• Trade policy has become a source of systemic uncertainty

• Markets are waking up to fiscal risk

• Risk assets float on muscle memory and hope, bonds struggling

This post discusses—implicitly or explicitly—investments in US rates, bonds, equities and FX.

King of Clay and Unforced (Trade Policy) Errors

Roland Garros is underway, my favorite tournament. Mostly because it’s where fellow Mallorcan Nadal built his myth not by brilliance, but by outlasting. One more shot, one more rally. Win by attrition. Let the other side commit the unforced error.

That brings us to the U.S. economy, where Trump 2.0 has so far shown a near-religious obsession with tariffs—on, off, back on again. (Have you tried turning them off and on again?)

What was expected to be a business-friendly administration has so far introduced significant uncertainty and volatility around trade policy, complete with daily covfefe and a now-infamous press conference that felt clearly written by AI—as opposed to this text—and introduced new tariffs on islands populated solely by flightless birds.

Markets are noticing. So is the economy.

The ISM manufacturing print missed yesterday… now at 48.5, the weakest since last November. Imports have collapsed to levels not seen since 2009. Prices stayed sticky. Forward commentary wasn’t glowing with the term “tariff” showing up often and not in a positive light.

The takeaway is mechanical, not moral: friction is rising.

Bond Vigilantes: no longer fossilized remains of financial Americana

Meanwhile, fiscal spending remains wide open — as expected, and consistent with what I noted in my last missive. The “One Big Beautiful Bill” locks in strong outlays well into 2026 and 2027. And yet, when you're running 6–7% deficits and still posting soft numbers, it says less about stimulus and more about resistance. This is an economy that, on paper, should be flyin’ — but instead feels jammed by policy volatility and ambient uncertainty.

Fiscally, the US will maintain its aggressive support stance, irrespective of political leadership. While I refrain from taking sides in the political arena, it’s clear that the current candidates resonate with today’s Zeitgeist.

Read more: $30 GOLDILOCKS (2.0) AND THE THREE BEARS

Enter Moody’s and it’s recent downgrade of the U.S. credit rating from the top level of Aaa (negative) to Aa1 (stable). Moody’s downgrade didn’t tell us something new about deficits. None of this is radical in terms of fiscal / debt math, the U.S. position did not meaningfully deteriorate only last month.

I recently got my boat license. One of the first things they teach you: when a storm approaches, you can confront it or try to outrun it. Increasingly, voices around the administration are confirming their choice. Outrun the deficits, the debt. The bond market’s patience. A bet on nominal growth, with hopes that markets won’t blink.

What has been and is changing is perception. The market is starting to care again. It’s in the public eye—podcasts, pundits, prominent investors. And credit is about trust, not arithmetic.

Bond vigilantes may no longer be fossilized remains of ‘90s and ‘00s financial Americana. Are we seeing a comeback?

The notion that debt levels matter—a concept so foreign during this past MMT-heavy lustrum—seems (re)nascent today. I may have written about this before. It was theory then. It’s curve structure now.

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The rates market has responded with a steepener. The long end is almost untouched—Bloomberg led with “Buyers’ Strike Rocks US Long Bond”, and for once weren’t exaggerating. Pimco and DoubleLine are fading duration. The 5s30s spread hit 100bps for the first time in years.

The long bond now is Bessent’s and everyone’s problem. Cracks are “going to happen”. Jamie.

Equities: nihilistic & expensive

Equities remain somewhat nihilistic and expensive. Earnings estimates are drifting lower and valuations are stretching. On some metrics, net earnings revisions are the worst since 2020. The market’s paying more for less.

Part of that is the belief / muscle memory, that this entire episode is one tweet away from being reversed, despite the growing question mark around the lasting impact of these trade policy blunders, both economically and geopolitically. But is it? As per Nomura, you could literally trade it IRL like that. Stone’s throw, ATHs.

The Fed, meanwhile, remains flat—boxed in between inflation that’s too sticky to ignore and momentum that’s too soft to provoke a hike. Every meeting feels like a placeholder. Powell & Co. can’t move without triggering a tantrum on one side or fueling doubt on the other. So they sit, watching the data drip in—the paint dry—, hoping that “wait and see” eventually turns into clarity.

Markets, for their part, aren’t offering much help. Growth is ambiguous, labor is lagging, and inflation expectations are stuck in a gray zone. In other words, it’s not a moment for bold positioning.

No hero trades here. Just Nadal logic: stay in the point. Let the other side take the risk.

$$$

Thanks for reading,

John Galt

• Economy has proven surprisingly resilient, but some cracks are emerging on the consumer side

• Easing cycle may trigger residential asset sales in Q4, just as demand is starting to soften

• With another rate-cutting cycle on the horizon, ‘Mag-7’ might continue to prosper, this time via valuation multiple expansion

This post discusses—implicitly or explicitly—investments in US rates, equities, housing and FX.

Happy Nosommar

Welcome back, dear readers.

As I pen this, I can't help but notice a few investors online indulging in Midsommar celebrations under beautiful weather conditions. If you’re based anywhere close to where I am (Zug, Switzerland), you’ve probably enjoyed Nosommar so far... Anyway.

The current investment environment remains muddled and characterized by numerous cross currents that complicate visibility. Few great / clear investment ideas emerge. If any at all.

Today’s post brings a couple of short, rapid-fire ideas / observations I find intriguing, but will require further refining / patience to see how they ultimately unfold. A preliminary sketch rather than a detailed map.

Hard landing > soft lading > no landing?

We questioned the hard landing narrative for a while, swiftly pivoting early on towards a ‘no landing’ outcome for the US economy. For the past 18 months, we’ve maintained a bullish stance, touting the possibility of new all-time highs for markets as early as one year ago.

As some other participants, we’re starting to see some cracks on the consumer side in the form of data softness. We are not ready yet, however, to turn bearish as we can foresee a scenario where these issues resolve as Powell & Co cut rates later this year.1 You know the drill…

All this boils down to potentially Goldilocks 2.0, with a resilient economy and investor-friendly monetary / fiscal policy supporting top-line growth and valuations. And even if the economy slows down, I believe the monetary headroom (i.e., higher rates and somewhat lower balance sheet) helps underwrite the vaunted Fed put. Famous last words…

Read more: $30 GOLDILOCKS (2.0) AND THE THREE BEARS

Now onto our thoughts.

The Unbearable Weight of Massive Housing Supply

Real estate sales have been bottling up in the US, creating a massive lack of residential stock for sale. New listings are “still near historic lows” and “becoming stale”, which has been supportive of housing prices. Despite these being at record highs, we believe many sellers are holding back, waiting for the best moment to put their assets back on the market.

The upcoming Fed cutting cycle is the most widely anticipated in history. There’s a good chance most find this the optimal time. Our concern is that—as the Fed starts its easing cycle—we start seeing a significant influx of residential assets for sale in Q4, potentially triggering a glut in the market. This could happen just as demand is starting to soften, reshaping the US housing landscape and potentially de-stabilizing the rest of the economy. Lots of ifs, I know.

It’s a scenario worth monitoring as we move towards the latter part of the year. The Unbearable Weight of Massive Housing Supply. Nick Cage.

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“Heads, I win…”

I had been mulling over the implications of ‘higher for longer’ rates for a while and Kevin Muir's latest insights have added some sharp clarity to my thoughts. Kevin argues that recent rate hikes have been oddly stimulative, especially for “those with capital”.

The explanation is a combination between “How The Economic Machine Works” by Ray Dalio and Mosler’s Modern Monetary Theory (“MMT”), as popularized by Kelton.

The US Treasury pays higher rates on its debt, benefitting the bondholders—primarily wealthy individuals and companies with a strong balance sheet. These increased interest payments act are additional—somewhat covert—government spending, bolstering the economy’s strength by funneling money into the hands of these players. Unprecedented fiscal stimulus underwriting US economic resilience, talked about this before…

The impact is positive on those holding financial assets. Wealthy individuals and large, cash-flow positive companies with strong balance sheets are reaping the benefits (large caps). Lower propensity to consume > plow extra income back into markets > fuel for speculative bubbles. Rinse repeat.

In turn, the impact is negative for lower-income individuals and small, pre-profit companies with weak balance sheets. Effectively the small cap space and cash flow-negative tech.

Now, the twist.

Many saw large-cap companies suffering from rising rates due to compressing valuation multiples, clashing head-on with ‘TINA’ (“There Is No Alternative”). But these big players have thrived. They’ve levered higher interest to bolster their positions, using their balance sheet to accrue positive carry! “Heads, I win; tails, you lose!”

We all love discounted sales and underdog stories, but… with another rate-cutting cycle on the horizon, the ‘Magnificent 7’ might continue to prosper, this time benefiting from valuation multiple expansion.

Essentially, while everyone expected the giants to stumble, they’ve been dancing—and the music might just keep playing!

No wonder every investor has their eyes on these...

That’s it for today—hope you are enjoying a great start to your Summer!

$$$

Thanks for reading,

John Galt

• Our last post suggested all time highs were a possibility, but just wow!

• Even if the economy slows down, monetary headroom helps underwrite the vaunted Fed put

• Chinese stocks are the cheapest we have ever seen them on most metrics and it seems to be attracting the most opportunitistic / tactical investors

This post discusses—implicitly or explicitly—investments in US rates and equities, energy and Chinese equities ($KWEB, $BABA, $JD, $BIDU, $NIO and Linklogis).

Happy 2024, everyone.

I’m genuinely honored to appear in your inbox again.

I enter 2024 with a clear intention to share my thoughts more often than what i have in the past year. I also intend to tweak the format a bit to make them a bit shorter, where I do not feel like a major change in stance is warranted to briefly show up in your lives.

This year, I'm setting a goal to share my insights more frequently than in 2023. I hope that a shorter, somewhat less ambitious format allows me to provide more updates. We’ll see.

On a broader note, I’m happy to live in Switzerland now that it’s becoming increasingly apparent that ideology is starting to overshadow common sense in much of the decision-making landscape.

This trend presents both challenges and opportunities for us as investors and observers of the market. I look forward to navigating these complexities together with you.

What landing?

It’s entirely possible that expectations for a cooler core CPI going forward could force rates lower. Such rate drop could happen even if the slowing of headline CPI stalls, as long as the market is able to digest the reasons (i.e., positive base effects fading, ‘temporary’ uptick in commodities’ prices). […]

This exercise suggests that we might see even loftier S&P levels going forward, even before looking at other positives. Perhaps even all time highs? Never say never.

Read more: $29 WHAT LANDING?

We ventured into Q4 2023 with a constructive view on equities, touting the possibility of all time highs for the S&P. We must admit this rip to the upside took even us by surprise! Not sure about Goldilocks, but the three bears cannot be happy.

Today, we continue to ask ourselves the question “what landing?”

This is how we see things:

• Recent data reveals a significant shift in inflation metrics, with the 6-month annualized Core PCE rate stabilizing at 1.9% for two consecutive months, and the MoM annualized Core PCE hovering close to or below 2% in six of the last seven months.

• The impact of tightening measures may now be fading into the background with the US economy exhibiting robust growth (3.3% GDP growth in Q4). This growth encapsulates a bifurcated economy where interest-rate sensitive sectors are experiencing challenges, while others demonstrate remarkable resilience and strength.

• On the monetary front, the Fed’s balance sheet has been shrinking, creating some monetary headroom.

  

• With policy rates currently restrictive and the most sensitive sectors feeling the pinch, there’s growing discourse around the need for "normalization" (towards the neutral rate, r*). The market anticipates roughly six rate cuts in the coming year, yet I believe these expectations boil down to two distinct scenarios: an economic recession that warrants 300-400bps in cuts or gentle (50-100bps) ‘insurance cuts’.

• Fiscally, the US will maintain its aggressive support stance, irrespective of political leadership. While I refrain from taking sides in the political arena, it’s clear that the current candidates resonate with today’s Zeitgeist. If you don’t like these wait until you see who’s next in line.

  

All this boils down to potentially Goldilocks 2.0, with a resilient economy and investor-friendly monetary / fiscal policy supporting top-line growth and valuations. And even if the economy slows down, I believe the monetary headroom (i.e., higher rates and somewhat lower balance sheet) helps underwrite the vaunted Fed put. Famous last words…

A quick note on energy, which we continue to like in the current environment. We have been massive uranium bulls over time ($22 IT’S PRONOUNCED NUCULAR), but have consitently reduced our exposure as the risk-return is different now with uranium at $106 / lb vs. $60-65 / lb cost of production1.

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“The biggest contrarian long trade on the planet.”

Contrarian investing is tough.

Only a year ago, were all riding high with our ChinaTech investments, the market seemingly on our side and optimism at its peak. Tides always turn, however.

While some, skillfully exited near the market highs (shout out to Contrarian8888, always gracious!), a portion of my portfolio became value-trapped for over a year.

An expensive reminder of the unpredictable nature markets and the razor-thin line between timely exits and prolonged entanglements.

Today’s sentiment is succinctly captured by BofA's Harnett’s quote above.

But why now?

China's real GDP did grow by 5.2% in 2023, outperforming many others. However, its nominal GDP increase was a more modest 4.6%, lagging behind Japan (5.4%), the Euro Area (6.1%), and the US (6.2%). China's GDP in USD terms actually shrunk as the CNY depreciated >5% vs. the USD. No bueno.

Authorities seem to recognize the importance of delivering on the fiscal and monetary support promises that market participants have been since the pandemic. Testament to that is last week’s recent 50bps RRR cut, the first double cut in >2Y.

Chinese stocks are the cheapest we have ever seen them on most metrics.

It also seems to be capturing the attention of, well… the same investors that exited surfed this wave circa a year ago.

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Interestingly, it’s starting to show in the numbers. BofA reported a record influx of capital last week with a massive $12.1bn to EMs…

… $11.9bn of which actually went into Chinese stocks. Furthermore, $FXI and $KWEB call volumes exploded over the past 10 days.

I’m long a basket including $BABA, $KWEB, $JD, $BIDU, $NIO and Linklogis.

Only for the brave. Only for the foolish.

That’s it for today, hope you had a great start to the year!

$$$

Today more than ever, thanks for reading,

John Galt

• Over past months, financial currents were underscored by discussions around Goldilocks 2.0 and the ‘immaculate disinflation’ narrative

• In housing, reluctant sellers are holding the door to significantly lower valuations / housing prices shut

• Right tail outcomes now seem more palpable, as markets more often than not have historically continued to ‘crash up’ from here

This post discusses—implicitly or explicitly—investments in US rates / bonds and equities.

Damn, it’s been a long time…

First of all, I’d like to extend a warm welcome (back) to everyone. For those who don’t follow me on Twitter (@GoingJGalt) you must have been wondering what I’ve been up to lately.

Well, I’ve been connected to the markets as intensely as ever. However, I had the brilliant idea to tangle myself up in all sorts of new non-listed investments that required my attention. These include a couple of investments in Indonesia (mainly real estate / villas and tourism-oriented ventures) and some private equity type of investments (e.g., preferred equity in an technological QoE firm).

There have also been a couple of personal changes, the most important of which is Mr. Galt’s full-time move to Switzerland.

On the other hand, my listed portfolio was relatively well positioned for the most part… owning uranium (spot), big oil equities and ChinaTech. I’ve been taking it on the chin on my long JPY exposure, though. Bottom line: performance has not been anything to write home about, but I’ve not had to make too many changes.

I’ll share more details in upcoming posts (if you’d like!). But for now let’s jump right into today’s note, which will bridge some of the key developments I’ve seen across markets between today’s and my last missive and lay out the foundations for future notes…

Today more than ever, thanks for reading.

Where we left off

Recall our previous discussions in the wake of the decline of Silicon Valley Bank, Silvergate Bank, and Credit Suisse? We touched upon how markets had “moved substantially already—particularly in rates and bonds” and were “discounting substantial damage from lower credit creation and reduced inflationary pressures”. Something’s gotta give…

With systemic risk concerns abating, data needs to start reflecting this damage soon or public discussion will shift back to inflation, reverting / scaling back some of the latest moves.

Such a reversion would see a U-turn in equities, while interest rate-sensitive assets such as bonds / gold / certain FX currency pairs sell off and oil / energy / commodities go bid.

Read more: $28 MONETARY TIGHTENING VS. BANK CREDIT TIGHTENING

Market resilience soon became evident (again) forcing a swift recalibration reminiscent of a timely Reverse Uno card move.

Over past months, financial currents were underscored by discussions around Goldilocks 2.0 and the ‘immaculate disinflation’1 narrative. These conversations were underpinned by several key developments.

