell of impending policy-maker panic drifting across our trading floor like freshly brewed coffee. We were discussing relentless dollar strength, what it means, where it leads. “It’s harder to answer in this cycle, because I don’t really think that dollar strength is specifically because of the Fed, at least not completely,” said Lindsay Politi, our inflation-strategies portfolio-manager, brilliant. “It’s the logical consequence of the QE bubble bursting. Fed tightening is part of it, sure, but it’s not like when the Fed pauses all the root cause of the problems will go away.”

Desk-mates II: “One thing I’ve learned about market collapses is that what gets you into them won’t get you out of them, and the people who rode the wave on the way up will not be the ones stepping in to buy the bottom,” continued Lindsay. “That’s why, this time, I wouldn’t be looking to central banks to save us,” she said. “Some of this is also because, in a high debt, inflationary world, the US is just a better credit. In this crisis, markets are going to go after sovereign credits. And remember, pricing default risk is about combining default probability and recovery rate.”

Desk-mates III: “Sovereign nations represent the ultimate collateral free asset,” said Lindsay. “They’re not like corporations, where you can take the plane or factory in bankruptcy; you can’t show up to a nation’s Treasury and seize assets. With sovereign nations, you can’t easily calculate a recovery rate, so it’s all about default probability. For countries whose debt is denominated in currency they can create, default is usually considered very remote. Because it’s not about the ability to pay, they always have the money to pay, it’s about willingness to pay.”

Desk-mates IV: “The only reason a country wouldn’t print money to pay their debt is the social and political costs of depreciating the currency by printing money becomes greater than the cost of defaulting on the debt. The dollar is strong, and in a way it’s a good reserve currency, because the US is economically the least currency-sensitive economy in the world. The US is the ultimate large, closed economy.” According to World Bank data on openness - a measure of an economy’s dependence on trade - the US is at the far extreme.

Desk-mates V: “The US produces large amounts of food and energy and has a diverse domestic services and manufacturing economy. Americans rarely notice even large currency fluctuations and it has minimal impact on inflation.” The UK, by comparison, is substantially more open than the US and it’s much more dependent on the rest of the world for necessities like food and energy. “By contrast, the average Brit is very aware of sterling weakness and currency fluctuations impact inflation more directly. The point where the UK decides the cost of currency weakness to pay creditors is higher than the cost of default is much closer than it is in the US.”

Desk-mates VI: “There is a temptation for people to now wonder when the Fed will pivot and make these problems all go away,” said Lindsay. “But it’s important to first understand why central bankers did QE in the first place. Central bankers can only directly control nominal interest rates but it’s real interest rates that impact the economy. When inflation is falling, if the central bank can’t cut rates more quickly than inflation is falling then real rates rise despite their rate cuts. Higher real rates are even more disinflationary and it’s possible that central banks lose control in a sort of deflationary spiral.”

Desk-mates VII: “Negative nominal interest rates are not normal. They are a sign of a deeply dysfunctional market. No long-term investor would ever buy them except under duress because they’re guaranteed to lose money. But this fear of a deflationary spiral caused central banks to take yields negative despite the market issues they created. There were concerns about the size of the purchases and that they’d create too much inflation. Central banks rationalized that they knew how to fight inflation and would do so if the time came. I think they grossly underestimated the amount of market distortion they were creating.”

Desk-mates VIII: “The moment has come for central bankers to tighten, unwind their market distortions, and the impact has already been catastrophic,” said Lindsay. Year-to-date, the drawdown in the market cap of US bond and equity markets has been over $57 trillion. “And central banks aren’t done yet. Inflation changes the calculus, and many central banks don’t have the option of returning to QE anymore. Remember, they don’t control real rates. So every day they wait to fight inflation, real rates remain too low, the currency weakens creating more inflation, pushing real rates even lower and it becomes an inflationary cycle.”

Anecdote: “I’ve seen a few bubbles in my career,” said Lindsay Politi, our inflation-strategies portfolio-manager. “I think what’s easy to miss if you haven’t seen one before is how reasonable the valuations seem at the peak,” she continued. “It’s never just speculators pumping up prices, there’s always an entire academic construct justifying the valuations. Dow 36,000 was published months before the dot com bubble burst.” AIG asserted that they couldn’t imagine losing a single dollar in CDS months before the Bear Sterns bankruptcy. “I don’t say this to pick on anyone but to point out that most smart people rarely see them coming.” It all makes perfect sense until it doesn’t. And a lot of people don’t even realize they’re experiencing a bubble burst until it’s almost over. Bubbles bursting are not just about inflated prices falling, they’re about the recognition that an entire way of thinking was wrong. “QE, like many justifications for ridiculous valuations before it, was a bubble. And what we’re experiencing now is a bubble bursting.” A 30+ trillion-dollar bubble, by far the largest in history. “It’s important to remember that the bursting of a bubble takes a long time to play out. It may feel fast and chaotic at various points in the process, but it isn’t really. Look at 2008. Everyone thinks of Lehman’s Bankruptcy on September 15, 2008, as the big catalyst for that crisis, but the S&P 500 had peaked the previous November. Bear Sterns failed on March 13th, 2008. From the Friday before Lehman’s bankruptcy to the end of that month, the S&P was only down 7%. The real weakness was in October with a local low in November.” The final bottom wasn’t until March of the next year. “The bubble was bursting before Lehman Brothers.” That was just the large cathartic event that caught our attention, ignited our imagination. “And even after that it took months for the market to bottom. Markets don’t clear imbalances instantaneously. So we should be preparing ourselves for a marathon, not a sprint.”

Good luck out there,

Eric Peters


Chief Investment Officer

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, converse 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.