In early 2000, the Nasdaq soaring, American businessman Dennis Tito planned a trip to space. He paid $20mm to spend 8-days on the International Space Station (ISS), and then watched the 2001 bust from orbit. He was the first private citizen to leave earth. In 2008, Richard Garriott paid $30mm for 12-days on the ISS. On his 3rd day in orbit, he watched Lehman declare bankruptcy far below. On July 20th, Blue Origin will head to space with Bezos and his brother on board. Jeff just auctioned off a seat for the brief sub-orbital ride. The anonymous buyer is unlikely a value investor, having paid $28mm for the 11-minute roundtrip. Then in Jan 2022, three private citizens will pay $55mm each to ride a SpaceX rocket to the ISS for an 8-day visit. What kind of market will they see below?
Overall: “What the hell,” whispered the bewildered bureaucrat, pulling out his protractor. The CPI report had surprised again to the upside; headline, core, the components. “How’d this thing get away from us?” asked his colleague, heart racing. Following decades of oscillating in a tight range, the trajectory of consumer prices went parabolic. But of course, everyone at the agency with a command of calculus left ages ago for more interesting endeavors. Those left behind were more comfortable with algebra, geometry. And secure in a linear world, they sought to produce flat lines for a living. In the late-1990s they introduced ‘hedonics’ at the Bureau of Labor Statistics (BLS). The term is derived from the Greeks, well known for hedonism and hyper-inflation. Applying the technique to a good or service that had improved in quality and/or functionality allowed the bureaucrats to magically turn price inflation to deflation. In this way, anything whose price increased at a pace that lagged the increase in pleasure it produced, would be seen to have grown cheaper. Hedonically speaking that is. And this was not the only innovation. BLS bureaucrats substituted hamburgers for hotdogs when the former’s price jumped faster than the latter. And vice versa. Such an innovation could be applied to almost anything. And since 1983 they used an alchemical equation called Owner’s Equivalent Rent (OER) to turn rapid housing price inflation to something more stable. Flattish. Linear. With so many wonderful tools to temper each price blip, reported inflation barely budged even as the cost of living rose inexorably for the 332,418,508 Americans who don’t work at the BLS. “Alright ladies and gentlemen, back to work, let’s flatline this baby, and bring things under control,” ordered the big boss, irritated to have been temporarily outsmarted by the latest Fed and Treasury monetary machinations, “A nickel to the first one of you who can figure out how to turn Bezos’s $28mm Blue Origin trip into a $25 hedonic roller coaster ride!”
Week-in-Review (expressed in YoY terms): Mon: Yellen says Biden should push forward with $4t spending plans even if it means higher inflation/rates, G7 Fin Mins agree on at least 15% minimum corp tax, AMLO’s government in Mexico held congress but performs poorly in midterm elections, S&P revised Australia’s outlook to stable from negative, German CDU outperformed in local elections, Peruvian presidential election too close to call, China impts 51.1% (53.5%e) / expts 27.9% (32.1%e), Swiss unemp 3.0% (3.1%e), Swiss CPI 0.6% (0.5%e), Russia CPI 6% (5.8%e), S&P -0.1%; Tue: US DoJ recovered majority of the BTC ransom Colonial Pipeline paid to hackers, UK expected to extend covid restrictions following recent jump (albeit from the lows) in new cases, a US study says it is possible that covid started from a Chinese lab, US senate passes $250b spending bill for R&D, Bidens infrastructure talks with Republican leaders stall, Japan 1Q GDP -1% (-1.2%e), German IP 26.4% (29.5%e), Italy ret sales 30.4% (22.9%p), German ZEW 79.8 (86 exp), EUR 1Q GDP final -1.3% (-1.8%e), S. Africa 1Q GDP -3.2% (-3%e), Brazil ret sales 23.8% (18.4%e), US NFIB 99.6 (101e), S&P flat; Wed: Bank of Hungary deputy gov says will begin tightening cycle with an “effective” rate hike, China vows to control prices after red hot PPI data, Fed RRP demand continues to surge ($502.9b – new high), S. Korea unemp 3.8% (3.6%e), China CPI 1.3% (1.6%e) / PPI 9% (8.5%e), Hungary CPI 5.1% (5.3%e), Mexico CPI 5.89% (5.86%e), Brazil IPCA 8.06% (7.93%e), S&P -0.2%; Thur: ECB unch as exp, undocumented migrants caught at the US southern border rose above 180k (21y high), US increases its covid vaccine donations (500m new Pfizer vaccines), TC Energy formally gave up on Keystone XL pipeline, JBS announces that it paid $11m (in BTC) ransom to hackers, Socialist Castillo tentatively wins Peru presidential elections (legal disputes begin), US/China commerce ministers continue (3rd) constructive calls, Japan PPI 4.9% (4.5%e), Norway CPI 2.7% (2.9%e), France IP 43.9% (44.9%e), Turkey unemp 13.9% (13.1%p), Sweden CPIF 2.1% (2.2%e), US CPI 5% (4.7%e) / Core CPI 3.8% 3.5%e), US initial claims 376k (370k exp), S&P +0.5% Fri: Russia CB hikes 50bps as exp, G7 meeting begins in UK, Peru CB unch as exp but drops commitment to keep rates unch for “a prolonged period”, BoK gov Lee suggests normalization getting pulled forward, US largest reservoir (Lake Mead) at lowest level ever, UK IP 27.5% (30.5%e), Turkey IP 66% (63.1%e), Mexico IP 36.6% (37.6%e), India IP 134.4% (121.1%e), US UofM Sentiment 86.4 (84.2e) / 5-10y infl exp 2.8% (3%p) / 1y infl exp 4% (4.7%e), S&P +0.2%.