• Labor markets have shown signs of strain. A notable point of interest was the recent U.S. JOLTS Job Openings data, a reported 8.8mn vs. 9.5mn (est.), even with unemployment metrics remaining stable. Immaculate disinflation is possible, after all.

• Inflation (core and headline) has cooled, with wholesale prices teetering on the precipice of deflation. MoM may be have been stalling somewhat lately, but the YoY trend is lower, as hotter datapoints roll off.

• Services remain a beacon of resilience, driving surprisingly robust GDP prints and suggesting that the primary driving force of the US economy remains defiantly strong. Or perhaps not as suprising considering unprecendeted fiscal...

  

US Housing deserves special mention

US home prices remain relatively resilient despite a staggering rise in mortgage rates and payments. As per the Atlanta Fed, median housing payments represent 43.2% of median income, which is the highest in at least 20Y.

This resilience can be explained by the immense delta between mortgage rates and effective rates, which includes mortgages fixed at much lower levels over time. This differential has fostered a virtual ‘seller’s strike’ among existing homeowners that has driven US mortgage applications to their lowest since 1995. Context.

Who would renounce a 3.6% rate to enter into a 30Y 7.53% mortgage?

Reluctant sellers are holding the door to significantly lower valuations / housing prices shut. It’s hard to envision a significant drop in prices with these dynamics going on. Hodor.

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Never say never

The market's skepticism around that the economy can handle “higher for longer” has been noticeably alleviated. The economy seems to have turned the corner…

Just a short while ago, the strategy du jour among investors was hedging against left tail risks. Now, the pendulum has swung and the probability of a right tail outcome seems more palpable to many. Historically, more often than not markets have continued to ‘crash up’.

Now picture this. It’s entirely possible that expectations for a cooler core CPI going forward could force rates lower. Such rate drop could happen even if the slowing of headline CPI stalls, as long as the market is able to digest the reasons (i.e., positive base effects fading, ‘temporary’ uptick in commodities’ prices).

Now paint a picture where 10-year US reals plummet considerably from their 14Y highs. Don’t you think the S&P could undergo a significant mechanical re-rating in response?

This exercise suggests that we might see even loftier S&P levels going forward, even before looking at other positives2. Perhaps even all time highs?3 Never say never.

As the great Marko Papic recently asked himself… “what landing?”

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As you see, I continue to be relatively constructive about the markets, even more so than about the economy itself. There are just more scenarios where things remain somewhat positive.

That’s it for today. I promise you won’t have to wait for such a long time for the next post. I leave you with a quick poll…

$$$

Thanks for reading,

John Galt

• Replacing monetary tightening with bank credit tightening leads to an uneven distribution of its impact across firms, markets & the economy

• Effects of increasingly dovish Fed (lower rates) on valuations to be felt by all companies—yet disproportionately benefit certain sectors

• At the intersection of these points there is a subset of beneficiaries experiencing smaller earnings / growth declines due to size and sector exposure that also benefit from lower rates going forward

This post discusses—implicitly or explicitly—investments in equities, rates / bonds, commodities (gold, oil, etc.) and FX.

Powell’s covfefe

Welcome back, everyone! Let’s jump right in today with some takes of last week’s FOMC that lead to a few ideas I’ve developed in past days.

Powell kicked the presser off (unknowingly) confirming his alignment with Blankfein’s ‘situation similar to a rate rise’ comment earlier in the week…

“The events of the last two weeks are likely to result in some tightening credit conditions for households and businesses and thereby weigh on demand on the labor market and on inflation.

Such a tightening in financial conditions would work in the same direction as rate tightening. In principle as a matter of fact, you can think of it as being the equivalent of a rate hike or perhaps more than that, of course it's not possible to make that assessment today with any precision whatsoever.

…, which paved the way for a single hike with a side of dovish covfefe1…

So our decision was to move ahead with the 25 basis point hike and to change our guidance, as I mentioned, from ongoing hikes to some additional hikes maybe, some policy firming may be appropriate. […] Really I would focus on the words “may” and “some”, as opposed to “ongoing”.”

Now, please take a few moments to peruse the quotes below and let’s play a little who-said-what game.

1. “The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.”

2. “So going forward, as I mentioned, in assessing the need for further hikes, we’ll be focused as always on the incoming data and the evolving outlook, and in particular on our assessment of the actual and expected effects of credit tightening.”

Bonus: and when?

If you know the answer you probably see where I’m going with this. Shoutout to the great Dario Perkins, who dug out this quote from Bernanke’s Fed dating back to when the Fed paused in 2006.

The similarities are striking. What today’s Fed is saying rhymes with what the previous Fed said to cap off the previous hiking cycle.

Markets have been interpreting the situation accordingly, by aggressively turning hikes (into cuts). Charlie.

In the same vein, today’s situation seems to align with previous financial stress-related jitters, as Goldman Sachs indicates. The Fed’s preferred direction has often been easing, but those were hardly analogous inflationary predicaments.

OK, let’s take that at face value. Let's say it’s the last hike. What happens next?

According to BofA's Hartnett, adding risk after the last hike delivered strong positive 3-month (8.1%) and 6-month (13.1%) performance for the Dow Jones Index ($DJI) going back 35Y. The table below shows there is a path to higher equities from here.

On the other hand, “stocks fell in the three months after every last hike in the ’70s/’80s”, a more inflationary environment. It’s hard not to see merit in Hartnett’s expectation for today’s performance to follow that of other inflationary periods as “negative feedback loop from higher unemployment to day traders, retail, consumers and corporations is likely to be very pronounced”.

Hartnett specifically believes there will be a “final lurch lower” before the rebound.

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Bank credit tightening replaces Fed tightening

Some thoughts on what's going on in equities today. Let’s start with the credit crunch.

Deposit outflows from smaller banks to G-SIBs are expected to constrain credit creation and impair economic growth. To wit:

The problem is that the US relies on the depth and capillarity of the banking system to provide the lifeblood (in the form of funding) to the US economy. And most of that heavy lifting is done by small / mid-sized banks.

Per Goldman Sachs, “banks with less than $250bn in assets account for roughly 50% of commercial and industrial lending, 60% of residential real estate lending, 80% of commercial real estate lending, and 45% of consumer lending.

Read more: $27 NO PERFECT TIME FOR HIKES

Replacing monetary tightening with bank credit tightening—as the source of negative economic pressure—will likely lead to an uneven distribution in the impact of tightening across firms, markets and the economy.

This will disproportionately affect companies’ earnings depending on:

• Small vs. large firms: Smaller firms are more likely to bank with smaller / regional banks than larger companies… and feel the crunch more intensely.

• Listed vs. non-listed: Stock markets are populated by larger companies, which benefit from enhanced access to more Baja and capital markets. Listed firms should be less affected than smaller, non-listed firms.

• Capital intensive vs. capital light, cash flow positive vs. negative: The more capital required to operate, the weaker its position.

• Sectors: Sectors with higher consolidation—few, large companies dominate the market—should fare better than less consolidated / more atomized sectors teeming with small firms. Sectors more directly influenced by credit issues (e.g., housing, autos, (C)RE, etc.) will underperform. Finally, note sector weights vary across countries (e.g., US has substantially more tech than EU, as do its indexes).

  Wild dispersion across sectors are common in earnings recessions:

  The largest earnings declines were highly amplified by concentrated sector weakness, as it was the case in 1990 due to Autos (only -10% EPS ex. Autos), in 2001 with Info Tech (-9% ex. Tech) or the most recent example in 2008 when Financials ultimately sunk index EPS to a record decline (-19% ex. Financials).

  Read more: $11 'TIS THE (EARNINGS) SEASON

Similarly, the impact of an increasingly dovish Fed (lower rates) on valuations / valuation multiples will be felt by all companies, but disproportionately benefit certain sectors.

There is a subset at the intersection of both of large, (often) listed, companies that will likely experience smaller earnings / growth declines due to size and sector exposure, while benefitting from lower rates.

That is in fact what we have commenced to see in past weeks across equities:

• Growth (i.e., tech, communications) / duration proxies2 and defensives (i.e., consumer staples, utilities and health care) remain in positive territory, outperforming their more cyclical counterparts (i.e., financials, real estate, materials, energy, industrial and consumer discretionary)…

  

• …, while large caps and growth have fared better than small caps and value.

  

Where do we go from here?

A few closing words.

Markets have moved substantially already—particularly in rates and bonds. These are discounting substantial damage from lower credit creation and reduced inflationary pressures.

With systemic risk concerns abating, data needs to start reflecting this damage soon or public discussion will shift back to inflation, reverting / scaling back some of the latest moves.3

Such a reversion would see a U-turn in equities, while interest rate-sensitive assets such as bonds / gold / certain, FX currency pairs4 sell off and oil / energy / commodities go bid.5

$$$

Thanks for reading,

John Galt

PS: The first quote is Bernanke’s.

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• Fed rates and short-term interest rate markets cratered, fueled by concerns of systemic risk in the banking sector

• Macroprudential measures put in place stabilized / normalized markets… helping underwrite further hikes

• US relies on depth / capillarity of the banking system to provide funding to the US economy, as most of that heavy lifting is done by small / mid-sized banks

This post discusses—implicitly or explicitly—investments in rates / bonds.

Global Financial Crisis PTSD

Our last post—aptly titled $26 HIGHER FOR LONGER—was published in early February, at a time when US equities had enjoyed a “grind up” fueled by the infamous “‘Fed pivot’ narrative (i.e., pause in Fed hiking on the back of rapidly decelerating inflation)”.

Back then, we pointed toward “small signs” of a “puzzling re-acceleration in economic data” that we saw “at odds with calls for imminent recession and significant monetary softening / rate cuts”. Market-implied terminal rates relentlessly rose in subsequent weeks— approached 6%—while 2Y Treasuries breached the 5% mark.

Then they proceeded to hit a brick wall. Or three1.

Fueled by concerns of systemic risk in the banking sector (and some PTSD), Fed rates and short-term interest rate markets jumped on the Tornado for a wild rollercoaster ride.2

The yield curve re-steepened, which Morgan Stanley’s Mike Wilson (and others) noted is a harbinger of recession:

“An inversion of the curve typically signals a recession within 12 months, but the real risk starts when it re-steepens from the trough, especially in cycles that exhibit high inflation where the Fed’s hands are tied—i.e., ’70s / ’80s.”

Today’s note focuses on how recent events may have factored into the Fed’s decision later today at the March FOMC meeting and their reaction function going forward.

Macroprudential measures + Monetary tightening

To hike or not to hike, that is the question. Or at least it was. For a brief moment.

Over the past few days, we have seen Central Banks (CBs) across developed economies coming together to shore up markets through the institution of newly-created programmes and enhanced facilities.3

These macroprudential measures have managed to stabilize / normalize markets (i.e., higher rates, lower volatility, rebouding bank equities, etc.)... helping underwrite further hikes.

Following a 50bps hike by the ECB late last week, it seems clear the Fed’s Committee will hike 25bps today.4

Investors will also fish for other hints:

• Hawks will get their fix from comments around price stability remaining the main Fed objective today—particularly in light of re-accelerating economic activity data.

• Doves will get their fix from references to renewed banking sector distress.

• Vol traders will get their fix, period.

  Going John Galt is a reader-supported publication. Please, share this post to support our writing!

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Second-order consequences

Data—however anecdotal—already reflects the impact of these events on deposits / cost of capital over the past days5:

• Individuals and corporates have come to the sudden realization that their deposits are not as safe as they thought. Without a higher standard FDIC-insured deposit amount, deposits will continue to flow out of smaller / mid-sized banks into G-SIBs (i.e., J.P. Morgan, Bank of America, Citi and Wells Fargo).

• Individuals and corporates will move their funds from deposit accounts into higher-yielding, protected accounts such as a mutual funds.

• Both of these moves are facilitated / sped up by today’s technology. It’s never been easier to set up an account. Transfering funds across banks and different accounts is literally at our fingertips.

• Access to information has also augmented / accelerated this exodus. It’s never been easier to gather information that allows individuals and corporates to maximize for protection and return.

Deposits are structurally less sticky than anticipated now. Lower levels of deposits at small / mid-sized banks increase a bank’s cost of capital, as deposits tend to be the cheapest source of funding available.

Now, what are the longer-term, second order consequences of these bank failures?

It’s increasingly clear that banks—particularly small / mid-sized ones—are starting to curtail credit, while tightening lending conditions.

As Lloyd Blankfein—ex-CEO of Goldman Sachs—put it, “this situation will act in a way that is similar to a rate rise”.

The problem is that the US relies on the depth and capillarity of the banking system to provide the lifeblood (in the form of funding) to the US economy. And most of that heavy lifting is done by small / mid-sized banks.

Per Goldman Sachs, “banks with less than $250bn in assets account for roughly 50% of commercial and industrial lending, 60% of residential real estate lending, 80% of commercial real estate lending, and 45% of consumer lending.

The biggest question today is when and to which extent this curtailment of credit from small / mid-sized banks will be felt and how public authorities will react.

It seems fairly clear that economic activity should be negatively affected by these events, a positive vis-a-vis inflation. Lower activity and milder inflation data should lessen the need for additional hikes.

Please do let us know what you think.

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John Galt

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• Recent grind up in US equities rests on ‘Fed pivot’ narrative (i.e., pause in Fed hiking on the back of rapidly decelerating inflation)

• In past days we witnessed a puzzling re-acceleration in economic data, at odds with calls for imminent recession and significant monetary softening / rate cuts

• Latest repricing of rates increases odds of finishing the year (well) north of 5%, an ominous sign for US equities

This post discusses—implicitly or explicitly—investments in rates / bonds, US equities (tickers: MSFT, GOOG) and energy equities.

“STOP FORREST”

If you’ve been following our work you’ll remember how in Q4 we ventured off-piste and turned fairly constructive on US equities, indicating the most likely path forward for them was a “range-bound / slowly upward-sloping grind with substantial rotation within equities” ($23 A MORE BALANCED APPROACH).

The footnote called for “S&P trading from 3,500 to 4,100” and identified how going forward the “downside is more capped” and how “some great assets might have seen their lows”.

Fast-forward two months and a bit. For the most part, US equities ran in line of our expectations… then ran some more. Out of the stadium, out of our stated range.

It’s undeniable that (animal) spirits are running high. Junk has rallied. The GameStops of this world seem back in the menu. Even crypto. As investors we find ourselves in a deeply uncomfortable place, with some of us penning notes on how we “just don’t know”. John Snow.

In the past week, I’ve started to see small signs that the situation may start to revert. Something seems to be brewing across assets, driven by an emerging narrative. If you agree, note we are not alone.

“I think markets are already behaving far more rationally now even just versus a few days ago, and we see new pricing across the board in the rates / USTs / duration space, as terminal moves higher and further out [while] that legacy ‘imminent 2023 hard landing recession’ probability gets REKT and pushed into 2024.” —Nomura’s Charlie McElligott

Today’s piece examines what this nascent narrative looks like and where some of the latest developments fit in the context of the past months’ market action.

Pause? Possibly. Cuts? Highly unlikely.

The recent grind up in US equities was predicated on the ‘Fed pivot’ narrative (i.e., pause in Fed hiking on the back of rapidly decelerating inflation), which took center stage starting in October. Weak economic data—including early signs of disinflation—allowed markets to swiftly anticipate a terminal rate just below 5% followed by the start of a new cutting cycle (7 months after and for roughly 200bps).

This dampened / compressed volatility—with VIX and MOVE both peaking in October—and underwrote the current rally in everything.1

Now, over the past days we’ve witnessed a puzzling re-acceleration in economic data:

• December JOLTS data showed US job openings at 11 million (vs. 10.4 in December), a 5-month peak

• January Non-farm Payrolls (NFP) surprised to the upside: headline figure (517,000) was ~3x consensus, ~2x December’s number; Unemployment dropped to 3.4% (vs. 3.6% previously); average hourly wages accelerated to 4.4% YoY; the visual below underscores how much of an outlier this print was.

  

• US ISM January services PMI back to expansion territory at 55.2 (vs. 49.2 in December)2; little disinflation seen in the ‘new’ “services ex-housing” component

• Even within goods, items such as used car prices—a major component in inflation indexes, a poster child of this inflation cycle and one of the first experiencing disinflation—seem to be unexpectedly picking up again (2.5% in January)

• Inflation pressures remained strong globally on the back of Europe’s economic recovery post-energy crisis and China’s reopening, with core inflation in the EU attaining peak levels and Japan’s inflation hitting >40Y highs

The economy is proving surprisingly strong. Labor markets, scorching. A recession is less imminent than what markets are pricing.

Now, where does this leave us?

