wknd notes: Doing the Impossible

“Start by doing what’s necessary; then do what’s possible; and suddenly you are doing the impossible,” said Christine Lagarde, quoting Saint Francis of Assisi, born 1182. It was her first major speech as ECB President. And she used it to press the case for increased European fiscal expansion. “We have a unique possibility to respond to a changing and challenging world by investing in our future, strengthening our common institutions and empowering the world’s second-largest economy,” said Lagarde. “This was a true bipartisan moment and a clear signal to the rest of the world that political threats from corrupt regimes will not stand in the way of America supporting the millions of freedom fighters in Hong Kong,” said Senator Ted Cruz, boasting of the unanimous 100-0 passage of the Hong Kong Human Rights and Democracy Act of 2019. The House passed it 471-1. It’s chilling that the solitary issue unifying the world’s most powerful country is that the next greatest nation is our chief adversary. China’s foreign minister called the bill a serious violation of international law and warned, “I'd like to stress once again that Hong Kong is part of China, and Hong Kong affairs are China's internal affairs. We urge the US to grasp the situation, stop its wrongdoing before it’s too late, and immediately take measures to prevent this act from becoming law.” President Trump’s public impeachment hearings confirmed to the world what everyone already knew: unambiguous quid pro quo. The polls barely moved. Betting odds of his impeachment/removal remained at 24%. Odds of the Republican’s winning in 2020 remained 48%. Warren/Biden/Buttigieg ended the week virtually tied in the betting sites. And investors were left to consider the three most important market questions: Will a material fiscal expansion first require economic crisis? Will the US/China trade war inadvertently lead to hot war? And will America’s elect a democrat who in addressing inequality, savages the market?

Week-in-Review (expressed in YoY terms): Last Sat/Sun: HK clashes intensify (unarmed Chinese military clear debris and remove barricades), Saudi Aramco to price IPO at $1.7trln valuation, Powell met Trump/Mnuchin at White House to discuss economy; Mon: China cuts 7-day reverse repo by 5bps to 2.50%, global equities +20% YTD despite $230bln net outflows (offset largely by buybacks), S&P +0.1%; Tue: US Senate passes the Hong Kong Human Rights and Democracy Act of 2019 unanimously, S&P -0.1%; Wed: China cuts 1yr and 5yr LPRs by 5bps to 4.15% and 4.80%, German PPI -0.2 to -0.6%, US House passes the Hong Kong Human Rights and Democracy Act of 2019 in 417-1 vote, S&P -0.4%; Thur: Henry Kissinger “US/China are in the foothills of a cold war,” UK government borrowing hits 5yr high in Oct, S&P -0.2%; Fri: reports that Phase One trade deal being pushed into 2020, UK flash PMI falls to 48.5 (3yr low), EU flash PMI -0.7 to 51.5, Lagarde urges governments to boost fiscal expansion, Moore capital announces closure, Schwab to buy Ameritrade for $25bln after they both cut trading fees to $0, S&P +0.2%; Sat/Sun: Yale beats Harvard in double football overtime, Brazil’s Lula vows to fight far right politicians.

Weekly Close: S&P 500 -0.3% and VIX +0.29 at +12.34. Nikkei -0.8%, Shanghai -0.2%, Euro Stoxx -0.5%, Bovespa +2.0%, MSCI World -0.5%, and MSCI Emerging -0.4%. USD rose +17.3% vs Ethereum, +15.1% vs Bitcoin, +2.8% vs Chile, +1.0% vs Mexico, +0.6% vs Canada, +0.5% vs Sterling, +0.5% vs Australia, +0.4% vs China, +0.3% vs Euro, +0.2% vs Russia, +0.1% vs Brazil, +0.1% vs Indonesia, and flat vs South Africa. USD fell -0.6% vs Turkey, -0.1% vs Yen, -0.1% vs Sweden, and -0.1% vs India. Gold -0.5%, Silver +0.3%, Oil -0.2%, Copper +0.2%, Iron Ore +2.6%, Corn -0.6%. 5y5y inflation swaps (EU -2bps at 1.21%, US -1bp at 2.04%, JP +1bp at 0.12%, and UK +5bps at 3.56%). 2yr Notes +2bps at 1.63% and 10yr Notes -6bps at 1.77%.

YTD Equity Index Returns: Greece +39.9% priced in US dollars (+45.3% priced in euros), Russia +35.5% priced in dollars (+24.4% in rubles), Israel +28.8% (+19.1%), NASDAQ +28.4%, S&P 500 +24.1%, Italy +22.3% (+26.9%), Switzerland +21.4% (+23%), Canada +21.3% (+18.4%), Germany +20.1% (+24.7%), France +19.9% (+24.6%), Ireland +19.9% (+24.5%), Taiwan +18.8% (+18.9%), New Zealand +18.6% (+24.2%), Euro Stoxx 50 +18.3% (+22.9%), Russell +17.8%, Japan +17.3% (+15.5%), Netherlands +16.9% (+21.5%), Denmark +16.9% (+21.4%), Belgium +15.1% (+19.6%), Portugal +14.8% (+19.3%), Australia +14.4% (+18.8%), Brazil +14.3% (+23.7%), Sweden +14% (+22.4%), Colombia +13.2% (+19.3%), China +13% (+15.7%), Austria +11.4% (+15.6%), Thailand +10.1% (+2.2%), UK +9.6% (+8.9%), Philippines +8.2% (+4.8%), Turkey +8.1% (+16.8%), Norway +7.2% (+12.5%), Czech Republic +6.7% (+9.7%), India +6.5% (+9.7%), Mexico +5.9% (+4.5%), South Africa +5.5% (+8%), Finland +5.1% (+9%), Singapore +5% (+5.1%), Spain +4.3% (+8.4%), Hungary +4.2% (+12.6%), Saudi Arabia +3.1% (+3%), HK +3% (+2.9%), UAE +2.6% (+2.6%), Indonesia +1.3% (-1.5%), Korea -2.6% (+3%), Poland -3.2% (+0.3%), Malaysia -6.4% (-5.5%), Chile -19.5% (-7.4%), and Argentina -30.1% (+10.9%).

