The Morning Run podcast by BFM 89.9 featured Tony Nash, CEO of Complete Intelligence, discussing the state of the US economy, market movements, and supply chains. The podcast began with a brief overview of the previous day’s market performances. The key US markets had ended in the green, while all Asian markets were in the red, except for the FBMKLCI, which was up by 0.3%.
The podcast host then discussed with Tony the state of the US economy. The US retail sales in January increased the most in two years, and the home builder sentiment rose in February by the most since 2020. Meanwhile, US inflation rose by 0.5% in January. According to Tony, these indicators suggest that there is still demand, and consumers are still willing to spend. Companies are able to raise prices pretty dramatically, resulting in more revenue and faster growth, even if the volume of sales is slightly lower. Tony believed that the Federal Reserve will continue to raise interest rates. He felt that the Fed should have kept the foot on the brake a little more in the last meeting when they hiked by 50. He thinks that the interest rate will remain at 25 for the next three meetings, but the question is how much beyond that will they raise it.
The podcast then moved on to discuss company performance, particularly in the tech industry. Cisco delivered strong results and beat street expectations, suggesting that companies still have money for capex. Tony believed that companies are having to build out more robust technology infrastructure for their existing operations, which is good for tech infrastructure companies like Cisco. However, there is a divergence in the tech industry, with old tech like HP Enterprise and Cisco doing better than new tech like Apple and Amazon. Companies like Apple, Amazon, and Meta suffer on the ad side because there is a growing supply of ad space, but there are not as many ad dollars, and companies have generally less to allocate to marketing on a proportional basis.
Finally, the podcast touched on supply chains. Tony believed that supply chains have generally recovered, partly due to the falling demand. However, there are still challenges, particularly with logistics and labor shortages. Companies are looking at how to reduce supply chain risks and increase resilience, including reshoring and nearshoring. Tony believed that the current supply chain challenges could last up to two years, and he recommended that companies should develop more robust supply chain strategies.
In summary, Tony Nash shared his insights into the state of the US economy, the tech industry, and supply chains during The Morning Run podcast. He believes that there is still demand in the US economy, with consumers willing to spend and companies able to raise prices. The tech industry is experiencing a divergence between old and new tech, with old tech companies doing better. The supply chains have recovered, but there are still challenges, particularly with logistics and labor shortages. Companies should develop more robust supply chain strategies to increase resilience and reduce supply chain risks.
BFM
This is a podcast from BFM 89.9, The Business Station.
BFM 89.9, 7:05 A.m. On Thursday, the 16 February you are listening to The Morning Run. I’m Shazana Mokhtar with Wong Shou Ning and Chong Tjen. Now, in half an hour, we’re going to move the proposal for Petronas to be publicly listed in order to pare down national debt. But we are going to kickstart the morning as we always do, and it looks like it’s going to be a glorious morning with a look at how global markets closed overnight.
So all key US markets ended in the green. The Dow was up 0.1%, S&P 500 up 0.3%, NASDAQ up 0.9%. In Asian markets, they were all in the red, except for our very own FBMKLCI. The Nikkei was down 0.4%. Hang eng down 1.4%. Shanghai Composite down 0.4%. The Straits Times Index down 1.1%. But the FBMKLCI, it was up by 0.3%.
So for some thoughts on what’s moving markets, we have on the line with us, Tony Nash, CEO of Complete Intelligence. Good morning, Tony. Now, US retail sales in January jumped at the most in two years, and home builder sentiment rose in February by the most since 2020. While US inflation rose by 0.5% in January. What do all these indicators tell us about the state of the US economy?
Tony
It says that there’s still demand. It says that consumers are still willing to spend and that people really aren’t slowing down. We’re seeing things like price over volume. Meaning as we see more companies report, their earnings reports, they’re able to raise prices pretty dramatically, say, eight to say 12%, generally with a volume decline of, say, one to 3%, meaning the number of sales. Okay, so these companies are choosing to raise their prices and have fewer sales, but it results in more revenue and faster growth. So consumers are willing to pay more. They’re just buying slightly less of things.
BFM
And Tony, taking all this into account, what do you think the Federal Reserve will likely do next?
Tony
Yeah, they’re going to continue to raise. I do think that Powell missed a trick in hiking 50 in the last meeting. I do think they probably should have kept the foot on the brake a little bit more as a transition from 75 to 25. But I think for 25, it’s kind of as far as the I can see right now, at least while the current pace of the economy holds up. So, you know, we’ll certainly see 25 for the next three meetings. The question is, how much beyond that will we see it?
BFM
And Tony, are you in the camp where I have seen more economists raising their forecast for US GDP growth? I see numbers jumping from 1% to 2% for the first quarter. Are you in that camp?
Tony
Our view has been 1.4 this year, so it really hasn’t changed.
BFM
Okay.
Tony
We do reforecast each month.
CI Futures covers 50+ economies around the world. You can see historical data and forecasted data in an instant, like the US GDP here. Learn more about CI Futures: https://www.completeintel.com/futures
BFM
All right. And then looking at some results right. Old tech, Cisco delivered really good numbers, beating street expectations with strong spending on tech infrastructure, suggesting that companies still have money for capex. Is this indicative that actually companies are doing better than we expected?
Tony
Well, I’m not sure it means companies are doing better because earnings generally are on a slowing trend. But I think what it means is that companies are having to build out more robust technology infrastructure for their existing operations. And that’s good for the tech infrastructure companies like Cisco. So we are at the emergence of a new tech cycle with generative AI, there’s a ChatGPT and so on. So companies are going to need more robust infrastructure to deal with that.
BFM
But then we also notice there’s a divergence right when it comes to results. So old tech like HP Enterprise and Cisco doing better versus new tech like you see results being soft from the likes of Apple, Amazon. Will this divergence continue?
Tony
Well, I think when you look at things like Apple, Amazon, Meta, these sorts of guys, part of their revenues are ad revenues. And what’s happening on the ad side is we have a growing, say, supply of ad space with different companies coming on, like Netflix offering ad models. So there’s more ad supply. There are not as many ad dollars out there, or even if you assume the same ad dollars. With inflation, people are having to make trade offs. Companies are having to make trade offs, so they have generally less to allocate to marketing on a proportional basis. But there’s more ad supply out there. So many of those tech companies where ads are a part of their revenue mix, they’re suffering on the ad side.
BFM
Turning our attention to supply chains. During the Pandemic, the world faced a series of supply chain stresses made worse by the Ukraine conflict and China’s sporadic lockdowns. Do you think that global supply chains have recovered? Are they functioning better now? Or do you still see some kind of rocky road ahead?
Tony
I’d say generally supply chains have recovered. Part of that is demand falling. So we had in the port of Long Beach, we had the volume declined by about 28% in January. So the volume of imports have have actually gone down year on year on the west coast of the US. So the demand there is slowing. We’ve seen one of the indicators is headcount cuts. Guys like Federal Express or FedEx and UPS are cutting headcount. FedEx has announced about a 10% workforce cut, which tells me those are usually the guys who see the supply chain issues first and the guys who see the slowdowns first as well. So if they’re cutting staff, it tells me that some of these things are really slowing down.
When we look at delays at Chinese port, for example, they’re about half the time of what they were about a year and a half ago. So they’re not really bad at all. And then when we look at, say, freight that’s waiting on ships that’s down dramatically to, say, Q1 of 2020 levels before all of the COVID stuff set in. There’s a great just for your listeners, keel. The Kiel, K-I-E-L, I think in Germany has a great indicators on supply chain delays. So I would recommend you guys to check that out.
BFM
And Tony, ASEAN is a key player in this global supply chain. Which countries in this region are likely to be major outperformers in that regard?
Tony
Well, you guys know Malaysia is seeing more inward investment, especially around electronics, so I wouldn’t be surprised if we saw some upside in Malaysia. I know the expectations for Malaysia aren’t as aggressive as, say, Indonesia or Vietnam, but it’s possible that Malaysia overperforms those expectations. Indonesia, I think there are a lot of expectations on indonesia’s outperformance partly on AG prices, but also partly on movement of some manufacturing to Indonesia, which has a pretty low base. And then Vietnam, of course, you know, we’ve seen blistering growth in Vietnam. We expect that to continue as people look for a substitute for Chinese supply chains.
BFM
And Tony, are you still a bull on energy stocks? Because if you look at the sector, it’s the worst performing in the S&P 500 today and also for the month so far. We see energy stocks all coming under pressure, I think in part due to all prices stagnating and weak earnings from some of these companies. Is it time to buy or is it time to just step back and say, hey, maybe I should cash in my chips?
Tony
Yeah, I think you have to look at the different segments of energy. So, for example, oilfield service providers, we’re starting to see upstream, meaning people who take oil and gas out of the ground starting to spend on development outside of the US. So some of these oil and gas services providers, it’s a very interesting space to look at right now because we haven’t had CapEx in so long in oil and gas. And as we get that, we could see some of these service providers do really well. In terms of oil price. I do think that we do see upward pressure. I don’t think anybody really expected that to hit in Q1, but as we end Q1 and go into Q2, we do start to see that. And I think we do see I don’t think we see two or $300 crude oil this year, but I think low 100s, 110s, high 90s. I think those are definitely within possibility and likelihood.
BFM
Tony, thanks very much for speaking with us today. That was Tony Nash, CEO of Complete Intelligence, giving us his take on some of the trends that he sees moving markets in the days and weeks ahead. Ending the conversation there with just a projection on how oil prices could be trending later on this year.
Yeah, so I think we’ll have to watch this space. But I want to focus on one of the names that I mentioned earlier on, which is Cisco. Right. So their results came out. In fact, it went up 8% after market hours trading because the street was really impressed with the numbers. Apparently the earnings, the last time we saw this kind of level earnings was in 2013, and that’s like a long time ago. So a lot of attention on Wall Street has been on what I call the new tech. So Amazon, meta, Apple, Microsoft, even on some level. But there’s a little bit of a shift. And I think what these names are showing is that, hey, there is still spending out there.
Yeah, I think the CEO actually said that the public sector business performed stronger than expected as compared to historically. While in the service provider category, some customers are adjusting to better delivery of the company’s products into the environment. In terms of the guidance for the next quarter, Cisco is guiding adjusted earnings of 96 to 98 cents to share and revenue of roughly about 14.25 to 14.5 billion dollars.
So currently the street doesn’t really like this name that much because there’s only 14 buys, 15 holds, and one sell. Consensus target price for the stock is $53.83. Like we say, it was already up 8% after market hours, right. I won’t be surprised. After these set of numbers, we will see quite a number of upgrades on this name because the company is already suggesting on giving guidance a more positive one.
That’s right. Their guidance is more positive for the next quarter. But turning our attention to other earnings report we have, the Canadian ecommerce platform Shopify. Shopify, in contrast to Cisco, didn’t have such a great report. They reported a loss of $623.7 million in the fourth quarter after adjusting for stock based compensation, gains on investments and other costs. The company reported earnings of 7 cents a share, down from adjusted earnings of 14 cents per share in the holiday quarter.
And revenue came in at about $1.73 billion, up from $1.38 billion. And the analysts on average expected an adjusted loss of a penny a share on sales of about $1.65 billion. The company said Black Friday sales rose close to 20% last year from 2021. And this year is working to recover from a misplaced bet that the Pandemic Field search in online shopping would become more permanent. Although he’s cut jobs, raised prices, and expanded offerings to merchants.
19 buys, 25 holes, five sells. Consensus target price for the stock, $46.48. Actually, the current share price is already above that, to $53.39 year to date. Actually, the stock is up 53%, but I think came from a very low base because 2022 was very painful for them.
All right, 07:17 A.m.. We’re going to take a quick break, but we’ll come back and cover more top stories in the newspapers and portals this morning. Stay tuned to BFM 89.9 you have.
Been listening to a podcast from BFM 89.9, the business station. For more stories of the same kind, download the BFM app.
In this video, our first-time guest Jim Iuorio leads the discussion on the topic of whether markets are too good for the Fed. With speculation around CPI, layoffs, and interest rates, the question of the Fed’s direction and potential pivots later in the year is raised.
Jim also delves into the recent success of the metals market and offers insight into where the market may go in the future. He also offers his thoughts on the potential impact on equities if the S&P hits his target of 4060.
Next, Tracy takes the lead in discussing cracks and Freeport. She explains the significance of rising crack spreads and its impact on the market. She also shares her insights on the recent opening of the Freeport facility and its effect on US natural gas prices.
Albert then discusses the risks associated with Ukraine’s new hardware. He addresses the classification of “direct involvement” and its potential impact on European countries. He also offers insight into what actions Russia may take to further complicate the situation and the potential impact on markets such as wheat.
Finally, the team gives their expectations for the upcoming Fed meeting and what to look for in the week ahead.
This is the 51st episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Hi, and welcome to the Week Ahead. I’m Tony Nash and today we’re joined by Jim Urio. Jim is at TJM Institutional and he’s with the Futuresedge podcast. Or is it on the Futuresddge podcast, right? Yes. Also with Albert Marko and Tracy Shuchart with Hightower Resources Advisors.
