wknd notes: Peak Technology, Peak Inequality

Lindsay Politi, who joined One River to manage a fund focused on opportunities in inflation markets, is authoring Weekend Notes during my late-summer hiatus. She came from Tudor and previously built/ran a $10bln TIPS business for Wellington. For the next two weeks, she’ll share her thoughts and ideas on inflation as well as conversations she has had with institutional investors, managers, and endowments (see below).

Week-in-Review (expressed in YoY terms): Mon: Chinese industrial profits slip for 3rd mth (-3.8 to +16.2%), Turkey blames Trump for fueling terrorism, German business confidence bounces strongly after H1 slump, Trump tweets “Trade deal with Mexico looking good,” Nasdaq crosses 8,000, S&P +0.8%; Tue: May “no Brexit deal not the end of the world,” Trump attacks Google for political bias in search results, US consumer confidence 2000 highs, Case/Shiller home prices -0.2 to +6.3%, S&P flat; Wed: Iran’s Khamenei “negotiating with US not possible on any level,” Putin softens pension reform plans after protest, Britain’s Brexit minister “UK/EU deal within our sights,” Argentina asks IMF to accelerate bailout (IMF agrees to revisit plan), Moody’s downgrades Ford to just above junk, US trade commission rejects tariffs on imported Canadian newsprint, US pending homes sales -2.3% (high prices, low supply), Trump labels CNN “Enemy of the people,” Q2 GDP revised +0.1 to +4.2%, S&P +0.6%; Thur: Deputy governor of Turkish central bank quits, EU consumer sentiment slips (concerns over unemployment), EU trade commissioner “EU would be willing to lift all auto tariffs,” Italian 10yr auction at 3.23% (4yr highs), Argentina hikes rates 1,500bps to 60% (peso still closes day -12.6% and -51.7% YTD), US core PCE inflation +2.0% (headline +0.1 to +2.3%), consumer spending rises (savings rate dips -0.1 to 6.7%), real disposable income +2.9%, Trump threatens to roll out $200bln Chinese tariffs next week, Trump threatens to pull out of WTO, Amazon shares top $2,000, S&P -0.4%; Fri: China PMI manu +0.1 to 51.3 (services +0.4 to 53.4), Japan IP +2.3%, India Q2 GDP +8.2% annualized (manufacturing +13.5%), Turkey waives tax on domestic savings (supporting lira), EU CPI -0.1 to +2.0% (core unch at +1.0%), EU unemployment 8.2%, Fitch cuts Italy outlook to negative, S&P warns it could downgrade Argentina (IMF’s Lagarde to meet Fin Min nest week), Brazil Q2 GDP +1.0% (QoQ +0.2%), Trump cuts $300mm Palestinian aid, S&P flat; Sat/Sun: US/Canada vow to resume Nafta negotiations next week. 

Weekly Close: S&P 500 +0.9% and VIX +0.87 at +12.86. Nikkei +1.2%, Shanghai -0.2%, Euro Stoxx -0.3%, Bovespa +0.5%, MSCI World +0.9%, and MSCI Emerging +0.7%. USD rose +8.9% vs Turkey, +3.3% vs Chile, +3.1% vs South Africa, +1.9% vs Australia, +1.6% vs India, +0.9% vs Mexico, +0.6% vs Russia, +0.5% vs Sweden, +0.4% vs Indonesia, +0.3% vs China, +0.2% vs Euro, and +0.1% vs Canada. USD fell -6.1% vs Bitcoin, -1.3% vs Ethereum, -1.2% vs Brazil, -0.9% vs Sterling, and -0.2% vs Yen. Gold -0.4%, Silver -2.1%, Oil +2.0%, Copper -1.7%, Iron Ore -3.2%, Corn +0.8%. 5y5y inflation swaps (EU flat at 1.71%, US -1bp at 2.40%, JP +7bps at 0.27%, and UK -3bps at 3.42%). 2yr Notes +1bp at 2.63% and 10yr Notes +5bps at 2.86%.

Aug Mthly Close: S&P 500 +3.0% and VIX +0.03 at +12.86. Nikkei +1.4%, Shanghai -5.3%, Euro Stoxx -2.4%, Bovespa -3.2%, MSCI World +1.3%, and MSCI Emerging -2.7%. USD rose +52.4% vs Ethereum, +33.1% vs Turkey, +10.6% vs South Africa, +9.2% vs Bitcoin, +7.9% vs Brazil, +7.9% vs Russia, +7.2% vs Chile, +4.3% vs Sweden, +3.6% vs India, +3.3% vs Australia, +2.3% vs Mexico, +2.1% vs Indonesia, +1.3% vs Sterling, +0.8% vs Euro, +0.3% vs Canada, and +0.2% vs China. USD fell -0.7% vs Yen. Gold -2.1%, Silver -6.8%, Oil +3.8%, Copper -6.4%, Iron Ore +0.7%, Corn -5.2%. 5y5y inflation swaps (EU -3bps at 1.71%, US -5bps at 2.40%, JP -13bps at 0.27%, and UK -3bps at 3.42%). 2yr Notes -4bps at 2.63% and 10yr Notes -10bps at 2.86%.

