wknd notes: America's Tumultuous Decade

“Our Constitution and our Republic will overcome this stain and We the People will come together again in our never-ending effort to form a more perfect Union,” said General Mattis, a remarkable man of the highest integrity. The role of a leader is to lift, no doubt about it. And so, on the descent, we should look for moments that may mark the low. But as investors we must remain clear-eyed. And having spent the past four years with at least one-third of the country believing Trump was an illegitimate president. We will now spend the next four years with at least as many seeing Biden as illegitimate. Which reflects the depth of the challenges that will push us further apart before we can come back together. And this sets the stage for the kind of tumultuous decade America experiences just a few times in a century.   

Overall: It was a January like any other. By the time it arrived, we were somehow prepared. Resigned. A little snow, some ice. A failed coup. Or was it a stolen election? Truth, you see, is in the eye of the beholder. Anyhow, barbarians sacked the Capitol. In the rampage, we each saw what we wanted to see. Fantastic beasts raged in our hallowed halls. Some saw QAnon, others sensed an Antifa plot. Patriots. Traitors. The whole world, our allies, adversaries, marveled at the horned shaman. And we feigned surprise. Shock. But not a single seditious act should have been unexpected to anyone objective, honest. A soaring number of Americans died every day in January, lungs on fire, our intensive care units as crowded as a Miami bar. And while the 3,000 daily Covid-19 deaths exceed the 2,977 who died on 9-11, we adjusted, perfectly, completely, so that today’s normal was yesterday’s outrage. Through it all, the Fed created money like magic, crediting banks electronically, the sums limited only by our self-restraint, which itself is in flux. Bitcoin surged 27% in the week just ended, outpaced only by Ethereum’s 39% rise. Gold fell -2.7%. And we each found in this market perversity whatever it is that we want to believe. 10yr bond yields jumped 20bps to 1.12%. Stocks hit new all-time highs, tracking our rising infection rates, the virus mutating, evolving like the world around us. And so much seemed incongruous in our start to this wild year that it felt like a new reality is upon us, a strange thing, to resist out of stubbornness, or accept out of necessity, for survival. And this unfamiliar world is perhaps even something we must learn to grow comfortable in. Adapting to the mysterious fundamentals that drive this change but have yet to fully reveal themselves. So that in time we forget what it was like before. As our common hope for a return to what was, slowly fades away, dissolving into the fog of what now is.

Week-in-Review (expressed in YoY terms): Mon: Johnson imposes strict new lockdown across UK, NYSE scraps plans to delist Chinese telcom firms, WaPo releases recording of Trump pressuring Georgia Republican to find votes, every one of America’s living defense secretaries warn Trump against using the army to cling to power, S&P -1.5% Tue: Trump bans Americans from transacting on Alipay and WeChat pay, Dems win both Georgia Senate seats, S&P +0.7%; Wed: HK arrests 50 pro-democracy politicians and activists, Kim Jong Un admits his economic development plan has failed (trade fell 80% due to covid), Pence tells Trump he has no power to prevent Biden’s confirmation, Trump incites mob to storm the Capitol (5 dead), NYSE will delist China’s three largest telecom firms, Biden victory is certified, S&P +0.6%; Thur: Japan declares state of emergency in Tokyo and 3 adjacent prefectures due to covid, EU buys another 300mm doses of Pfizer vaccine, Trump commits to a peaceful transfer of power, S&P +1.5%; Fri: North Korea claims to be on verge of building nuclear submarine (labels the US as its greatest enemy), Democrats to begin impeachment proceedings unless Trump resigns immediately, Senator Murkowski calls for Trump to resign, Twitter permanently suspends Trump’s account, Tesla market cap exceeds $800bln, payrolls -140k (first decline since April), S&P +0.6%.