Weekly Close: S&P 500 +0.4% and VIX -0.77 at +15.65. Nikkei +0.0%, Shanghai -0.1%, Euro Stoxx +1.1%, Bovespa -0.5%, MSCI World +0.5%, and MSCI Emerging +0.0%. USD rose +7.1% vs Ethereum, +2.1% vs South Africa, +1.4% vs Brazil, +0.7% vs Chile, +0.6% vs Canada, +0.6% vs Sweden, +0.5% vs Euro, +0.4% vs Australia, +0.4% vs Sterling, +0.1% vs Yen, +0.1% vs India, and +0.1% vs China. USD fell -3.2% vs Turkey, -2.0% vs Bitcoin, -1.1% vs Russia, -0.7% vs Indonesia, and -0.4% vs Mexico. Gold -0.8%, Silver +0.5%, Oil +2.0%, Copper +0.8%, Iron Ore +4.7%, Corn +3.3%. 5y5y inflation swaps (EU -2bps at 1.57%, US -4bps at 2.37%, JP -8bps at 0.25%, and UK -2bps at 3.68%). 2yr Notes +0bps at 0.15% and 10yr Notes -10bps at 1.45%.
YTD Equity Indexes (high-to-low): Venezuela +35% priced in US dollars (+271.3% priced in bolivars), UAE +33.1% priced in dollars (+33.1% in dirham), Austria +24.4% in dollars (+26.4% in euros), Saudi Arabia +24.3% (+24.2%), Canada +21.3% (+15.5%), South Africa +20.6% (+13%), Russia +20.5% (+16.8%), Norway +20.2% (+16.9%), Hungary +19.9% (+16.2%), Sweden +19.6% (+21.5%), Taiwan +18.9% (+16.8%), Russell +18.3%, France +17.7% (+18.9%), Czech Republic +16.6% (+14.6%), Mexico +16.4% (+16.4%), Poland +16.3% (+16.1%), Netherlands +15.4% (+16.6%), Euro Stoxx 50 +14.9% (+16.2%), Belgium +14.5% (+15.7%), Argentina +14.1% (+29%), UK +14.1% (+10.4%), Italy +13.9% (+15.7%), Greece +13.2% (+14.4%), S&P 500 +13.1%, Spain +12.8% (+14%), Finland +12.8% (+14.6%), India +12.7% (+13%), Germany +12.6% (+14.4%), MSCI World +12% (+12%), Ireland +11.8% (+13%), Israel +11.2% (+12.3%), Australia +11.1% (+11%), Singapore +10.6% (+11%), Korea +10.2% (+13.1%), Brazil +9.9% (+8.8%), NASDAQ +9.2%, Thailand +8.8% (+12.9%), Switzerland +8.6% (+10.6%), Denmark +8.5% (+10.2%), HK +5.8% (+5.9%), China +5.4% (+3.4%), Chile +1.7% (+3.2%), Indonesia +0.6% (+1.9%), Japan -0.7% (+5.5%), Portugal -1.6% (-0.6%), Philippines -2.8% (-3.2%), New Zealand -5% (-4.1%), Malaysia -5.3% (-3.2%), Turkey -12.3% (-1.1%), Colombia -17.6% (-12.3%).
Drinking Games: “The extraordinary thing about what we’re living through is that the number of amplification circuits in the market, in psychology, and in the economy for inflation being brought forward is unlike anything ever seen,” said the CIO, high atop his prodigious pile. “We all know about supply chain issues. But it is so much more than that,” he said. “To think about rebuilding inventories just to a normal level, it is helpful to think about the MIT Beer Game, where even a small move in ordering patterns creates a big move in demand.”