We’ve got a couple of key themes. Obviously, it’s the week before the Fed and we’ve had a really good week in markets. So one of our key themes is our market is too good for the Fed. Second I think Tracy is going to talk about crack spreads and Freeport and what’s happening there. And then we’re going to look at the risk with Ukraine’s new hardware. There’s been a lot of talk about tanks going to Ukraine this week, so we’re going to talk about some geopolitical risks with Albert.
So Jim, first, thanks again for joining us and watching some of your comments through the week with markets breaking through some of the key levels that you were looking at, the Fed’s direction is obviously a big factor in markets and there’s a lot of conjecture around CPI, layoffs, rates going lower or pause or pivot or whatever you want to call it, and people saying the Fed may do 25 and then pause.
What’s your view on that? You’ve been obviously speaking about this several times this week. So I’m curious, what’s your view after seeing a whole week, where do you think we go from here?
Jim
Well, I’ve been somewhat more of a bull, I think, than most over the last few months. And I’m not trying to take a victory lap or anything, it’s just a fact. And my reasoning was that every one of us knows that these Fed rate hikes have a huge lag period before we feel the efficacy. Fed knows that too. As stupid as the Fed is, this is something that’s so fundamental, but I think they genuinely do know that. So now we’re starting to see things happen. We saw a pretty good PCE report today. CPI has been trending lower too. The only things in CPI that are stubbornly high, consistently, are food and energy, which are the two things that are least rate sensitive. The yield curve is still wildly inverted, signaling to them that they still are in a financially tight market. I believe that the Fed is getting close to having some sort of gentler language. Now, whether they go 25 basis points this time and then 25 basis points again, that’s fine to me. Now, the one thing I do have a problem with is that the Fed Funds futures curve says 50 basis points over the next two meetings.
And then toward the end of ’23, there’s going to be an ease. But they say it’s only going to be a quarter, two and a half point ease. And that I say “no way.” If they’re ever going to actually pivot and start easing, it’s only going to be as if something is burning and something is falling down and then it’s not going to be a quarter point ease. That being said, I still like risk assets. And I have because I think we are nearing the end of the Fed tightening cycle. I believed, I’ve been doing my podcast for the last hour. I wanted the market to settle above 4070. It certainly did, right? We went into the closed pretty strong, I thought. And I think that that green lights the next move higher. I particularly like the metals market, and I’ll shut up in 1 second, I swear to God. I particularly like the metals market because I think that… I don’t mean to talk for so long. I thought copper was being held down by China news, by the Fed, by the strength of the dollar, and all those things have seemed disappeared. And I’ve made good money on that so far, and I plan on keeping those lumps.
Tony
So it’s a good question about metals. What are you looking at? You said China and you said China reopening other things. What are you looking at in metals? Are you looking at industrial metals, copper and so on? Are you looking at precious metals or kind of all of the above?
Jim
Copper is number one and that’s my biggest position. Silver and then go down from base industrial all the way to just gold being pressured. And the gold thesis for me is different than the copper one in that I believed at the time when I started buying more gold, that Bitcoin and Etherium in the crypto market and all that dollar safety hedge or whatever the hell it is, if that was disappearing, then money would go back into gold. Well, that didn’t disappear. Bitcoin is butting up against new cycle highs now, but gold is still doing well. So in that I was kind of wrong on the thesis. The thesis was also the dollar weakening, which happened as well. Once the Pound of the Euro started really bouncing off those October lows, I thought, okay, the green light is on for all these metals. So I’ve done okay in gold, even though my thesis about crypto was wrong.
Tony
Okay, but was your thesis wrong? Do you see crypto and gold as substitutional somewhat at the margin still?
Jim
I don’t know. I was going to ask you that same question. I always did. And I thought that the $3 trillion crypto market was sucking away some of the gold. And I thought that that was a big deal. But then it doesn’t seem to be now, so I guess I can’t answer that. I’m confused, I guess.
Tony
Yeah. I’m curious. What do you think about that, Tracy, in terms of crypto and gold? Do you think there’s a trade off there?
Tracy
This is not really my… Crypto market, is not really my market.
Tony
Internet, say whatever you want.
Tracy
Albert knows way more about this than I do, to be honest, because I’ve never traded crypto, and he’s traded a lot in the past. So I’m going to defer this to Albert.
Albert
Before I do think that there was a correlation between how much money was flying into crypto versus taken away from gold, I think there is no doubt that gold suffered because of that. I don’t think that as the case right now, simply because there’s been too many blow ups in the crypto world at the moment. I don’t really know how liquid it really is. There’s certainly no retail left in the crypto market, so it looks like it’s all institutional. So I don’t know. You can’t really make a fundamental call on crypto at the moment.
Tony
Could you ever make a fundamental call on crypto?
Albert
You could at some point, because institutional money was flying in there because their clients were forcing them to get into the space. So you could make a little bit of a fundamental case for crypto, but as all these ponzi schemes blew up, like FTX and everything, that’s just gone completely out the window at the moment.
Jim
Sure, Tony, I can make a slight fundamental argument of it. When they were adding an additional $7 trillion, throwing it into the money supply, and really being poor stewards of the dollar, that was somewhat of a fundamental argument for crypto, I guess, right?
Tony
Yeah. Okay. Are markets too good for the Fed. As we’re going into next week, are these levels too good for the fed? Is Powell going to come out and really, you know, say, look, this is irrational or whatever, and it’s too much, and is he going to pour out, say, 50 basis points and disappoint a lot of people?
Jim
Just to punish me a rug pull? I mean, I think he’s capable of that. He certainly did at the Jackson Hole meeting a while back. So you have identified, I think, the major risk, and it’ll probably go into that somewhat hedged. And again, hedging is probably going to be expensive going into it because people realize that that’s where the risk is. So on balance, I will say, no, I don’t believe he is. I think he believes that going too far this way. And again, I think he thinks going not far enough in this direction is the worst possible thing. But I also think he’s starting to realize going too far and what that looks like. He sits around and talks about creating slack in the job market, and to him, it’s just an equation on a whiteboard where the reality is talking about people losing their jobs. I think he balances a lot of realities. I think he’s incompetent. His entire tenure has been mostly incompetent, but I think he’s done a pretty good job trying to clean up the mess that he made over the last year and a half, and I don’t think he’s going to do something stupid like that. But, yes, to your point, it is a risk.
Albert
I actually disagree with Jim on this.
I think it’s going to really matter about what the market does. If we start flying into the 4200 before Tuesday on the SPX and whatnot. I think that Powell will come out. I don’t know if he’ll do 50. I don’t think he’ll do 50, but he might come out with a 25 basis point rate hike and then start talking extremely hawkish and dismiss all the rate cuts that everybody’s been talking about, which would be essentially the same thing as doing 50 to the market. If the market says that. If the market here is that we’re not getting rate cuts till 2024, I don’t see that as positive whatsoever.
Jim
I certainly hope you’re right in the near term, too, because I’m short some of those 4200 calls, like, too many. That’s the position I keep checking in my bold position was like, oh, sh*t, they’re getting too expensive. So I actually like what you’re saying a little bit in the short term.
Albert
Yeah, I have a problem because of this is falling liquidity right now and tightness at the same time. I look at the market and I’m like, well, money is starting to fly out into Asia, which we talked about Tony, repetitively for months now. Where are we going to get that $5 trillion incremental money coming into the market to keep this thing afloat? For me, it’s like I don’t see the math adding up to 4300 on the S&P and anytime soon. And on top of that, if you calculate rate hikes and everything you’re looking at the market, 4150 or 4200 is more expensive than 4800 was. It’s technically even higher valuation. So for these things, I’m just like I think we’re probably going to retrace the 3850 on some kind of ridiculous Powell talk. And on top of that, Brainard is talking about leaving. She’s not leaving if Powell is talking about being dovish. She wouldn’t be doing that, in my opinion.
Tracy
I asked a question. I was just saying and that’s for both of you. I mean, considering that the Fed has hiked so quickly, do we even think, and the data has remained pretty good, considering right, so do we think that the rate hikes have actually even been able to filter down into the economy at?
Jim
I don’t, Tracy. I think that that’s the point. I think when you look, just take the real estate market. How in the world is it not going to be a major hurdle for the real estate market to take mortgage rates from 2.8% to 7%? I think that it’s silly to think that if they just left things the way it is, I believe that we would certainly go in recession at some point in time with money being restrictive as it is compared to… I’ve argued for 30 years that rates had to be inorganically low to make up for the fact that we have all these crappy regulations and punitive taxes on companies. They need low rates to function. I think rates are to point now where eventually they would drag on us too much. Albert, do you agree with that?
Albert
I do. But the flip side of that is, like, if Powell doesn’t stay the course, Yellen is using the TGA, in my opinion, from what I heard, to offset quantitative tightening. This could set off another round of inflation if China comes on too fast, or even Europe starts to gear up a little bit and reset their manufacturing sectors with stimulus. The fear I have is a second half inflationary run again, and then we’re going to be talking no more pauses, but another round of 50-75 basis point rate hikes.
Tony
Second half of Q2. I don’t think it’s a second half inflation run. I think it’s Q2. I think it happens a little bit sooner than that.
Albert
Yeah, it could. I mean, you could have any kind of geopolitical event like Russia re-invading Ukraine with some gusto this time.
Tony
Okay, guys, here’s my question, though. We’re talking all this potential dovishness, but all we’ve seen is the rate of inflation slow. We haven’t seen prices come down. Okay, so why would he go to zero? Or why would he just do 25? I’m not seeing it. When you look at the job market, sure, you’ve lost 70,000 tech jobs, but they hired 2 million since 2020 or something like that, right? So it’s nothing. It’s dropping the bucket.
Tracy
Chipotle hiring 15,000 so those people can get a job.
Tony
Exactly. What is it that would tell us that he’s going to go 25 or pivot or whatever? I’m just not seeing that thing because the job market is still really strong.
Jim
So here’s what I would say to that, is that the job market is going to be strong and tighten. It’s a weird kind of anomaly that happened with 3 million boomers leaving the job market prematurely over the last three years. To your point about why would he not stay the course if prices aren’t coming down? Because, remember, ultimately, the end of the day, the inflation was intentional and it was done because of this wild indebtedness all over the board. But I always focus on the five states that could not possibly have paid their bills under any possible scenario. And that’s why for ten years, they kept telling us that they needed inflation. So I think in Powell’s mind, he tells us 2%. I think he’d be perfectly happy with three and a half.
Albert
And they’ll get three and a half because they’re starting to change the way CPI has waited starting 2023.
Jim
Just like when Nixon changed the definition of unemployment back in the 70s.
Albert
The BLS have done that in the past. They changed the way unemployment is calculated. Now they changed the way the CPI is calculated.
Tracy
They changed the way inflation is calculated.
Albert
Perception is reality in the market. We can sit there and b*tch about fake data from China and fake data from the Europe and the US. But perception is reality in the markets.
Tony
Yes. So we’re going to change the rules to win.
Albert
Well, yeah, of course.
Tony
And the CPAC calculation changes this month, right?
Albert
Yeah, January 2023.
Tony
Fantastic. Okay, so you guys are in the 25 basis point camp for next week, right? 25 and very hawkish. 25 and very hawkish.
Jim
Okay, I don’t I like what Albert saying. I say 25 and mildly hawkish.
Tony
All right, we’ll see. I think it might be a little harder than that. So we’ll see. That’s good, though. I appreciate that.
Tony
Okay, Tracy, I want to talk a little bit about refineries and crack spread. You sent out a tweet on Monday about diesel prices.
Can you help us, help us understand what’s happening at refineries and what’s happening with diesel and gasoline and other refined products prices?
Tracy
Well, this is actually the perfect segue because I tweeted out a chart of ULSD, which is diesel, basically. And so we’re seeing those refinery margins explode again. And most people say, well, that’s anticipation of the diesel embargo in Russia and refineries across the world that are not part of Russia are seeing these increases. But that’s not just happening in the diesel market, that’s also happening in gasoline cracks. And so higher refining, basically the long and short, higher refining margins mean higher prices for consumers. Right. So Tuesday we just hit a three month high of $42. And when oil was at its highest price, those crack spreads were at $60. So this should start ringing alarm bells a little bit about inflation. This is why it kind of correlates to what we were just talking about. And so CBs, even though they don’t count energy in the CPI as part of inflation, they should be keeping an eye on these indicators because it kind of indicates that we’re going to see higher gasoline, diesel costs, jet fuel, et cetera. And that could add to inflationary pressures across the board, not only for just the consumer, you and I, but for companies that are heavily dependent on these products.
Tony
And when there’s inflation in energy, there’s inflation in everything.
Tracy
Right, right.
Tony
Second or two tier impacts.
Tracy
Exactly, yeah.
Albert
One of my oil friends was telling me that normally January, February, they’re running at minimum rates, trying not to lose money. But this has been like absolutely insane, where they’re just making money hand over fist right now because the demand is so high.