Manufacturing PMI (high-to-low): Sweden 64.9 (previous 59.8), Brazil 61.5 (previous 64), US 60.7/57.5, Taiwan 59.4/56.9, Germany 58.3/57.8, Netherlands 58.2/54.4, Switzerland 58/55.2, Canada 57.9/55.8, UK 57.5/55.6, Czech Republic 57/53.9, India 56.4/56.3, Austria 53.5/51.7, China 53/54.9, South Korea 52.9/52.9, Italy 52.8/51.5, Norway 51.9/52, Vietnam 51.7/49.9, Poland 51.7/50.8, Indonesia 51.3/50.6, Hungary 51.1/51.9, France 51.1/49.6, Spain 51/49.8, Turkey 50.8/51.4, Singapore 50.5/50.4, South Africa 50.2/50.3, Japan 50/49, Russia 49.7/46.3, Greece 46.9/42.3, Hong Kong 43.5/50.1, Mexico 42.4/43.7. Services PMI: Sweden 56.6/58.3, China 56.3/57.8, US 54.8/58.4, India 52.3/53.7, Brazil 51.1/50.9, Ireland 50.1/45.4, UK 49.4/47.6, France 49.1/38.8, Spain 48/39.5, Russia 48/48.2, Japan 47.7/47.8, Germany 47/46, Italy 39.7/39.4.

Weekly Close: S&P 500 +1.8% and VIX -1.19 at +21.56. Nikkei +2.5%, Shanghai +2.8%, Euro Stoxx +3.0%, Bovespa +5.1%, MSCI World +2.4%, and MSCI Emerging +4.8%. USD rose +4.4% vs Brazil, +4.1% vs South Africa, +0.8% vs Sterling, +0.7% vs Yen, +0.6% vs Mexico, +0.3% vs Sweden, +0.2% vs India, +0.1% vs Russia, and flat vs Chile. USD fell -38.7% vs Ethereum, -26.9% vs Bitcoin, -1.2% vs Turkey, -0.8% vs Australia, -0.8% vs China, -0.2% vs Indonesia, -0.2% vs Canada, and flat vs Euro. Gold -2.7%, Silver -3.9%, Oil +8.9%, Copper +4.9%, Iron Ore +6.0%, Corn +2.3%. 5y5y inflation swaps (EU +6bps at 1.32%, US +1bp at 2.31%, JP -9bps at 0.04%, and UK +8bps at 3.55%). 2yr Notes +1bp at 0.14% and 10yr Notes +20bps at 1.12%.

YTD Equity Indexes (high-to-low): Chile +9.6% priced in US dollars (+9.2% in pesos), Korea +9.2% in dollars (+9.7% in won), Portugal +8.1% (+8.1%), Hungary +6.7% (+5.6%), Poland +6% (+4.9%), Russell +5.9%, UK +5.8% (+6.4%), Norway +5.6% (+3.7%), Mexico +5.6% (+6%), Russia +5.4% (+5%), Thailand +5.4% (+6%), Turkey +5.3% (+4.3%), Taiwan +5.3% (+5%), Austria +5.3% (+5.8%), Singapore +4.9% (+5.3%), Czech Republic +4.5% (+4.7%), Ireland +4.4% (+4.4%), New Zealand +4.3% (+3.6%), Spain +4.2% (+4.1%), Indonesia +4.1% (+4.7%), Canada +4% (+3.5%), Belgium +3.9% (+3.9%), Sweden +3.7% (+4%), China +3.6% (+2.8%), Australia +3.5% (+2.6%), Netherlands +3.4% (+3.4%), South Africa +3% (+7.4%), Israel +3% (+1.9%), France +2.8% (+2.8%), Finland +2.8% (+3.3%), Euro Stoxx 50 +2.6% (+2.6%), NASDAQ +2.4%, HK +2.4% (+2.4%), UAE +2.3% (+2.3%), India +2.2% (+2.6%), Italy +2% (+2.5%), Philippines +2% (+2.1%), Germany +1.9% (+2.4%), S&P 500 +1.8%, Japan +1.8% (+2.5%), Greece +1.3% (+1.3%), Brazil +1.1% (+5.1%), Denmark +0.9% (+1.4%), Saudi Arabia +0.6% (+0.5%), Switzerland +0.5% (+0.9%), Malaysia +0.1% (+0.4%), Colombia -0.2% (+1.1%), Venezuela -0.2% (+43.1%), Argentina -0.3% (+0.9%).

