Pro Perspectives 2/28/22

March 1, 2022

Oil broke above $100 today (trading as high as $106).  No surprise, the last time oil was here was 2014, a few months into the last Ukraine/ Russia conflict.
 
What's different this time?  The global economy is running about a percentage point hotter than it was in 2014.  And today global demand is outstripping supply for six straight quarters. 
 
Back in 2014, a large increase in global oil production was driven by a surprisingly strong and growing U.S. shale industry.  So, back then at $110 oil, supply was growing.  Today, it's shrinking, driven by global anti-oil policy. 
 
Bottom line:  While the price looks familiar, the supply/demand dynamic has been flipped on its head.  We should expect much higher prices.
 
That brings us to the mid-March Fed meeting.  What's the most scrutinized data point for the Fed?  Inflation expectations.  And what feeds into inflation expectations, like no other?  Gas prices. 
 
So the Fed will be facing another gut punch to the price pressure problem, while also facing uncertainty about economic shocks that could come from the growing conflict in eastern Europe.  We have a higher prices and potential slowing growth scenario.   
 
What will the Fed NOT do, in this environment?  Surprise markets. The market is already pricing in a quarter point rate hike– which will officially end the pandemic induced "emergency policies."  Jay Powell will testify before Congress tomorrow and Thursday, and will likely set the table for this outcome. 
 
But the Fed's job to tame inflation will likely get a lot harder (if that's possible).  Tonight, Biden's State of the Union will be a platform to pitch Build Back Better to the country, rebranded as an "economic relief" package (addressing rising "costs").
 
As I said in my Feb 24th note, the day Russia invaded Ukraine:  "if economic disruptions unfold, we can be sure that the democrat-led Congress will quickly resurrect the 'Build Back Better' plan to be rubber-stamped."  Adding a few trillion dollars in new fiscal spending as the medicine for the hottest inflation we've seen in forty years.  Hmm.  

Pro Perspectives 2/28/22

February 28, 2022

Let's take a look at the fireworks in Russian financial markets today …
 
Below is a chart of the U.S. dollar vs. the Russian ruble.  This is conventional way in it's quoted in the foreign exchange market (rubles per dollar).  The orange line rising represents appreciation in the dollar/depreciation in the ruble. 

Now, the white boxes in this chart above represent the start/end of the Russia/Ukraine conflict in 2014, and the start (November) of the latest conflict, to present, in the far right box.  
 
Observation:  If we look back at 2014, when Russia ultimately annexed Crimea, the damage to the Ruble was worse — about twice as bad as the current case (thus far).  But it's early.
 
When the currency is collapsing (from a combination of capital flight and speculation), the central bank has to step in and become the buyer of last resort (defend the currency).  But to buy rubles, the Central Bank of Russia has to exchange foreign currency, from their reserves.   This is where it becomes dangerous for Russia.  When the central bank is selling dollars and buying its own currency all day, every day to fend off speculators it can quickly bleed the country's currency reserves (a component of the country's global net worth). 
With the above in mind, Russia ratcheted up short term interest rates today from 8.5% to 20%!  
 
For any speculators now trying to short the ruble, they now have to pay an overnight interest rate of 20%.  That will end a speculative rout quickly.  That's precisely what the Bank of Thailand did to George Soros back in the late 90s, when he was trying to force a devaluation of the Thai baht.  They chased him away by spiking the overnight interest rate. But they ultimately did give way to a big currency devaluation.
 
Thus far, the Russian central bank comes into this crisis with a larger war chest of foreign currency reserves (as you can see in the above chart) … and a customer, in China, that will probably be happy to buy all of the oil Russia will sell them (if the West were to go farther down the road of sanctions). 
 
So, this confrontation building between Russia and the West probably won't be short-lived. 

Pro Perspectives 2/25/22

February 25, 2022

There has been plenty of attention given to Russia/Ukraine, and the swings in stocks over the past week.
 
Let's end the week with some perspective on global markets and asset prices, as we approach the Fed's official end of emergency policies  (just weeks away). 
 

In the graphic above, you can see commodity prices continue to rise.  This is consistent with an inflationary environment, where the Fed has intentionally left themselves behind the curve, to let prices run hot.
 