Jim
Tracy, I have a quick question for tracy, by the way. Is that okay?
Tony
Yes.
Jim
So, Tracy, just last week, I don’t know if it was Chevron or Conical Phillips, where they announced raising the dividend or whatever, paying bonuses and not investing in it. Was that an indication that they still feel that the government is not smiling upon fossil fuel companies expanding their operation?
Tracy
Oh, 100%. Right. For over a year now, we’ve seen elevated energy prices in that seventy dollars to eighty dollars range. Negating, the spikes that we saw from the Ukraine invasion. But so after a year of pretty much stable higher energy prices, we are still not seeing anybody want to invest in this sector. Right. They still want to cater to the investor. They still want to pay down debts. They still want to do higher dividends. They still want to engage in stock buybacks. All to placate the investor. And so that is very telling that after a year, they’re still not willing to reinvest into capex, particularly in shale.
Tony
It’s nothing but downside to invest, right?
Jim
No doubt.
Tracy
Yeah, absolutely.
Jim
It’s maddening when you think about it. Everything seems like it’s such a self inflicted wound. And this is the kind of thing that keeps me up at night. It seems like a government that’s working against us. And I’m not trying to be that guy. I’m not political. I just see policies and they’re asinine.
Tracy
Who wants to invest when they say, we want to phase you out, we want to kill you?
Jim
Right? Yeah.
Albert
Well, this is the problem when politics gets mixed up in economic policy, it starts muddying things up and mistakes become exponential at this point.
Tony
But politics is always mixed up in economic policy everywhere. You know that. I’m not telling you you don’t know, but it’s always there. When I hear you talk about refineries, and it’s been how many decades since we built refineries in the US, Tracy? The 70s was the last time we built refinery?
Tracy
70s was the last major. We’ve had a lot of brown projects, which means we’ve added refinery capacity to already existing refineries, but we haven’t had any new green projects, which means building new refineries. And we were talking about, I think, last week or the week before the expansion that we’re having in Texas. But the problem is that the amount of refining that is coming offline is more than the refining capacity that is coming online.
Tony
Right. So what’s our capacity utilization right now in refineries?
Tracy
Well, we’re down right now because we’re in the middle of maintenance. And we also had Elliot storm, which some refineries, for instance, Baytown, is just coming back up this week from the storm in December. So utilization rates right now at about 89.5%. But, you know, you have to realize that, you know, we’ve been over, well over 90%.
Tony
Yeah, 94 or something like that. Right?
Tracy
Yeah. And we have aging refineries. And so what does that mean? Those refineries are more prone to breakdown because we’re running them at, like, ridiculous max capacity. Right, exactly.
Tony
Okay, so since you mentioned Texas, let’s look at this tweet that you put out a couple of days ago saying that Freeport gets approval.
So USLNG, the Freeport terminal has been approved and reopened. So can you talk us through what that means for European nat gas and what that means for US nat gas prices?
Tracy
Well, for US natural prices, that is positive. And I know that all nat gas prices have tumbled 35% to 45%. Regardless, we’re back into that two area that is pretty much where we’ve been for several years. But it is a good thing. I think the market, I think, spiked 15% or 15% $0.15 sorry, on that move. And they kind of retraced it. I think the market is a very Freeport is an export place. So what that means is that if Freeport being closed basically landlocks US nat gas, which is obviously a negative because we have a lot of it. But I think that the market in general is a little bit skeptical. But as soon as we actually start seeing export capacity increase from that facility, then I think that the markets will be more enthusiastic about the success of that because it’s really been since August since that facility is shut down.
Tony
So you’re saying we should see US nat gas prices rise as we have more export volumes from Freeport?
Tracy
Absolutely. And even this week, Semper Energy announced that their new Port Arthur facility has already been booked. And that facility isn’t even all the way built yet. And that’s another export facility. So there’s a lot coming online and a lot being built out that we will be able to see. I think that just market participants have become a little bit placated because they look at European stocks and European stocks, of course they’re still full. They’ve had a mild winter, but everybody kind of forgets that last year 50% of their storage capacity came from cheap Russian pipeline. And that’s not going to happen this year.
Tony
Yeah. So all of those new roads that are being built in Texas, it may have been started with other money, but it’s going to be finished with European money. Right. So I just want to take this moment to thank our European friends for finishing our transportation.
Albert
About time they give back.
Tony
That’s right.
Jim
Finally, their currency has come back a little bit, so now they can actually buy stuff here.
Tony
Perfect. Okay, very good, Tracy. Anything else on nat gas? Are you still keeping eye on fertilizer for kind of late spring time period?
Tracy
Yes, absolutely. I think that’ll still come into play. I mean, nat gas prices are extremely low right now, which is great news for fertilizer prices. That will give farmers a break. This is all good news in that respect, but I still think we need to keep an eye on this going forward and keep an eye on that gas prices because obviously that’s going to affect fertilizer prices and farming in general.
Tony
Jim?
Jim
Tracy, you talked about diesel before, and I don’t trade diesel. Is the spread between diesel and regular WTI still blown out? And what could possibly get diesel back in line?
Tracy
Well, I think that there’s been a shortage for a very long time. That spreads come in a lot, comparatively speaking. But now it’s starting to blow out again because again, you have the EU embargo of diesel, and they got literally like 95% of their diesel came from Russia. Another dependent project. And I’m sure Russian diesel will go somewhere else. It’s not more about that, but it’s more about really boils down to refining capacity as well. Because even in the United States, we can’t refine. If Europe wants to buy from us, we can’t even refine enough. We’re sending what we have over there as well as our domestic needs. So really, diesel to me comes down to refining capacity altogether.
Jim
That’s an unfixable problem, right?
Tony
Until Russia’s solved, right?
Albert
What about the Jones Act waivers for sending diesel up to these coast cheaper?
Tracy
Yes, they could do that, but they haven’t done that. They’ve done that in the past for Puerto Rico after the hurricane and all of that, but they still haven’t given waivers. Even when prices were extremely high in the United States, when we were at the height back in June, July, when prices, gas prices were highest, diesel prices were highest, they still wouldn’t give Jones Act waivers. You have to understand that the Jones Act came into play into 1920 when we had a fleet of over 1000 vessels, and we now have under 100 vessels that can transport that. So, you know, it’s the government could do it. They’ve chosen not to. Why? I’m not sure, but…
Jim
We can come up with some guesses. They’re either stupid or they’re nefarious. I believe at some point in time you’re going to have to say some of it’s nefarious, where they keep making the wrong decision at every turn. And I apologize for that.
Tony
No, don’t apologize. Look, it’s making it more expensive for people on the East Coast to get diesel. It’s not good.
Tony
Okay, great. Speaking of Russia, Albert, we saw a lot of news over last week about tanks going to Ukraine. And there’s a tweet from Max Abrams, who’s a great geopolitical professor talking about Russia, says that tanks from the west count as, quote, “direct involvement in the war”.
So I wanted to get your… Jim said what would solve the diesel problem. Obviously, Russia coming back into the market would solve the diesel problem. Now with a lot of Western countries sending tanks to Ukraine, that doesn’t sound like we’re coming closer to a solution on that. So first of all, why are they sending them if they don’t have the people to operate them? Second, tanks are to take land. Right? So what do you think is being planned? And third, how risky is it? Do you think it really implicates these kind of donor countries as direct participants in the war?
Albert
I don’t really buy into the whole direct participants of the war. The rhetoric coming out of Russia is a little bit bombastic in that respect. Referring to those tanks, there’s only going to be about 100 of them, right? They’re not going to be able to push out the Russians with those tanks. On top of that, they’re going to be about six months out until they’re actually even deliver, and then you still have to train these guys and they need supplies, and the Ukrainians don’t really have all that. So the best guess that I have is that they’re forcing Russia to come into a ceasefire in about six to eight months time, which gives them a window now to try to take Dambus and have some kind of wind before these tanks get delivered. Listen, they’re no joke. The Leopard tanks and the Abrams are better than what the Russians have. But in terms of the Ukrainians using them to push Russians out of all Ukrainian territories, that’s just not happening.
Tony
Right. So are these just old tanks or is it a quality kit that they’re getting?
Albert
Well, I think they’re getting like the second tier tanks of what the west has, but that’s still better than what the Russians have or even willing to use for Ukraine. So, like I said, this is more of a measure to force the ceasefire later on in the year.
Tony
Okay. Yeah, Jim?
Jim
Albert, a couple of days ago, when this escalation started in Germany, we announced I immediately put on my screens, looked at oil, wheat, even the defense sector ETF, and nothing really budged. Do you think the market was looking at it like it wasn’t a big deal? Or do you think the market was looking at it as somewhat balanced, perhaps a quicker end of the war and not an escalation, or perhaps an escalation, the two things come around?
Albert
Oh, man, that’s a good one, Jim. I honestly think that the market’s probably in a wait and see position at the moment.
Jim
Numb to the shit kind of. Right?
Albert
Yeah. You got to wait and see what Moscow is going to do. I certainly think they’re going to use wheat and grains and other grains asymmetrical responses to the west to push inflation out over there, make it hurt. That’s the only thing they have. They don’t really have anything else to go after. I mean, the oil that they’re selling to India and China is enough to sustain their pocketbooks for a little while until this gets sorted out. But until there’s some sort of major upheaval in Ukraine, I don’t think the defense stocks will take off or wheat yet. But they will. I think they will. They haven’t moved.
Tony
The defense stocks haven’t moved for a while. If it is we and other AG stuff that is going to be their lever, that probably means the Turks will get more involved in the discussion because they’re the ones who arbitrated the discussion earlier. Is that right?
Albert
Well, they’re trying to get into the discussion. I actually have really good connections with the Turks and their main thing is to distract the West and the Russians into Ukraine while they push their trade deals out into Africa at the moment. You know, the Turks have a great drone, the TB Two, which they sell to pretty much everybody. So that’s as far as they’ll actually get into the war besides making media comments.
Tony
Right, okay. And so what risk do you think there is on wheat? Do you think we see more wheat risks, say, in Q2 – Q3 this year?
Albert
I absolutely do. The Ukrainians, they’re planting a lot less. I think 40% less is what they’re reporting, is probably even more than that.
Tony
Right.
Albert
And on top of that, if the Russians decide to blow up a port or blow up a few ships that are trying to get out with wheat, and all of a sudden, wheat, you know, takes off back to the 900 or $1,000 mark again. So I definitely see that happening in Q2 Q3.
Tony
Okay. That could be exciting. All right, guys, let’s close it up. We’re in that quiet period for the Fed. We have that Fed discussion next week. So what are you keeping an eye on next week aside from the Fed, of course, but what are you keeping an eye on in markets? Tracy, why don’t you get us started.
Tracy
Well, I know that most people are looking forward to OPEC is next week at the beginning of February. My personal stance on that is that I think they will keep everything as is. Right. They made that 2 million cut, even though it’s technically not 2 million, because they were under quota anyway. They said they were going to carry that through 2023 unless something came up that they really needed to address. And I just don’t see anything coming. I don’t see any reason they would need to change this policy stance right now. We have Russian barrels still on the market. We have China is still kind of an unknown because they haven’t really opened up yet. So that’s what I’m looking forward to, or at least that’s what my feeling is about the data.
Tony
Great. Okay. Albert, what are you looking at next week?
Albert
Well, obviously the Fed. I think, is in order with a hawkish tone, but honestly, I want to see how the dollar reacts to all this. And the VIX. The VIX at 17, start looking at some good old put options and call options with the 17 VIX is fantastic. But, yeah, basically what the dollar is going to do. I really want to see if the dollar breaks into the 90s with some kind of bull market talk.
Tony
Excellent. Okay. And Jim. Wrap us up. What are you looking at?
Jim
The unemployment numbers on Friday. Big deal. The last shooter drop is going to be the slack in the labor market that they want. Albert mentioned that level on the dollar. I call it like 101 to 100. As soon as it goes below that, as soon as we get a nine handle on the dollar, I think it greenlights a lot of risk assets. But the thing I’m mostly focused on is unemployment and then the week after that my trip to South Florida. Because every time I leave these damn markets, something crazy happened. So you guys can count on that. I’ll tell you when I’m on my flight. Something weird is going to happen.
Tony
When is that?
Jim
I don’t know. My wife makes the arrangements. I think it’s the next, like a week from next Thursday. I think we’re going on vacation.
Tony
Keep an eye on. Jim, thanks so much for joining us, Jim. Guys, this has been great. Thanks very much everyone have a great weekend. Thanks Jim.
In the current Week Ahead, Harris Kupperman (Kuppy) of Praetorian Capital discusses his hypothesis that crude oil prices may reach $300 per barrel due to a decrease in supply resulting from environmental regulations, a lack of investment, and government actions. Kuppy also argues that high demand for housing in the US, driven by population growth and migration, will lead to a positive outlook for the housing market. However, he notes that high mortgage rates could impact the market, but a pause on interest rates or an acceleration of inflation could lead to a more favorable outlook. Kuppy suggests that the US housing market may see a shift towards lower-priced homes with fewer amenities in order to accommodate growing families. He also highlights the attractiveness of housing markets in emerging markets due to high interest rates and positive real yields on property appreciation.
