The United Arab Emirates has the world’s best performing equity market this year (+52.8% year-to-date, priced in US dollars). Russia has the second-best performing market (+33.6% priced in US dollars). Saudi Arabia is third (+33.5% in dollars). All three have a lot of oil, the consumption of which quite obviously contributes to climate change. Public companies throughout the developed world, and the stewards of private and public capital that fund investment, have raced to divest from firms that extract hydrocarbons. And while a growing majority of the world sees climate change as an existential threat, the markets do what they are built to do.
Overall: “It would be catastrophic to not pay the government’s bills,” warned Yellen. No doubt. But the probability of sustained default is negligible because the constraint our politicians place on the national debt is arbitrary. In a fiat currency system, neither money nor government debt are real. They are illusions, mass delusions. This allows politicians to periodically bring the nation to the imaginary brink, point the cameras into a fictitious abyss, and then rescue us from a crisis of their own creation – all with the stroke of a pen. Markets barely budge in response to such silliness. They move on matters of consequence. As a rule, any problem that can be solved with a little ink is no problem at all – the world’s consequential issues cannot be remedied so. An undereducated person cannot become a highly productive, well-informed voter overnight. An impoverished community cannot become prosperous after a late-night negotiation. A depleted ocean cannot teem with fish upon congressional order. Such projects take decades, generations. The forces that produced Earth’s catastrophic 6th mass extinction will not be turned on a dime. Quite the contrary. And as humanity takes its first tentative steps on a century-long journey to temper our environmental impact, we are getting an early glimpse of the real consequences, reflected in markets. Underinvestment in fossil fuel production will naturally lead to energy shortages unless the transition to renewables provides a perfect offset. In a world economy that is as highly optimized as it is heavily subsidized, smooth transitions require enlightened leadership, public/private partnerships, international solidarity, and near flawless coordination. On a planet shared by 7.9bln individuals and 195 nations not known for selflessness and cooperation in times of great stress, the probability of extreme outcomes is thus rising. Naturally, technology and temperance provide the only way out.
Week-in-Review (expressed in YoY terms): Mon: Facebook suffered worst outage since 2008, Facebook accused by whistleblower of amplifying hateful content and fostering unhealthy online behavior by teens, Biden administration sustains tariffs after US finds China not in compliance with Phase 1 of Trump’s trade deal, China sends 50 planes into Taiwan airspace, NZ extends Auckland shut down but hints at transition away from the zero policy strategy, Golden week in China, Evergrande Group has suspended share trading as the developer is selling its property services unit to raise much-needed cash, another Chinese real estate developer (Fantasia) missed $205m bond repayment, OPEC disappoints hopes for larger scheduled output hike, Swiss CPI 0.9% (1.1%e) / ret sales 0.5% (-2.3%p), Turkey CPI 19.58% (19.65%e) / Core CPI 16.98% (16.62%e) / PPI 43.96% (44.65%e), EU Investor confidence 16.9 (18.6e), S&P -1.3%; Tue: RBA unch as expected – remains dovish, UK holds talks with the Taliban, EU PPI 13.4% (13.5%e), S&P +1.1%; Wed: RBNZ hiked 25bps as exp, Polish CB hiked 40bps when unch was exp, Biden reiterated his commitment to the one-China policy / Taiwan defense minister says China relations are worst in 40y, German factory orders 11.7% (16.4%e), Russia CPI 7.4% (7.3%e), US ADP emp 568k (430k exp), S&P +0.4%; Thur: US lawmakers strike short term debt ceiling deal, Tesla announces moving headquarters to Texas (from CA), Russia pledges to help alleviate global gas crunch, US energy secretary says US ready to release emergency oil reserves, ECB studying a new bond-buying program after PEPP ends next year, Mexico CPI 6% as exp, US init claims 326k (348k exp), S&P +0.8%; Fri: US NFP 194k (500k exp) / private payrolls 317k (450k exp) / unemp rate 4.8% (5.1%e) / AHE 4.6% as exp / Labor force participation 61.6% (61.8%e), Polish court challenged the supremacy of EU law over national legislation, RBI unch as exp, China told US to cut military ties with Taiwan after reports that US Marines were training Taiwanese soldiers how to defend an attack from mainland China, Chinese ordered coal miners to boost production to combat rising global energy prices, Peru CB hiked 50bps as exp, Japan household spending -3% (-1.2%e), Brazil IPCA infl 10.25% (10.34%e), Canada chg in emp 157.1k (60k exp) / unemp 6.9% as exp, S&P -0.2%.