Fiscal: ECB Chief Lagarde included these key points in her pitch for fiscal expansion: Annual domestic demand growth is -2% lower than before the eurozone debt crisis. Public investment remains lower than its pre-crisis level - infrastructure, research and development and education spending has dropped in nearly all eurozone countries. The debt crisis would have been much worse if not for the strong export demand for European goods and services. The high rate of trade growth that the bloc has grown used to can no longer be relied upon going forward.

Fiscal II: Lagarde continued: Eurozone countries should, therefore, innovate and invest more to support growth within the bloc. Public investment will help rebalance the economy toward less export reliance. Pan-European funds should be created to target digital and green projects. The ECB ultraloose monetary policy stance, which has been a key driver of domestic demand during the recovery, remains in place. The central bank’s monetary policy measures would be more effective and have fewer side effects if they were backed up by the suggested spending policies.

Diplomacy Today: “Most people in the world can see insanity of HK rioters, restraint of the HK police and Beijing’s respect to HK autonomy. But US lawmakers have gone blind all together. President Trump needs to sign the bill using braille,” tweeted Hu Xinjin, Editor-in-Chief for China’s state controlled Global Times (reacting to the US Senate’s Hong Kong Human Rights and Democracy Act), “So a friendly reminder to American farmers: Don’t rush to buy more land or get bigger tractors. Wait until a China-US trade deal is truly signed and still valid six months after. It’s safer by then.”

Diplomacy Today II: “President Trump told Fox, if it weren’t for him, thousands of people would’ve been killed in HK and HK would have been obliterated in 14 minutes. I don’t think it’s something a president should boast of. And I don’t think there should be people who like to hear such hot air,” tweeted Hu Xinjin of the Global Times, “The US has the upper hand in US-China trade war, which allows it to decide when to end the trade war, but far from enough for it to decide how to end the trade war. The US side wants both, then it needs to change an adversary.”

PredictIt: Elizabeth Warren is polling as the most popular democratic candidate. But in the betting websites she’s steadily slid as Americans digest her progressive plans and the democratic establishment attacks her. Since peaking on Oct 4th at a 52% probability of winning the democratic nomination, Warren has fallen and is now at 23%. In that same time, Joe Biden drifted sideways at 22%. And Pete Buttigieg has trended steadily higher, rising from 8% on Oct 4th to 22% as he takes the defacto centrist lead. Sanders was 8% on Oct 4th and is now 16%. Bloomberg was 1% on the 4th and just hit a personal high of 12% on Friday.

Anecdote: We were playing the game called Institutional Investor. Winners develop an equation to produce +7.5% returns in perpetuity. All other players declare insolvency. Beginners play backwards through time, everyone wins, participation trophies abound. They simply average long-term historical equity and bond returns, combine them in any ratio, and can’t help but hit +7.5%. The advanced game is played in real time, requiring you to look forward. Your bonds pay exactly +1.77% each year for the coming 10yrs. What of stocks? The S&P 500 Shiller Price-to-Earnings Ratio is 30.2 which implies a -2% compound annual return over the coming 8yrs to return the ratio to its 17.0 mean. But not all things return to mean. If the Shiller P/E is 50% above mean in 8yrs, it implies a nearly +3% annualized S&P 500 return. And if it falls 50% below mean, stocks annualize at roughly -10% for the coming 8yrs. There is no mathematical equation using even the most optimistic of those returns which produces +7.5%, even playing the leveraged private equity game. Of course, it’s possible a new bull market has begun. But in 150yrs, only have secular bear markets started with the Shiller P/E above 30 (secular bulls all began with the Shiller P/E between 5-10). The thoughtful guys at GMO estimate the following 7yr forward annualized real returns: US large cap equity -3.9%, US small caps -1.0%, Int’l large caps -0.1%, Int’l small caps +1.7%, EM equity +4.7%, EM value equity +9.3%, US bonds -2.2%, Int’l bonds (hedged) -3.9%, EM debt -0.1%, US TIPS -1.7%, US cash +0.1%. The only equation using GMO estimates that gets you to +7.5% includes a 75% allocation to EM value equity - and that move is strictly prohibited in the game of Institutional Investor. In fact, playing the game forward, the only equations that work include heavy allocations to aggressive asset allocators, activist investors, absolute-return relative value strategies, volatility trading, and trend following. Or else they contain an ill-defined ‘hope’ function.

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.