Next, Brent Johnson of Santiago Capital discusses recent policy changes by the Bank of Japan (BOJ) and the market’s reaction to them. Brent argues that the changes, which included increasing the amount of quantitative easing (QE) and widening the range within which the yield curve control operates, were not a real policy change and that the market misread the situation. He suggests that the BOJ is trying to avoid a repeat of earlier this year, when rising interest rates caused chaos in the Japanese banking system and the market had to be halted. He also discusses the challenges central banks face in balancing the bond market and the currency market, and the impact of these challenges on the yen.
Finally, Tracy Shuchart of High Tower Resource Advisors talks through the relationship between oil demand and household savings during economic recessions, stating that past recessions have not significantly impacted oil demand. She also covers the potential long-term effects of declining population rates on global energy consumption, then comments on the potential for energy consumption to increase in the short-term, citing data from the International Energy Agency and discussing the impact of economic stimulus on household savings and consumption.
Hi, everyone, and welcome to the Week Ahead. My name is Tony Nash. Today we’re joined by Harris Kupperman. You may know him as Kuppy on Twitter. We’ve also got Brent Johnson and Tracy Shuchart. Kuppy is with Praetorian Capital. Brent Johnson, of course, is with Santiago Capital. And Tracy Shuchart is with High Tower Resource Advisors. So, guys, thank you so much for joining us. I think this is going to be a great discussion.
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We have some key themes here. The first, really looking at some of Kuppy’s discussions lately, looking at $300 crude, and kind of still with a question mark, bullish housing? I think that’s the first thing we’re going to jump into.
Then we’re going to look at Japan’s normalization. We had some news this week with BOJ Chair, kind of starting to normalize the Japanese money supply environment. So we’ll jump into that with Brent. And then we’re going to look at recession on oil demand elasticity with Tracy.
So, guys, thanks again for joining us. I’m looking forward to just a great discussion today.
So, Kuppy, you know, you have posted quite a lot about $300 oil in your newsletter and online. And, you know, there are a lot of, we had a show last week that was full of oil bulls. I don’t know that anybody particularly said $300. So I’m really curious about your $300 call. Can you walk through your thesis and just help us understand what you’re thinking?
Kuppy
Yeah, sure. I mean, overall, oil is just like all the commodities. It’s supply and demand. And since 2014, no one’s really invested and the supply side is really constricted. You have ESG mandates. You have lack of capital from institutional investors. You have banks that won’t lend. You have governments around the world that are canceling pipelines and canceling permits. And now you have UK talking about excess profits, taxes. That’s not an environment for guys to go explore and drill. And the thing about oil is that if you’re not drilling new wells, they decline over time. And so the question keeps being, where does the oil come from? People just think that the US. Shale, you can flip a switch and barrels show up. And maybe that was the case a decade ago, but that’s not how it works anymore. We’ve really hit the best acreage.
And from here on out, not only are you working mostly at tier two locations, but you’ve seen massive inflation in terms of oilfield services and those wells that everyone used to lie about and say it had 100 IRRs at 60, what we learned is they don’t break even at 60. And now you have massive oilfield inflation. I don’t know if you have decent IRRs at 80 or maybe even 100 in a lot of these places.
And I mean, it’s no secret why no one’s drilling. The numbers don’t work. And then, you know, you flip it to the other side on the demand side. Look, 6 billion people want the same standard of living and the same energy per capita utilization that all of us have. And you could have said this decades ago, but what’s changed is that they’re all in that part of the S curve where their per capita consumption explodes. I mean, look what’s happened in India. We’re having, I guess, a global recession this year, but demand is up teens.
You look all around the world, Africa, LatAM and demand is up. Even in the US demand is up. And so demand grows one or 2 million barrels every year. And where is the supply going to come from? What we’ve seen, like I said, is the supply is restricted. And even if you try to add supply, it takes a couple of years.
And so I think you’re going to have a massive mismatch. And what’s hidden that for the last year is that China has been offline. That’s two or 3 million barrels. The SPR is globally of about a million, million five. So you’re really looking at, let’s call it four and a half million barrels. That that’s been kind of like subsidizing the balances.
And, you know, you could debate, you know, exactly what the number is, and it moves around some. But for the most part, you’ve had this weird subsidy to the oil price, and I don’t think that’s going to be there next year. China has been pretty clear they’re opening and the SPR is empty. Meanwhile, Russian production is in free to fall after the US firms left. That’s another million. And like I said, global demand grows a million or two a year.
And I don’t think we can see much growth on the supply side. I think you’re going to have a four to 5 million barrel deficit, and that’s one of the biggest deficits in 40 years. And it may even be as large as we saw in World War II as a percentage of total consumption. And I think the price is going to scream out of control. I don’t think 300 is the clearing price long term, but I think you could get there in a super spike, especially given how much structured products out there that’s synthetically short. So that’s how I see it, and that’s why I’m so bullish.
Tony
Okay, so is your time frame for ’23 for the $300 price, or is that just kind of a longer term target?
Kuppy
I think it’s like the next year or two.
Tony
Okay.
Kuppy
Like I said, we’re going to have massive supply demand mismatch next year, and I think it’s going to scream out of control. There’s some things we could still do. They’re going to jump some more SPR. Maybe there’s some things around the margin they can do. But in the end, if you’re structurally short oil and there’s no oil to be had, I think the price goes crazy. And you always have a geopolitical kind of upside there to whatever happens to the price of oil, because it’s never really the downside, but it’s usually the upside if something crazy happens.
Tony
Right. Okay. We just had Zelensky speak to US Congress this week here in the US. And it doesn’t really sound like the war there is slowing down. Maybe it is, maybe it isn’t. I don’t know that we get a clear picture anyway, but I think there are a lot of assumptions that that will calm down next year for some of these guys who aren’t seeing super high oil prices. If that war intensifies, does that speed up your $300 price target, or does it affect it at all?
Kuppy
I don’t think it affects it at all. I mean, Russian oil is still making its way to the market. But US technology for the Russian oil fields isn’t. And so Russia is going to be in slow motion decline in terms of production, and I don’t really see what would change in the Ukraine situation. I think it’s very likely that as soon as the ground freezes there, those half million conscripts will be set loose behind the Ukrainian army and kind of surround them all. The only reason that Ukraine is still in the war is really just because it’s been kind of warm there. I think it doesn’t look very good, but that’s like more of a personal view. But I don’t think it really matters who wins this war. In the end, Russian production is rolling over.
Tony
Right, okay. And is there a possibility of, let’s say, a load of investment going into Venezuela in the short term and that volume that supply, hitting markets to save markets? I’m just trying to kind of figure out, is there a near term supply side solution?
Kuppy
Not really. I mean, who wants to invest in Venezuela? You can get a bunch of pieces of paper with guarantees, but the history…
Tony
Chevron does, of course.
Tracy
No, but it’s absolutely true. I mean, it would take billions. And it’s still the problem is geology there? And what’s going on…
Tony
Explain that. When you say the problem is geology.
Tracy
It’s not only their infrastructure which is decrepid after, it’s also geology. Right. They have very sludgy oil. It’s very hard to get out of the ground. So even with investments, you’re facing an additional challenge of the geology there being very, very difficult. And so that’s just going to add. So anybody thinking that Venezuela oil is going to change this dynamic is off base, in my opinion.
Tony
Okay, and then Africa supplies other stuff. There’re Brazil. There isn’t really anything that can be accelerated on the supply side. I’m just trying to poke through this, guys, just to get a better view.
Kuppy
I think you’re going to see an increase in offshore oil production around the middle of this decade. Guiana, Suriname, West Africa, Brazil, it’s all coming online. But it doesn’t come online fast.
Tony
Right?
Kuppy
Well, you have a lot of places that are rolling over or really struggling just to stand in place. I think we should look at is what’s happening in Saudi, where they’re frantically procuring every jackup that could be had globally. They’re going off into the Gulf. I mean, if their oil production was stable or they thought they had more onshore, which is the cheap stuff, they’d just be drilling more onshore. The fact that they’re going into the Gulf, it’s an increase in complexity and cost means that their existing fields are now getting old. And it’s obvious they’re old. They’ve been going for 70 years, but they’re finally seeing that water cut really pick up and they’re starting to panic. No, I think you have a lot of problems everywhere. Plus you have some swing places. Iraq, Libya gets cut off again from exports. You have a bunch of places where you could lose a million barrels in a hurry.
Tony
Okay. No, it sounds pretty ominous, actually. So I’m trying to find ways to push back on that. But again, we have some really smart folks last week, including Tracy, who had a similar thesis, maybe not 300, but a similar thesis. And I think what you’re saying, Kuppy, makes a lot of sense.
Kuppy
I think the pushback is really that something could happen on the demand side where you have a global economic crisis. They lock us down for monkey pox or the next pox they invent. Something like that is what I’d be looking at in terms of the wild card where demand falls off. But all it really does is postpone things. I mean, look, it’s December. 2023 budgets are being set at all the majors, and they’re being set in the context of mid 70s WTI. Do you think board of directors are going to approve an increase in spending? Like, I think 2023, and as a result of ’24 production, at least onshore US, is kind of baking the cake based on @75 price today.
Brent
Hey, Tony, I typically would defer, and I will defer on all things oil to Kuppy and Tracy, but I would say that to be completely truthful, I actually shorted a little bit of oil this morning. And it’s just a tactical thing. It’s not a huge deal. If it goes against me, we’ll stop out and it’ll be fine. But what Kuppy just said, I think could happen. The interesting thing is I think it’s possible we do get this demand shock right, and we get some kind of a global slowdown in the first half, which could potentially push oil a little bit lower. But if that were to happen, I would then, well, I already do agree with Kuppy’s thesis kind of medium to longer term. I think he’s kind of nailed the overall structural issues and why it is. And I would just say that if we do get kind of a short term demand drop that pushes the price lower, that could actually help to cut supply even more because firms go bankrupt or they can’t invest or whatever it is, and then it constricts supply even more, and then you get a military action. And in my opinion, that’s how you get oil at $200 or $300. I tend to agree with the Kuppy’s overall position.
Kuppy
You’re just talking about the slingshop, right?
Brent
Yeah, that’s exactly right.
Tracy
Absolutely. And you have to realize that if we have the lower oil prices we have and gasoline prices we have, that increases demand in a supply side constricting environment. So that’s where you get your selling shot. So it really depends on, I think, how you’re trading this definitely depends on your time frame. If you’re longer term, that’s one thing. If you’re shorter term, I think oil is going to be volatile for the next few quarters.
Tony
So because we’re actually talking about $300 oil, I think it’s Citi who always does the extremes in crude. So now we’re going to have a Citi report that says $500 oil. Right. Thank you.
So, Kuppy, you also had a very interesting call on housing. And when I sent out the Tweet about this recording, I had some questions about your housing call, your bullish housing call. And I want to ask, are you still bullish housing? And can you go into that thesis a little bit either way? What’s your thinking on US housing now?
Kuppy
I’m bullish US housing. Structurally, you have a shortage of 5 million homes. This is population growth, especially people my age a little younger that are starting families and they need homes. And there’s been a lot of migration in the US. And so you need a lot of homes in Texas and Tennessee and Florida and not where these people are fleeing from. And so as a result, there’s just strong demand for homes. At the same time, if you take mortgages up to 7%, no one could afford a home.
And so we’re having a bit of a pause as the Federal Reserve kind of intercedes in the housing market. And it’s kind of like a Brent Slingshot in oil. All you’re going to do is make the problem worse if you’re not building enough homes for the demand. Because the demand keeps growing, the population keeps growing and so they’ve kind of postponed us a little. You’ve seen rent spike out of control, though. That’s kind of stabilizing a little just with the economy kind of slowering. But no, I think the housing market is going to do very well, but it’s going to need a pause on interest rates or an acceleration on inflation.
I mean, you could look at a lot of emerging markets where you can’t borrow for 30 years, you can’t maybe get five years and you’re going to pay 15% interest rate on that. But you know what? They’re having huge demand for housing because if inflation is 20 and you fund it at 15 and you get put a couple of terms of debt on that, well, you’re making 20 30% on your equity. That’s a good place to be as a 25 year old guy or 30 year old guy with a family trying to get a home.
Tony
Yeah. When people don’t understand why real estate is so attractive in Asia and why, say, Hong Kong homes or Chinese homes or whatever, why you always have this inflationary environment in real estate in Asia? What you talked about, Kuppy, is exactly why. I think it’s very hard for people in the US particularly to understand why real estate in Asia is so appealing. And it’s exactly for that reason.
Kuppy
Yeah, LatAm and Africa too, where interest rates are high, but you still have a positive real yield on owning your property because it’s appreciating.
