“Miami's yachts are way bigger than a few years ago,” bellowed Biggie Too in baritone. “And it’s getting crowded on the water,” he said. “All my boys say this isn’t 2008, we still got time.” Like in 2007. “But things are feeling weird to Biggie,” said Too, sliding comfortably into 3rd person, like a warm bubble bath. “We been here, seen this, like right before the pandemic, like when we all were saying this is just another SARS, MERS – like a few hundred get sick in some crowded Hong Kong block, the media gets hysterical, then it’s over,” barked Biggie Too, global chief strategist for one of Wall Street’s too-big-to-fail affairs. “But now it’s Putin on the border, and Biggie’s starting to feel like we’re all complacent. Like we think it’ll play out just fine, like it has for decades,” whispered Too. “And this rotation in equities feels like a real bear market.” And the Fed hasn’t even hiked or sold a single bond yet. “Biggie smells the kind of market that grinds, churns, until one day the bottom just falls out.”
Overall: “We are facing a blatant attempt to rewrite the rules of our international system,” said Von der Leyen. “China and Russia seek a ‘New Era’ as they say, to replace the existing international order,” continued the EU Commission Chief. “They prefer the rule of the strongest to the rule of law, intimidation instead of self-determination, coercion instead of cooperation.” The existing international order is a historical anomaly. It took a second world war to thrust humanity sufficiently deep into the darkness that we came to see the light – the first world war was insufficient. The 1944 Bretton Woods agreement between 44 allied nations marked a departure from all previous post-war accords. The US could have demanded anything it wanted in exchange for supporting our allies and winning the war. But instead, it agreed to secure global trade routes, and open America’s vast consumer market to imports from allies (even from adversaries). In exchange the US asked for allegiance, but little more. It was an utterly extraordinary display of using strength in the service of good, and in so doing, lifting us all, inspiring our better angels. The rise in human prosperity that followed Bretton Woods is unparalleled in human history. We came to accept the resulting stability as a permanent state. This encouraged entrepreneurs to optimize the economy for low latency, just-in-time delivery. It allowed our financiers to leverage balance sheets to generate the highest possible returns. The process, in all its complexity, was disinflationary. The pendulum swung from a pre-war position of low profitability and high redundancy to a recent extreme of extraordinary profitability and high fragility. Irrespective of how events unfold in Ukraine and Taiwan in the months and years ahead, that pendulum has begun its long arc back.
Week-in-Review (expressed in YoY terms): Mon: Biden/Putin call over the weekend failed to ease tensions / Ukraine ambassador to UK suggests considering abandoning NATO membership to avert war, Ukrainian pres Zelenskiy says Russia to invade on Wednesday turned out to be a “sarcastic comment”, Fed’s Bullard reiterates that hikes should be front loaded, Fed’s Daly says too abrupt and aggressive rate hikes are counterproductive, ECB’s Lagarde continues to push back against market bringing forward rate hikes, US/Canadian border crossing reopened after Canadian police removed protestors blocking bridge, HK covid cases surge, India wholesale prices 12.96% (12.7%e) / CPI 6.01% (6%e), S&P -0.4%; Tue: Russia rumored to withdraw some troops from the border (but US would not confirm evidence of this by the end of the day) / FM Lavrov is confident diplomatic efforts will succeed / Putin and Scholtz discuss energy cooperation, BOJ kept lid on 10y rates despite weakness across the curve, Japan 4Q GDP 5.4% (6%e), China 1y MLF 2.85% as exp, US PPI 9.7% (9.1%e) / Core PPI 8.3% (7.9%e), S&P +1.6%; Wed: NATO sec general says there are grounds for cautious optimism but no signs of de-escalation yet / Russia def min says more troops returning home / US Blinken says “haven’t seen any pullback yet”, Fed minutes offer little/no new information, ECB’s Kazaks says any normalization will be gradual and current market pricing is too harsh, ECB’s Villeroy says no long appropriate to keep APP open-ended after Oct, US says Russian and US war planes flew “dangerously close” to each other this past weekend, Argentina CPI 50.7% (50.8%e), China PPI 9.1% (9.5%e) / CPI 0.9% (1%e), UK CPI 5.5% (5.4%e) / RPI 7.8% (7.4%e), S. Africa CPI 5.7% as exp / Core CPI 3.5% as exp / ret sales 3.1% (2.6%e), UK house prices 10.8% (9.4%e), Canada CPI 5.1% (4.8%e), US ret sales control 4.8% MoM (1.3%e), US import price index 10.8% (10%e) / expt price index 15.1% (13.1%e), US capacity utilization 77.6% (76.8%e), Russia PPI 23.1% (25.8%e), S&P +0.1%; Thur: reports of cease-fire violations by Ukraine forces are quickly denied / Russia denied US claims that there are MORE not LESS troops along border / Russia expelled 2nd ranking American diplomat, Fed’s Mester acknowledges Ukrainian tensions as one of the risks the economy is facing, former Fed gov Rosengren suggests QT should be preferred tightening tool over rate hikes, NY judge ruled that Trump must comply with subpoenas related to fraud investigation, Canadian police threaten to arrest protestors if they don’t leave the capitol, HK announced plans to covid test the entire city among surging infections, Japan expts 9.6% (17.1%e) / impts 39.6% (37.1%e), Japan machine orders 5.1% (0.9%e), Poland PPI 17.9% (20%p), US Housing starts 1638k (1695k exp), US init claims 248k (218k exp), US philly Fed 16 (20e), S&P -2.1%; Fri: Russia Foreign Min Lavrov agreed to meet Blinken next week, Ukrainian separatist leaders order woman and children to flea to Russia urgently for fear of impending invasion, wild Polio outbreak uncovered in Malawi, Ottawa police arrest two leaders of the truck convoy, Tesla accused SEC of “unrelenting harassment of Elon Musk”, US Trade Representative added Alibaba and Tencent to its “notorious markets” list for significant levels of counterfeiting, Japan nat'l CPI 0.5% (0.6%e), US leading index -0.3% MoM (0.2%e), S&P -0.7%.
Weekly Close: S&P 500 -1.6% and VIX +0.39 at +27.75. Nikkei -2.1%, Shanghai +0.8%, Euro Stoxx -1.9%, Bovespa -0.6%, MSCI World -1.0%, and MSCI Emerging -0.7%. USD rose +9.9% vs Ethereum, +8.9% vs Bitcoin, +1.2% vs Turkey, +0.6% vs Sweden, +0.2% vs Euro, +0.2% vs Russia, and +0.1% vs Canada. USD fell -2.1% vs Brazil, -1.2% vs Mexico, -0.9% vs India, -0.8% vs Chile, -0.6% vs Australia, -0.5% vs South Africa, -0.5% vs China, -0.4% vs Yen, -0.2% vs Sterling, and -0.2% vs Indonesia. Gold +3.1%, Silver +2.6%, Oil -2.2%, Copper +0.4%, Iron Ore -4.1%, Corn +0.3%. 5y5y inflation swaps (EU -1bp at 1.75%, US -7bps at 2.34%, JP -6bps at 0.61%, and UK +3bps at 4.01%). 2yr Notes -4bps at 1.47% and 10yr Notes -1bp at 1.93%.
YTD Equity Indexes (high-to-low): Brazil +16.6% priced in US dollars (+7.7% in reais), Chile +12.3% priced in US dollars (+5.6% in pesos), Saudi Arabia +10.7% in dollars (+10.6% in riyals), Singapore +9.9% (+9.8%), Colombia +9.7% (+5.9%), South Africa +9.2% (+3.9%), UAE +7.9% (+7.9%), Thailand +7.1% (+3.4%), Greece +6.4% (+7%), Turkey +6% (+9.4%), Indonesia +3.9% (+4.7%), HK +3.9% (+4%), Philippines +3.3% (+4.2%), Argentina +3.1% (+7.1%), Czech Republic +2.8% (+0.6%), Hungary +2.3% (-1%), UK +2.1% (+1.7%), Malaysia +1.6% (+2.3%), Taiwan -0.6% (+0.1%), India -0.7% (-0.4%), Austria -1.1% (-1.2%), Mexico -1.2% (-1.9%), Spain -1.4% (-1.4%), Canada -1.8% (-1%), Israel -2% (+1%), Norway -2.1% (+0.1%), Italy -3% (-3.1%), Ireland -3.5% (-3%), China -3.6% (-4.1%), France -3.7% (-3.1%), Poland -3.9% (-5.2%), Australia -4.4% (-3%), Germany -5.2% (-5.3%), Japan -5.7% (-5.8%), Euro Stoxx 50 -5.7% (-5.2%), Venezuela -5.8% (-8.6%), Belgium -6.7% (-6.1%), Portugal -6.9% (-6.3%), MSCI World -6.9% (-6.9%), Netherlands -7.2% (-6.6%), Switzerland -7.4% (-6.7%), Korea -8.3% (-7.8%), S&P 500 -8.8%, Finland -8.8% (-8.8%), New Zealand -9% (-6.8%), Russell -10.5%, Sweden -12.5% (-9.2%), Denmark -13.2% (-13.2%), NASDAQ -13.4%, Russia -13.6% (-10.4%).