Drinking Games II: “Not only are we trying to bring inventories back in line with demand, but we’re also learning it’s better to have some just-in-case inventory,” continued the same CIO. “And we’re all hearing about inflation so it’s better to have a bit more inventory. Plus there are so many reported shortages that we see hoarding behaviors. Bringing forward the level of working capital to satisfy demand is going to be here for more than a couple months.” Economists expect supply and demand to return to rough balance by September. “The pull-through of demand will take us into 2022.”
Drinking Games III: “Consumer demand numbers will come down. But the inventory build is still needed and given the scaring and hoarding and inflationary psychology behind it, it is going to last longer,” he explained. “Then there’s the financial market effects. Investors think inflation is coming, so the 60:40 portfolio is broken. But how do they protect against it? They buy commodities, invest in trend. It means financial demand in commodity markets extends the trends that amplify the dynamic. We bring inflation forward through financial demand for protection from inflation.”
Drinking Games IV: “The monetary/fiscal regime shift implies that fiscal policy is the impulse that matters most for demand,” he said. “It is the tool that’s being applied through the lens of the virus, which provides the excuse that we have to deploy fiscal at scale,” he added. “So when the virus is no longer an issue, and we attempt austerity, it will be when all the other amplifying forces also act in reverse. This will create tremendous volatility, But for the moment, policy, financial markets and financial processes are all amplifying the inflationary impact.”
Drinking Games V: “What happens to unit labor costs as we go through this year?” he asked. “The standard response is we can’t find enough workers and so once we pull benefits, there will be more labor, reducing upward wage pressure. But there is a path dependency to it. The effect of supply not coming back now is that the number of people quitting their jobs to find other jobs at higher wages is rising. The velocity of labor is increasing. So, we’re pricing a large part of the labor market to the marginal price of labor, which is going up now. Where does that leave us if the inflationary narrative is still here in Q4? We may find that unit labor inflation is stickier than conventional output gap analysis would suggest.”
Drinking Games VI: “We may well see that the fireworks of soaring ticket prices, TV prices, and used car prices, give way to underlying sticky phenomena that are associated with a more sustained inflation,” he said. “And the Fed will still say that inflation expectations are not becoming unanchored. Then at some point, the market will test it. We’ll get the reverse of these inflationary feedback forces. It will all work the other way for a time. Amplifying everything in the reverse direction. The 60:40 portfolio will work again for a time. We’ll get downside inflation. That will be the end of the first phase of the great inflation. It will be short lived, and we will then resume the upward path in prices. Driven by rising debts, and a series of rolling currency crises.”
Anecdote: “Feels like we’re at a historic crossroads,” said the CIO, an early venture investor in digital assets and the blockchain entrepreneurs who engineer them. “The rise of China, their deliberate advance, their vision for humanity, their disregard for human rights,” he continued. “And here, the inequality, growing division, political conflict, social clashes. We struggle to find common ground on even the most basic issues, facts.” The policy experiment now underway throughout the west would be unnecessary had we managed our affairs with wisdom, vision, discipline, integrity. “I read research from the greatest macro thinkers drawing parallels between today’s reality and the 1930s, the early 70s. The decline of Rome, the fall of empires, reserve currencies. And when I see the dysfunction of our political system, archaic regulatory frameworks that drive innovation abroad, at some intuitive level I know these risks are real,” he said. “But nothing is inevitable. And we have this technological revolution unfolding. Accelerating. I’m immersed in it all day, every day. The most creative, stunningly brilliant engineers in the world are building projects that have the potential to revolutionize virtually everything we do, and things we have only begun to imagine.” He started his journey in 2012, attending west coast bitcoin gatherings, meeting the beautiful young minds. Vitalik Buterin. Charles Hoskinson. So many others. Each boom in digital asset prices attracted more hungry, curious risk takers. Each bust shed the weak. The tenacity of those unwilling to quit created an antifragile ecosystem, unlike the legacy institutions that they sought to reinvent in ways that will create a more transparent, efficient, inclusive and just economy, society. Now he runs one of the leading early-stage digital funds. Identifying entrepreneurs, connecting them, producing extraordinary returns. “I feel that if we have the courage to embrace this change, as a society, we will experience another Renaissance. The potential is that consequential. But I just don’t know whether we have that in us anymore as a nation. And I worry that at this moment of incredible promise, we fail out of fear. Feels like the outcome is binary.”
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.