But there is more to it.  This a longer-term secular trend underway — a repricing underway of real assets, relative to financial assets. 
 
As we've discussed over the past few years, commodity prices have been at historically cheap levels, relative to stocks.  In fact, only two other times on record, have commodities this cheap: 1) at the depths of the Great Depression in the early 30s, and 2) in the early 70s (which was at the end of the Bretton Woods currency system).
 
Commodities prices went on a tear both times.
 
The last time commodities were this cheap, relative to stocks, a broad basket of commodities returned 50% annualized for the next four years – up seven-fold over 10 years. 
 
Remember, we've looked at this chart many times …
Along with the deflationary forces of the post-financial crisis, commodities prices were flashing depression-like signals.  We may not have recognized it so easily, given the buffer of trillions of dollars of central bank intervention (which manufactured sluggish growth).
 
Now, we have a massive government spending response (fiscal), inflation, a boom in commodities, and likely the early-stages of an aggressive economic expansion (finally).  With that, the new bull trend in this chart above is in the early stages.
 
Consider this:  Our Billionaire's Portfolio has 35% exposure to commodities-related stocks – and another 10% in asset heavy/ infrastructure related stocks.  And in the face of this recent stock market decline, our portfolio is up on the year.   It's a stock-picking market now (sectors matter, value matters, catalysts matter). 

Pro Perspectives 2/24/22

February 24, 2022

As we discussed yesterday, markets don't like confusion.  Will Russia invade?  Is it an invasion, or isn't it?  Will there be a bigger, more draconian response from the West, or is it mostly tough talk?
 
Now we have some answers.  Invasion:  check.  Tougher response:  no.
 
With that, we get two triggers for buying stocks today:  1) some clarity, and 2) the potential for a slower exit of global emergency monetary policies.
 
On the latter, the events of the past 24 hours have the market now locked in on just a quarter point rate hike, to come from the Fed next month — instead of half a point.  And in Europe, members of the European Central Bank were suggesting today that the Ukraine conflict may delay an exit from the pandemic-induced stimulus policies.
 
So, markets like a more cautious path on rates, especially if the risks of economic disruption are rising.  On that note, don't underestimate the appetite for politicians to leverage crisis.  This should be no secret to anyone that has paid attention over the past two years.
 
As of early this morning, we're already hearing talk about cyber attack threats.  On the one hand, the Biden administration has warned of cyber attack risks to U.S. banks and utilities, and on the other hand, the administration seems happy to stoke these threats, by publicly discussing options to launch cyber attacks against Russia.
 
If such economic disruptions unfold, we can be sure that the democrat-led Congress will quickly resurrect the "Build Back Better" plan to be rubber-stamped.  "Never let a crisis go to waste."
 

Pro Perspectives 2/23/22

February 23, 2022

Markets continue to trade on confusing information.  When that's the case, the direction will be down. 
 
For perspective, let's take a step back and take a bigger picture perspective.
 
Consumer and company balance sheets remain strong.  And the tailwinds of $6 trillion of new money supply created in the past two years continue to blow.
 
This will continue to drive a very tight labor market, where employees are commanding higher wages.  And as prices have risen, consumers are showing the ability and willingness (thanks to the conditions mentioned above) to accept higher prices.  With this, despite all of the noise out of Washington (and eastern Europe), we should expect economic growth to continue running above long-term trend levels.  
 
What about rate hikes?  In a recovering economy, rising rates are historically accompanied by rising stock prices.  With this, despite the hand wringing over the Fed, the trajectory for stock prices (and asset prices) should continue to be up. 
 
With the above in mind, I want to copy in an excerpt on one of my past notes on stock market declines.
 
How The Best Billionaire Investors Respond To Stock Market Declines

"During market declines – with the constant barrage of market analysis and opinion on financial television, in newspapers, or through the Internet – it’s easy to get sucked into drama played out in the media.

And that tends to make many investors fearful.

But while the fearful start running out of the store when stocks go on sale, the best billionaire investors in the world, start running IN.

The fact is, the best investors in the world see declines in the U.S. stock market as an exciting opportunity.  And so should you.