Pendulum: “If Russia invades, that means tanks and troops crossing the border of Ukraine again, then there will no longer be a Nord Stream 2,” threatened Biden a couple weeks ago. “We will bring an end to it.” The pipeline is complete but not yet operating. Gas prices are well off the highs, but still painfully firm. Shutting Nord Stream 2 would be economically painful for both Russia and Europe. “We are jointly ready, all of NATO is ready,” Biden said, unsure of the political price to win an economic war with Russia, while his ratings sink, as inflation rises.
Pendulum II: Over 90% of the world’s most sophisticated microprocessors are produced by Taiwan Semiconductor Manufacturing Company (TSM). While all sorts of design work happens in the US and Europe. Nearly all the manufacturing is done on a heavily fortified island just off the coast of China. It would take a nation/company an estimated tech spend of $30bln a year for a minimum of 5yrs to have any reasonable chance of success in catching up with TSMC. Naturally, we have started to see that. It is only the beginning, as the pendulum swings back.
Pendulum III: “I’ve been doing this for 30yrs and never seen markets like this,” said Goldman’s Jeff Currie, in a recent interview. “This is a molecule crisis. We’re out of everything, I don’t care if it’s oil, gas, coal, copper, aluminum, you name it we’re out of it,” continued the bank’s head of commodities. High commodity prices cure high commodity prices as both demand and supply adjust. But we’re used to this dynamic in a post Bretton Woods world. What we do not yet know, is how this process will unfold as the pendulum swings back toward creating higher redundancy.
Pain: Exchanging low profitability and high redundancy for extraordinary profitability and just-in-time delivery is a pleasurable process. The cost, of course, is high economic fragility. And therefore, the return to greater redundancy will result in pain. After decades of pleasure, the prospect of incurring real pain to achieve our economic and political objectives seems hard to fathom. And that is why so few people believe that the US and Europe will be willing to impose crushing economic consequences on Russia or China, in a world with already high inflation.
Pain II: The same thinking applies to the Fed. No credible economist believes the Fed would willingly drive the US into a deep recession to return inflation to target. Even those who call for another Paul Volcker, don’t see political appetite. And this means we are left to simply hope inflation naturally subsides with the help of a little economic softness. Even then, in a world with a pendulum swinging back toward greater redundancy, no one knows how sensitive inflation will be to economic weakness. Putin and Xi know this too. Which makes this time so dangerous.
Anecdote: “This is many years in the making, decades,” said the CIO, an extraordinary strategic thinker I respect deeply. “The forces now in play are self-reinforcing, trending toward an extreme event.” Los Angeles sprawled before us, beyond it, the Pacific, a hazy blue, timeless. “There is a bloodlust that is brewing within the mob, and these things are ultimately satisfied, you see it repeatedly though history.” Far north, Canadian protests endured, a reflection of some deep frustration, conflict brewing within. “For all our posturing, the US has in substance abandoned the rule of law in the sense that virtually no one still believes that laws apply evenly. The rich and powerful are above the law, everyone knows. We don’t even really pretend anymore. We see it in politics most clearly, but business too. And when a society passes this point, it trends toward a state of each for himself, take what you can. Smash and grab. It’s nihilistic,” he said. “Dalio writes that there is a 50:50 chance of civil war in the US. He’s wrong. The odds are 90:10.” I remained quiet, more interested in listening than debating. In periods of great change, it is vital to consider many possible futures. “There were 600k Jews in pre-war Germany. Hitler killed 250k. The other 350k left, the greatest scientists amongst them.” Einstein was one. “The US will become the most dangerous developed nation in the decade or two ahead. Blood will be let. And it is unclear what form that will take, but these sorts of cycles do not reverse without a climax. You should be positioned to be a leaver.” And I smiled, laughed. Not at the subject matter, but at myself. “You know me, I’m a stayer, for better or worse, it’s my nature,” I said. “And my oldest two kids have chosen military academies, committed to service. Our country needs a new generation of principled leaders. I hope we can all play a part,” I said, optimistic but unsettled. “These things run their course,” he said. “You must be prepared to leave and know there will be a time to return.”
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.