Helicopters buzz the football stadium; bank hard then climb. Paratroopers jump, descend, circling, landing in succession, midfield. 4,500 cadets pack the stands, camouflage, mayhem. National anthem, hats off, hands to hearts, cannons, kick off. To my left is a graduate, Class of 1970. All around us are veterans, season ticket holders. At halftime a POW is honored, pilot, war hero, 1,000+ days in the Hanoi Hilton, notorious North Vietnam prison, tortured, unbroken. He salutes the cadets, holds their gaze, fighting back tears, their cheers, a standing ovation, longest I’ve ever known. Authentic, raw, real. Liv surprises us in the 3rd quarter, marches up the stands, radiant, full fatigues, boots, green cap. Mara bursts into tears, holds our girl tight, won’t let go, me too. Life’s latest chapter.
Overall: “Yen moves have been quite rapid over the past few days,” Japan’s Finance Minister told reporters. “If we were to step in, we will do so swiftly without any interruption,” continued Suzuki, threatening to sell US dollars and buy the Yen. He wasn’t the only Japanese public servant to muscle markets. BOJ central bankers created Yen with the click of a mouse and purchased Japanese government bonds to prevent their prices from falling. This prevented yields from rising, which made the bonds less attractive, resulting in Japan’s utterly awful 25yr JGB auction. You see, when governments hold interest rates artificially low, their currencies weaken, which lifts inflation, and this makes bonds even less attractive if yields are not allowed to rise. Such interventions are therefore unsustainable. And yet, governments engage in such action, hoping temporary support can turn the tide. It most often works. Just not always. And it is during those exceptional cases that the biggest market movements occur. “Our nation’s rail system is the backbone of our supply chain,” said Biden, announcing a tentative deal to avert a rail worker strike. “It’s hard to realize this but everything from clean water to food to gas - every good that you need seems to end on a rail getting delivered to where it needs to go,” explained America’s president, justifying a 24% pay increase to the unionized workers, delivered over 5yrs, benefits boost too. This, of course, is all part of the mega macro trend of restoring balance to the distribution of economic spoils between capital and labor. It will surely inspire higher wages across the US economy. Lifting domestic inflation. Which will pressure America’s public servants to raise interest rates higher still, boosting the dollar against currencies like the Japanese Yen, further complicating Tokyo’s efforts to manipulate their markets. Which they’ll surely continue to do, knowing that it most often works. Just not always.
One River Digital’s Deputy CIO, Marcel Kasumovich, and Mathias Nwokejiobi, Research, published a piece on The Pulse: One River Digital’s systematic snapshot of the digital ecosystem’s fundamental health. We translate on-chain data on more than seventy assets into the health of digital assets with a single number – The Pulse. The Pulse suggests that the worst of the fundamental downdraft is behind us. For a peek [click here].
