NYTimes Magazine, 2000, John Lloyd.
“Our problems are man-made, therefore they may be solved by man. And man can be as big as he wants. No problem of human destiny is beyond human beings.”
John F Kennedy, 1963
I wrote in my piece last week entitled “Welcome to the new Cold War” suggesting that we were not in Kansas anymore. Markets have been churning as it is trying to factor in a lot of new near and longer-term geopolitical risks and realities, economic sanctions, repricing some known risks like CB tightening, growth, and earnings. But with liquidity extremely poor and with end-of-month rebalancing, the movements have been breathtaking. Nowhere is this more obvious than in the rates market where the MOVE index has ratcheted up to levels not seen since the beginning of Covid, US rates markets did a round trip in February moving from pricing in 7 hikes back to 4, and European rates moving most since the Euro crisis in 2011/2012.
Last week, we saw firsthand how vicious bear market or short-covering rallies can be, as the common refrain was “buy when the bombs drop and sell when the trumpets blare.” Honestly, I got caught out a bit – giving up some of my monthly gains, as names like ARK rallied almost 20%. Luckily I took a lot of shorts off near the lows, but the moves were vicious enough to turn my month from great to just OK. At present, I am extremely cautious, as inflation is still too high and Atlanta Fed Nowcast has GDP at 0% for Q1 – the dreaded stagflation. My old JPM colleague Bilal Hafeez now at Macro Hive noted today that his recession indicators (primarily using 2/10 spreads) are now at 40%. There are times to stick one’s neck out, but headline risk and unfolding events have me at peak cash, and a lot of time hitting golf balls and walking Bauer.
I am finishing off this piece as the President delivers his State of the Union address. I am not expecting much new information, and some shaking their heads at his plans to reign in inflation and making nonsensical political statements about the number of jobs “he” created in 2021. Anyhow, I am more interested in Olaf Sholz because Germany appears to be waking up to the fact that they are not Switzerland, and have a role to play to protect the global order put in place after WWII. An order that helped their cruel vanquished regime to become a thriving and peaceful nation. That they are re-thinking their energy and defense policy is welcome – which is once again part of the reason I am long uranium ETF.
My two cents on Russia and Ukraine:
I grew up during the Cold War, which made a 1998 investor trip to Moscow even more startling. As I walked through Red Square, I paused and thought for a moment about all the times I had seen parades through that section of Moscow with shows of military might. I almost could not believe it, thinking to myself, “wow, the world has really shifted.” If you have never laid eyes on the Kremlin’s fortress, it is a sight to behold. But, there were two other memorable moments from the trip. The first was a presentation given by the then head of the Russian tax collector, which was important then because they were struggling to collect taxes that were in arrears. He was escorted by four heavily guarded agents, as his life was in constant jeopardy. I thought to myself, “I don’t like the IRS myself, but I doubt their head has that type of protection!” The second was at a bar that a few of us happened into after the taxman speech. Boris Yeltsin was on the black and white TV, and a few Russian patrons yelled at the bartender to turn it off. Here I thought Yeltsin, bridging the old USSR to the new Russia of greater freedom and opportunity would be liked. It was not that simple. Russia is a complicated place with a bloody history. Perhaps the customers of the bar were just tired of government after all they had endured and led to believe. And, as we have learned over Soviet history and certainly Putin’s rule, politicians and opposition are routinely exiled or killed, so maybe people just get on with it. Either way, it was a quick look into a pretty dysfunctional place, that does not appear to have reformed.
As much as we (including myself) like to talk about Reagan breaking the USSR and winning the Cold War with his searing oration – “Mr. Gorbachev, tear down this wall” – and forcing their system to economically collapse, the reality is, that journey was not a short one. Lots of twists and turns from the end of WWII to the collapse of the Berlin Wall and the end of the Cold War in 1999 or 1991 depending upon how it is defined. Russia was always the enemy, and it was always front and center. I did not experience the nuclear drills that my parents did in school, but I was well aware of black and yellow fallout shelter signs. Today, I root for Igor Shesterkin of the NYRangers. In my childhood, those players were not allowed to leave Russia to play in the US or Canada. So, while I think we are moving into a new Cold War that I hope and pray doesn’t turn hot, it is important to keep in mind that vast populations have experienced a better life within the realm of the post-WWII US-led new world order. Of course, it is not perfect and there are material imbalances, grievances, and free riders, but no world wars in 77 years, and economic prosperity generally has been a good thing.
Now, this world order did not come about because really wise and forward-looking leaders said, “boy, wouldn’t it be nice if we had this interconnected world where everybody could rise and achieve through hard work in a stable and peaceful way.” It was put in place after two bloody world wars to prevent such from happening again. One can say, “well, the Treaty of Versailles gave rise to Hitler, etc.” or that “our energy policies forced Japan into bombing Pearl Harbor,” but that is merely historical post-game hindsight analysis that fails to appreciate the difficulties of the political realities at the time. And, none of it meets with the cold hard facts that war and killing is not a good answer for nation disputes, and NATO is not a force that seeks to gain territory, period. True, the NATO movement eastward could theoretically bring some risks to Russia. But, we have nuclear subs near enough to Russia, as do they near our shores, and it has been mutually assured destruction that has been critical to keeping the peace.
Economically, the system in place has been generally acknowledged – warts, imbalances, and all – as lifting global prosperity and many out of poverty, including China, the most populated nation on earth in a generation. Without the rest of the world buying their products, investing in their economy, lending expertise, and letting them into the economic world order, they don’t move as quickly as they did. China has a lot to answer for with CoVid, and they have a lot to answer for because Putin would not have moved without Xi’s support. China is now suggesting it was duped by Putin. Both Xi and Putin understand power. They watch how the west has become divided, soft, focusing on some silly nihilistic issues and they took a shot. They need to roll it back.