Ahead: The humblest practitioners of prediction are those who must do so for a living. And we therefore search for every advantage to tip the scales in our favor. The most natural place to look is price. Because of course, if something is priced in a way that suggests a particular outcome is a near certainty, either for the better or worse, then predicting the opposite is likely to be wrong, but the reward for being right is immense. You don’t need many such outcomes to more than pay for the rest. And so we look for those things, particularly when the world starts changing.

Ahead II: Decades of an ageing demographic throughout the western world (China too), slowing population growth, expanding global trade, and accelerating technological advance, allowed central bankers to vanquish inflation. They did so just as their tools to stimulate the economy had lost their effectiveness, and in an odd irony, perhaps inflation was vanquished because their tools had lost their effectiveness. But either way, inflation expectations were low and stable, yields had adjusted to reflect these inputs. And markets were priced for a world devoid of inflation.

Ahead III: Governments are so deeply in debt and accustomed to running large deficits that they must engineer deeply negative real interest rates for a decade at least. That requires them to create inflation while artificially suppressing bond yields. They can do this by simply buying an unlimited quantity of bonds. But the consequences are material and manifold. For one thing, such a policy debases the currency, which they welcome. In fact, governments continually do this. Another consequence is that bonds prices neither fall nor rise, but their real value is eroded.

Ahead IV: In a world of accelerating monetary debasement, driven by aggressive fiscal deficits funded through central bank buying, a few things are highly likely to happen: (1) volatility of every asset will rise alongside inflation with the ironic exception of bonds which are bought aggressively by central banks, (2) trends will increasingly emerge and extend in all the other asset classes - at least in nominal price terms, (3) equities will eventually decline dramatically – at least in real terms – as input costs rise, and the ultimate central bank policy exit is priced.

Ahead V: The policy and market environments ahead differ profoundly from the those behind. As macro forces manifest, (1) equity multiples will contract (the Shiller PE at 34.7x is more than double its long-term avg), (2) bonds will no longer be a source of positive convexity that carries positively but will rather produce real capital losses with negative convexity, (3) inflation strategies will finally perform well, (4) trend strategies will do extremely well having finished their worst decade in a century, and (5) digital assets will prove to be wildly undervalued.

Ahead VI: By engineering deeply negative real rates to unburden themselves from growing debts, governments will create the most difficult environment for asset allocators in 50yrs. To build robust portfolios capable of delivering consequential returns they will no longer be able to rely on government bonds to offset equity/credit risk. They’ll reluctantly turn to trend strategies, volatility strategies, inflation strategies, macro strategies, and digital assets. The process will be gradual at first, then speed up. And this will create acute shortages of good portfolio diversifiers.

Anecdote: “It really doesn’t feel like 24 degrees,” said Teddy, awake, alive, starting our run. He’d been annoying the hell out of me for all sorts of teenage reasons. I decided on something that produced maximum pain with a potential gain. From December 3rd, for a month, I condemned him to a 3-mile father/son morning run at 5:30am sharp, rain, snow or shine. A couple weeks in, Teddy nearly blew up the barbeque, and I added an extra two weeks, taking us until mid-January. Truth be told, by that time, we had started to enjoy the ritual. “What once seemed freezing barely even feels cold now. Isn’t it amazing how the world seems to change with your mindset? Humans are the most adaptive creatures in the universe, at least as far as we know,” I said. That big storm before Christmas was especially fun. We imagined Louis and Clark wandering their way as we trudged through snow drifts. Each morning is different of course, shooting stars, crescent moons, dark mist, every morning a change, nature’s clock. Midway in the run we stop, pushups. We roll over, look up. “The big dipper moves Dad, each day just a bit,” noticed Teddy, our dog Ollie rolling in the frozen grass, cooling down. We let him off leash in the dark, no cars, just deer, a different world. Each morning we pass a skunk den, “No Covid for me Dad, you smell it today?” And we talk about trading, deals, the larger-than-life characters that fill my life. He tells me about his girlfriend, the drama. And we talk about the future, how the decade ahead is destined to be tumultuous. Naturally, we’ll adapt, that’s what we do. But mostly, for forty minutes each morning, we’re just together in the moment.

Good luck out there,

Eric Peters

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.