I think the other thing I’d say in the US and I think people kind of lost the narrative here. Guys are complaining that when their parents, like my parents were buying homes, it used to cost two or three years of salary and now it’s eight years or ten years of salary. And they say homes are really expensive.
Yes, homes are really expensive. But the guys got buying a McMansion today. It’s like a 4000 square foot home in the suburbs. If you look at what the people were buying in the 70s and 80s, it was like 1200 square feet, it was a two bedroom with a little kitchen. Now the kitchen has $200,000 of appliances in it. Like right. The reason these things got really expensive and, and unaffordable.
I think you’ll see some reversion back to a lower price point home with, with less amenities because you got to put people into homes as they were to put them. And so, big picture, I’m super bullish you know, you, you can’t go indefinitely with, you know, having a family with three kids and they’re in a two bedroom that’s 1200 sqft.
They need space, but that’s going to take until rates come back and as soon as rates peak out and start dropping or when inflation accelerates again, I’m going to be all over housing.
Tony
Great. Okay, that’s good. Thanks for that clarification. I think that’s really interesting, but in the near term you’re not necessarily bullish on housing in the near term, while rates are rising?
Kuppy
I think housing is going to do just fine because the tailwind is so strong, but at the same time, I think there’s better stuff to own. I’d much rather be in things that are pro inflation. I really just want to stick with energy. Uranium. I think those are trends that do well really in either market environment, but just because of the supply demand imbalances of the next year or two, I think they just work idiosyncratically no matter what. And I don’t know, I just think it’s easier trades.
Tony
Great. Okay, we did have some questions actually about emerging markets, so I just want to ask you first Kuppy, but then the rest of you guys, what emerging markets are you looking at and why?
Kuppy
I’m not really looking at any, so I can’t say. I will say I have a lot of friends that specialize in emerging markets, and they could show me a bunch of metrics that say emerging markets haven’t been this cheap in a very long time on cash flow, book value dividend. And there’s some reasons why maybe they deserve to be cheap. But those things come and go in terms of the why. But you buy cheap assets, things usually happen to you that are beneficial over time. I see Brent laughing, so explain.
Brent
Okay, to be clear, I’m not laughing at Kuppy’s answer. I tend to agree with, if his friends are telling him these things, I’m sure that’s true because they tell me the same thing. I just kind of laugh because I feel like every year for the last seven years, the trade of the year at the beginning of the year is to short the dollar and go long EM. It’s always the trade, it’s always the big idea, and to me it just never plays out. And I don’t think it’s going to play out right now.
I personally am not looking at any EM other than to stay away from it or perhaps to go on vacation to it. I don’t want anything to do with it from an investment perspective. Probably, not surprisingly, I don’t think the move in the dollar is over. And I think if we get a slowdown in the first half, which I think we will, I think that will play out in the Euro dollar market, and the emerging markets just as much, if not stronger than it will in the US markets. I don’t see an environment where EM outperforms the United States right now
Tony
In dollar terms.
Brent
In dollar terms. Yeah. Maybe in local terms. In local terms, that could easily happen. I mean, take a look at Turkey, right?
Tony
Right.
Brent
Turkey stock market has gone up two or 300% in the last 18 months, but they’ve got 80% inflation in local terms.
Tony
Right. So you have to.
Brent
So you have to yeah, right.
Tony
So Brent, can you talk us through you mentioned the dollar and you know, everyone always wants to know what your thoughts on the dollar? Can you walk us through what you’re looking for, say, over the next three to six months with the dollar?
Brent
Yeah, so, I mean, over the next three to six weeks or a couple of months, I don’t know, maybe it just goes sideways. But I think by, if not the end of Q1, beginning of Q1, kind of April-May time frame, I think the dollar is much higher than it is right now because I think that, you know, I sent out a tweet earlier today where because I, was kind of laughing.
I was talking to somebody and they said, well, rate hikes are over, so the dollar is done. And I was like, well the, the dollar can go up for reason other than rate hikes. And he was like, what are you talking about? And here’s the thing. From 2008 to 2019, the dollar went up 20% and there weren’t any rate hikes. I mean, there was a few in 2018. And in 2014, in 2014 and 2015, the DXY went up 25%. There were zero rate hikes. It’s because there was a global slowdown, right.
And when dollars aren’t circulating and the world needs dollars, there’s a dollar shortage. Supply, demand, it pushes the dollar higher. And so I feel like the move of the dollar in 2020, I’m sorry, in 2022 was all about rate hikes. Interest rate differentials, right. And maybe that is potentially over.
But the dollar can move for reasons other than interest rate differentials. And I think people have forgotten that if we go into a recession or if we go into a global slowdown, all that debt that is issued in dollar still needs to be serviced. And so I think perhaps the run in the dollar due to rate hike differentials is over. But I don’t think the run due to dollar shortage, due to a global slowdown and the need to service dollar debt is over.
Now, if I’m wrong, I don’t think that the Fed will come out and totally flip until they’re forced to do it. And the only reason they would be forced to do it is if the dollar was higher and all these asset prices were lower. So is it possible by the end of 2023 the dollar is lower? Sure. But I think at some point in 2023 we’re going to get another run in the dollar. And I think it’s probably in the kind of the March to April-May time frame.
Tony
Well, I think what people also forget is that the Fed has eight plus trillion dollars on its balance sheet, and if they start to sell it off in any sort of volume, that takes dollars out of circulation, right?
So that’s a big assumption because they’re shrinking it on a small basis now. But if they accelerated that, that would take dollars out of circulation. That’s bullish dollar as well, right.
Brent
Well, the other thing I want to make this point because I think this is a critical point. And I was speaking to, I went to a conference in October, and I’m not going to pick on this conference because it’s happened at every conference I’ve gone to. And I had so many people come up and me and say, what’s going to happen with the Fed? How’s the Fed going to get out of this? How’s the Fed going to get out of this? They’re trapped. Nobody has ever come up and asked me how the ECB is going to get out of it.
Nobody’s ever come up and asked me how the bank of Japan is going to get out of it. Nobody’s ever asked me how the Bank of England is going to get out of it. And the thing is, they’re in worse shape than we are. I hear you, and I understand all the problems associated with the dollar. Listen, it’s a horrible currency. It’s just better than the other three jokers.
Tony
Gold or CNY, Brent. Gold and CNY solves everything.
Brent
Exactly. So my views on the dollar are not just based on what the Fed is going to do. A lot of it’s based on what these other central banks are going to do. And I just don’t think their leaders are any smarter than ours.
Tony
Perfect.
Brent
And I think they’re trapped even more than we are. So anyway, not to go off on a whole tangent, but that’s why I don’t want to have anything to do with emerging markets.
Tony
That is not a tangent. In fact, that’s a segue to our Japan normalization discussion. Right.
So thanks for that. So we saw Kuruda come out, talk about changing policy a little bit, and markets reacted with a stronger yen and yada yada. Right.
So is this, do you see this as a real change? I see this tweet that you sent out earlier this week saying if you think happened to think today’s move in the BOJ is going to work out for Japan, it’s not.
So can you talk us through? Is it just preparing for the next BOJ chair to reduce risk if they change policy? Is it a real policy change? Is it going to work out? What do you see there?
Brent
I don’t really think it’s a policy change. And if you actually look at a lot of people, just see the headline and just react, and they don’t even think about what the headline means. And I think the market has got into a habit, and people in general have got into a habit of reading into it what they want to read into it. So I think very much the world wants Japan to get out of this, and they want the dollar to go down. And so anything that shows that another central bank is going to outperform the dollar, they ultimately want that to be true, whether it is or not.
If you read what they actually are doing, they’re actually increasing the amount of QE that they’re doing. So if you just read that sentence, you’d say, holy cow, the end is going to go even lower. Because not only did it have a horrible year this year, but now they’re going to increase QE. But at the same time, what they said is that we’re going to let the bond, the yield curve control, the band with which in yield curve control moves, we’re going to widen that.
So we could have interest rates in Japan go up to 50 basis points rather than 25 basis points. And so the market kind of interpreted that as, okay, they’re actually moving towards rate hikes. Now, they didn’t say they’re moving towards rate hikes. They didn’t do a rate hike. But everybody wants to believe that they’re going to raise rates.
But here’s the thing. Earlier this year, and I think it was March or April, interest rates in Japan, because of inflationary pressures, are now actually even hitting Japan. Long term rates in Japan moved up 25 basis points. And because the two to five to ten years prior to that, they were doing QE and negative rates. The banking system is chock full. And when I say the banking system, the banks, the hedge funds, the endowments, the all the institutions in Japan have all these zero yielding bonds, Japanese bonds on their banks, and because, and they’re long term bonds.
And so when yields even go up 25 basis points, the convexity makes the balance sheet of all these institutions go upside down. And so when interest rates went up 25 basis points in April, it caused all kinds of chaos in the Japanese banking system, and the market had to be halted, and the Bank of Japan had to come in and promise to do more yield curve control in order to keep it from blowing up.
And two days ago, or three days ago, whenever that announcement was, they made that announcement, the market took it as an interest rate hike. And guess what happened? They had to halt the Japanese bond market again. So I understand if they do raise rates, that would strengthen the yen.
But the problem is you cannot, and this is for every country, the US included, again, there’s a progression in how it’ll go, but you cannot save both the bond market and the currency market because they work at cross purposes. Whatever you do to save the bond market hurts the currency. Whatever you do to save the currency hurts the bond market. And every central bank in history has promised they won’t sacrifice the currency, and every central bank in history has ultimately sacrificed the currency.
And the reason they always choose the currency over the bond or the reason they always choose to sacrifice the currency over the bond market is two reasons. One, the currency affects the citizens more than the government, and the bond market affects the government more than citizens. So they’re going to bail themselves out before they bail the citizens out. And the second thing is, if the bond market blows up and the banking system blows up, there is no longer a distribution system for the government to raise money.
So they can’t let the bond market blow up because then they can’t get money anymore. And then if they can’t get money, they can’t operate. So this is a very long way of saying that I understand why the market moved the way it did. I think maybe in the short term it makes sense, but in the medium to long term, it doesn’t make any sense to me at all. Again, kind of watch what they do, not what they say. I think the yen is going much, much lower.
Tony
Okay, interesting. How long do you think it will take before markets call their bluff, is that?
Brent
Maybe a couple of months?
Tony
Really?
Brent
Again, I think we’re going to have a lot of problems by the end of Q1 all over the world, not just in Japan, not just in the US, not just in Europe, but everywhere. I think we’ve been slowly moving towards this crisis, and I think we’re almost there.
Kuppy
Brent, I think a lot of the move in the yen over the past couple of weeks is really just guys degrosing. That was the funding currency for all the risk assets, and risk assets went no bid, basically all year, and guys are finally getting redeemed from their hedge funds, and it’s year end redemptions. You got to pay it out. It’s got to unwind your yen to unwind your Tesla, which is also in free fall.
Brent
That plays into it as well. Yeah, I see your Tesla queue there. That’s a good timing.
Kuppy
I’ve had this, what, five years? Six years. It’s probably coming due today.
Tony
When is the Twitter Q month coming?
Kuppy
I don’t know.
Brent
Oh, they should have one of those, shouldn’t that’s a good idea. We should start selling those.
Kuppy
I’m a little conflicted here because I feel like Elon might be doing the right thing on the Twitter side, whereas Tesla is still like the evil empire. So I don’t know.
Tony
Okay, we’ll have another discussion about that at some point. Brent, you talk about things coming in Q1. Can you share a little bit of your thoughts there around markets, potential recession that might…
Brent
Well, yeah. I mean, in general, it’s kind of amazing. Now, let’s reverse ten days ago to the Fed meeting. At that time, the Fed had raised four and a half, almost 4% for the year, and markets were down, but they weren’t down that much. Now, since then, they’ve sold off another 5% or 10%. So now they’re getting close to the lows of September again.
But this is what I think. I think a lot of people are surprised that the market hasn’t crashed more than it has based on the four and a half percent or, or 4% rate hikes. And I think what sometimes people forget is that we may not even be feeling the effects of the very first rate hike yet, because oftentimes rate hikes take nine months to a year to actually.. The effects of the rate hike to show up in the economy and work their way through the economy.
Tony
Powell talked about that a lot in his last…
Brent
Well, no, exactly. And the first rate hike was nine months ago. It was in March. So it really wasn’t that long ago. Right. And now they’ve raised four times since then. So I just feel like by the time we get into February, March, that stuff is going to have started to show up, perhaps dramatically. And I think the Fed is going to continue raising until they just can’t raise anymore.
Now, whether they should or not, whether you believe Powell or not, again, that’s kind of a separate subject. I just think he’s going to do it because he wants to do it, and the last thing he wants is for inflation to reaccelerate on his watch. Right. And if he crashes the market, then everybody will be begging him to do QE and he can go do QE and be the hero. So I just kind of see that that’s how it’s playing. And I think that probably a lot of people agree with me on that. I don’t think that’s any kind of a crazy view right now. I think a lot of people think he’s going to hike until it crashes the economy, but I don’t see him slowing down until he has to.