In the post-WWII and post-Colonial world, things have been choppy, mistakes have been made, crises have emerged, some of been left behind or failed to assimilate, but progress has been made. Most nations follow different forms of capitalism and attempt to retain political legitimacy by making the lives of their citizens better and their dream more achievable. Much of this evolution was covered in Branko Milankovic’s “Capitalism Alone” where he argues that there is a spectrum of capitalism from free market to heavily managed state/political capitalism, but that every nation will operate with essentials of capitalism and market activity that best suits their needs. What undergirds all of that, however, are the rules written amongst the rubble and destruction of WWII. The idea that a globally interdependent, mutually beneficial rules-based market-oriented system would make grand hot wars obsolescent. And, yet, here we are.
I wrote last week that perhaps China, Russia – each with their real historic security concerns – want a bigger say at the table and for the US and Europe to be more tolerant, understanding of their needs and culture. But, it is simply hard to accept that Pandora’s box Putin has opened is helpful. Was their security really at risk? No, it was merely a land grab instigated because the West (mainly Europe/Germany) forgot that autocrats think differently and that appeasement and subverting principles are always a losing strategy. As a parent, as a manager, as a political leader – it always comes back to haunt. How Germany could have missed that given all the self-flagellating they have done (of course some of it is rightly so) is a question for another day, but perhaps this piece (good, but a bit over the top) explains how important it is to not lose the forest from the trees. Reagan said, “Trust, but verify” and “don’t be afraid to see what you see” because he was hopeful, but understood that only virtuous and honorable actions matter. Yes, the world is warming, and yes, something needs to be done about it, but virtue signaling and pandering to the unrealistic factions of a country while the largest polluters are laughing is not a good solution either. Putin saw that thought the West would flinch, and he would move the country one step closer to its USSR map.
So, as I write, I am well aware that there are important near-term and longer-term issues the world is going to have to solve. Maybe China – after getting “duped” by Putin – comes in and saves the day in the here and now. Maybe the G20 will have to come together and figure out how the global economic and monetary system needs to be reworked so we can get back to the boring work of discounting cash flows – all of which assume an operating environment we can predict out 10-15 years. Or maybe, Russia takes Ukraine, Russia shuts off energy exports, China takes Taiwan economies and markets crash as the globalization takes a massive dive, inflation spikes further, and the world is a hot stressful mess. Or, global leaders can figure it all out before it gets stupid!
Other things that caught my attention this week:
Freezing of Russian Central Bank Reserves:
Nowhere in the rule book does it say that Russia has to keep its reserves in any particular currency. It does so for its own reasons. So does China. I was reading an interview between Ken Griffin and David Rubenstein, whereby Griffin made the comment that perhaps freezing the assets would chill other nations and make them think about where to hold their reserves, thus undermining the long-term supremacy of the US Dollar. And, here is Bloomberg’s Matt Levine talking about this topic, and while he accounts for those risks, he lays out a compelling case – similar to what I made above – that implies retention of the post-WWII global world order is more accretive than not.
So, we can all quibble about $ dominance, but has it really stopped Russia from becoming more prosperous than under the Soviet regime or China in the communist or pre-WTO period? If their concerns that there are costs and consequences for being a part of the economic system that does not look kindly if they operate a mercantilist system or run roughshod over a sovereign nation, then so be it.
In 1971, at a long weekend gathering at Camp David, Nixon decided to close the gold window. Along with that, there was some agreed-upon $ devaluation (and price and wage controls). Many were concerned – including Paul Volcker – about floating fiat currency generally and the $ specifically given these actions. And, yet, the world kept on turning, and the US, in spite of an awful 1970s, did fine and retained its status. Sure, there may be some pain from these actions, but weighed against the risks of WWIII or letting Putin operate without impunity, seems like the right call.
China is still far away from being the beacon of hope, known for selfless and fair dealing that is attracting human capital seeking citizenship. It has not spilled blood to protect non-domestic populations from murderous dictators. Not arguing the US$ Is without foibles, nor are other developed nations. But, there are economic and political realities for why the US is generally trusted, and this event does nothing to diminish that. I would argue the opposite.
Dalio piece on recent events:
Very good piece and his latest “Changing World Order” book is well worth reading.
A slip of the tongue:
When I played baseball in college, it was customary for opposing players (and fans) to rag on our players and vice versa. You had to have thick skin. I got called all sorts of things. Occasionally, the weaker-minded would take it too seriously, and we would yell at them and call them “rabbit ears” because they heard everything and our taunts got to them. Well, Dmitry appears to have some rabbit ears. Still, it does signal that there is a lot of tension that could evolve badly.
Goldman concerned market is underestimating risks (I agree):
The evolution of company value:
In a BAML private client piece, there was a reference to this evolution, and it surprised me a bit. I asked them about it, and they said there was some other research – non-academic or peer-reviewed – but basically supporting the idea that US market values are largely driven by intangibles (Brand awareness, R&D, marketing, distribution, human capital, clients, supplier relationships, etc) and less by tangibles. In Europe, that number is closer to 70%, Asia 40%.
BAML also added that other research shows that the increase in intangible asset value relative to tangible is driven by soaring corporate valuations. The amount of tangible assets per dollar of revenue is little changed.
Analogue of the Week:
What happens when SPX closes down > 3% in both Jan and February. The number of events is not high, but for the most part, the following few months are typically positive. Of course, one needs to look at the contexts of each episode to see if there are similarities with respect to expected monetary/fiscal stance, valuations, growth and earnings trajectory, inflation, geopolitical risks, etc. And, of course, buying the dip when stocks generally go up almost always looks good. But, a useful starting point.