Manufacturing PMI (high-to-low): Switzerland 68.1 (previous month 67.7), Sweden 64.6 (previous 60.1), Austria 62.8 (previous 61.8), Netherlands 62/65.8, US 61.1/59.9, Italy 59.7/60.9, Norway 59.21/61.7, Germany 58.4/62.6, Greece 58.4/59.3, Spain 58.1/59.5, Czech Republic 58/61, UK 57.1/60.3, Canada 57/57.2, France 55/57.5, Taiwan 54.7/58.5, Brazil 54.4/53.6, India 53.7/52.3, Poland 53.4/56, Turkey 52.5/54.1, South Korea 52.4/51.2, Indonesia 52.2/43.7, Hungary 52.1/55.6, Hong Kong 51.7/53.3, Japan 51.5/52.7, Singapore 50.8/50.9, South Africa 50.7/49.9, China 50/49.2, Russia 49.8/46.5, Mexico 48.6/47.1, and Vietnam 40.2/40.2. Services PMI: Sweden 69.6/65.1, Ireland 63.7/63.7, Spain 56.9/60.1, Germany 56.2/60.8, France 56.2/56.3, Italy 55.5/58, UK 55.4/55, India 55.2/56.7, US 54.9/55.1, Brazil 54.6/55.1, China 53.4/46.7, Russia 50.5/49.3, Japan 47.8/42.9, and Australia 45.7/45.6.
Weekly Close: S&P 500 +0.8% and VIX -2.38 at +18.77. Nikkei -2.5%, Shanghai +0.7%, Euro Stoxx +1.0%, Bovespa -0.1%, MSCI World +0.8%, and MSCI Emerging +0.5%. USD rose +2.7% vs Chile, +2.7% vs Brazil, +1.2% vs Turkey, +1.2% vs Mexico, +1.2% vs India, +1.1% vs Yen, +0.3% vs South Africa, and +0.2% vs Euro. USD fell -13.5% vs Bitcoin, -11.6% vs Ethereum, -1.4% vs Canada, -1.3% vs Russia, -0.7% vs Australia, -0.6% vs Indonesia, -0.5% vs Sterling, -0.1% vs Sweden, and flat vs China. Gold -0.2%, Silver +0.5%, Oil +5.1%, Copper +1.7%, Iron Ore +1.8%, Corn -2.2%. 5y5y inflation swaps (EU +1bp at 1.81%, US +12bps at 2.58%, JP +11bps at 0.35%, and UK +12bps at 3.93%). 2yr Notes +6bps at 0.32% and 10yr Notes +15bps at 1.61%.
YTD Equity Indexes (high-to-low): UAE +52.8% priced in US dollars (+52.8% priced in dirham), Russia +33.6% priced in US dollars (+28.9% in rubles), Saudi Arabia +33.5% in dollars (+33.4% in riyal), Czech Republic +29% (+33%), Argentina +28.8% (+51.4%), Austria +24.9% (+32.7%), India +24.4% (+28%), Hungary +22.2% (+28.3%), Norway +21.3% (+20.8%), Poland +20.1% (+28.6%), Canada +19.8% (+17.1%), Israel +18.1% (+18.5%), Netherlands +16.9% (+23.6%), S&P 500 +16.9%, Venezuela +16.9% (+327.9%), MSCI World +13.3% (+13.3%), NASDAQ +13.1%, Russell +13.1%, Taiwan +13% (+13%), Sweden +12% (+19.5%), France +11.8% (+18.2%), Mexico +11.6% (+16%), Italy +10.3% (+17.2%), UK +9.6% (+9.8%), Denmark +9.4% (+16.3%), Euro Stoxx 50 +8.5% (+14.7%), Belgium +8.3% (+14.5%), Ireland +8% (+14.2%), Finland +7.9% (+14.6%), Indonesia +7% (+8.4%), Singapore +6.7% (+9.5%), South Africa +6.3% (+8.2%), Australia +5.5% (+11.1%), Spain +4.9% (+10.9%), China +4.8% (+3.4%), Switzerland +4.6% (+9.9%), Greece +4.4% (+10.3%), Germany +4.3% (+10.8%), Portugal +0.2% (+5.9%), Thailand -0.1% (+13.1%), New Zealand -3.7% (0%), Japan -5.9% (+2.2%), Korea -6.3% (+2.9%), Malaysia -7.5% (-3.9%), Philippines -8.2% (-3.3%), HK -9.1% (-8.8%), Brazil -11.4% (-5.2%), Colombia -11.4% (-2.6%), Chile -14.4% (-0.8%), Turkey -21.5% (-5.3%).