Week-in-Review (expressed in YoY terms): Mon: Ukraine retakes Russian occupied territories in Kharkiv region – major successful offensive / Russia hit power plants deep behind Ukrainian lines causing blackouts / contingent of prominent Russian war hawks calling for removal of Putin, EU draft energy plan includes mandatory power cuts, China’s Yibin City (4m people) locked down, Fed’s Waller says Fed can hike aggressively until unemp greater than 5%, Sweden right wing bloc wins majority seats – unseating PM Anderssson’s left block, ECB’s Nagel says further clear steps must follow, Iran deal hopes fading, Japan Machine Tool orders 10.7% (5.5%p), Denmark CPI 8.9% (9.4%e), S&P +1.1%; Tue: US CPI 8.3% (8.1%e) / Core CPI 6.3% (6.1%e) / Shelter strong support / S&P has worst day since June 2020, US may buy oil below $80 to rebuild SPR, Scholtz says Germany will be able to import all necessary gas via LNG by end 2023, ECB’s Simkus sees at least 50bp hike in Oct, US / the West reportedly in early stage talks on sanctions aimed at deterring China from invading Taiwan / Taiwan pushing EU to prepare potential sanction package against China, NZ house sales -18.3% (-36.7%p), Japan PPI 9% (8.9%e), Germany ZEW -61.9 (-59.5e), US NFIB 91.8 (90.8e), S&P -4.3%; Wed: BOJ conducts “rate check” – preparing for FX intervention, EU’s Von der Leyen targets EU 140b from windfall taxes on energy companies / Russian sanctions are here to stay – disappoints markets expectations, some China state run banks said to be cutting deposit rates (1st such cuts since 2015), China sets yuan rate with the strongest bias ever, ECB’s Holzmann says CPI likely to accelerate even more / ECB’s Lane expects rates to rise further due to stubborn infl, Chengdu lockdown begins easing, Japan core machine orders 12.8% (6.6%e), UK RPI 12.3% as exp / CPI 9.9% (10%e) / Core CPI 6.3% (6.2%e), Sweden CPIF 9% (8.8%e) / Core CPIF 6.8% (6.9%e), India Wholesale prices 12.41% (13%e), HK PPI 0.8% (2.3%e), US PPI 8.7% (8.8%e) / Core PPI 7.3% (7%e), S&P +0.3%; Thur: Biden announces tentative railway labor agreement, Fedex misses earnings due to weak global demand, ETH survives the Merge, PBOC kept 1y mlf unch as exp, US senate passed $6.5b bill to fund weapons and other support to Taiwan, Yuan breaks above key psychological level of 7.00, Japan and EU trade deficits worsen due to energy shock by more than exp, Putin tells Xi he understands China concerns over the Ukraine war, Argentina CPI 78.5% (78.2%e), Japan expts 22.1% (24.1%e) / impts 49.9% (46.9%e), Australia infl exp 5.4% (5.9%p), Australia emp change 33.5k (35k exp) / unemp 3.5% (3.4%e), Turkey home sales -12.7% (-12.9%p), EU trade bal -40.3b (-32b exp), US init claims 213k (227k exp), US emp mfg -1.5 (-12.9e), US philly fed outlook -9.9 (2.3e), US ret sales 0% (0.5%e), US impt prices 7.8% (7.7%e), US IP -0.2% MoM (0%e), US business inv 0.6% as exp, S&P -1.1%; Fri: Germany econ min announces that Rosneft’s German refinery unit is now under German control, China imposes sanctions on CEOs of US defense companies for arm sales to Taiwan, ECB’s Nagel says will continue to raise rates to tame infl, huge oil spill in Iraq will take over a week to contain, Russia CB cut by 50bp as exp, China IP 4.2% (3.8%e) / ret sales 5.4% (3.3%e) / unemp 5.3% (5.4%e), UK ret sales -5.4% (-3.7%e) / core ret sales -5% (-3.5%e), EU final CPI 9.1% as exp / Core CPI 4.3% as exp, US UofM 59.5 (60e) / 1y infl exp 4.6% as exp / 5-10y infl exp 2.8% (2.9%e), S&P -0.7%.
Weekly Close: S&P 500 -4.8% and VIX +3.51 at +26.30. Nikkei -2.3%, Shanghai -4.2%, Euro Stoxx -2.9%, Bovespa -2.7%, MSCI World -4.2%, and MSCI Emerging -2.7%. USD rose +19.1% vs Ethereum, +7.0% vs Bitcoin, +2.0% vs Brazil, +1.9% vs Australia, +1.8% vs Canada, +1.8% vs South Africa, +1.6% vs Chile, +1.5% vs Sterling, +1.1% vs Sweden, +0.9% vs China, +0.8% vs Indonesia, +0.7% vs Mexico, +0.3% vs Yen, +0.3% vs Euro, +0.2% vs India, and +0.2% vs Turkey. USD fell -0.7% vs Russia. Gold -2.6%, Silver +3.3%, Oil -1.9%, Copper -1.4%, Iron Ore -0.2%, Corn -1.1%. 5y5y inflation swaps (EU +3bps at 2.21%, US -2bps at 2.50%, JP flat at 0.97%, and UK -9bps at 3.81%). 2yr Notes +31bps at 3.87% and 10yr Notes +14bps at 3.45%.