Latest data could cast doubt on prospects of a pause following 25bps increments in March and May and cuts this year. Inflation deceleration will potentially reverse course and go higher again soon (although not back to peak). Do you think an economy churning out strong data, where inflation is substantially above target (and re-accelerating) warrants rate cuts (and an 18x P/E multiple)? Pause? Possibly, for a bit. Cuts? Extremely unlikely. “And like that... it’s gone”.

A cacophony of Fed voices—only in the past 24h we had Williams, Waller, Kashkari, Cook and Powell—have flagged the possibility of ‘higher for longer’ in the past days.3 So much so they might have engaged Timiraos to parrot their talking points! McElligott is right, investors are “not taking a Fed ‘higher for longer’ path at face value”.

If you agree with the incomparable Kevin Muir—of The Macro Tourist fame (great resource, btw!)—that markets are forward discounting and have been anticipating / pricing the pause all along, the terminal rate moving ‘higher for longer’ should be an ominous sign for US equities.

Well, the repricing of terminal rates seems to have already started and accelerated in the past couple of days. The odds of finishing the year (well) north of 5% in rates is markedly higher.4 It has coincided with rebounding volatility indexes (i.e., MOVE and VIX), mixed results in US bond auctions (some atrocious, some stellar) and broad weakness in equities.

I mention in the “About” section that I always expect people to state how strongly they feel about any given call. Just to be clear, this one truly rests on a couple of data points. This nascent narrative resembles the Death Star in that it’s spectacularly vulnerable5 if these few “data points [truly] don’t make a trend”. It’s early. Caveats.

A couple of ways to play it.

As JPM’s Kolanovic put it, I’ll be using “current strength in order to reduce exposure” across my book. This does not mean the S&P is going to 3,000 in a heartbeat. It only means I'm comfortable we’ll meander back to our range.

On the other hand I think compounders / dividend / shareholder remuneration plays should be fairly well positioned in this ‘higher for longer’ world, where a recession is not imminent. I continue to like energy in particular—some of these names are almost literally printing money ($25 GREAT THINGS HAPPEN TO CHEAP ASSETS). BP's FCF is 25%?!

Finally, I suggest you keep an eye on the AI wars. Seems Microsoft ($MSFT) truly has something special in their hands with the integration of OpenAI’s technology (ChatGPT) in their browser and MS Office products. Google’s ($GOOG) monopoly in search (>90%) might be at stake… and that’s a lot of billion in market cap.

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Thanks for reading,

John Galt

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“For some people, money is... money is a foreign film without subtitles.” —Matchstick Men

Revolut is a regular, licensed bank, with great technology behind. But—on top of all the usual features you can expect from your bank—Revolut allows you to automatically convert the balance in your account from one currency to another using the interbank exchange rate (!) and avoid exchange fees. Trust me, complete transparency in FX exchange rates is a valuable asset.

Sign up here (it’s quick & easy!)—use my link to support Going John Galt

• Markets have been fairly benign for us—problem with victory laps is not only that they are pedantic, useless, and universally uncool, but also that they perpetuate the misguided impression that investing is easy

• Few saw China’s recovery coming or Europe’s pressures subsiding—now global growth outlook seems to be improving

• ChinaTech remains cheap, European equities seem overextended, Japan’s defense of Yield Curve Control unsustainable and commodities / energy still in a supercycle

This post discusses—implicitly or explicitly—investments in ChinaTech (tickers: KWEB, BABA, BIDU, JD, PDD, KC), European equities (VNA), FX (USDJPY, EURUSD), energy equities (XOM, CVX, XLE, BP, SHEL, OXY, TTE, SPUT / U.UN), commodity futures (Brent, WTI) and bonds (JGBs, US bonds).

“Where is John Galt?”

Not the question that was popularized by Rand’s novel, but surely one many of you have asked in past weeks, as my activity on Substack took the path of FTX.

The explanation is quite simple: I thought I had little to offer over these past weeks beyond what I had already shared. I’m not here to waste anybody’s time. Especially not my own.

Anybody that goes back and re-reads the latest missives will deduce that markets have been fairly benign for us. The situation has been generally playing out in line with our expectations, which is often not the case. Needless to say, our portfolio1 has benefitted massively and—considering subscribers often have a view on / open positions in these assets—I hope yours did too.

In broader market terms we called for a “range-bound / slowly upward-sloping grind with substantial rotation within equities” ($23 A MORE BALANCED APPROACH) and that’s roughly what we got. US equities have gone nowhere in the past month…

Problem with victory laps is not only that they are pedantic, useless, and universally uncool, but also that they perpetuate the misguided impression that investing is easy. And it’s anything but.

Today’s piece represents my best effort to remain “noble and poetic” in victory. The point of it is really to provide a ‘portfolio update’ on the themes we highlighted in our past posts (i.e., China, Japanese Yen, and Europe’s energy crisis, commodity supercycle, etc.) and discuss where things might be heading.

The other point is getting back into the fold of things. I’ve been developing a few new investment ideas and I’ll be sharing them in coming missives.

Remember when China was uninvestable?

Starting end of October, I wholeheartedly made a point of pounding the table on what I considered an extraordinary investment opportunity in China, with visible, positive developments on all fronts (i.e., regulation, macro, geopolitics and COVID). But one can only do as much and at one point there simply is little else to add.

Bottom line: assets were dirt-cheap (technical term) and you know the old adage. Great things happen to cheap assets.

In theory, should BABA, BIDU or KC decide to liquidate their non-core investments and buy back their stock, they could get very close to acquiring full ownership of the company (see ‘Cash + Disposable assets as % of Market Capitalization’ column). In theory communism works… in theory.

Read more: $20 ANOTHER BEAR MARKET RALLY?

Going back, it was an uncomfortably out-of-consensus call rooted in comprehensive research… that got quite some heat. This platform, however, also helped me realize that many of you were here because you somewhat agreed with me that there was value to be unlocked.

I rarely comment on my readership statistics. This time, however, it offers anecdotal evidence of how brutally polarizing the subject of China has become and how underloved this thesis is.

Four members unsubscribed from Going John Galt within 10 minutes of publishing—quite rare for a Substack with virtually zero churn (just one unsubscribed member in nearly 6 months live). Now, however polarizing the subject may be, the bigger truth is that investors love a bargain… and over 40 readers clicked the subscribe button since.

Read more: $20 ANOTHER BEAR MARKET RALLY?

For some of these companies I truly was their biggest advocate out there. Just type Kingsoft Cloud ($KC) alongside my handle on Twitter, for example.

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Whatever the case, I continue to find these cheap relative to most equities.

I’ve not pared down my ChinaTech exposure although I’ve rotated some to Nio ($NIO) at around $11 (~$18bn market cap, ~$14.7bn Enterprise Value). They are one of the leading electric vehicle (EV) companies in China with focus on delivering high-end autos. It’s expected to be profitable by the end of 2024, while revenues grew >40% this year and are expected to almost double next.

I love how horribly bad it’s been trading, as it’s taking a two=fold blow. It first got struck alongside the rest of ChinaTech and it’s now joining Tesla ($TSLA) in its descent into the inferno. Not my usual investment.

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Unwinding JPY shorts

A few weeks ago, I argued in favor of being long JPY (vs. USD), coinciding with the Bank of Japan’s (BoJ) decision to finally allow the tolerable trading band of Japanese 10Y bonds (JGBs) to widen from ±0.25 to ±0.5%, to arrest mounting pressures on Japan’s sovereign bond market.

Markets interpreted this as a first hawkish step, opening the door for a broader BoJ pivot. It’s both “symbolic” (as SocGen’s Juckes called it) and “a precursor to either retiring the target or even outright rate hikes” (BMO’s Lyngen & Jeffery).

Read more: $24 JPY: A GREAT 2023 STORY GETS BETTER

Since then, the “massive short JPY trade” we flagged has been unwinding, driving Yen appreciation.

This week, Japanese 10Y bonds (JGBs) broke the 0.5% ceiling, forcing widespread intervention (i.e., bond-buying by Japanese authorities). The barbarians have regrouped and are at the gate again.

Once again, it’s become only a question of when it’ll prove unsustainable. The situation looks oddly familiar to investors… and it can trigger an oddly familiar response from the BoJ. Short JGBs (higher yields) and long JPY.

What I said then remains my base case—the “low 120s [vs. ~130 today] can be in play by the end of 2023”. Caution, though. US bonds seem tactically overbought and a sell off (higher US yields) may be due. This would lead to a (temporarily) lower JPY via widening US-Japan bond yield differentials.

Europe: from terrible to just bad

In early Q4, it became particularly evident that years of compounding mistakes in their energy policy had cornered Europe’s economy. The situation seemed untenable and extremely costly... and not just literally in energy support programs.

Many expected Europe’s energy crisis to only worsen. Using an obscure reference that I will most likely regret, the bet seemed to follow the name of an English boy band captained by a handsome young man who loves skirts (quite literally).

Anyway, European companies—good and bad—were getting hammered in this environment and some reached long-term attractive levels. Finding a price vs. looking for the price. Enter Vonovia ($VNA).

This is a bet that Germany makes it through the crisis.

Read more: $18 DRINKING RED BULL & VODKA

In the note above we picked Vonovia as our preferred European / German recovery play, considering it’s the largest real estate company in Europe, managing >600k residential units mostly in Germany (~89%). We went through the main financial metrics and concluded that few things are safer and offer superior risk-return than an above-average quality residential portfolio in Germany at deep value / discount to valuation. Again, great things happen to cheap assets.

Demand destruction and mild winter temperatures (La Nina played a role) drove natural gas prices off a cliff (now at Q3 2021 levels). Energy prices fell sharply. Gas storage levels are uncommonly elevated (~90% vs. ~65% for mid-January, historically). Headline inflation remains high, yet rapidly declining. Bomb, defused. For now.

With European growth resilient yet soft and financial conditions tightening2, the steep repricing phase for $VNA and European equities is largely over. Exit.

On a related note, all these developments are incrementally EUR positive. I’ve been shifting my FX exposure accordingly. In case you were wondering.

Energy: ultimate compounders & 2022 winners

At the core of the commodities / energy thesis is the decade-long structural underinvestment in natural resources and ever-growing global demand, which conspire in favor of higher prices. I see the commodities supercycle only to be tamed in the longer term by eventual capacity expansion / project development or recession.

On the later, its impact would only be temporary as it would not alleviate these pressures in the long run. With Chinese / European growth outlook improving considerably, chances of an all-out recession in 2023 seem to have somewhat subsided. Left tail, less fat.

If US indexes continue trading sideways in the medium term, I favor “extraordinary performance not tied to price appreciation, but rather to shareholder remuneration (dividends and share buybacks / repurchases)” and in that scenario I “expect energy companies to become the dividend stocks of our generation, […] great businesses with high yields that institutions don’t want to own” (Read more: $13 THE BOOK OF MUIR).

This is how my picks ($XOM, $XLE, $CVX, $BP, $TTE, $OXY, $SHEL) have fared since the note on oil was published compared to owning oil futures (i.e., Brent and WTI) outright. Anywhere close to these oil prices, their equities print cash.

Finally, uranium is one of the big winners of 2022 despite it’s relatively lackluster performance in 2022.3 The Sprott Physical Uranium Trust (SPUT)—which delivers exposure to the spot price of uranium—ended the year up only ~15%. But…

Public perception is doing a 180. The world's soap opera in energy markets has been great publicity. Governments have consolidated this pivot via pro-nuclear regulation. Structural underinvestment across commodities applies to uranium as well. Miners are confirming the start of a new contracting cycle with the signature of massive long-term agreements. M&A and consolidation is happening. And... there are chances that sanctions limit access to Russian uranium

Read more: $22 “IT’S PRONOUNCED NUCULAR"

The set-up is great into 2023 and until uranium trades at the very least in line with the upper range of its cost of production ($55-65 per pound).

If you were actually asking the question “where is John Galt”, just know that he’s made his way back from Asia and is currently enjoying the European ski season. The land of milk and money.

Hope all of you enjoyed the holidays and started off the year on the right foot. I also hope you are as excited about this 2023 as I am.

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Thanks for reading,

John Galt

*Sponsored Content*

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John Galt is an avid traveler and a superuser of Revolut. For years. I really love it! It’s for this reason I’m particularly excited that our friends at Revolut came through with their sponsorship for this post.

“For some people, money is... money is a foreign film without subtitles.” —Matchstick Men

Revolut is a regular, licensed bank, with great technology behind. But—on top of all the usual features you can expect from your bank—Revolut allows you to automatically convert the balance in your account from one currency to another using the interbank exchange rate (!) and avoid exchange fees. Trust me, complete transparency in FX exchange rates is a valuable asset.

Sign up here (it’s quick & easy!)—use my link to support Going John Galt

• Bank of Japan (BoJ) took a first hawkish step this week, opening the door for a broader pivot in 2023

• Japan’s path leads to higher domestic bond yields, lower US-Japan bond yield differentials and strong JPY appreciation

• Implications for global assets are vast, as this pivot risks the flight of Japanese capital from global toward domestic assets

This post discusses—implicitly or explicitly—investments in FX (USDJPY) and bonds (JGBs, US bonds).

Preparation meets opportunity

If you’ve stuck around with me long enough (thanks!), you know I’ve been spending quite a bit of time in Asia this quarter. I concede the nomadic lifestyle is not for everyone, but it does have its unexpected perks.

At least that’s what I thought when the Bank of Japan’s (BoJ) decision to finally allow the tolerable trading band of Japanese 10Y bonds (JGBs) to widen from ±0.25 to ±0.5% caught me savoring my third cup of morning brew, with the homework done and the finger on the sell trigger. Luck and such.

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For years, the BoJ has been the most dovish central bank in the world, holding rates at 0% while aggressively engaging in Quantitative Easing (QE). Yield Curve Control (YCC)1 was instituted in 2016 and yields responded accordingly.

Things seem to be changing though. Today’s post is an explainer on how I see the situation in Japan playing out, the way to play it and its global implications.

“You’re probably just having a mid-life crisis. Did you buy a Porsche yet?”

You might recall this quote by Charlotte, impeccably portrayed by Johansson in Coppola’s Lost in Translation (cliché?). Not sure this qualifies as a mid-life crisis for BoJ Governor Haruhiko Kuroda2—now well into his 70s—but I’m sure many investors would have preferred for him to buy a Porsche.

Last Tuesday, the BoJ decided in its Monetary Policy Meeting to leave policy generally unchanged for a 50th (!) meeting in a row, but… tweak the tolerable trading band for their 10Y bonds from ±0.25 to ±0.5%! Surprise, surprise.

None of the Bloomberg-surveyed economists expected this so soon, as Kuroda-san had done a magnificent job squashing rumors. To be clear, the expectation was there, but the domino was only expected to fall after Kuroda's term expires in April 2023 (in two meetings' time).

Whatever the case, several circumstances underpinned the decision:

• JGB yield curve displaying a wrinkle (see green and red curves below showing a dip in the 10Y, maturity the BoJ targets), which put the functioning of the broader bond market (i.e., bank loans, corporate bonds, etc.) at risk. Note how the curve shifted up after the tweak (red curve), yet still displayed the wrinkle. Interestingly, this “malfunction” is the primary reason quoted by Kuroda for this week’s step.

• Widening US-Japan bond yield differentials putting strenuous pressure on a rapidly depreciating Japanese yen (JPY), notwithstanding the most recent US bond rally.

  

• Monetary policy works with a lag—today’s changes to be felt in 12-24 months—and inflation has already started to veer off the BoJ’s 2% mark (3.7% YoY, 0.6% MoM), despite other measures (e.g., CPI swaps, CPI expectations) still at subdued levels / lagging. Yen depreciation had likely been amplifying price pressures, importing inflation. Furthermore, Japan’s largest trading partner (China) reopening skews inflation risks to the upside.

  

In short, conditions were no longer compatible with the BoJ’s long-standing dovish monetary stance.

What followed was a massive reaction across global markets:

• Appreciation of the yen against the dollar (USDJPY from ~138 down to ~131), now no longer the worst performing currency Year-To-Date (a dubious honor passed on to the SEK).

• 10Y JGB yields almost doubling to ~46bps (sounds like some Chamath math!) and the 2Y rising above zero for the first time since 2015. A move cheered by banks—which rose over 7% at one point as their business benefits from higher rates—while the broad Nikkei stock index lost 2.5%3. The latter is because of the expected loss in competitiveness of Japanese goods / exports when priced in a higher currency (JPY).

• US bond yields moved >10bps lower, its curve steepened, and the S&P was ~0.9% down. Textbook risk-off.

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A great story gets better

Markets interpreted this as a first hawkish step, opening the door for a broader BoJ pivot. It’s both “symbolic” (as SocGen’s Juckes called it) and “a precursor to either retiring the target or even outright rate hikes” (BMO’s Lyngen & Jeffery).