Kuppy
Brent, I got a question. Lagarde has been super dovish for a very long time. Depending which country in the Eurozone you’re at teens, maybe even high teens inflation all of a sudden, last week, she just came out swinging.
Brent
She did.
Kuppy
And what do you think changed? Did someone just whisper in her ear? Did she look at a debt bad data point? Did a politician be like, hey, the peasants are upset about the price of bree? Like, what happened?
Brent
I think it’s a little bit of that latter. I’ve talked about this before. I think we all know that financial repression is the name of the game for governments. That’s how they get out of these big debt, these big debts that they, you know, they want to inflate it away over time. The problem, though, is what they would ultimately like to do is to get very steady rate of inflation at four or 5% a year for ten years right. And inflate away 50% of the debt. The problem, as we’ve kind of figured out and found out that it’s very hard to just get four for four or 5% inflation. It goes from 2% to 12% pretty quickly. They don’t have as much control as they think they do, right?
And the problem with four or 5% inflation, you can kind of get away with it because it’s annoying and it is frustrating, but it’s not totally ruining your life. But with 8, 9, 10, 12, 15, 80% inflation, that starts to ruin the pledge life, as you mentioned. And that’s when they start to push back from a political perspective. And that’s what central banks and governments don’t want. They don’t want the populace revolting. But when you’re cold and you’re hungry, that’s when you revolt. Nobody revolts when they’re full and warm and have a great job and going on vacation. Why would you revolt in that environment? But when things are going against you and they start pushing back politically. And so I think that the pressures in Europe are a little bit just too much for them to not at least acknowledge it publicly. Now, whether they actually do anything and follow through on it, that will be interesting to see because, again, ultimately, I think they will save the currency rather than save the bond market, or I’m sorry, they will save the bond markets rather than save the currency. But I do think it’s a little bit of why Lagarde came out as strong as she did.
Kuppy
Do you think she follows through or?
Brent
No, she’ll try again. And it’s like Powell. Powell will keep trying it. Well, eventually the markets will push back on them and won’t let them, but I think she might try. But I think Europe is just screwed for lack of a better word.
Tony
So let me ask you guys and Europe, are we in a position where we have to approach what Japan is doing, where eventually the central bank will come in and buy up equities and they’ll buy their debt? And this is a cycle that just can’t stop? Is that what’s going to happen in the US and Europe as these central bankers are put in a quarter? And are we getting closer and closer to kind of D Day?
Brent
I think we probably are. Now, and I think there’s many people who believe that there’s nothing that central banks can do to squash inflation. I actually think that’s wrong. I think they could cause a depression which would have put a damper on inflation. Now, I don’t think that they can engineer a soft landing, but I think that’s what could happen at the end of kind of Q again, Q1, Q2. I think we could get some deflationary pressures coming through the markets due to the rate hikes that central banks have been trying and we’ll force them to U turn.
The biggest question I have, to be really honest, I’m not sure how this plays off, is whether or not we can get one more cycle of QE of risk on before they have to kind of reset the whole system. I could see a thing where we just have a couple maybe things just go down from here and a year from now they have to reset everything. But I could also see a scenario where we again have a bad first half of 2023. They reverse everything, we get another QE cycle that takes us into 2023 through the election five.
Yeah, exactly. And I don’t really know how that one plays out. I could see it kind of going either way. But ultimately to your point, Tony, I think the central banks will have to reverse.
It was funny. For several years, we were in a currency war where everybody was cutting rates to weaken their currency. Now, in the last couple of call a year, they’ve been raising rates to kind of strengthen their currency to try to fight against the inflationary pressure. So now the currency wars, who can outhawk the other one? It’s all going to end in tears.
Tony
Sadly. I think you’re right. Speaking of tears, Tracy.
Brent
No. Are you going to cry?
Tony
As we talk about difficulties
Tracy
every day?
Tony
…Recession and consumption and Kuppy started talking about oil at the start and oil demand. You posted a chart about looking at oil demand elasticity and household savings as central banks take different actions. Of course, that changes as stimulus have stopped. If it doesn’t come back on, there are changes to household savings, these sorts of things. So you posted a really interesting chart about household savings and can you talk us through a little bit of that and a little bit around oil demand elasticity?
Tracy
Yeah. What I think, I think there is a misconception that when there is a recession, that oil demand suddenly falls off a cliff. Right. Everybody has a very short memory and they look at COVID when we literally shut down the planet, but that’s not the reality. So if you look at past recessions in general, 2008, the most recent one, great financial crisis.
Now, we did see a dip in demand, but it was only about 2%, and it was only about 2% for two quarters. And then by the third quarter, demand increased over what it was before the great financial crisis. And so when I talk about the fact that everybody talks about savings, rates are going down, credit card rates are going up, nobody’s going to be able to afford oil, everything’s going to shut down, there’s a lot of fears running around. We’re going to have this global recession and nobody’s going to use oil anymore. And that’s kind of been the prevailing narrative. And we’ve seen this in open interest.
We’ve seen many funds sort of lose interest over oil. That’s been a great year for them. They shed their positions. But this prevailing narrative that we keep hearing in the media, “oh, it’s a global recession. Nobody’s going to use oil again.”
It’s just not a fact. We look at the data, we look at every recession. Recessionary pressures really have not taken much demand off the market. And every time that demand has been taken off the market within a very relatively short period of time, we’ve seen demand increase over that prior level. And so to use this kind of as a narrative, I think is not correct if you actually look at the data.
Tony
Okay, so we had this weird kind of almost recalibration of expectations with COVID where really everything came to a stop, right? So demand just cratered compared to, say, 2008, 2009 crisis. And so kind of the base effect of demand coming back has been really impressive, kind of year on year growth each time, right? And then we’ll continue to see that as China comes back.
But there are some real concerns for example. China’s population peaks out, peaked out in 2022 or ’23 or something like that, right? So their population is peaked out, and it’s all downside from here, right? Unless there’s real growth in their consumption. Europe’s pretty peaked out. Japan’s peaked out. The US hasn’t peaked out.
But we have some of those long term trends, and we have a recession. I’m just trying to play a little bit of devil’s advocate here. How much of an impact do you think those have on consumption, on the consumption dynamics, particularly with regard to savings and how, if people don’t have rising incomes and their saving rates decline just to make ends meet, which wasn’t necessarily the case in say, 2010 eleven. Can all of those things come together to really impact kind of the overall consumption trend or is that just not really a concern?
Tracy
I think there’s two separate things. If we’re talking about declining population rates, that’s sort of a long term view. We’re looking 20-50 years out, does that trend continue? And of course, at that point, you’re talking about global energy consumption decelerating, obviously.
Tony
And we’ll have nuclear powered flying cars right by then. So.
Tracy
Absolutely. But if we talk about, you know, shorter term things or near term things, things that we’re looking at, you know, over the next, say, you know, year to five years to ten years, I mean, there are still, regardless of a recession, we still are seeing year to year global consumption increasing. And in fact, we just had IEA, which I know is a WEF show, but we just had them completely revised their whole global oil growth demand system going back to 2014. They redid their entire numbers and added millions of barrels. And the media really likes to use that IEA data. They just repackage it and whatever. And they’ve been completely wrong at that point.
This goes back to when we had missing barrels and everybody was talking about that back in 2014. But the fact is that by any measure, global consumption is rising, right? Because you still have emerging markets that are trying to get out of the darkness. You look at countries like India, which they’ve had the strongest global demand increases so far this year. So there is always demand coming from somewhere, and the problem always goes back to supply.
In fact, we just don’t have the supply catching up with the demand. So even if we look at the Western world and even perhaps China years out, I mean, you still have to understand they’re still increasing demand, even though they’re absolutely even if their population is elderly and declining, their consumption energy wise is still on the uptrend.
So we still have these huge markets that are still on an uptrend. We’re going to see this in emerging markets. We’re going to see this in India, we’re going to see this in South America. We’re going to see this in Africa in particular, because BRI, suddenly they got a lot of money from China. They can build out this infrastructure, and they need, there is more demand there. So even though the west may be looking towards this green energy transition, we have to realize that that green energy transition also has not been working out. We just saw the biggest increase in coal demand in the EU in ten years this year.
Tony
Yes.
Tracy
Incredible that energy policy is not.
Tony
Reporters on sarcasm. Green energy transition. It’s on sarcasm.
Tracy
Really what we have to boil this all down to, long and short of I know I always talk in, like, broad picture, but really it all boils down to the data. What is the supply coming online? What is the demand going forward? And so far, demand outstrips supply. There is no way around that right now.
Tony
Okay. And it’s fairly inelastic it sounds like.
Tracy
It is fairly inelastic, even if you have, you know, again, look at the data. Anytime we’ve had a recession, demand is bounced back very quickly, and we’ve only seen a 1 to 2% pullback in demand. It’s not like COVID where everything crashed.
Tony
Okay, so we started and ended with crude. And I usually finish up guys with kind of, what do you see for the week ahead? But I’m going to change it up a little bit. As we go into 2023, with regard to markets, what keeps you up at night? What is that thing that you think about and you’re like, well, Account Odd sees this, and it’s obvious to me. What is that thing that keeps you up at night, Kuppy? I know you’ve got some amazing things in there. So what is that thing? And I know none of us see what you see.
Brent
You can’t say bourbon. That’s not a legitimate answer.
Kuppy
I think next year is the year that oil matters. We’ve lived in this world where oil has been sort of range bound, really for eight years. And people just got used to energy being cheap. I mean, we had a little bit of an energy scare in Europe, and I say “little” because that should have been the wake up call. And instead, I think you’re about to see the big one and you’re going to see energy as a percentage of GDP go to some crazy level like in the 1970s. And I think as a result, most of the Q sips on my screen are going to get smashed and everyone’s worried about JPowell. But in the end, JPowell is not the world central banker, oil is. And JPowell is going to chase oil higher on the screen for a while. He effectively has been chasing oil higher on the screen. And when oil rolled over from the summer onwards, that’s what cooled off the inflation. It’s not Fed funds rate that kind of helps. It’s really just oil. And as oil reaccelerates, JPowell is going to chase it higher on the screen and it’s going to get to a price where he’s going to have a dilemma.
He could either keep chasing oil higher or he could bail out the real economy with the rest of the economy. And I think he’s going to bail out the rest of the economy by cutting rates and sending oil parabolic. I think that’s how you get to my 300 number. And I don’t think people realize that oil at 90. Who cares? Oil got to 120 for a couple of weeks this summer. Who cares? What if oil is consistently in the high 100 and it just stays there? I think it just dramatically changes the arithmetic for every other QSIP on the screen. Absolutely. Aren’t plugging that in.
Tony
Okay, good. Thank you. Tracy, what keeps you up at night?
Tracy
I actually think that looking at 2024, I think that the metals markets are going to make a huge comeback. I’m not talking precious metals, I’m talking basin industrial metals only because I think that oil plays a part in that. If we have higher oil prices, we’re going to have higher metals prices. And because the west, in particular the EU, does not seem to want to be giving up on this green energy policy. We’re going to need a lot of metals, we’re going to need a lot of copper, we’re going to cobalt, nickel, whatever, if they want to continue down this path.
Tony
Sorry, you’re saying you need more industrial metals for batteries and other infrastructure for the green transition?
Tracy
More than we’re currently. In fact, we don’t even have the known reserves to get to the 2030 goals right now. If we were talking about copper. And certainly the mining industry has suffered the same problem as the oil industry has a lack of capex for the last seven years. And so we simply just don’t have that. So what I’m looking at, I think that oil is a big story and will continue to be a big story in 2021, 2022, but I think metals are going to start to come into play in 2023 and ’24. And what I’m worried about is we literally, again, no capex, and we don’t even have proven reserves anywhere. So that’s what I worry about. The metals based in industrial metals.
Tony
Okay, so so far it’s commodities keeping you guys up at night. Brent, wrap us up. What keeps you up?
Brent
It’s kind of interesting. I think that the underappreciated risk, even though the dollar made a hell of a run this year, is that we could have a funding market problem in the euro dollar market. And to be honest, it doesn’t keep me up at night because I’m kind of ready for it. I’m expecting it.
You know what keeps me up at night is these guys in Washington and Frankfurt and DC, and Tokyo and Beijing figuring out how to extend this game because they’re masters at keeping the plate spinning. And I’m always trying to figure out what are they going to do next to keep this whole house of cards going. And to me, that’s the wild card. I feel like I can kind of figure out markets. If markets are just left alone, I can kind of figure them out. The wild card is when the masters of the universe are the powers that be, however you want to describe them, come in and start messing with things, because that can change things, at least for a day or a week or a month, and sometimes that’s enough to wipe you out.
Tony
Yeah. Okay, guys, thank you so much. This has been really enlightening. I really appreciate the thought we put into this. Want to wish you all the best for the holidays and a fantastic 2023. Thank you so much.
Gasoline prices have continued to decline in the US. Big Fed meeting. 50bps. JPow insists the terminal rate is 5.5. Markets seem to want a rosier picture. How do you trade this? Bob Iaccion shares his expertise.