YTD Equity Indexes (high-to-low): Turkey +31.7% priced in US dollars (+81.8% priced in lira), Argentina +25% priced in US dollars (+74.5% priced in pesos), UAE +20.2% priced in dollars (+20.2% in dirham), Chile +18.2% (+28.2%), Brazil +9.6% (+4.3%), Saudi Arabia +4.8% (+4.9%), Indonesia +3.8% (+8.9%), Singapore +0.2% (+4.6%), Portugal -2.4% (+11.1%), India -5.6% (+1%), Mexico -10.4% (-12.2%), Thailand -11.2% (-1.6%), Israel -11.8% (-2.4%), Norway -12.8% (+1.3%), Canada -13% (-8.7%), Malaysia -14.2% (-6.4%), Venezuela -16.5% (+45.7%), Australia -16.7% (-9.5%), UK -17.5% (-2%), Greece -17.7% (-6.4%), Philippines -18.1% (-8.1%), S&P 500 -18.7%, Spain -19% (-8.4%), South Africa -19.3% (-10.5%), Russell -19.9%, HK -20.3% (-19.8%), MSCI World -20.5% priced in dollars, Russia -21.1% (-35.7%), Colombia -21.4% (-14.3%), China -21.9% (-14.1%), Switzerland -21.9% (-17.6%), New Zealand -22.5% (-11.2%), Japan -22.9% (-4.3%), Czech Republic -23.3% (-14.4%), Denmark -24.7% (-14.8%), France -25.3% (-15%), Belgium -26.7% (-16.7%), Netherlands -26.8% (-16.7%), NASDAQ -26.8%, Euro Stoxx 50 -28.4% (-18.6%), Italy -28.5% (-19.1%), Finland -28.7% (-19.4%), Germany -29.1% (-19.8%), Ireland -29.4% (-19.7%), Taiwan -29.5% (-20.1%), Korea -31.2% (-20%), Austria -33.2% (-24.5%), Sweden -34.7% (-22.2%), Hungary -36.3% (-21%), Poland -38.8% (-28.8%).
Standing Desks: “The question I get most is whether this is like the 1970s,” said Lindsay Politi, our inflation portfolio manager. We were discussing the phase of quantum change that has arrived and will unfold in the coming decade(s). “I’ve been batting around an answer to this. The short answer is only in the most superficial ways and the longer answer is a book,” she said. I naturally prefer well written books to short answers. But when writing, I keep word count tight as a core discipline. So this short note captures key highlights from our discussions this week.
Standing Desks II: “Except for the fact that inflation is high and increasing, and other than the similarities that come from that, this new period is very different, far worse in many ways than the 1970s,” said Lindsay. “The broadest point is that the world is moving from an industrial revolution economy to an information revolution economy.” We’ll discuss that later. “But there are massive additional factors underlying this transition,” she said. “Specifically, there are four lesser points that are part of this industrial/information transition. But ‘lesser’ somehow seems wrong given their impact.”
Lesser Points I: “Climate change is happening,” said Lindsay, explaining the first of four lesser points impacting the great transition. “Rivers that defined national economies for centuries are drying up, our best farmlands are becoming infertile, and devastating weather events are now seen as normal.” Investors try to ignore this because it’s hard to analyze. “There are no good analogs, this is a once-in-human-history event. The extent of the impact is hard to process but this much is now obvious: we face a reliably predictable series of unpriced inflationary shocks.”
Lesser Points II: “No previous inflationary period was preceded by $30trln of quantitative easing,” said Lindsay, identifying the second lesser point. “14yrs of QE, by design, manipulated market pricing of inflation risk, flattening yield curves, lowering yields, forcing them negative.” These rates were embedded in all global financial asset prices. “Markets and central banks weren’t just surprised by inflation, they were surprised at a moment when they were, by design, more vulnerable to that surprise than at any point in recorded financial history.”