Now, what would that pivot look like and when would it be?

It’s unlikely that any decision is made before Kuroda’s term expires and the BoJ gains visibility on the outcome of shunto wage negotiations playing out in the spring4.

The BoJ would have two main paths at that point:

• Widen the tolerable trading band from today’s ±0.5%

• Outright terminate YCC / Negative Interest Rate Policy (NIRP), in favor of no or a milder version of QE

I favor the second outcome. First, Kuroda alluded to bond market “malfunction” (the yield curve wrinkle around the 10Y described above) as the main reason for the tweak. The malfunction still exists today after the tweak—the curve (red) only shifted up. pushing it further up offers no guarantees of a functioning market. Secondly, the band is already ridiculously stretched at 100bps…

Whatever the case, both paths lead to higher Japanese bond yields, a lower US-Japan bond yield differential (ceteris paribus) and JPY appreciation (USDJPY down).

How to play it?

My preferred play is shorting USDJPY—betting on JPY appreciation. The bigger question is when we'll get the next leg down, considering timing.

Several reasons underscore the coming yen appreciation:

• Bond yield differentials: BoJ is turning more hawkish, while the Fed has telegraphed their intent for the next two meetings and will be soon on hold (priced in). Yield differentials will likely have to compress. Taking the chart produced by the powerhouse on 200 West St. above, the low 120s can be in play by the end of 2023. By almost any measure, JPY remains undervalued.

• Positioning: Short JPY is a massively crowded trade. A monster position that seems to be unwinding as we speak, driving positive flows.

  

• Global recession concerns: JPY commonly outperforms in global recessions and tough macro environments, as yield differentials tighten, and JPY-denominated investors import / repatriate capital.

  Also, in unstable macro environments FX benefits from safer, ‘relative’ returns. While stocks can (and often do) go to zero, FX quotes the relative value of a pair of currencies. Thus, unlevered FX positions are effectively impossible to go to zero.

Allow me to be clear. Because I’m patient and recognize the potential for it to become a massive 2023 story, I'm already somewhat short. But I’m similarly cognizant of the fact that bond yield differentials compressed from the ~400bps peak even before the BoJ’s tweak, due to US bond yields coming off their highs. I consider US yields tactically overbought, which could trigger a reversion providing a headwind for JPY.

I intend to add as things progress. Coincidentally, this was already a great story that has gotten only better… as it was one of my preferred short USD plays for 2023 already ($21 THE ‘EVERYTHING TRADE’).

Shorting JGBs is a close second. The problem is that a terrific trade can turn terrible fast if the global recession everyone foresees crystalizes, as JGBs benefit from safe heaven flows and the BoJ would likely goes ballistic.

Finally, I’m in the camp that expects this pivot to have vast implications for global assets as it can significantly alter cross-border capital flows.

Japan’s ~$5tn economy is highly intertwined with global markets, as one of the world’s leading exporters / importers. More importantly though, Japan is a large exporter of capital with savings exceeding $20tn due to high household saving ratios (~10% recently). NIRP and Japan’s central bank monopolizing the domestic bond market forced Japanese investors to purchase foreign assets for years.

The risk for global assets is that these increasingly pull out / shift their large global allocation toward domestic assets, as over time and on the margin, these become more attractive for long-term investors looking to hold them to maturity (remember: some JGB maturities have started to yield positive!).

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On Monday we got a first taste of what that might look like (i.e., US bonds and stocks sold off) and, if right, we’ll see further re-routing of cross-border capital flows in the coming months.

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Thanks for reading,

John Galt

*Sponsored Content*

One app, all things money. No exchange fees, get the real currency rate.

John Galt is an avid traveler and a superuser of Revolut. For years. I really love it! It’s for this reason I’m particularly excited that our friends at Revolut came through with their sponsorship for this post.

“For some people, money is... money is a foreign film without subtitles.” —Matchstick Men

Revolut is a regular, licensed bank, with great technology behind. But—on top of all the usual features you can expect from your bank—Revolut allows you to automatically convert the balance in your account from one currency to another using the interbank exchange rate (!) and avoid exchange fees. Trust me, complete transparency in FX exchange rates is a valuable asset.

Sign up here (it’s quick & easy!)—use my link to support Going John Galt

• Highly uncertain environment leads to a more balanced approach toward risk—increasing odds of a range-bound / slowly upward-sloping grind with substantial rotation within equities

• Increasing comfort with current long-term equity longs, less inclination to open short positions than before and willingness to add opportunistically

• Small caps seem particularly cheap relative to historical valuations—saw outperformance vs. large-caps over the inflationary mid-70s and early-80s

This post discusses—implicitly or explicitly—investments in bonds, FX, commodities (gold and uranium (ticker: SRUUF, U-UN.TO) and equities (small-cap equities [ticker: IWM] and ChinaTech).

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The ‘Everything Trade’

Expectations for a (relatively) calm, upward-grinding market did not disappoint.

A bit over a month ago in a note called $20 ANOTHER BEAR MARKET RALLY?, I underscored how technical (i.e., investor positioning, options positioning, corporate buyback flows, seasonality and midterms) and fundamental (i.e., earnings season and monetary policy / Fed) factors were conspiring for a “tactically constructive [view] on risk” leading me to “favor this outcome (bounce) in the short term”. S&P is up almost 5% since, VIX down ~20%.

That same note provided color on what would happen once markets sniffed out “peak inflation”:

The infamous ‘Fed pivot’ narrative (i.e., deceleration / pause in hiking, lower terminal rate or rate cuts / end of QT soon after terminal) could take off again, should peak inflation be re-established. […] If terminal rate peaks, […] it will drive what I call ‘The Everything Trade’ (i.e., long bonds, short USD, long equities, long gold).

It was followed up with an explainer of the ‘Everything Trade’ that would follow terminal rates peaking, including when to historically expect this / what to look for:

• CBs often stop hiking around the same time—at / close to the peak in headline and core inflation (YoY)—and anticipate substantial declines in inflation by several months.

  

• In 75% of cycles CBs cut within the first year since the last hike. Cuts generally arrive arrive 5-7 months from that last hike and average 200bps, with Canada and Australia generally leading the cutting cycle timing-wise. Inflationary periods exhibit only slightly larger cuts over the first year, despite averaging double the cumulative hikes.

  

Read more: $21 THE ‘EVERYTHING TRADE’

Enter October’s CPI miss—7.7% YoY and 0.4% MoM (vs. 7.9% and 0.5% estimated). Markets matched ‘peak inflation’ and ‘Fed pivot’, fuelling the ‘Everything Trade’. All positions touted in previous notes responded as expected.

Now, where from here?

Dr. Strangelove or: How I Learned to Stop Worrying and Love the Fed Pivot

The TL;DR of this is that I’m not sure I’m there yet. Loving the Fed pivot, that is. Doubts are starting to creep into my forecast for ‘lower lows’. Hear me out.

There’s a good chance this is just a relief rally built on top of some strong—yet temporary—technical and fundamental factors:

• There certainly was a cathartic feel to this rally. Markets found the relief they were looking for. Expectations of further rate hikes repriced down significantly in the aftermath of the CPI print, driving a sharp relief rally. But expectations have since trended up again toward the ~5% mark, peaking in June 2023.

• It historically takes a few months (5-7) from the last hike to the full pivot (i.e., rate cuts), making me skeptical of this rally. It's simply too early. Normally, lows align with actual Fed pivots following proper economic pain. Today's Fed is still working on their controlled demolition of demand!

The problem however is that we have seen Mr. Market look past these kind of issues before, anticipating an often wildly distant recovery.1 Some elements supporting the reflation narrative include:

• Markets have dropped quite a bit already, including one of the largest unwinds across fixed income in history. Everyone is already expecting earnings to drop on the back of next year’s recession, it may be priced in. Ask your banker / dentist / mechanic—they know this, too.

• If inflation has peaked, every in-line, downward-trending, monthly datapoint for CPI / PCE will fuel the market recovery. By the time we find a floor for inflation (i.e., a hard-to-break level, perhaps in the 3-4% range), the market may have run substantially.

  

  Furthermore, I didn’t expect Fed officials to take it seriously when I half-jokingly hinted in a previous note they might be willing to “move the inflation target / goalposts from the arbitrary 2% in a dispassionate exercise of cold, economic realism”. From the Fed Whisperer himself…

• China’s reopening is happening—I feel very strongly about this. Extrapolating the South Korean and Taiwanese re-opening experience, we might see some initial supply disruption from early wave of infections, but domestic demand will swiftly ramp up afterwards. China’s re-opening thesis turbocharged by fiscal / monetary stimulus underwritten by globally decelerating inflation could put a floor on global demand and somewhat offset the lack thereof elsewhere, as seen post-GFC.

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As investors, when facts change we need to reassess.

After recent events I'm leaning toward a more balanced approach vis-a-vis my ‘lower lows’ forecast for equities. I'm no longer as convinced of seeing a big drop below the previous lows (~3,500 on the S&P500) and acknowledge increasing odds of a range-bound / slowly upward-sloping grind with substantial rotation within equities2.

From a long-term perspective, the current situation makes me a tad more comfortable with my current equity longs and happier to add opportunistically, if I find a right price for a great asset3:

• In general, I’m starting to like small caps here—they seem particularly inexpensive relative to historical valuations. They also outperformed their large-cap counterparts over the inflationary mid-70s and early-80s.

  For reference, the Russell 2000 (i.e., the main US small-caps ETF) trades at >30Y lows in terms of forward P/E at ~12x, in line with GFC lows and below COVID and 2001 lows. I get that earnings can get scary fast, yet this seems overdone. The simplest way to play it is via the iShares Russell 2000 ETF (ticker: IWM), but there are some great industrials, mining and energy names trading fairly cheap, too.

  

• On the other hand, I increased my exposure to uranium (ticker: SRUUF, U-UN.TO), as explained in my last piece titled $22 “IT’S PRONOUNCED NUCULAR". I also remain bullish oil names as laid out in $13 THE BOOK OF MUIR.

• I ringed the register on some ChinaTech on the way up—the main ETF is ~33% up since my original piece $19 CHINATECH: RETESTING CYCLE LOWS—and started reloading a couple of days ago, when news out of China (i.e., public revolt and subsequent shift in their COVID policy stance) proved they were running against their material constraints. Papic.

I wish I could offer a cleaner narrative—one which unequivocally hints in one direction, but unfortunately it would be intellectually dishonest to do so. That's not how markets work, it's often about probabilities and paths. I can only offer you my thought process.

In the face of uncertainty we all need to re-assess our views. Shifting toward a more balanced stance seems the right move for me, today. Let’s see what happens with Thursday’s PCE figure...

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$$$

Thanks for reading,

John Galt

If this is not of interest to you, please do skip altogether. Note this post does not alter the delivery schedule of the usual content—a new piece will be published in coming days.

A bit over a month ago I set up a poll explaining how “I started this newsletter with the idea to offer a bit of ‘building in public’” and asking if you’d be curious to see what happens behind-the-scenes . The answer was an overwhelming “yes” (85%).

Few writers open up their metrics to their audience for somewhat of a backstage access, despite growing interest from readers to understand the business of market commentators. The reason for that clearly is avoiding the awkward conversation about audience monetization. Well, I’ve said this before…

“I wouldn’t consider myself a journalist… and nobody else would consider myself a journalist”—Carlyle’s David Rubenstein

I’m not a writer. I’m an investor. First and foremost. So let’s get this started.

Traffic & Subscriptions

For reference, Going John Galt launched as a fully anonymous blog roughly half a year ago.

Organically growing an audience while retaining anonymity is excruciatingly slow. It takes a while for readers to recognize you know what you’re talking about. It takes ages to get things just off the ground, particularly if you make a point of not trafficking in hyperbole. To drive traffic when your follower count truly is at the Zero Lower Bound, if you catch my drift. A veritable walk in the desert.

If you are anonymous simply for privacy reasons as it's my case1, I can assure you there's great temptation to renounce anonymity. If anyone is interested in growing quick, this ain’t the way.

Now, in my case I don’t really care. Eyeballs and clicks don’t change my life. I approach this as yet another game of compounding, yet one where I don’t take accelerating metrics too seriously.

Fostering a sense of community and establishing a relationship with these new investors pouring in via subscriptions is more important (i.e., reaching out to all of you individually, privately discussing investment viewpoints with many of you and responding to all questions in public).

A healthy community of 500 is better than a loosely held group of 50,000. With audience / readership as with many things in life, it’s more about quality than quantity.

What I get out of it today is two-fold (primary goals):

• Writing was always part of my investment process—sharing my views is a natural step

• Growing an audience allows me to meet new investors and exchange perspectives about investment topics. A larger and more qualified / educated audience creates better investment dialogue, which (hopefully) enhances performance. As I don’t have a team of fully-dedicated investment professionals behind me any longer, this is the next best thing.

Traffic

Traffic has grown steadily with help of two primary sources: word of mouth (“Direct”, 7.8k views since inception) and Twitter (3.7k views).

Word of mouth (“Direct”) entails readers directly sharing my content (i.e., forwarding the email to a friend or colleague or sending a link), while Twitter drives traffic depending on the amount / quality of interactions (i.e., your comments, likes, retweets) disseminate the content through the digital void.

Supporting Going John Galt is really easy—it only requires for you to engage… Please do so!

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Other takeaways re: traffic are:

• Spikes cluster around publication dates. My traffic seems to have substantially accelerated after the summer.

• Metrics are better posting early in the week, as the audience mostly perceives this content as work vs. leisure (i.e., weekend read). It also increases the odds of getting picked up by other platforms / financial content aggregators.

• Carrying an audience across platforms (i.e., Twitter and Substack) is very helpful.

• Getting retweeted by a large Fintwit account can be a game changer. While this has rarely happened for me, I’ve gotten a taste recently of what those boosts can be like… shoutout to my buds @contrarian8888, @BrianTycangco and @quakes99, who I’ve met via Twitter and often discuss views with. To name a few.

• Getting featured / re-posted or even cracking the “top” lists of aggregators / content sites, such as Harkster (I consistently make it into the top-5 most-read pieces), TalkMarkets or Commonstock can move the needle.

Subscriptions

The relationship of traffic and subscriptions depends mainly on your content’s fit with the audience exposed to your content and the ease of subscribing:

• Most of my subscribers are sophisticated investors—easier to find / tap in niches than out in the open.

• Existing Substack readers are easier to tap as they will open the content directly on the platform and simply click “Subscribe” vs. putting their email into a yet ‘unknown’ platform (i.e., there’s less friction in the process).

In line with these two points, Substack may not be great at driving traffic, yet it surely is at generating subscriptions, with a whopping 22.4% Conversion Ratio! It also helps that some great publications actively recommend Going John Galt on Substack. Shoutout to my buddies Investment Talk, Capital Notes and Invariant!

Twitter offers a great combination of eyeballs and clicks. My audience has grown from zero to >650 followers in six months. Apparently, it all depends on how much the algorithm likes you that week. Whatever the case, I found it’s the best place to interact.

Following the traffic profile, there’s been a dramatic uptick in subscriptions after the summer. Churn is virtually non-existent—I’m very thankful that only a handful of subscribers have unsubscribed so far.

All things considered, my subscriber count organically doubles each month-and-a-bit and we’re currently close to 5002.

With an expanding subscriber base, growing outreach via increasing “shares” and and a stable Open Rate at 50-55%, my pieces currently approach 2k views in many cases. =ROUNDUP()

Finally, my top-5 countries by subscribers are USA (33%), Great Britain (12%), Spain (6%), Australia (5%) and Canada (5%). Most readers subscribe using personal email vs. corporate (83%). The majority are players in the financial industry, with great representation from investment banks / investment managers, often in executive positions.

The future (of Going John Galt)

Content will continue to flow as usual, with a few tweaks.

Audio / Podcasting

If you are anything like me you probably consume quite a bit of content via audio. John Galt is a big fan of audiobooks. I hesitate to tell you what platform I use for that, as I want to steer away from free publicity… not that Audible needs it anyway! For podcasts I use Spotify, btw.

Many have reached out asking me to consider recording my posts for consumption via audio. Some version of this (podcasting?) is in the cards in coming weeks.

Monetization?

John Galt believes in capitalism and money as a tool of exchange. The fruit of his work for somebody else’s. He also values his time.

Money is a tool of exchange, which can’t exist unless there are goods produced and men able to produce them. Money is the material shape of the principle that men who deal with one another must deal by trade and give value for value.

Money is not the tool of the moochers, who claim your product by tears, or of the looters, who take it from you by force. Money is made possible only by the men who produce. Is this what you consider evil?” —Atlas Shrugged

Now, I have a strong preference for not putting any content behind a paywall! Mercifully, there are other ways for me to find support, though.