We’ve seen some weakness in crude prices, of course, and consumers are seeing a bit of a break with energy prices. Jay Powell doesn’t see inflation abating soon – he seems to believe it’ll be persistent. Part of that must be with energy. Our Complete Intelligence US headline CPI forecast looks at a reacceleration in early Q2. Is that around the time Josh expects energy prices to re-accelerate or does he have a different expectation – and why?
Tracy posted a really interesting chart recently. We’ve been talking about the SPR releases for a long time, but this chart is super stark. She walks us through what this means.
Hi, and welcome to The Week Ahead. I’m Tony Nash. Today we’re joined by, by Bob Iaccino. Bob is with Path Trading Partners. We’re also joined by Josh Young. Josh is with Bison Interests, and Tracy Shuchart, who is with High Tower Resource Advisors. Guys, thanks for joining us today.
And Bob, I know this is your first time to join us and I really appreciate you taking your time. I’m always really shocked by the the quality of people who will talk to us, which is just amazing. So it’s, it’s great to have you here. And Josh, this is your second time and you have just hit a lot of home run since your fund started. I think you’re up 140% or something while the industry index is down like 20% or something. Is that right?
Josh
I can’t talk about my performance.
Tony
Okay. So I think you’re doing pretty well. So I’m just really grateful to have you guys here. We’ve got a few key themes here.
Of course, there’s been a lot of macro data out and some of that stuff has been classified by a few people as kind of widowmaker trades. So let’s get a little bit into that with Bob.
We’re going to look at energy and inflation and Josh is going to lead on that. And then we’ll look at WTI and the SPR with Tracy. So Bob, let’s start. You had sent this tweet out from Emma a few days ago where she says that markets kind of are believing what they want to believe and it’s really a trap and some of them are kind of widowmaker trades.
So can you talk us through that? Of course. We just had the big Fed meeting with a 50 bps rise and JPowell now insists that the terminal rate is 5.5 or somewhere around there. We saw PMIs come out today that were a lot lower than expected. We saw a downward revision in unemployment by over a million jobs sorry, of employment by over a million jobs. So why do markets continue to want to see a rosier picture or where are we right now and where is it going?
Bob
Well, it’s interesting, Tony, and again, thanks for having me. When you’re looking at equity markets specifically okay, let’s just talk when we talk about markets in a general sense, we’re usually talking about equities, which is one of the things I think the mainstream gets wrong.
But when we’re talking about equities, you’re talking about just a natural upward bias. There’s many millions and billions of dollars that go into 401ks and long only mutual funds every single month that people don’t even look at. So when all else is equal, you have a slight upward bias in equities.
And therefore it kind of stands to reason that people in general, investors, retail investors, want things to go up. And I suspect when somebody starts trading I remember I gave a speech pre COVID and somebody came up to me and said, I don’t understand how you trade the ES, which is S&P futures. I said, what do you mean? They said, well, stocks always go up, right? So sometimes you can be short ES. And I’m like, oh, my Lord, let me show you a chart. Stocks don’t always go up. If you take a look at an equity chart going back to 1920 or however long you want to be, yes, it is angled this way.
But when you see what’s going on right now, there’s a lot of old adages in the markets that I honestly can’t stand. But one of them gets repeated a lot is, you can’t fight the Fed. And most people are trying to fight the Fed. And Jerome Powell keeps coming out there and says, why are you guys fighting me? So the more and more stern Jerome Powell gets about interest rates, the more and more the markets get comfortable with what the Fed is doing and saying, sort of, and I’m paraphrasing what I think the market would be saying as a whole, “okay, we know what you’re doing now, so we’re comfortable with it, and we’re just going to buy stocks.”
And that seems to me to be troubling. It’s interesting because I’m bearish medium to long term, but I own the S&P Futures right now. I actually bought them on the first day of the fourth quarter with a mindset toward this type of activity. I said, okay, the fourth quarter is going to be higher than the third quarter, so I can go ahead and buy a small ES position within the context of my thesis that toward the end of the first quarter, beginning of the second quarter, I think equities dump again. I don’t think that the lows that we saw in October are the ultimate lows for this particular bear market.
Tony
So you’re saying that selling out of Trump’s NFT doesn’t mean we’ve hit the bottom yet or whatever.
Bob
I took screenshots galore of that Trump Superman thing with the laser. I’m like, if he could have a body like that, so can I, right? By eating McDonald’s and drinking Coke. I thought that was amazing.
No, I mean, again, these kinds of things a lot of people would think is peak bullishness just in any market overall. It certainly is probably peak bullishness, at least in the short to medium term and NFTs that that happened.
Tony
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Why do you think we’ll continue to see ES rise through, say, first quarter? Like, what are you seeing? Is it sentiment or is it some of the data coming out?
Bob
It’s the data being done and it’s the big events being finished. So, again, as I mentioned the beginning of this conversation, Tony, all else equal equities have an upward bias. And I said to myself, okay, we’ve got one more Fed meeting, one PCE, one CPI, a couple of small to medium sized business PMIs in the form of the S&P PMIs, and then not a whole lot.
So given that backdrop, people say, okay, we’re still near enough to the lows, or this is probably the lows. Even some of the people that I respect a lot think that the October lows are the lows, and I just happen to disagree with them going into next year. But they’re probably, they’re likely this is not a bold statement, the lows for 2022. It’s not a very scary thing to say considering we’ve only got, what, ten trading days left, 20 trading days left at the most.
So from that perspective, I feel very comfortable with the buy at the end of the third quarter and sell somewhere near the beginning of the first quarter position that I put on and I have a break even stop. I mean, I’m not going to lose money on this trade, which means I’m not going to pay a whole lot of attention to it anymore.
Tony
Right? Okay, very good. So, Josh, let’s talk about the data for a minute. Josh highlighted a chart that was sent out today looking at the difference, say, the divergence between hard and soft economic data. And hard economic data is still relatively positive, significantly more positive than the soft data.
So can you help us understand what’s the difference between hard and soft data and then what’s your view of the divergence between hard and soft data?
Josh
Yeah, so I focus more on sort of the energy side than the general broader market data side. But it is interesting. So the hard data and my understanding of this is the measures of actual activity and the soft data is more measures of sentiment or sort of modeled or forecast activity. And then I guess where I sit on it is I’m looking at actual oil and gas consumption data, and it looks a little weak. And so when I look at it looking a little weak, and that doesn’t mean I’m bearish I like the supply situation a lot. It’s very bullish, and that probably overwhelms. But from my perspective, tracking oil and gas consumption, it looks like maybe some of this ostensible hard data isn’t as hard as it’s represented. So that’s my take on that.
Tony
Let’s talk about that a little bit. Bob, you seem to be a little bit skeptical of some of the hard data.
Bob
Yes.
Tony
What do you think is a little bit overstated right now?
Bob
Well, I’ll give you an example. This past non farm payrolls report. Negative 40,000 on retail jobs. When have we seen that going into a holiday season? It’s likely that a lot of it has to do with seasonal adjustments in my view, because how do you correctly adjust for seasonality that changes every season, along with technology changing every single season at a rapid pace what seasonality may or may not look like?
So I’m not a conspiracy theorist by any stretch of the imagination, but hard data produced by the government is where there is possible manipulation. I’m not accusing anyone of manipulating anything. I’m just saying that’s where it’s possible. In sentiment data, that is the survey respondent sentiment. That’s what it is. And that generally shows up in hard data.
Josh mentioned in his tweet about this divergence between hard and soft. Right now we have a divergence between iron ore and crude oil prices, right. Which has a very positive correlation over time. We can look at the data. Josh can look at the data, and so can Tracy better than I can, and say, okay, I believe these will converge, and I think this one will leave because it’s data.
Sentiment, you can’t say, that’s not the respondent sentiment, whereas data coming out of the government, if you believed the government’s data isn’t manipulated, then the data is what it is. But when you look at something so strange as retail employment falling going into the holiday season, that’s either economically catastrophic. Is that a word? Economic catastrophe?
Tony
Sure. Catastrophe.
Bob
Economic catastrophe. Or it’s wrong. One of the two. Catastrophic. That’s what it’s right.
Tracy
And we have all these huge revisions and the employment data every month, right. Going back, they’ll revise two, three months back.
Tony
They’ll revise two years back, Tracy. There are generally four revisions on OECD country data, and so they’ll go two years in and revise stuff. And whenever I see an initial kind of print of economic data, I always say, and you see this regularly on Twitter is I say, I’ll wait for the revision. And it’s not the first revision. It’s typically the second or third revision.
My view is that the first two say the initial print and the first revision are really PR for every macroeconomic print. Not just in the US. Globally. And then we start to kind of see back adjustments of what really happened. So I just don’t understand why initial prints of economic data move markets. I don’t understand why the financial media make a big deal about these initial prints of data because they’re wishful thinking. In the same way, Bob was talking about how investors have a rosy view of stocks always going up. Macro data typically has the bias of those government statisticians either too negative or too positive.
Okay, good. So is the view, guys, that the soft data will pull the hard data down? Is that kind of where we’re kind of falling on this?
Bob
It’s definitely my view. I mean, again, if that’s your sentiment, something has to happen to flip that sentiment. I always like watching the politicians. I don’t make political statements on shows like this. I make political statements, unfortunately, at the dinner table. But when you’re talking about political statements, you’ll see jobs are strong and you’re making enough money to pay for the inflation. That doesn’t change the reality on the ground for people. You’re not going to actually have somebody say, well, the President said, I have the money to pay for this, so everything is fine. So I always believe that the sentiment is much more reliable than the data, even though it shouldn’t be that way. It really should be the opposite.
Josh runs a fund and he can’t talk about his performance even though the performance is real data. That’s what his performance is. I was at a fund of funds years ago as part of the investment committee. We had nine full disclosure, was a low volatility fund. So our biggest up year was about 90 basis points. But we never had a down year. I’m sorry, 3.9 basis points, 390 basis points. But we never had a down year in nine years.
And our auditors and our regulators said we couldn’t publish that performance. And when we said why, they said, because it implies that you can’t have a down year. Well, yeah, if you’re stupid, it implies that.
But, you know, this was our actual performance, but we can’t put it forward. Josh has great performance and can’t talk about it. And this is the same kind of thing where to me, the sentiment will pull the actual data down and then you question whether that’s going to be manipulated for political gains or not by either side.
Tony
Right, exactly. Not one party or the other. It’s both parties.
Bob
Absolutely.
Tony
We don’t figure that anybody individually.
Tracy
I mean, I think the employment data has been wrong all year, for two years now. You just look at labor force participation rate and how many people are multiple jobholders, not single job holders. And we just had that huge revision of 1.1 jobs.
Tony
Yeah. So we saw jolts turn over a couple of weeks ago and then we have this downward revision of jobs. So if we look at the Fed’s mandate, they’re kind of not really doing either, right? Either they’re not doing either or they’ve already achieved the job stuff which they said six months ago that they hadn’t achieved and they continue to persist that they haven’t achieved. So is it fair to say that with the downward revision and employment data and the downward trend in jolts data that they’re kind of getting there already? So this is kind of a bad news is good news thing potentially?
Tracy
Potentially if the market chooses to read it like that. I don’t think the algos know how to read it that way. But yeah, I mean, it’s possible. We already are at 4.5% with all these revisions on unemployment.
Tony
Right? Okay, very good. So we’re going to get off the macro data for a minute. We’re going to move to energy prices. Actually, we’re going to stay on some macro data for a little bit. I put on the screen our Complete Intelligence CPI forecast and what we’re looking at potentially is a gradual rise of CPI accelerates a bit in April and goes into the summer.
So it’s possible, according to our forecast, that we do see a second bump in CPI. I have to say there is no human intervention in this. This is all machine driven. And so we’re reading things in the markets or the machines are reading things in the markets that are saying we could see a second bite of inflation coming in, say end of Q1 or early Q2.
So Josh, the question for you is we’ve seen some weakness in crude prices and consumers are seeing a bit of break with energy prices, gasoline prices and so on. But we saw from the Fed meeting that JPowell doesn’t see inflation abating anytime soon. So it seems like it’ll be fairly persistent. How do you expect energy prices to fit within that?
Are you seeing energy prices accelerate quickly or do you expect energy prices generally? Of course, I know there are different segments, but generally do you expect them to kind of accelerate quickly or do you see kind of a delayed acceleration of energy prices?
Josh
This is a great opportunity to run real briefly a potential economic analog to where we are in some respects. And the potential economic analog is the Asian financial crisis, the ’97 and ’98 scenario. And where that might be real similar to what we’re seeing now is one, we’re actually seeing consumer deposits start to fall with loans increasing. We’re seeing mortgage rates start to fall even though the Fed reset or keeps raising rates. And so we’re seeing the housing markets start to clear and then we have this very low labor force participation, sort of similar to what you saw in prior periods.