2018 YTD Equity Indexes: NASDAQ +17.5%, UAE +13.4% priced in US dollars (+13.4% in dirham), Russell +13.4%, Norway +10.4% priced in US dollars (+13.1% in euros), Russia -5.2% in dollars (+11.2% in rubles), India -0.1% (+10.9%), New Zealand +3.4% (+10.9%), Saudi Arabia +10% (+10%), Israel +5.1% (+9.4%), Finland +4.9% (+8.8%), S&P 500 +8.5% (+8.5%), Portugal +4.2% (+8%), Colombia +4.6% (+6.8%), Sweden -6% (+5.2%), Australia -4.1% (+4.2%), Taiwan +0.4% (+4%), Netherlands -1.1% (+2.5%), France -1.8% (+1.8%), Malaysia -0.1% (+1.3%), Japan +1.8% (+0.4%), Mexico +2.9% (+0.4%), Brazil -18.9% (+0.4%), Canada -3.8% (+0.3%), South Africa -15.8% (-0.1%), Denmark -3.9% (-0.2%), Czech Republic -4.9% (-0.5%), Thailand -2.5% (-1.8%), Argentina -51.7% (-2.6%), Euro Stoxx 50 -6.6% (-3.2%), UK -7.4% (-3.3%), Austria -6.9% (-3.5%), Ireland -7.2% (-3.8%), Germany -7.7% (-4.3%), Switzerland -4% (-4.4%), Chile -14.5% (-5.3%), Indonesia -13.3% (-5.3%), Hungary -13.3% (-5.4%), Poland -11.7% (-5.6%), Singapore -8% (-5.6%), Korea -9.7% (-5.9%), Belgium -9.3% (-6%), Spain -9.7% (-6.4%), HK -7.2% (-6.8%), Italy -10.5% (-7.2%), Philippines -14.4% (-8.2%), Greece -12.3% (-9.1%), China -21.7% (-17.6%), and Turkey -53.8% (-19.6%).

Creative Risk I: The risk conference was a response to a series of events that surprised the markets in the mid-2000s. The dot com bubble bust in 2000, September 11th a year later, and the Enron/WorldCom bankruptcies the following year. The keynote speaker had written the textbook on risk analysis. “The best risk models use scenario analysis,” he said. But people only provide their models with historical examples. That isn’t enough. We must think creatively about what could happen, not just what has happened.

Creative Risk II: We were talking about possible market outcomes. “We’re a long-term investor,” she said, “so a sharp correction like 2008 with a strong recovery over the next few years would be okay for us. We would hold through it and maybe consider it an opportunity. What we’d struggle to deal with is a prolonged shallow bear market. For example, the market down 5-10% for 3 years in a row. That’s why we’re talking to you about inflation. We think inflation is the most likely catalyst for that scenario.”

Time Value of Money: “Why shouldn’t long-term risk-free rates be zero?” he asked, “No risk, no return: makes perfect sense.” It’s possible that time value of money (the idea that a dollar today is worth more than a dollar tomorrow) need not hold and does not hold in the future, I responded. But almost every financial business model (pension, insurance, even a traditional bank) assumes that it can receive a positive return on savings. If that’s no longer true, then it’s not a minor paradigm shift. The entire financial services sector will need to restructure.

Canaries: “What signal should we look for to see the inflation thesis starting to play out?” the family office asked. “It’s already started,” I responded. “The most vulnerable business models, are already falling. Look at MoviePass. It’s a model designed for a deflationary environment: it uses low prices to drive volume and it requires almost indefinite access to cheap financing. The slightest bit of inflation concern cut off their oxygen and now they’re on the verge of bankruptcy. I think the concern should be that a lot in the tech sector looks a little too much like MoviePass.”

Monopoly: Cornelius Vanderbilt started in steamboats and recognized rail as a disruptive technology. He consolidated the fragmented rail system, creating a transportation empire. The monopoly allowed the Vanderbilts to eliminate inefficiencies, lower prices, and generate tremendous profit. Then they boosted returns by charging unequal fares (high prices to the general public, discounts to favored customers). Then finally they used their monopoly to generate wealth by doubling New York City train fares despite public outrage.

Algorithmic Pricing: When ProPublica investigated how Amazon decides which sellers to feature, it found “about three-quarters of the time, Amazon placed its own products and those of companies that pay for its services in that position even when there were substantially cheaper offers available from others.” When a seller on Amazon’s platform was told of his product’s poor ranking despite its cheaper price, he just sighed and said, “Amazon is not really fair in terms of competition, but we don’t have much choice. We just have to be there.’”

Anecdote: The Guttenberg Bible was one of the most transformative technologies in human history. Without it, literacy, education and knowledge sharing as we know it would not exist. But Guttenberg wasn’t the first person to invent movable type. Archeologists discovered The Phaistos Disk on Crete -- the first known record of movable type, dating to 1700 BC. Movable type was used in China during the Song Dynasty, about 400 years before Guttenberg and then in Korea 200 years after that. In each case, the technology died with the dynasty. What was transformative about the Guttenberg Bible was not the idea behind the technology, but how the idea reached beyond the ruling elite to be used so widely. When we think about transformative technologies today, we often just think about cool ideas and less about how they permeate broader society in a tangible way. For all the talk about a technological boom, labor productivity remains very low. It’s possible that we just can’t measure the impact of new technologies correctly, but it may also be that the benefits of new technologies are failing to reach those below the elite classes in a way that materially lifts their productivity. Throughout history, periods of extreme concentration of wealth have often overlapped with declining productivity; peaks in the technology cycle tend to overlap with peak inequality. The period leading to the French Revolution and America’s Robber Baron period in the run up to our Civil War are examples. The Vanderbilt monopolies played a part. In each of these moments, the elite class was profoundly insulated, and blind to the tumult that follows periods when the power of new technology and the wealth it generates are tightly concentrated. 

Good luck out there,

Lindsay Politi

Head of Inflation Strategies

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.