To be clear, writing here is net cash negative for me, it costs me money. While making money is not my primary goal here, relevant third parties are interested in sponsoring the content and revenues will compensate for expenses related to data, research and tools and will allow the content to grow in terms of quality, quantity and delivery channels. For instance, John Galt is not well-versed with editing audio, so he might have to request some external help! It would also be great if it pays for a few beers every now and then.

Now, I will never sell your data. I will strive to find only the right sponsors and I will never spam you. Ever.

Without a paywall, if you wish to support the content, it's very easy. Just click on the brief sponsored content every now and then! Click, done… Think of it as buying me a beer!

I would like to hear from you, the reader.

Finally, borrowing from my bud Conor McNeil of Investment Talk fame, below you’ll find 3 questions. I encourage you to click on one of the options to help me understand my audience better! It’s 100% anonymous and should only take a second or two, and you’ll get to see the polls update after you answer. Thanks in advance, this will be very helpful.

While I hope this piece was useful—I will provide updates every now and then. Also, in the coming days we’ll go back to the usual content. A new piece is coming soon, so make sure you stay tuned.

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Make sure you reach out for any comments or inquiries via Twitter or at john.goingjohngalt@gmail.com.

$$$

Thanks for reading,

John Galt

• Nuclear’s history is that of boom and bust cycles pivoting around a couple of key incidents that shaped public perception and initiated large scale backs due to safety / waste concerns

• Today though, nuclear is a safe, independent, clean, low carbon source of reliable base load energy

• Public perception has turned around in favor of nuclear and the uranium market—fuel for nuclear power plants—offers a great asymmetric risk-return opportunity

This post discusses—implicitly or explicitly—investments in commodities (energy / uranium) and equities (CCJ / CCO, KAP.IL, URA, URNM, SPUT).

This week’s meme is not even one. It’s just too great as it is.

‘Long-time’ Going John Galt readers have probably asked themselves why I’ve not written about nuclear and its fuel (uranium or U3O8) yet, considering numerous references to the space across different pieces.

The reason is very simple. I’ve long considered it difficult to encapsulate the most relevant aspects of the uranium thesis in my typical 1-1.2k word missive. My friend Marina PM, been very invested in the space for quite some time has convinced me to give it a try and help me, though.

So, let’s dig in.

The Merits of Nuclear

The merits of nuclear today are not fully grasped by the general public, as technology has evolved substantially and misinformation has built over decades. The primary merits of this type of energy are:

• Clean, low-carbon: The fight against climate change and an accelerated energy transition can benefit from expanding this low carbon source of energy. Due to its energy density, waste is a much smaller problem than for other energies. For context, all the waste produced by all nuclear power plants (NPP) overtime can be stored in a facility the size of a football field and the height of a large warehouse. All waste is contained onsite after energy delivery compared to fossil fuels releasing it into the atmosphere, for instance.

  

  Finally, land requirements are minimal—regular NPPs take up 1-3 square miles in land.

• Energy independence / security: Difficult to run out of uranium fuel in the short-medium term—long fuel access restrictions (i.e., embargos, sanctions, etc.) are not being a problem. NPPs have 1-3 years of inventory onsite and sign long-term, diversified delivery contracts to secure access to fuel years in advance.

• Safety: No energy source has a pristine track record here, but nuclear is one of the safest energy sources.

  

• Reliable, base load energy: Nuclear boasts the highest capacity factor across the mix, with plants operating >90% of the time. This compares positively with renewable, intermittent sources which aren’t great for base load.

  

Finally, a thought. It would be a shame if we become the first generation in history that transitions to a less energy-dense fuel as its primary energy source. Wood > coal > oil > uranium, the trend should be clear.

Nuclear: History sometimes does more than rhyme

The history of nuclear since the build out of the first commercial NPP in the 50s is that of boom and bust. Cycles pivoted around a couple of key incidents (i.e., Three Mile Island in 1979, Chernobyl in 1986 and Fukushima in 2011) that shaped public perception and initiated large scale backs due to safety and waste concerns1.

The price of NPP fuel (uranium or U3O8) in the spot market historically is a function of those cycles and the broader economic environment. You can use the chart below to follow along the fundamental changes over time.

The 60s and 70s brought a major global boom in NPP construction along with the development of the uranium mining industry. The 1973 oil embargo led to an era of turbulent energy markets that culminated in the 1979 energy crisis intensified calls for energy security and diversification away from fossil fuels administered by ‘unfriendly’ states. Long lead times in uranium mine development—often 10Y+ affairs—instilled great concerns for availability and put tremendous pressure on uranium prices.

For many years, higher prices and planned NPP development incentivized the expansion of uranium production. With plans for new NPPs coming to a screeching halt following the Three Mile Island (United States) incident in 1979, demand was unable to catch up to increasing uranium supply and stockpiles grew from the surplus. The infamous Chernobyl incident in 1986 unleashed powerful demand destruction forces, which put the proverbial final nail in the coffin of NPP construction. A long walk in the desert ensued.

The collapse of uranium prices catalyzed violent demand destruction via curtailment of operations / full business exit. Surpluses turned into deficits in the early 90s again, allowing demand to digest inventories2 over the subsequent decade until uranium prices bottomed in 2001. The start of a nuclear renaissance.

Prices of uranium started rising again around 2003, unleashing a bull market for the ages driven by:

• Robust global economic development and demographic expansion turbocharged evergreen energy growth

• China’s 11th 5-year plan promoting nuclear power and other populous countries embracing it

• Unsustainability of secondary uranium sources and renewed push for energy diversification away from carbon

• Disruptions of production by natural and man-made external shocks / disasters (e.g., floodings of McArthur River mine in 2003 and of Cigar Lake mine in 2006)

• Increasing financialization of uranium and growing investor interest

This financialization exposed the industry to excess, only burst by the Great Financial Crisis (GFC) in 2008. Uranium prices cratered. The 2011 Fukushima incident dealt the final blow to a struggling industry as public perception of nuclear energy turned on a dime once more. Existing reactors closed in Japan and other countries scheduled closures (e.g., Energiewende). NPP development plans were scrapped. Uranium was once again oversupplied.

An entire $150bn+ industry collapsed down below $20bn. History sometimes does more than rhyme.

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Uranium Market today—Supply and Demand

Today’s healthy, uptrending uranium market stems from bold and unprecedented measures by the industry’s largest players dating back 5Y to push supply and demand back into deficit.3 Supply—primary and secondary—is roughly ~155mn lbs today with demand at ~170mn lbs.

Supply

The wildly popular Lyn Alden recently said “uranium was forged in the heart of stars”. Certainly the most beautiful way to describes the energy-density of this fuel. Now, while true from a cosmological sense, it is by no means rare on Earth. It’s commonly found in rocks / earth on the ground and in seawater, but the only relevant material is what can be economically mined.

• Primary Production: The above chart shows currently operating mines (“operation”) at ~125mn lbs, well below annual demand requirements. Today’s reality is that current uranium prices remain below cost of production, generally estimated at ~$55-65 / lbs. And even if uranium reached an economically viable price for new mines to come online, mine development is always a multi-year / often a multi-decade affair.

• Secondary Supply: A significant, yet decreasing, source of supply which includes stocks / inventories, nuclear fuel reprocessing of spent reactor fuels and from surplus military plutonium, underfeeding4 and uranium produced by the re-enrichment of depleted uranium tails.

The most frustrating aspect of the uranium thesis is the lack of reliable information relative to legacy stock / inventories. Some sources indicate we might be getting close to full depletion, while others point to a few more years of additional supply.

Demand

There are three main sources of uranium demand, all tied to its use as NPP fuel:

• NPPs—existing / under construction / planned / proposed: Number of NPPs worldwide expected to double from ~440 NPPs today, with governments recognizing nuclear’s role as a safe, low / zero-carbon, independent, base load energy source.

  Today, nuclear has a ~10% share in the world’s energy matrix. Even maintaining that share, nuclear generation should grow on the back of steady population growth (~11bn est. in 2100 vs. 8bn today) along with rising living standards, tied to increases in energy consumption per capita. The International Energy Agency (IEA) projects >2x nuclear generation by 2050.

  Most of the new NPPs being built and planned are in emerging markets (EMs). Despite the strong shift in public perception across western developed markets (DMs) and the renewed push for energy security / diversification forcing governments to announce NPP life extensions (e.g., Inflation Reduction Act in the US, Europe and South Korea’s new “green” taxonomy, UK, Japan, etc.) and new builds in those jurisdictions, this was always a DM demand story.

  

  Finally, new technologies such as novel Small Modular Reactors could unleash a new wave of demand.

• Financial demand: Vehicles of the likes of Sprott Physical Uranium Trust (“SPUT”) or Yellow Cake PLC were formed to stimulate price discovery in the physical spot market. The strength of this demand should not be underestimated. Since SPUT’s inception in July 2021 it has “sequestered” ~41mn lbs of uranium (U3O8) through its at-the-market mechanism of capital formation, which allows it to accumulate uranium as money flows into the fund.

For years I’ve been an advocate of nuclear energy. I’m an investor in the space since 2019 and it’s one of my highest conviction, long-term investments.

What is clear is that stars are aligning. Public perception is doing a 180. The world's soap opera in energy markets has been great publicity. Governments have consolidated this pivot via pro-nuclear regulation. Structural underinvestment across commodities applies to uranium as well. Miners are confirming the start of a new contracting cycle with the signature of massive long-term agreements5. M&A and consolidation is happening. And... there are chances that sanctions limit access to Russian uranium.

I started off owning Cameco—the largest, safest producer / miner based out of Canada)—but I soon moved onto riskier pastures adding two thematic ETFs (ticker: URA and URNM). These ETFs own primarily (junior) miners, offering explosive exposure to uranium prices along with substantial risk.

As URNM approached ~$90, I transitioned out of equities into outright exposure to the uranium spot market via Sprott Physical Uranium Trust (SPUT). My investment had become a bit too spicy and I did not want to give back P&L, so I simply chose a less risky expression of that view. History has taught me that uranium cycles aren’t short and sweet, but long and winding. Manage your risk accordingly.

SPUT remains to this day one of my largest positions and a great buy at today’s levels after yesterday’s questionable fire sale:

• Spot uranium trades at ~$50 / lbs. It’s >2x from the cycle lows, but only one third of the all-time highs and well below cost of production. Asymmetry. You can follow the price here (spot) and here (long-term contracting price).

• SPUT trades at $15, which represents a 10% discount to NAV. This essentially means you can buy uranium held in drums across different facilities in North America and Europe at ~$45 / lbs. Discounts aren’t rare but tend to close shortly.

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With that… John Galt out. I’m off to add some SPUT.

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Thanks for reading,

John Galt

• Peak inflation and peak central bank (CB) tightening pace might be here, as CBs bet that the ‘controlled demolition’ of demand pursued this year will be successful in bringing down inflation over the coming months / years

• Peak CB tightening pace / a less urgent Fed, slowing inflation and markets already pricing a somewhat high terminal rate (~5%) may put a lid on bond yields in coming months and revive the ‘Fed pivot’ narrative

• Peaking bond yields will create a monumental shift across assets affecting all investors, an event that could reverberate throughout the whole financial system

This post discusses—implicitly or explicitly—investments in bonds (ticker: TLT), FX (USD, EUR, GBP, JPY), gold, commodities and equities.

“A stopped clock is right twice a day”

If there is one (mostly) right call I’m proud about over the past year it’s been consistently calling the direction of US bond yields1. If you’ve been following along, you probably know my view, as summarized by the quote below from a previous note:

Following a four-decade bond bull market fostered by deflationary forces (i.e., the triple D) and the largest QE program the world had ever seen over the pandemic, inflation feels entrenched and sometime in Q4 / early 2023 markets may have to come to terms with the notion of structurally higher inflation for longer.

A scenario where inflation hovers above / around 4% would warrant a protractedly restrictive Fed—in terms of both rates and balance sheet reduction, freeing up countercyclical breathing room. That or a Fed that moves the inflation target / goalposts from the arbitrary 2% in a dispassionate exercise of cold, economic realism.

Read more: $14 BAD AND BETTER

Now, I believe the ‘easy money’ shorting bonds may have already been made. I've recently closed my shorts.

This year, bond yields traded up on the back of higher rates (tighter monetary policy), driven by exceedingly high and resilient inflation. Recent developments suggest, however, we might be witnessing coinciding peaks in inflation and central bank (CB) tightening pace. At the center of which is a bet by CBs that the ‘controlled demolition’ of demand pursued this year will be successful in bringing down inflation over the coming years.

In today’s piece I explain the recent shift seen across CBs in developed markets (DMs), how often in history it foreshadows the vaunted CB “pivot” and how to position for it before it’s here.

The end of (monetary) front-loading

CB rhetoric in past weeks indicates the "end of monetary front-loading”, as officials extensively deployed ‘peak tightening pace' rhetoric2. CB action followed words, with the Bank of Canada (BoC) and Reserve Bank of Australia (RBA) delivering less hikes than estimated:

• BoC: Undershot consensus with a 50bps hike (vs. 75bps est.) in the policy rate. Governor Macklem stated they were “getting closer to the end of tightening”.

• RBA: Hiked 25bps (vs. 50bps est.), with minutes showing officials highlighting this cycle’s fast hiking pace and long and variable lags.

• Bank of England (BoE): Raised 75bps, but hinted that markets were pricing too many hikes. Furthermore, Governor Bailey downplayed the hike stating it “should not lead to higher mortgage rates”.

• European Central Bank (ECB): Mainly rhetoric pointing toward meeting-by-meeting data-dependency, while softening their December hike commitment.

Examining how pace, “pauses” and cuts interact, I found a fantastic Goldman Sachs piece explaining how it’s not surprising to see Canada and Australia slow down before other CBs—as they tend to front-run the US—while offering a few important history lessons:

• Hiking cycles across DMs average 15 months regardless of inflation level, with 70% exceeding the year.

  

• 75% of DM hiking cycles incorporate a pause—3+ consecutive months without hikes—an event more common across Europe than in the US (<40%).

• Front-loading of hikes allows longer cycles to still average similar cumulative hikes, but inflationary backdrops amplify the dispersion of outcomes.

  

• CBs often stop hiking around the same time—at / close to the peak in headline and core inflation (YoY)—and anticipate substantial declines in inflation by several months.

  

• In 75% of cycles CBs cut within the first year since the last hike. Cuts generally arrive arrive 5-7 months from that last hike and average 200bps, with Canada and Australia generally leading the cutting cycle timing-wise. Inflationary periods exhibit only slightly larger cuts over the first year, despite averaging double the cumulative hikes.

  

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The ‘Everything Trade’

We shouldn’t mistake peak CB hiking pace with the end of the fight against inflation, as CBs have made it clear that smaller hikes do not entail a lower terminal rate and that they are not thinking about pausing yet. However…

Combining Goldman’s analysis which anticipates the proximity of a pause / cuts, a less urgent Fed3, slowing inflation and markets already pricing a terminal rate of ~5% next year (vs. 3.75% today), we might start seeing a lid on bond yields in coming months and potentially the revival of the infamous "Fed pivot” narrative (i.e., deceleration / 'pause & see' in hiking, lower terminal rate or rate cuts / end of QT soon after terminal).

To be clear, I don’t think we are there. As long as circumstances don’t change much, the signal I’m looking for today is long bonds approaching 5%, as I expect them to overshoot. That first leg of inflation down should offer strong upside (particularly for long bonds), despite my view of higher for longer inflation expressed above.

Peaking bond yields will create a monumental shift across assets affecting all investors, an event that would reverberate throughout the whole financial system.

My favorite of these assets on a risk-adjusted basis and with a long-term view are—with Stanley Druckenmiller’s permission—long duration bonds (ticker: TLT), beleaguered G10 FX (long EUR, GBP, JPY vs. short USD) and gold (possibly on an FX-hedged basis). Equities—particularly longer duration might outperform in the short-run—and other commodities should benefit as well. Thus, the ‘Everything Trade’…

To be clear, the situation is quite fluid and the goal posts might change. That’s what I have Twitter for, where I tend to offer updates…

Follow GJG on Twitter

The point of this piece is really to draw attention to the massive impact the bond sell-off has had on the global economy and all asset classes, USD strength being the highest expression. Things might change soon, though… And I wouldn’t want to miss out on this one.

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Thanks for reading,

John Galt

• ChinaTech remains incredibly inexpensive and fully disconnected from fundamentals

• Similar combination of market forces launched last summer’s bear market rally

• Tactically constructive on risk today, favoring a bounce in the short term yet with lower lows in the cards in the medium term

This post discusses—implicitly or explicitly—investments in ChinaTech (tickers: KWEB, BABA, BIDU, JD, PDD, KC), US equities, bonds, FX (USD) and gold.