Most average investors in stocks are NOT leveraged. And with that, they should have no concern about U.S. stock market declines, other than saying to themselves, 'what a gift,' and asking themselves these questions: 'Do I have cash I can put to work at these cheaper prices? And, where should I put that cash to work?'

Billionaire Ray Dalio, the founder of the biggest hedge fund in the world, has said what I think is the most simple yet important fact ever said about investing.

'There are few sure things in investing … that betas rise over time relative to cash is one of them.'  
 
In plain English, he’s saying that major asset classes, over time, will rise (stocks, bonds, real estate). The value of these core assets will grow faster than the value of cash.
 
That comes with one simple assumption. The world, over time, will improve, will grow and will be a better and more efficient place to live than it was before. If that assumption turned out to be wrong, we have a lot more to worry about than the value of our stock portfolio.

With that said, as an average investor that is not leveraged, dips in stocks (particularly U.S. stocks – the largest economy in the world, with the deepest financial markets) should be bought, because in the simplest terms, over time, the broad stock market has an upward sloping trajectory.
 
This is the very simple philosophy Dalio follows, and is the core of how he makes money and how he has become one of the best, and richest, investors alive.
 
Billionaires Bill Ackman and Carl Icahn, two of the great activist investors, lick their chops when broad markets sell off on fear and uncertainty.
 
Ackman says he gets to buy stakes in high quality businesses at a discount when broad markets decline for non–fundamental reasons.  Icahn says he hopes a stock he owns goes lower so he can buy more.
 
What about the great Warren Buffett?  What does he think about market declines?  He has famously attributed his long-term investing success to 'being greedy when others are fearful.'
 

Pro Perspectives 2/22/22

February 22, 2022

It's been three months now since satellite images showed a Russian troop build-up on the Ukraine border.
 
Today, after a LOT of posturing, a line has apparently been crossed and "costs" have been imposed on Russia, from the West.  These costs include an asset freeze on three Russian banks, and sanctions on all members of Russian parliament.
 
Keep in mind, Biden lobbed warnings of sanctions as early as December 7th.  It's safe to say, there has been plenty of time to move money.
 
With that in mind, consider this chart below …

This chart explains the wild swings we're seeing in stocks (and markets, broadly).  Liquidity has dried up.
 
The end of crisis-level monetary and fiscal stimulus (i.e. the closing of the global liquidity spigot), should (and has) triggered the exit and repatriation of some foreign capital from U.S. capital markets (namely stocks and Treasuries).  In fact, December was the biggest outflow of foreign money (from the U.S. capital and financial account) since September of 2020. 
 
Add to this, at precisely the same time (over the past three months), this geopolitical event has bubbled up.  And with sanctions telegraphed, and World War 3 prognostications loosely thrown around, it's an environment for foreign capital to be on the move (not just Russian).
 
This all results in lower market liquidity.  
 
So, after two years of a liquidity deluge, we're now seeing the effects of illiquidity on markets.  Translation: The swings become exaggerated.   

Pro Perspectives 2/18/22

February 18, 2022

As we end the week, the chatter continues about Russia/Ukraine. 
 
Today, the White House Deputy National Security Advisor talked about our preparedness to respond, if Russia were to retaliate against sanctions, with cyber attacks on U.S. companies and/or infrastructure.
 
Of all of the things we should consider as possible in 2022 (after the chaos of '20 and '21), it's further destabilization of economies (and life) through cyber attacks.  
 
If for no other reason, should we consider this possible/likely, than it was gamed out by the World Economic Forum last year, here (as was the pandemic, back in October of 2019, here). 
 
This group (WEF), with constituents that include leaders of virtually every major government and company around the world, is the force behind the global climate agenda, and much of the economic and social agenda.  As we know, global governments have embraced these agendas, and are executing in "global cooperation."   
 
What else will require "global cooperation" to combat, in the words of the WEF leadership?  A cyber pandemic.  This is a cyber attack, as they describe it, with covid-like characteristics.
 
For the sake of being informed, it's probably not a bad idea to take a few minutes and familiarize yourself with the way they view the world and the cyber threat (in this video).  Not a bad idea to be prepared.  