Stop: Peel back every great trade and you will discover a gigantic stop-loss. Some are more obvious than others of course. The $1bln that Soros made in 1992 by betting against the British pound required the Bank of England to trigger its own stop-loss. As humiliating as it was at the time, the BOE’s defeat unshackled the UK from an exchange rate mechanism (ERM) that was suffocating its economy for no good reason. And that is the beauty of free markets. They push us toward sensible policies that can withstand assault by those who dare bet against them.
Stop II: Paulson’s trade in 2008 required the government to step aside and allow a cascade of stop-losses across the financial sector. The magnitude of leverage and corruption that fueled the housing bubble was so extraordinary that the cost of subsidizing a continuation of the status quo exceeded the price of picking up the pieces after its collapse. Whether the government could have better buffered the effects of the disorderly stop-loss or not is beside the point. The market did what it was built to do and cleansed the system to the extent that it was allowed.
Stop III: Late on the afternoon in February 2018, the VIX index exploded higher for no particularly good reason other than the fact that a number of exchange-traded and structured financial products would suffer catastrophic losses if it did. Had the size of those products been far smaller, the market would have had insufficient energy to generate a move of the magnitude required to destroy them. But that is how markets work. They build energy as a major participant(s) grows weaker and stumbles. The dynamic is Darwinian.
Stop IV: Beijing triggered a stop-loss, ordering China’s energy companies to “do whatever it takes” to secure fuel supplies. Prices had been surging with natural gas up over 5x in a year. Efforts to reduce CO2 emissions, a shift away from coal, along with myriad complexities in global supply chains conspired to produce electricity shortages. This hampered Chinese industrial production. Winter is not yet upon us. And half a world away, Lebanon’s national grid completely stopped and is unlikely to restart for days. It has run out of fuel to run its generators.
Anecdote: “Always buy ahead of buy orders,” he said on my first day. I’d started my career in the corn pit because old-timers said I’d lose money less quickly there. “Sell in front of sell orders,” he said. Made sense. If brokers held large orders to sell corn at $2.50 per bushel and a buy order entered the pit, I’d fight to sell at $2.50. If prices subsequently dropped, I’d make money, and if they pressed higher, I’d cover my short with the brokers and break even. “But what you really want to know is where big stops are,” he said. When prices rose toward large buy-stops, you would get long knowing that if the stop triggered, brokers would be forced to pay any price. You’d sell your longs to them for a big profit. The same principles held true for sell-stops. Naturally, investors defended their stops from being triggered. Shorts would sell even more as prices approached their buy-stop, hoping to pressure the market lower. Sometimes their defense succeeded, prices fell, and for those of us who had bought hoping prices would surge higher, we had to puke into a market without buyers. In the most basic sense, that’s what pit trading (now called market making) has always been about. Through this mechanism, prices move up and down - triggering stops, inflicting pain on those who can least bear it, concentrating capital in those with the greatest skill - gravitating toward some underlying economic reality, which itself is always evolving. But that is not simply how the pit works. This is how the world operates. It is how we come to terms with our mistakes, like Europe’s ERM in the 1990s and the housing fiasco in the 2000s. Now we are grappling with how to mitigate climate change. The profound adjustments required will apportion historically unprecedented costs and benefits unequally across competing regions, nations, industries, individuals. Global markets will highlight systemic pressures, policy successes, failures. Helping us identify where to focus resources to enhance prosperity and forestall conflict. All of which is a pleasant way of saying that markets will do what they are built for - hunting the weak, ferociously, mercilessly, delivering to us prices that best reflect reality.
Good luck out there,
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, 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.