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Disconnected fundamentals

Wow, what a rollercoaster the past few days have been in markets since I published $19 CHINATECH: RETESTING CYCLE LOWS on Sunday. Monday’s sell-off in Chinese equities—ADRs in particular—was truly egregious, with most ChinaTech stocks down 15% on the first day following the 20th National Party Congress. Hang Seng, party like it’s 1999.

Markets decidedly looked past China’s beat in economic figures—with GDP at 3.9% (vs. 3.3% est.) and industrial production at 6.3% (vs. 4.8% est.)—and the appointment as premier of the “capable pro-market and pro-growth politician” Li Qiang, as per Nomura’s Chief China Economist Ting Lu1. Underreported.

The drawdown was aptly described by JPM’s Kolanovic as “disconnected from fundamentals” and “present[ing] an opportunity”.

The table below evidences how big of “an opportunity” this is. Cheap AF.

In theory, should BABA, BIDU or KC decide to liquidate their non-core investments and buy back their stock, they could get very close to acquiring full ownership of the company (see ‘Cash + Disposable assets as % of Market Capitalization’ column). In theory communism works… in theory.

I rarely comment on my readership statistics. This time, however, it offers anecdotal evidence of how brutally polarizing the subject of China has become and how underloved this thesis is.

Four members unsubscribed from Going John Galt within 10 minutes of publishing—quite rare for a Substack with virtually zero churn (just one unsubscribed member in nearly 6 months live). Now, however polarizing the subject may be, the bigger truth is that investors love a bargain… and over 40 readers clicked the subscribe button since.

This proved to be a testament to what happened next. An aggressive, >10% rebound off the lows, sponsored by China’s national ‘Plunge Protection Team’. If you are wondering what happens now, simply consider what historically happens 60 days after such drawdowns…

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Let’s leave it there for now, as I promised to speak about the market in general, including the ongoing earnings season. Let’s jump right in.

Up or down?

Looking at the various vectors exerting force in different directions on the market helps when it comes to determining direction. Below I’ve outlined some of these, split between technical and fundamental factors:

Technical factors

• Investor positioning: Massively underweight with few indicators far from minimum, as per many different sources. It’s difficult for investors to be more bearish, potentially not many marginal sellers left.

  

• Options positioning: Today’s long gamma regime insulates market against outsized moves (up and down) and compresses volatility / reduces absolute range of daily returns.

  VIX at ~27 and dropping should increase long participation of vol-related strategies and mitigate option dealers’ need for downside protection from delta-hedging, fueling the put rally.

  

• Earnings season / corporate buyback flows: As companies report earnings, they leave behind the blackout period and restart share repurchases. 65% of the S&P will have reported by Friday, including the largest US tech companies. ~21% of buybacks are done from November to December—strongest two-month period in the year.

• Seasonality: November to December tends to be a strong period for equities.

  

• Midterms: This is even more so from the end of October up to the US midterm elections—average S&P return of ~1.7% from 1970 to 2018—and over the subsequent year.

  

Fundamental factors

• EPS: Earnings won’t be great, however these have been slowly adjusted downward already (sandbagging), leaving a low bar to clear. Nominal GDP in excess of 10% represents a potent tailwind for corporate revenues. Pricing power and a relatively strong consumer will likely not be enough to avoid some (mild) margin compression. Forward earnings remain incredibly above trend, but it’s early for full earnings capitulation. Inflation tailwinds.

  

  There should exist a strong divergence across sectors—with energy still king—but there are good chances it will disappoint bears.

• Monetary policy / Fed: The infamous ‘Fed pivot’ narrative (i.e., deceleration / pause in hiking, lower terminal rate or rate cuts / end of QT soon after terminal) could take off again, should peak inflation be re-established. Fed Whisperer Nick Timiraos has continued telegraphing the Fed’s intentions and they seem set on softening their messaging around further hikes. If terminal rate peaks, the chart below becomes more relevant as it will drive what I call ‘The Everything Trade’ (i.e., long bonds, short USD, long equities, long gold).

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Louder calls for softer Fed policy (i.e., US politicians, IMF, et al.) should have an impact on the margin, along with unforeseen developments across other jurisdictions (including central bank interventions).

We saw a similar combination of forces launch last summer’s bear market rally, as overshooting EPS were turbocharged by bullish technicals. All things considered, I’m tactically constructive on risk and favor this outcome (bounce) in the short term, yet continue to think lower lows are in the cards in the medium term.

I've liquidated my shorts over the past weeks while the S&P was in the 3,600s and have more recently started (slowly) nibbling on my preferred longs.

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Thanks for reading,

John Galt

• ChinaTech rebounded a whopping 53% while the S&P traded relatively sideways—it is now retesting the March lows

• Opportunity to acquire cash-rich, profitable, long-term double-digit growth companies at deep value persists, offering an asymmetric risk-return profile

• Improvements in coming months on the COVID (i.e., potential re-opening) and macro front (i.e., increasing stimulus) could have a massive impact on the global economy

This post discusses—implicitly or explicitly—investments in equities (tickers: KWEB, BABA, BIDU, JD, PDD, KC), FX and commodities.

Whatever it takes, with Chinese characteristics

In early June I penned a three-part piece on ChinaTech / internet equities, pounding the table about the opportunity to acquire growth at deep value in China. Some notable takeaways included:

• Rare opportunity to acquire cash-rich, profitable, long-term double-digit growth companies at deep value

• Perfect storm of regulation, macro, geopolitics and COVID has relentlessly battered China’s technology / internet names, creating an attractive entry point often >70% below cycle peaks

• Asymmetric risk-return as the bottom seems in—downside scenario seems largely priced in and already-apparent catalysts and improving drivers offer strong re-rating potential

I argued that on March 16, Vice Premier’s Liu He had “channeled his inner Draghi” to deliver his own “whatever it takes” speech, with Chinese characteristics. This speech “presented a floor on valuations and swiftly boosted the market over the subsequent days”. The bottom seemed to be in.

Oh man, was I wrong about that.

Of course, back then it made fundamental sense (i.e., Chinese authorities speaking in favor of resolutely supporting markets, regulation intensity moderating with the regulation cycle transitioning from its announcement into the implementation stage) and for markets confirmed the view. ChinaTech proceeded to rebound a massive 53%—proxied by the largest ChinaTech ETF (ticker: KWEB)! All of this while the S&P treaded water.

Now ChinaTech is retesting the March lows without any words from Liu He this time. Coincidentally, the 20th National Party Congress (NPC) finished yesterday, where Liu He was dropped.

Today's piece provides a brief summary1 of the ChinaTech thesis alongside an update of the four pillars driving valuations (i.e., regulation, macro, geopolitics and COVID policy). Additionally, I offer my take on how to possibly benefit from this opportunity and explain the impact some of these developments could have on the global economy.

“Investability” concerns valid, yet overblown

If this is not your brand of whisky, I get it. It’s not for everybody.

The majority of investors today consider China uninvestable and their concerns are valid. Precisely that’s where the opportunity lies—buying outside of foreign / institutional liquidity and selling back into it once the situation improves from terrible to less bad.

Regulation: Jack Ma’s Icarus moment

Regulatory tightening focused on “New Economy” participants—and clustered particularly around antitrust, FinTech / capital markets, data security, and social equality issues—had instilled profound investability concerns among foreign investors even prior to the Russian invasion. It was the scope and length of the regulatory cycle which surprised even the most experienced investors, who know these cycles are not uncommon.

Since June and against all odds, authorities have actually fulfilled their pledges to finalize reforms aimed at “platform companies” (i.e., “New Economy” / Web2). I strongly believe the moderation in regulation intensity we have seen in past months was the main catalyst for the 53% rally off the March lows and continues to support the re-rating of beleaguered ChinaTech equities.

Macro: Bad and better

China’s timid stimulus / policies has been a great source of frustration for investors. Cutting a few points on rates here, injecting a few million there and some mild FX intervention on the side definitely undershot investors' expectations.

My view is that Chinese authorities enjoyed first row seats to the world’s egregious Inflation Show… and hated what they saw.

They postponed expansionary policies until inflationary pressures abate across the world, an easy call for a country with just a 2.8% inflation rate and a perilous real estate situation. If you see your neighbor's beard on fire, water your own.

Geopolitics: China ≠ Russia

There’s no question, the geopolitical situation is perilous. However, we have seen China recently turning colder on Russia, holding back from supplying drones and other military equipment to Russia and publicly voicing “concerns” about Russia’s invasion of Ukraine, which Putin acknowledged. It seems they might be testing the limits of their “unlimited friendship”.

The geopolitical reality can be derived from the excerpt below, included in a previous piece titled $16 ON CHIMERICA & EURUSSIA:

When China joined the WTO in 2001, 80% of countries traded more with the US than China. 2018 saw two-thirds of countries trading more with China than the US.

The reality is that China today is the largest trading partner of (checks notes…), basically everyone! We need to acknowledge the emergence of a multipolar world order. Putting our western biases aside for a minute will allow us to perceive the world as it truly is. Rosling. Papic.

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This is how I see the situation going forward:

• Unlikely widespread support for sanctions against China—it has become “Too Big To Fail” for the global economy, its exports too systemic2

• If you didn’t like the impact of Russia’s fallout with the West on inflation, wait to see what happens if you disconnect China; remember: China ≠ Russia

• Reasons abound for the West to disapprove of many of China’s policies (i.e., treatment of Uyghur population3, consolidation of Taiwan, tensions in the South China Sea, etc.), but the reality is such "unfair” policies are certainly not uncommon in other parts of the world and do not receive the same treatment by the West / US4

To be clear, I believe today’s hard stance of China will persist as the US comes to terms with Zoltan’s emergence of a multipolar world order5. Prove of that is the recent CHIPS Act, which aims to slow down their perceived opponent while the West retools its economies (i.e., re-arm, re-shore, re-stock and re-wire). But I don’t think the West / US will be able to turn China into the economic pariah Russia is today.

COVID: Reopening Episode IV – A New Hope

With the efficacy of China’s anti-COVID vaccines / pills in doubt and low vaccination rates among the elder, Beijing can only dampen case numbers via rolling lockdowns / closed borders.

To make matters worse, Xi publicly vowed to manage the COVID matter personally, tying his political fate come the 20th NPC—where he “runs” for a third 5Y term—to that of China’s COVID numbers, in a rare act of political ingenuity.

Previously we flagged that “experts [didn’t] expect broad COVID-related restrictions and rolling lockdowns to relax before the 20th NPC held this autumn”. Well, the NPC just concluded and many of us see a chance of Xi quietly claiming victory over COVID and transferring those responsibilities to a scapegoat going forward.

Other relevant developments have been largely overlooked by Western media. China has quietly reduced quarantines in some large cities and is debating the expansion of these reduced quarantines to the rest of the country. The population is starting to protest loudly against restrictions. Seeing leaders meeting / on official events without masks has been a first since the pandemic broke out.

There are reasons to believe China will start to move in this direction—expect to hear more of that going forward. It won’t be noisy, but many of us will watching with great care.

Keep. It. Simple. Part II

I believe things might change in coming months on the re-opening and stimulus front. Do not underestimate the impact of these developments on the global economy—it could be massive.

We have seen China carrying global growth on their shoulders before, what would happen is:

• Commodities supercycle turbocharged / extended; where does oil go if China adds 1-2mb/d to today’s demand?

• Global economies re-float—particularly China’s largest trading partners in Asia (and the EU)—which would have a large positive impact on FX via shifting surplus / deficit, with the USD taking a large, sustained hit.

• If you don’t like prices in 2022, wait to see what happens if China re-opens and pulls its fiscal / monetary levers! A massively inflationary development that could foster higher rates worldwide albeit in a stronger economic environment…

On ChinaTech, I continue to favor the same approach I laid out before:

My China tech portfolio is comprised of a majority position in $KWEB—the great, beleaguered proxy for China tech—and a fairly large position in Alibaba ($BABA), surrounded by a constellation of much smaller, different names including Baidu ($BIDU), JD.com ($JD), Pinduoduo ($PDD) and (sometimes) Kingsoft Cloud ($KC). Also, note that roughly 30% of KWEB is composed of those 5 stocks.

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I strongly encourage reading the final installment of my ChinaTech series for additional depth. Most hasn’t changed6, including my recommendation to stay cautious and avoid the all-in. I was lucky enough to trade around my positions and pare exposure on the way up, which allowed me to post a small profit on the previous leg and freed capital for the next one. I intend to do the same this time.

I would recommend you to follow me on Twitter if you are interested in seeing the updated metrics for those companies. Find one of the tables below7, the remainder will be shared on Twitter soon.

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It’s not the time to be greedy. No fun ‘til the Fed’s done.

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Thanks for reading,

John Galt

PS: Working on a more generalist, earnings-season-centric note, expect it this week. Make sure you subscribe below if you are interested in receiving it first. It’s free. No Spam, ever.

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• Years of compounding mistakes have resulted in an untenable situation that is / will be exceedingly costly for the UK and Europe

• Countries rolling out pro-cyclical fiscal policies during today’s inflationary environment must be prepared to make a choice between saving the bond market or protecting their currency

• Markets will continue testing their resolve until they adopt a credible fiscal stance and responsible monetary policies—in absolute terms and relative to other countries

This post discusses—implicitly or explicitly—investments in FX (USD, EUR, GBP), bonds and Vonovia (ticker: VNA).

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Mistakes compound

Last Summer, my father and me set sail around the island of Menorca in Spain (near Mallorca and Ibiza). In the second day of navigation, we realized the rope which tied the dinghy to the sailing boat was slightly short and somewhat eroded. Not terrible news when cruising the tranquil waters of the Balearics, so we decided against its replacement. A few days later we were anchored in Cala En Porter—just in front of the famous Cova d’en Xoroi—when a summer storm broke out.

In the middle of the night, the rope we didn't replace broke. Mistake #1. We decided to lift the anchor and go after it. Mistake #2… and by far worse. In the end, our efforts came up short and we lost the dinghy. Yet we could have lost the sailing boat and much more...

I’m going a bit off-piste here, but it was a stark reminder of the compounding nature of mistakes… and the absolutely bizarre operating leverage imbued in some elements of our lives.

Pick your poison

“In Germany, $2 trillion of value added depends on $20 billion of gas from Russia… that’s 100-times leverage—more than Lehman’s.”—Zoltan Pozsar, Credit Suisse

Avid readers probably see where I’m going with this—the mistakes and the operating leverage remind me of the current situation in the UK and Europe. Years of compounding mistakes have resulted in an untenable situation that is / will be exceedingly costly. The table below is self-explanatory.

My note $17 ALL HAIL KING DOLLAR! from a few days ago, described how these fiscal moves (i.e., energy support plans, tax breaks, etc.) add to economic vulnerabilities, which together are hurting sovereign bonds and / or domestic currency.

Countries rolling out pro-cyclical fiscal policies1 during today’s inflationary environment—these days, everyone really—must be prepared to make a choice between:

1. Saving the bond market through central bank intervention and let their currency take the plunge

2. Let bond markets trade (relatively) freely and potentially crash, but protect their currency

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A Tale of Two Economies

“So here we are, with the BoE mixing ‘uppers’ with their ‘downers,’ drinking Red Bull and vodka as they simultaneously hit the gas and brakes in chaotic fashion.”—Charlie McElligott, Nomura

A few weeks ago, the UK got a taste of economic reality. They decided to pursue several unfunded tax breaks2, on top of an expansive energy support plan unveiled in September. They then proceeded to go down the second route (#2 above). They took the red pill.

Markets didn't like it one bit. It only took authorities a few days and an almost collapse of the pension system—one of the main owners of these bonds3—to revert their choice and (temporarily) save the bond market through central bank buying. Mercifully and unlike in the Wachowskis’ masterpiece, it seems you can take both pills.

Since then, authorities have sent mixed signals (i.e., cutting somewhat back on the tax breaks, while telegraphing the end of the “emergency bond-buying program” this Friday and the start of quantitative tightening [QT] in the coming weeks). Drinking Red Bull and vodka.

I find it more likely that the dollar turns around when interest rate differentials (actual and expected) close down and the economic vulnerabilities abate.

Read more: $17 ALL HAIL KING DOLLAR!

Markets will continue testing their resolve until they adopt a credible fiscal stance and responsible monetary policies—in absolute terms and relative to other countries. The latter potentially referring to a deceleration in US tightening vs. the UK’s, closing down the infamous interest rate differential.

The story is analogous to Europe’s.