Pro Perspectives 2/17/22

February 17, 2022

Last Friday, a wave of risk aversion hit markets after the White House postured over a potential Russian invasion of Ukraine.
 
The outlook since, for such an event, has been unclear and confusing at best. 
 
Let's take a look at the behavior of markets for any signals on whether or not a serious conflict may be imminent.  
 
What happened last Friday, following the White House warnings?  There was aggressive buying in the safe-haven assets. Treasury prices jumped (price higher, yields lower).  Gold jumped.  And oil prices jumped, on the potential for a supply shock. 
 
What happened today?  For a second time in less than a week, money moved out of "risk assets," like stocks, and into Treasuries.  And gold traded to the highest levels since June of last year (over $1900, and marching toward record highs). 
 
But oil was down.  That doesn't square with an increased chance of a war (especially involving the third largest oil producer in the world). 
 
With that in mind, remember from my note last Friday, Bitcoin moved lower on the "risk aversion" trade.  It did so today, too. 
 
This is an asset thought by many to be the "new gold," and therefore the new store of value/ safe-haven asset.  It hasn't performed as such, even in as extreme a case as a prospective World War.  Confusing. 
 
So, with the behavior of oil and bitcoin in mind, we have to consider that this recent market activity may have more to do with Fed policy (i.e. the coming tightening cycle). 
 
Supporting that consideration:  The inflated "companies of the future" are continuing to deflate — the manifestation of which is Cathie Wood's ARK Funds (now down 57%).  And as we discussed in my January notes, the "money of the future" (i.e. bitcoin) appears to be highly correlated.  

Pro Perspectives 2/16/22

February 16, 2022

China's inflation data overnight came in softer than expected.  But the producer price change from last year is still running at over 9%.
 
Meanwhile, curiously, the consumer prices in China are reported to have risen less than 1%. 
 
How is that possible? 
 
Price controls.

As an example, the Chinese government intervened in the domestic iron ore market last summer.  Iron prices had more than doubled from pre-covid levels.  The government stepped in, with "investigations" and "inspections" into producers and speculators.  The price of domestically produced iron ore (in China) did this … 

The Chinese government intervened in the domestic coal market in late October.  Coal prices had tripled over the prior twelve-months.  Coal prices did this …
You may recall, we talked about all of this late last year, and asked the question:  Would Biden follow the Chinese playbook to respond to hot U.S. inflation (i.e. go the route of price controls)?  
 
He's already alleged price gouging from the domestic oil and gas industry and (similarly) called for an "investigation" into U.S. producers (for the audacity of making wider profit margins on higher prices, which is now controlled by OPEC).
 
Yesterday, Biden said he would be "coordinating" with major energy consumers and producers, and will be "prepared to deploy all the tools and authority at his disposal to provide relief at the gas pump."
 
These "tools" may come in the form of some sort of subsidy, at some point, but a subsidy would sustain the demand dynamic for oil.  Apply that to a world that is undersupplied and underinvested in new supply, and the price of oil will continue to rise.   

Pro Perspectives 2/15/22

February 15, 2022

Producer prices for January were almost 10% higher than the year prior.  This follows the report last week of a year-over-year rise in consumer prices of 7.5%.
 
Tonight we'll hear from China on producer prices.  This number will represent the prices, in large part, we should expect to be paying for products in the months ahead.
 
Spoiler alert:  These prices have been hovering around the highest levels in 26-years, and will likely continue running hot (at a double digit yoy rate), thanks to the broad strength in global commodities prices (i.e. input prices).  
 
Here's a look at the chart …

If this number comes in hot, those that have been calling the peak in inflation will have to recalibrate — that includes some Fed officials.
 
On that note, as you can see in the chart below, the spread between market interest rates (market determined) and the Fed Funds rate (set by the Fed) continues to widen aggressively.    
 
This chart reflects a Fed that's not only way behind, but at risk of losing control of the interest rate market.  In that case, these market determined rates could soar, which could slam the brakes on the economy (not a good scenario). 
 
The Fed has some work to do.
 
Not helping matters, Jay Powell has yet to be confirmed by Congress for his a second term (which officially ended earlier this month).  Until then, he's considered a temporary Fed Chair.  This is not projecting stability, for an interest rate market that is already on shaky footing.