Lesser Points III: “The 2nd most common question I get is whether an aging population means we’ll have deflation like Japan,” said Lindsay, flagging the 3rd lesser point. “Like the 1970s, it’s risky to take one discrete example and use it as a template for anything at all similar. In a broader context, increasing populations are a consequence of industrialization.” Global population was roughly unchanged from 10,000 BCE until around 1750 AD when it slowly then rapidly started to increase. “Now the global population appears to be stabilizing again. In an industrial capitalist world view this is negative because success is selling more and more widgets to more and more people, and flat or declining populations makes this harder. Maybe this isn’t a negative but another, arguably positive, symptom of a much bigger transition.”
Lesser Points IV: “Investors make geopolitical assumptions based on fairly recent history,” explained Lindsay. “A common one is that the US hegemony gives way to Chinese hegemony. Perhaps. But just like the industrial age led a broad transition from monarchy to democracy, could we be on the cusp of an entirely different type of government?” What does citizenship or nationality mean when people can live and work anywhere? “Is it more likely the renminbi replaces the dollar as the reserve currency or that we use a nationless means of exchange like cryptocurrency? Certainly, we see some nations and groups trying - often violently - to hold onto power but this seems more like last gasp attempts to turn the tide than real shows of strength.”
(In)stability: “There’s an assumption that this transition will be disinflationary, but I really don’t think that’s right,” said Lindsay. “Most big transitions are inflationary with a lot of volatility and relative instability. In general, predictability, stability, peace, cooperation, etc. are disinflationary for goods prices and inflationary for asset prices. Instability, less confidence about the future, more combative markets/governments all add extra costs that translate into higher goods prices and lower asset prices,” she said. “Not all transitions are inflationary but transitions that will require a significant rerating of existing capital because of its obsolescence, transitions that create scarcity, transitions that shift power dynamics; those tend to be inflationary.”
Anecdote: “The problems we’re facing, to the extent they’re actually problems, are because the industrial age is ending,” said Lindsay Politi, our inflation portfolio manager, brilliant. “Check out this chart,” she said, early morning, awaiting CPI, standing desks, our screens aglow, pointing to an S-curve that tracked World GDP per capita from 1mm years ago to present. “Brad DeLong, one of my favorite economic historians, published this chart and what you see is that growth basically flatlined through human history until the industrial revolution. Then went parabolic. Now it’s leveling out again,” she said, tracing that S-curve with her finger on the monitor. “Economic philosophers who lived in that inflection period didn’t really know what to make of it.” Malthus observed that throughout the course of human history bouts of economic growth ended in collapse, not understanding the profound change industrial productivity created. Marx understood some failings of capitalism – the drive towards excess and resulting gluts that we now call recessions, and the tendency for labor to be undervalued relative to capital. He also couldn’t have understood how dramatically standards of livings would rise for all people. “Just like Malthus and Marx were struggling to understand the dramatic economic changes they were confronting, we’re also struggling to come to terms with the transition from the industrialized age to the information age,” said Lindsay. “In the context of this S-curve, the folly of quantitative easing becomes clearer.” Central bankers were trying in vain to escape the reality of the flattening inflection in this growth curve. “Capitalism broadly is poorly suited for an information economy. Capitalism is about maximizing the production of widgets and it is very good at that.” Over the course of a few generations, we have gone from people living in extreme scarcity to the point where industries now create storage spaces for the many things we own and buy.” This need for constant manufacturing of new things is literally killing us via climate change. “In the information age, ideas are not widgets. It’s not quantity that matters but quality. And almost everything we know about what creates quality ideas is the opposite of what drives people to create more widgets,” said Lindsay, and I considered my long walks in nature, hours of contemplation, triangulating information, free association, hunting for questions, ideas, answers, away from screens, the factory floor, soul destroying production lines. “The system will necessarily change. I have lots of ideas about where we might be going but I think the main idea is that looking to the past for an understanding of the future will be as fruitless today as it was for Marx and Malthus,” she said. “And along with that, expecting there to be limits on things like inflation or price movements because they existed in the past will also prove to be very wrong.”
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, 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.