On the fiscal front, European governments are unveiling varying energy support programs. No tax breaks, luckily.

On the monetary front, the ECB continues hiking and doing QT… yet buying peripheral bonds (i.e., Italy, Spain, Greece, Portugal, etc.) at the same time, attempting to close down core-periphery spreads (see below Italian vs. German bonds).

This combination of policies punishes bonds and the Euro. Anything that ameliorates the energy situation and / or reduces inflation could create a steep rebound in the short term, as the Euro seems quite oversold (-20% Year-To-Date [YTD] vs. USD).

Beyond this and in the longer term, Europe’s biggest risk is derived from the collapse of Eurussia ($16 ON CHIMERICA & EURUSSIA)4. Europe’s energy support programs could be here to stay, unless they are able to find an economic (i.e., cheap) alternative to those energy flows.

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Finding a price

European companies—good and bad—are getting hammered in this environment and some are reaching long-term attractive levels.

Remember, I’m not trying to find the price, but a price.

For instance, I’m currently looking at Vonovia (Ticker: VNA), the largest real estate company in Europe. Vonovia manages 621k residential units and owns 550k of them, primarily in Germany (89%). A few additional company highlights:

• At today’s share price (€‎19.2 ps), the company sits at the bottom of this year’s trading range (€19.2-52.61, down 64%) and at Q4 2014 levels

• Market cap is ~€‎15bn vis à vis an Enterprise Value (EV) of ~€‎59bn; its high leverage (16.5x Net Debt / EBITDA, mostly long term and very cheap) amplifies any negative impact on the equity piece

• Independently valued at ~€‎99bn (EPRA NTA, Net Tangible Assets) or ~€‎63 per share (ps), offering deep value at hefty (~70%) discount to NTA

• Revenues this year of €‎2.75bn, EBITDA of €‎2.65bn and Net Income of €‎1.96bn

• Dividend yield of 8.6%, Price to Earnings (PE) of 8.1x, Free Cash-Flow (FCF) yield of 12.4% with projected Revenue growth of ~17% and EBITDA growth of ~24%

This is a bet that Germany makes it through the crisis.

Markets are clearly not buying the current valuation of ~€‎63 per share. The only catalyst beyond improving macro relates to the fact that the company has put ~€13bn in assets on the market for sale, likely a Q1 event though. Macro-wise, not all is bad…

If these are disposed of anywhere close to their valuation—the use of those funds would go toward delevering—we might see a strong repricing to the upside.

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A final housekeeping note. The last piece on the US dollar had the largest traction out of all the pieces I’ve written so far… for this I'm very grateful, thanks.

I’ve not shared this before, but I started this newsletter with the idea to offer a bit of “building in public” (i.e., sharing the intricacies of the newsletter, my takeaways, including KPIs and metrics).

I would be more than happy to do this in the interest of transparency, yet wonder if readers are curious / interested.

I’ve set up a poll for you to vote on this. Depending on the outcome of the poll and also—very importantly!—the amount of engagement (i.e., shares, likes, comments and subscriptions!), I will make a decision next week!

To be clear, this would be just a post every now and then and would not affect the delivery of my usual content.

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Thanks for reading,

John Galt

• Asymmetrical stimulus and idiosyncratic, country-specific vulnerabilities are at the center of today’s diverging global interest rates / increasing interest rate differentials, which are the main driver of FX today

• Relative attractiveness of USD-denominated "cash equivalents" sucks the air out of the rest of the sovereign bond and FX complex

• Dollar likely to turn around when interest rate differentials (actual and expected) close and economic vulnerabilities abate

This post discusses—implicitly or explicitly—investments in FX (USD, EUR, GBP, NOK, CHF), bonds / cash equivalents, commodities and gold.

Do you know the feeling when something is so embarrassing / cringy you want to crawl under your desk…? If you missed Tesla’s ($TSLA) presentation, click on the tweet below for the clip.

Note that Boston Dynamics is owned by Hyundai since 2020—a company >25x smaller than $TSLA ($36bn vs. $919bn in MCap). Reposting these tweets reminds me of the terrible job I’ve been doing at “promoting” my own Twitter account, which boasts a lower subscriber count than this Substack… 😉

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A F1 Analogy

Prior to the pandemic, each economy advanced at their own pace according to their own economic reality. Slower / negative growth in certain countries were offset by larger growth elsewhere, smoothening out the global economic cycle.

Enter the pandemic, which I find analogous to an accident happening in a F1 race prompting the Safety Car to appear—a vehicle that limits the speed of competing cars on a racetrack during a “caution period”. The distance between cars and their speed prior to the Safety Car no longer matters, as all cars are now stuck in a line behind the Safety Car until the race resumes. During the time the Safety Car is en piste pilots strive to calibrate the car for an optimal re-launch—managing fuel consumption and maintaining the optimal temperature in their brakes. mRNA vaccines allowed the Safety Car to leave the track, with all cars re-accelerating at the same time.

Back to the economy. Fiscal-monetary stimulus / coordination and vaccine deployment strategies were highly asymmetrical across countries. A stark synchronous economic recovery ensued across the globe with economies re-launching at different speeds. But countries / regions were no longer offsetting each other—instead pushing against the limits of their material economic constraints…

Blah blah blah… all-time high demand… reh teh teh… supply constraints... Inflation skyrocketing.

We all know the story.

Central bank genie is out of the bottle

Asymmetrical stimulus and idiosyncratic, country-specific vulnerabilities (i.e., energy policy, COVID policy, domestic political issues, sovereign debt levels and central bank reaction function / credibility / reserves) are at the center of today’s diverging global interest rates / increasing interest rate differentials (actual and expected)1. This in turn is the main driver of FX today.

The US stimulated its economy to the tune of $1.7tn in monetary (QE) and $3.5tn in fiscal easing (~$1.7tn of which has actually been spent so far) since the Biden's inauguration.

The world’s largest stimulus underwrote one of the largest core inflation figures (ex-energy / food) among developed economies, even exceeding Europe’s! Once the Fed finally realized this, it became one of the fastest tightening central banks, with other central banks scrambling to hike fast enough. TD’s Andrew Kelvin calls this “Keeping Up With the Jeromeses”, which I find both apt and hilarious.

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Compounding choices

Marge: Homer you’re crazy. Reverend, tell him this is all crazy!

Reverend Lovejoy: Homer, you remember Matthew 21-27, "The Foolish man who built his house on sand"— The Simpsons

These economic vulnerabilities are a reflection of (often foolish) choices made by countries, compounded over time:

• US: Pushed strongly for energy and food independence. As a result its economy is relatively shielded from the economic implications of the Ukraine invasion. It has also cost them a third of the Strategic Petroleum Reserve (SPR)… so not entirely sustainable.

• Europe: Decades of increasing energy dependence, with Russia at the center2—in 2020, 27% of EU energy was gas, 46% of which imported from Russia. Gas stopped flowing—only Hungary still receives some today—and had to be procured elsewhere at much higher prices, pushing countries to institute costly policies (€250bn fiscal across the EMU-4, 2.7% of GDP) and curtail demand (i.e., factory closures, particularly in materials-based industries such as cement, steel, chemicals, glass, paper and ceramics).

• China: Remained impervious to public outrage related to their zero-COVID policy. The result is economic stress, particularly in its weakest economic link (i.e., real estate). Things might be changing though, which would drive sentiment and household / business spending / investment3.

  

• UK: Liz Truss got recently elected promising a large tax break. Truss’ government recently announced unfunded tax cuts raising the estimated debt ratio to ~104% in 2024 (vs. ~96% for March’ estimates)4. Bonds were obliterated—warranting an emergency intervention (buying) from the Bank of England (BoE)—and throwing the pound (GBP) under the bus in the face of renewed QE / ad minimum questions around the viability of QT.

• Developed Economies: Structurally underinvested in natural resources in the name of ESG, leaving them in short supply of energy / commodities / food today. This is particularly the case in Europe, but not only.

The cleanest dirty shirt

Considering interest rate differentials (actual and expected) and the economic vulnerabilities laid out above, it’s clear the US is the “cleanest dirty shirt” in the pile as it offers the highest-yields across the entire spectrum of “cash equivalents” (“cash”, proxied below by the US 1Y Treasury Bill below, for simplicity).

The relative attractiveness of USD-denominated "cash" favors the sale of foreign assets to buy these instead, sucking the air out of the sovereign bond and FX complex5.

Does this impact commodities?

Higher yields on “cash” raise the opportunity cost of carrying (holding) non-yielding assets such as commodities. Hence the current situation, where a basket of commodities can be up by ~20% YTD in USD-terms, yet >50% in JPY-terms. Gold has actually appreciated in value across some currencies, just not in USD-terms.

An indirect channel of FX impact on commodity prices results from the fact that most are produced / mined in foreign currency-denominated countries deflating the cost of production (i.e., local labor and input costs) in USD-terms.

Lower commodity prices in USD-terms press US real incomes and rates higher, favoring US economic growth and re-enforcing the “cleanest dirty shirt” narrative.

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All Hail King Dollar!

I believe FX will regain its importance in investors' portfolios in coming quarters. I would be very surprised if I don't find compelling arguments to short the USD fairly soon.

Read more: $15 IF YOU BREAK IT, YOU BUY IT

The global economy is unlikely to be able to cope with the USD at near all-time highs for long. International organizations (including the UN today) are pleading for a policy change that saves emerging economies. Being King in FX Land can be problematic.

It's also clear that central banks around the world are growing uncomfortable and starting to intervene. Japan’s BoJ and China’s banks did so in their FX markets in the past weeks already. The UK's BoE intervened in their bond market.

One way in which this dollar run could theoretically end is through coordinated central bank intervention à la Plaza Accords in the ‘80s. I question, however, the long-term viability of such coordinated response, as the underlying fundamentals would persist. I also struggle to see what's in there for the US—note the US was part of the original Plaza Accord and any such coordinated intervention would require their cooperation. I assign higher probabilities to independent interventions the likes of which we’ve seen in past weeks.

I find it more likely that the dollar turns around when interest rate differentials (actual and expected) close down and the economic vulnerabilities abate.

This could take several forms, some of which I outline below:

• US peak hawkishness (i.e., hike expectations see the top) is reached

• Rest of World (RoW) central banks outhawk the Fed

• Resolution to Russia-Ukraine conflict

• China moves on from zero-COVID policy

• Milder winter in Europe and steps toward more sustainable energy policy (i.e., nuclear reopening, new LNG terminals, intra-EU grid interconnection, growing capacity from Northern Africa, etc.)

• UK decides against the new fiscal package; by the way, this actually happened while writing this piece, pushing the GBPUSD to 1.13 from 1.0379 at the cycle lows

Depending on the type of relief, the turn could prove more sustainable or not. Let's not forget the Plaza Accord was preceded by over half a decade of USD appreciation. A long term pivot may take a while, but it won't be a straight line up. Guaranteed.

This is the lens through which I intend to look at all developments in coming weeks, in search for the vaunted USD reversal. FX is becoming increasingly relevant and, ad minimum, investors should spend some time reviewing their own exposures.

I’m based in Europe, but have been lucky enough to have the majority of my assets denominated in USD and CAD. I’m not planning on giving up those gains. I’m mulling a pivot toward NOK (energy independent, strong central bank with credibility and reserves) and CHF (responsible inflation-targeter, safe-heaven, all-around well-run country), even in the absence of a USD reversal.

Hope this was helpful and don’t forget to subscribe!

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Thanks for reading,

John Galt

PS: If you haven’t checked out OpenAI’s Dall·E 2, you’re missing out. Click here for a quick, practical explanation on how the technology works. Below, the outputs generated in 3 seconds after typing in “Palma de Mallorca painted by Georges Seurat”.

Now, Seurat never painted these from his studio in Montmartre! Breathtaking technology with long-term ramifications... OpenAI is already in a partnership with Microsoft Azure ($MSFT). You can try the free beta version here.

Again… would appreciate a follow on Twitter for live updates on investment ideas, portfolio updates and breaking news!

Follow GJG on Twitter

2

One might argue it started with West Germany’s Ostpolitik starting in 1969. Vast pipeline networks toward Europe through today’s Ukraine were built over the 80s and with the push to integrate Russia’s economy with Europe’s after the fall of the Soviet Union. A bigger push happened subsequently in the 2000s with Schroeder’s Nord Stream 1 and 2010’s with Nord Stream 2 to bypass Ukraine. There’s a great paper discussing this (available here).

Ever wondered why Gazprom spent the past ~20Y sponsoring the UEFA / European soccer teams / leagues? Lobbying.

• Lowflation regime was underwritten by globalization—it enabled the Fed’s Quantitative Easing (QE) programmes over the 2010’s

• Abrupt disintegration of Chimerica and Eurussia’s confirms the emergence of a multipolar world order, where (new) alliances / blocks fight for control over commodities, technology (e.g., chips), production and safe geographical / physical connection

• Ensuing re-arming, re-shoring, re-stocking and re-wiring will be commodity intensive, capital intensive, interest rate insensitive and uninvestable for the East

This post discusses—implicitly or explicitly—investments in commodities, bonds / bond proxies, TIPS, gold and FX.

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War and Industrial Policy

Over the years I’ve grown quite fond of the “dispatches” of Credit Suisse’s Zoltan Pozsar. His ascension to eminence in the world of central bank commentators is the best that has happened to Credit Suisse in quite a while. Super Mario of market-plumbing1.

Avid Zoltan readers will not be surprised to hear me confess it has taken me a couple of weeks to fully digest his latest missive, aptly named “War and Industrial Policy” (available here for you free!). Nothing short of a masterpiece, it delivers a fresh perspective on the coming multipolar world order, today's trade environment / geopolitics and how these are set to shape economic policy going forward.

Last week’s note ($15 IF YOU BREAK IT, YOU BUY IT) focused on inflation, monetary policy and what I was broadly seeing across markets. Today’s is intended to summarize this new global framework and explain how it might affect investments at the most fundamental level over the coming decade.

Let’s jump right in!

On Chimerica and Eurussia

At this stage, we are all familiar with the three D’s (i.e., debt, demographics and disinflation from technology) that underwrote the multi-decade period of subdued inflation leading to the pandemic. Fortunes and careers were made on the back of strategies levering this concept of ever lower rates in different manners. Risk-parity. Dalio. Real estate. Trump.

In his piece, Zoltan identifies three disinflationary pillars on which the “low inflation regime” rested, which facilitated the collaboration of two distinct blocks he calls Chimerica and Eurussia2:

• Cheap Chinese goods raising real wages / purchase power

• Cheap immigrant labor keeping US nominal wage growth stagnant

• Cheap Russian energy—natural gas in particular—fueling German industry and Europe more broadly

China and Russia would accept foreign currency (i.e., USD and EUR) and “recycle it into G7 claims” (G7 sovereign debt). This created an environment of common commercial / financial interests, incentivizing amicable attitudes and developing trust over time.

This lowflation regime facilitated by globalization was a key enabler of the Fed’s Quantitative Easing (QE) over the 2010’s. It’s now hard to imagine a Goldilocks regime without these disinflationary forces in play.

Yet, “when trust is gone, everything is gone”.

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The emergence of a multipolar world order

Zoltan goes on to explain how these relatively old frameworks (Chimerica and Eurussia) have disintegrated abruptly, in the face of war in Ukraine. This conflict seems to be the straw that broke the camels’ back, since Germany and Russia were seemingly going ahead with Nord Stream 2 prior to that, effectively looking past Russia’s annexation of Crimea in 2014.

The fall of Chimerica and Eurussia’s has forced a re-arrangement between commodities and industry3. The largest commodity exporter (Russia) and today's factory of the world (China).

He foresees a continuation of the “unfolding economic war”, which is broadly about control:

“Control of technologies (chips), commodities (gas), production (zero-Covid), and straits—chokepoints like the Taiwan Strait, the Strait of Hormuz, or the Bosporus Strait.”

Control shaped through new alliances / blocks4, sometimes based on “the enemy of my enemy is my friend” or the “alliance of the sanctioned”:

“Russia and China hold naval exercises with Iran around the Strait of Hormuz; Iran has recently hosted talks between Russia and Turkey regarding grain shipments through the Bosporus Strait; not surprisingly, the first shipment sailed to the Syrian port of Tartus, which hosts a technical support point (not a base) of the Russian Navy; even more recently, Turkey and Russia agreed to clear bilateral trade flows, including gas, in rubles.”

At the core of this is the US’ fading position as the preeminent, global economic partner, in favor of China.

When China joined the WTO in 2001, 80% of countries traded more with the US than China. 2018 saw two-thirds of countries trading more with China than the US.

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The reality is that China today is the largest trading partner of (checks notes…), basically everyone! We need to acknowledge the emergence of a multipolar world order. Putting our western biases aside for a minute will allow us to perceive the world as it truly is. Rosling. Papic.

Implications of growing mistrust

“If trust drove globalization, and globalization drove “The Great Moderation”, distrust will drive de-globalization, and de-globalization “The Great Reflation”.

For Zoltan, the disintegration of Chimerica and Eurassia entails that expectations of “a rapid deceleration of inflation are naively optimistic”. Crediting Pax Americana with enabling globalization and globalization with structural lowflation, he sees that “inflation is a big risk” today.

The key economic consequences of mistrust are:

• Decreasing structural disinflationary forces curtail the Fed’s ability to pursue expansionary monetary policies without a cost (e.g., inflation).

• Countries / blocks need to become increasingly self-sufficient, driven by investments sponsored / funded by governments. Wars—economic and hot—can only be sustained by industrial self-sufficiency, as “global supply chains only work in peacetime”.

• Fracturing of global supply chains mean flows of goods need to be re-drawn. “Re-drawn. Not blocked or eliminated”.

Again, it’s all going to be about access to commodities, technology (i.e., chips), production and safe geographical / physical connection (i.e., straights, trading routes, etc.).

How do you win? Slow down the opponent and accelerate build out.

Slow down through traditional economic warfare, including tariffs and sanctions.

Build out through implementation of a new industrial policy focusing on “pour[ing] trillions into four types of projects starting ‘yesterday’”.

Zoltan understands these items will be5:

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Zoltan’s piece is quite long and includes a few very interesting ideas that I’ve not even touched on (i.e., analogy to the pre-GFC / Too Big To Fail system, hints of Bretton Woods III, quite specific examples of the ideas laid out above, etc.), so I would strongly recommend to read it in full. (I’ve given you access to the piece in the intro.)

I’m aware that what I brought for you today was something a a little different, as it’s more of a broad framework… a new pair of glasses through which to look at the investment world.

The longer term implications of these changes are gargantuan and encompass various fields. Over the coming weeks I intend to refer to Zoltan’s framework in the context of more actionable investment ideas.

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Thanks for reading,

John Galt

PS: Please share this post if it was helpful to you. We’re extremely grateful for all the support we get from our readers!

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• Inflation might be rolling over, but August’s CPI figures surprised to the upside—the stickiest CPI components show little signs of easing

• “Hard landing” back in the cards for 2023, as Powell is expected to slam on the breaks harder and continue to tighten financial conditions (i.e., increase real yields, lower stocks, widen credit spreads and strengthen the dollar)

• Options Expiration week, positioning and mechanical / systematic flows are currently exacerbating market moves (up and down), expanding volatility and amplifying the absolute range of daily returns

This post discusses—implicitly or explicitly—investments in bonds / bond proxies, TIPS, FX, housing, US Equities, options and volatility.

With HBO’s House of Dragons killing it on TV, I can see Morgan Stanley’s Mike Wilson no longer being able to monopolize allusions to “Fire and Ice”. Fintwit has stepped up its jokes since the post-GFC “Optimus Subprime” characterizations. Worst Transformer ever.

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Inflation, the topic du jour

Having just made it (too) recently back from the island to the city and coinciding with the release of the latest set of inflation numbers for August, it’s only fitting I resume the missives where I left them. Price pressures remain the topic du jour.

In my last note, I half-heartedly praised July’s moderate CPI print—characterizing it as both bad (8.5% YoY) and better (0.0% MoM, following June’s 1.3% and May’s 1.0%). I paired this, however, with extensive commentary on how some onerous underlying signals might have been obscured by the headline figure:

Categories spearheading the decline are historically less sticky than their hotter counterparts—e.g., shelter as the largest contributor to services inflation increased 5.7% YoY in July, the highest since 1991. […] Core CPI (CPI ex. Energy / Food) was flat this month at 5.9% YoY. […] The bulk of the advances seen against inflation seem less rooted in the controlled demolition of demand the Fed’s is set out to pursue and more in exogenous factors that could turn on a dime.

Read more: $14 BAD AND BETTER

Fast forward a month and some of these warnings look prescient on the back of August’s CPI read. Headline and core came in hotter than forecasted, as inflation remained positive for the 27th consecutive month and core grew at twice the estimated rate.

Particularly disconcerting was the acceleration of the shelter (0.7% MoM, 30Y record high), food (11% YoY, highest since the 1970s) and healthcare (largest monthly increase since Q4 2019 and 5th highest in 30Y) components, in the face of substantial declines in energy (e.g., gasoline 10.6% down, following a 7.7% decline in July).

I see little added value in rehashing the intricacies of the print at this point. My previous assessment of inflation remains valid. The stickiest items show little signs of easing and—following four decades of lower inflation—markets will have to come to terms with higher for longer price pressures. To be clear, prices are rolling over, but the path will be slower than what's currently priced in.

A multi-year paradigm shift driven by entrenched inflation (e.g., wage-price spirals, unanchored inflation expectations, etc.), which fuels arguments in favor of outright shorting (US) bonds / bond proxies and buying Treasury Inflation-Protected Securities (TIPS).

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If you break it, you buy it

A 75bps hike from the Fed in the upcoming FOMC meeting on September 21st—resulting in the 300-325bps range for the Fed funds rate—has been in the cards for over a month, yet markets have recently repriced the second most likely outcome from 50bps to 100bps (now 22%)1.

The new terminal rate is now higher at 4-4.25% (vs. 3.75-4% prior to the CPI), signaling an increasingly hawkish Fed in November followed by a policy pivot next year (already ~40bps cut priced in for H2 2023).

Markets are effectively expecting Powell to slam on the breaks harder now and continue to tighten financial conditions (i.e., increase real yields, lower stocks, widen credit spreads and strengthen the mighty dollar)… So hard, in fact, he might need to reverse policy in 2023, as the old Pottery Barn rule proves to be true: “if you break it, you buy it”.

This movement is negative for bond prices (with a steepening undertone), as yields on 2Y T-notes have skyrocketed to 2007 highs and mortgage rates have surpassed 6% for the first time since 2008.

For what it’s worth, the latter continues to force the air out of the housing market, where transactions are already in steep decline in the most typical fashion:

Increasing mortgage rates > sellers unwilling to cut prices, yet buyers demanding discounts > number of transactions decline > housing repricing. Hiss.

Finally, the Fed’s relatively stark monetary stance—compared to its softer counterparts (i.e., ECB, BoJ, BoE, etc.)—allows the dollar to retain its crown and the US to export stagflation worldwide. This is the bane of emerging markets and especially of those with the largest share of dollar-denominated debt (e.g., Argentina, Indonesia, Colombia, etc.).

I’m following these currency pairs alongside the usual developed countries’, as I believe FX will regain its importance in investors' portfolios in coming quarters. I would be very surprised if I don't find compelling arguments to short the USD fairly soon.

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Behold: Modern Market Architecture

Equities remain under the tenuous authority of investor positioning and mechanical / systematic flows.

On the former, investor positioning is extremely low according to multiple different measures, as cash levels remain at historical highs dating back to 9/11 and investors’ net underweight in stocks reaches -52%.

Regarding mechanical / systematic flows, regular Going John Galt readers probably know we find ourselves in a (quarterly) Options Expiration (OpEx) week. The large downside move to the CPI print (-4.3% in the S&P) left the market in negative gamma regime (short gamma) and “implied a breathtaking de-allocation of -$17.9 billion forced mechanical exposure reduction”, 2.7%ile 1D change going back 10Y, as per Nomura’s Charlie McElligott.

The negative gamma regime leaves markets less insulated than usual against outsized moves (up and down), as it tends to expand volatility and amplify the absolute range of daily returns2.

This phenomenon is exacerbated by thin liquidity provision, which is conducive to self-reference / reflexivity as it adds fuel to outsized price swings in both directions. Wax on, wax off.

The point of all this wonkish verbiage and Greek letters is just to underscore the notion that there are many forces fighting below the surface of a market that has moved sideways since my latest missive. In this environment in particular, relevant data or market moving news / events can very automatically create gigantic moves in markets, catching investors off guard.

Imagine the market reaction, if Ukraine and Russia reach an agreement to halt this very inflationary war… Even if you’re fundamentally bearish, you're not alone. Lows in positioning often coincide with troughs, so tread (and trade) carefully.

I wanted to pen a shorter / less thematic note today to get back to the fold and very briefly touch on how I’m seeing markets in general, while I structure my thoughts around energy (including Europe’s lack of joules) / geopolitics in preparation for some movements in my portfolio and a few notes coming in very short order.

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Thanks for reading,

John Galt

PS: Hope everyone had a great summer break. I’m a big fan of the freedom it often brings, allowing us to jump into new projects.

Please give this post a ‘Like’ at the bottom of the page if it was helpful to you. We’re very grateful for all the support we get from our readers.

1

Nomura might have jumped the gun by assuming a 100bps increment—again, after doing so in July’s FOMC as well—in their latest Fed preview. I side with “Fed Whispers” Nick Timiraos and JPM on this one, it’ll very likely be 75bps.

• Price pressures are unequivocally turning better, but inflation is proving structurally persistent

• After four decades of lower inflation, markets will have to come to terms with higher for longer inflation—a potential, multi-year paradigm shift

• This time might be different, so beware of bonds and think outside the box

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Bad and Better

This concept—popularized by Hans Rosling’s masterpiece Factfulness—offers an appropriate way to depict last week’s July CPI print, at 8.5% YoY (bad) and 0.0% MoM (est. 0.2%).

“It seems that when we hear someone say things are getting better we think they are also saying “don’t worry, relax” or even “look away”. But when I say things are getting better, I am not saying those things at all.

I am certainly not advocating looking away from the terrible problems in the world. I am saying that things can be both bad and better. […] That is how we must think about the current state of the world.” —Factfulness, Hans Rosling

Price pressures are unequivocally turning better, as the headline gauge decidedly softened vis-à-vis previous torrid prints (1.3% in June and 1.0% MoM in May).

Here are the improvements:

• Inflation less broad, with outright declines in several components / categories.

• June’s 9.1% representing peak headline CPI inflation could be tantamount to leaving peak Fed hawkishness behind. Markets are experiencing some central bank policy relief and odds for Powell’s vaunted “soft landing” have increased.

• A less urgent Fed lessens the odds of a policy error or in the words of JPM’s Marko Kolanovic, it “reduces the tail risk of a policy mistake”. Colloquially, a better chance of not crashing.

• All of these improvements coincide with the Fed’s monetary policy stance being at “neutral”, according to Powell.

Is it possible we are taming inflation without being forced to delve too deep into restrictive territory?

Well… not so fast, paraphrasing Mr. Wolf. At 8.5%, things remain bad.

Categories spearheading the decline are historically less sticky than their hotter counterparts—e.g., shelter as the largest contributor to services inflation increased 5.7% YoY in July, the highest since 1991.

More importantly, core CPI (CPI ex. Energy / Food) was flat this month at 5.9% YoY. I explained in a previous note that “to some extent, monetary authorities are victims of circumstance” on my way to stating:

The Fed openly admitted last week that their capacity to deal with the effects of largely exogenous forces on supply—particularly war-induced energy / food shortages and pandemic-related supply chain shocks—is virtually zero. At the risk of stating the obvious, central banks cannot print oil or corn.

Read more: $9 MAKE 75BPS HIKES GREAT AGAIN

This cuts both ways—on our way up and down.

The bulk of the advances seen against inflation seem less rooted in the controlled demolition of demand the Fed’s is set out to pursue and more in exogenous factors that could turn on a dime:

• Global surge in commodity prices—including agricultural and oil—is in full reversion with agriculture prices at pre-conflict levels, Brent crude oil at 6-month lows and WTI crude oil down ~30% from the peak. Biden blowing through half the Strategic Petroleum Reserve (SPR) surely helped.

• Odds of a potential recession weigh on the price of energy, which in turn is the principal driver of last week’s cool CPI print and the subsequent easing of overtightening fears. If you see this as highly reflexive (circular reference, blue arrows!), it’s because it is. At least lower prices at the pump will partially boost US demand / discretionary consumption.

• Europe’s economy is decelerating, contributing to the softening in global demand. A deterioration in Europe’s energy position1 would boost deflationary pressures. With oil at these levels we might see substitution for gas, supporting lower energy prices.

• Effects are magnified by the dollar wrecking ball—a higher USD imports disinflation. China’s currency (RMB) and economy remains weak2, which in turn exports disinflation globally.

In terms of equities, let’s just say that these CPI reads shouldn’t be conducive to generous equity valuations—an “8.5% CPI implies 11x on trailing P/E” vs. “today’s PE of 19.4x, [which] implies 2.6% CPI”.

Finally, let’s not forget that CPI was not the only tier-1 economic indicator out in August. Monthly US labor figures came in scorching hot, with unemployment dropping to 3.5% (est. 3.6%) and average hourly earnings at 0.5% MoM and 5.2% YoY (est. 0.3% and 4.9%, respectively), adding to the sticky wage price spiral narrative. Note average hourly earnings, when adjusted for inflation, sit in negative territory for the 16th consecutive month, now at ~-3%.

Monetary policy works on a lag, so it’s not surprising that most of the effects on the real economy / main street should be felt starting in H2 and in 2023.

This time is different®

It’s mathematically impossible to bring down inflation to 2% in short order without multiple negative MoM CPI prints and that would likely entail job losses. Decisions, decisions.

Following a four-decade bond bull market fostered by deflationary forces (i.e., the triple D) and the largest QE program the world had ever seen over the pandemic, inflation feels entrenched and sometime in Q4 / early 2023 markets may have to come to terms with the notion of structurally higher inflation for longer.

A scenario where inflation hovers above / around 4% would warrant a protractedly restrictive Fed—in terms of both rates and balance sheet reduction, freeing up countercyclical breathing room. That or a Fed that moves the inflation target / goalposts from the arbitrary 2% in a dispassionate exercise of cold, economic realism.

The most accomplished investors are starting to recognize that the paradigm might have shifted. A multi-year regime change.

When Stan Druckenmiller’s regales us with one of his rare appearances they often become a gift that keeps on giving. After including one of his quotes in my last piece, I’ll weave in another one from that same interview on June 10, which seems particularly prescient today:

“I had to learn—particularly in bear markets—that I had to morph into bonds, commodities, foreign currencies, things like that. One of the most challenging things for me right now is—maybe it says something about my dysfunctional personality—but I’ve always made even higher returns in bear markets than bull markets. But the way I did it was just pretty much ignore equities, take them off the table, buy bonds, buy treasuries and go home.

Well… I’ve never been presented with a cocktail where you have 8% inflation you think the economy might weaken and bonds yield 3%. It's an analog with no precedent in history.

For the golfers out there, going into the situation I’m describing I feel like im about to play a round of golf without a driver and without a 60-degree wedge because bonds—which have been my go-to asset in terms of a recessionary, bear market atmosphere—may work, but there’s good reason to believe things will be different this time, because we’ve never had central banks with this situation.

[…] So you can’t get into black-and-white, it’s an art form investing from cycle to cycle… you have to constantly innovate and not be a slave to past models.”

There you have it, from the 🐐 himself. There are strong arguments in favor of bonds not rallying into this bear market.

Things might be different this time after all.

How (not) to play it

Under a “restrictive Fed for longer” scenario, Powell & Co would soon move—possibly after delivering 50-75bps in the next meeting—to a data-dependent single / no hike stance, but would not outright cut rates. That was wildly inconsistent with the cuts being priced by Eurodollar futures for Q1 2023 (EDZ2EDH3, -25bps at one point) and for 2023 (EDZ2EDZ3, -82bps).

The cuts priced in for Q1 2023 have since been fully reverted, but markets continue to price in -42bps in cuts for 2023. Thus, one way to play it is via Eurodollar futures either by betting on those -42bps reverting or by betting on outright hikes in Q1 2023. A simpler way is to simply short bonds or bond proxies because ~3% bonds don't belong in a prolonged 4% inflation environment.

I have not yet put on any of these investments (Eurodollar or short bond / proxies). The market has repriced fairly swiftly over the past week and I missed the train. I’m looking for a potential entry point while I mull over sizing and correlations in light of my current portfolio.

But the message I want to leave you with is this. Just as important as how you play it is how not to play it. Druckenmiller is quite literally telling us to beware of bonds and think outside the box.

Time to get creative.

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Thanks for reading,

John Galt

PS: I’m tremendously excited to share that over the past days we surpassed a hundred subscribed investors to the blog—in a very brief period of time! Thanks very much for your support. Onwards and upwards. Always.

Please give this post a ‘Like’ at the bottom of the page if it was helpful to you. We’re very grateful for all the love we get from our readers!