And you see this, they say, what is it that good times lead to weak men, and then weak men lead to bad times, and bad times lead to strong men. And sorry for the gender aspect of that, but just sort of the general idea. When I see all this, I think that there’s a real chance that we see much higher consumption of real goods and real inputs. And then when I tie that so that’s relevant for the inflation question as well as for oil and gas in particular, because there is this huge non participating aspect of the labor force that is increasingly likely to participate as NFTs and crypto and various day trading, tech stock and other sorts of speculative activity comes down.
And then there is this other aspect, which is that with oil and gas starting to come into China more, and other commodities potentially coming into China as they reopen and restimulate, there is the potential for inflation on raw materials and deflation on consumer goods and other stuff that China exports. And so it’s a sort of very weird, messy time. I’m not sure, I think that tech equities rebound like they did after that ’97, ’98 time frame. But other than that, it looks like sort of the most similar to maybe that plus 2003, something along those lines.
And I’m interested in your guys take on that, because it seems like we have room, actually, for significant uptake in demand, not just in China, for oil and gas, even in the US potentially, as employment potentially improves, just because you have all these people, you have all these open jobs still, especially in the low end, and you have a lot more people who maybe are relevant for those jobs and more interest in them now.
Tony
Yeah. So when you talk about uptake so if we look at China, for example, there were zero international flights going into China from, say, 2020 until, what, this month, right? Something like that. International tourist flights. And those are restarting. And so that’s just one kind of proxy indicator of, say, trade, the economy, travel, other things. Right. So do you have a view on that, on, say, passenger flights into China, tourism in China and how that would impact, say, crude?
Josh
So I have a better view on China to China flights than China to international. It actually does look like there’s a lot more bookings for international to China and vice versa flights, but there’s not a lot more actual flights yet. But there are way more China to China flights. We’re actually up from a low of two weeks ago or two and a half weeks ago.
We’re up about 100%, actually, maybe even more than 100%. And again, the data is not perfect, but I’ve been posting daily seven day average lag data just to to sort of show a moving average, and the moving average is up over 100% for that. So just those China to China flights, it looks like, represent about 200,000 barrels a day of jet fuel consumption and jet fuel is very oil intensive.
You use more than a barrel of oil to get a barrel of jet fuel because of the energy component and because of various other aspects of that refining process. And so also, jet fuel consumption historically has been a good proxy for oil and gas consumption in an economy. If you’re using more jet fuel, you’re using more gasoline, you’re using more diesel, you’re using more coal and natural gas and various other things.
It’s a great sort of real time economic proxy. And there’s lots of this is one of the places where I disagree on the sentiment surveys. I’m an economist by training and education. And the problem with surveys is that there’s no money in them, right? So people just tell you whatever they think, whereas consumption is actual money. It’s a buying decision. It’s not a speaking or a writing decision.
And the consumption matters more. So these real time actual consumption indicators are very promising, it looks like, from China, even as there’s headlines of Beijing is totally shut. So the headline is that and then the consumption data is that the consumption is way higher. I’m going to go with the consumption data, and that looks very promising. Again, that’s only part of this theory, and I’m interested in your guys take on it to the extent that you’re.
Tracy
Open to talking about bob was talking about iron ore earlier, and they came out overnight, actually, and said they have a state buying purchasing iron ore is how they purchase it now. They started about a year ago, and so they said they’re going to start buying iron ore again. So really, to me, that does say they are really getting ready to sort of push this stimulus, and they really want that 5% GDP for next year because of how much it has come down and how much has been lagging over the last two quarters, including this quarter.
So to me, hint, not that just them saying no more COVID passenger. I’m looking for real things that they’re actually doing. So look for them to start buying hard assets and buying sort of in the material sector and that’s kind of to me, that, okay, we’re ready to stimulate this economy.
Tony
Okay, that’s fantastic for everyone, right? I don’t think anybody in the world wants China to fail because it hurts everyone. There’s such a big economy, and especially their Asian neighbors, but also their big trading partners like the EU and the US. So I hear a lot of kind of sour China sentiment and people kind of cheering China failing. And I don’t think anybody in reality wants that to happen because it would hurt all of us.
So since we have three energy experts on, I guess let me ask you about China’s position with their crude reserves. Are they pretty tight? Do they have a lot in storage? Do they have stuff contracted? Like, if they grow, how will that impact the spot price.
Tracy
Well, they will have to buy more because when oil prices were at their peak just a few months ago, even though they were closed, and even into 2021, when oil prices really started to spike higher, they used a lot of their SPR, especially starting in summer of 2021. So they started using a lot of their SPR because they like cheap commodities and oil prices were Spiking. And so I do know that, you know, from what we can tell, you have to remember, we only know what’s above ground that we can see by satellite. We have no idea what’s underground for for what they have in storage.
I just want to preface that, because a lot of people say you don’t know what time. So we do know some storage. So what we can see is that they have drawn down their SVR quite significantly. If they start opening up and they need to purchase more, especially with kind of these oil prices lower and then being able to strike deals with Russia right now, I do think we’ll start to see them purchasing a lot more, not just for consumption now, but to refill their SBR.
Bob
Again, I’ll defer to Josh and Tracy more about China. I’m actually much more knowledgeable about Japan than I am about China, but from a perspective of what they’re likely to do there’s, the interesting sort of component of Chinese culture can be quite monolithic. And if you have sort of spikes in COVID cases and it brings about this sort of I mean, they obviously protested Lockdowns, but there were reports overnight about Beijing looking like a ghost town today because cases were spiking again.
And you could see this potential sort of spike in demand and then drop off in demand. And that would likely be the last drop off where I suspect that the demand that we saw here in the US. China’s demand, would increase three and four fold of the spike that we saw here in the US. Which is why I kind of agree with Josh’s overall bullish sentiment, even though we haven’t quite reached my downside WTI targets that Tracy and I talked about a couple of weeks ago. From that perspective, though, there is an interesting possibility of this downturn. But to Tracy’s point, I don’t think the Chinese government stalls their purchases because of their SPR usage.
It’s called an SPR globally, but they certainly use it quite a bit more than we do here in the US. To manage their it’s almost like a hedge account for them, where they sort of buy and sell much more rapidly in store. And they do the same thing with copper. And it’s interesting because when the copper market started really getting into the headlines and Spiking three years ago, there was all this talk about copper inventory and copper being used as a currency in China. You can store copper for quite a bit longer than you can store fresh crude oil. It’s got to be rotated.
Tony
So that’s a great point. That’s great. Okay, so speaking of SPR, Tracy, you punched out a chart this week on WTI versus SPR, WTI price versus SPR, and it looks like that divergence is pretty stark.
So you guys just mentioned China drawing down their SPR. The US. Has drawn down its SPR. So can you talk us through what this chart means and really what it means for crude prices?
Tracy
I mean, really what it’s showing is it’s showing all of the times that we’ve pretty much needed to tap into the SBR because of an actual emergency. You can see the difference between when we had to tap the SDR and say war or Katrina or Libya, right, how little that was compared to a non emergency event, that we drew it all the way down.
Now, Biden has said this really just showing the magnitude of this SPR draw for literally no reason. But if, you know, Biden did say that he was looking to refill it at 68 $72, we have gotten down on that in that area. We haven’t really been able to stay there. But it is possible that we could be looking at, by our calculations, Q2, they could possibly be looking to repurchase if oil prices are down there, which there’s no guarantees with China reopening and sort of seasonal tendencies and what have you. Generally, we see about mid February through summer really starts to kick in higher demand season, and you start refining for summer grades and things of that nature. But it is possible that we could see the US.
Kind of start at least thinking about repurchasing Q 223 again, that would buoy oil prices as well and kind of put a floor underneath it.
Tony
Okay, so that kind of reinforces the headline CPI data that I put out there saying, say, March, April, May, things really could tick up. I think it’s silly to expect crude to be down at that level, especially, as you guys say, if China is opening up, if they’re refilling their SPR, if the US. Is refilling SPR, that sort of thing. So that’s all super interesting. Is there anything on energy that we’re missing right now, guys? I just want to make sure going into the end of the year that we’re covering the areas we need to COVID on energy. What are we missing?
Josh
So I’ll jump in on this just real quick. On inventories, there’s a lot of uncertainty. Like Tracy was saying, we don’t really know how much oil is in storage in China right now. The way I approach it is just to assume the worst to some extent to to underwrite to that and then, you know, understand sort of upside. And the worst case is, is somewhat bad. Like it looks like for, for oil prices, it looks like there might be two or 300 million barrels of oil and storage in China.
More than some of the most optimistic analytics services or whatever are showing. And it is, in theory, possible, right? They have big caverns. They could store it like we do. It’s possible. To the extent that that’s the case, it still might not matter, because as China reopens, to the extent on the low end, again, of Chinese consumption, maybe you get another 2 million barrels a day or so of consumption versus where it’s been. And maybe they were importing a million barrels a day to store up until this point.
So you still have a delta of a million barrels a day. And so if you have 200 million in storage, 200 days from now you’re out of storage and you’ve been importing, you end up with this, like, million or 2 million barrel a day need to draw on world inventories.
But world inventories are really low ex China. So you end up with a situation where on the low end for recovery, you end up with an undersupplied situation. And that’s not assuming any Russia disruptions on the high end, if you end up with a sort of three or 4 million barrels a day.
Again, what Tracy and Bob were saying about the imports of iron ore and some of these other indicators, if those are right, and we end up on that sort of higher end of demand, which we also saw in the US. As we reopened, I mean, things could get crazy real fast, and China could end up looking like the world leader in oil trading from having imported and stored all of this oil to the extent they have it.
And then the last thing oil was in Biden’s buy target range, and they were selling from the SPR, not buying it in the last week or two. So that tells me it’s very unlikely that there’s repurchases of oil into the SPR anywhere close to these price levels and anywhere close to these economic circumstances.
Tracy
I mean, I think most people agreed they probably won’t buy back in the SPR, but they say they will. But I think if that even happens, we won’t see that until at least three of 2023. But again, prices will probably be higher than where they want them to be to purchase it anyway. But I do lean towards the fact that it’s going to be a very long time before they actually start repurchases.
Tony
Okay, great.
Bob
I have a couple of closing things, if I could, because first of all, I like Josh until he told me he was an economist. But I think that’s more of a strategist. We’re like a strategist, and we’re like the little brother of economists, and we’re always jealous of that. They get to put the economists, find their name and strategists. I could just say I’m a strategist. No, I don’t have to show a degree to do that. But from a perspective of the SPR, I worry about the political, the future political implications of what the administration did. If you look at the exact somebody sent me the exact definition of what the SPR is supposed to be and I guess in that context he used it correctly, right?
But I think I know at least Tracy and I agree that it was used incorrectly here because it was just a price increase. It wasn’t really an emergency. Prices were coming off on their own. Biden’s own. Treasury put out a report in July that said the SPR release only affect prices somewhere in the range of $13 to they revised that from about $28 to pump.
So it wasn’t even that big of an effect through Biden’s own. Treasury said this it’s not me saying this, but I worry about the future of prices are up, let’s dump a bunch because we’ve got midterms coming. And then next thing you know, there’s a massive outbreak of some sort of geopolitical problem in the Middle East and there’s a real emergency and we don’t have what we need. So that’s my concern about that. The last thing I’d like to say isn’t really energy based, it’s more about CPI.
I was on a Twitter space yesterday waiting for the mic. I never got the mic, and I heard somebody who I won’t mention say prices are decelerating at an accelerating rate when the exact opposite is actually true. Prices are accelerating at a decelerating rate. They’re not decelerating an accelerating rate. People forget. First of all, I don’t like the Consumer Price Index, but that’s a whole nother podcast. CPI is exactly that. It’s the consumer price index. It’s an index. If you go to the St. Louis Fred website and you look at a chart of CPI, it’s basically always increasing, right? That’s why the Fed’s target is a 2% increase in prices.
If we’re in the midst of disinflation, not deflation. And I think sometimes the public doesn’t realize, they’re like, oh, prices are coming down. No, they’re actually not. The rise in prices is actually slowing down, but they’re still rising. It’s like if you went to buy a car for $22,000, I don’t know where you’d get that, but and you go the next month and it’s up $23,000, and then you go the next month, that’s up 23,100. Prices didn’t go down, they just increased at a slower rate. And I’m going to be saying this everywhere I appear from now because I think the public’s misunderstanding of what’s happening with inflation, maybe I’m going to affect sentiment if I say it too much. Josh, I don’t know. But that’s the issue I have in terms of CPI specifically, and energy is obviously a huge part of that.
Tony
Well, I tweeted out almost the exact same thing this week about CPI, about inflation, and inflation isn’t falling right. The rate of price rises is slowing and there’s just a huge misunderstanding of that. So before we close up, as we go into these last ten or so trading days of the year. What are you guys thinking about over the next couple of weeks? Is there anything that’s on the top of your mind as the year closes? Josh, let’s start with you.
Josh
Sure. So people have talked a lot about this. We haven’t talked about this yet. The divergence in between oil prices and oil and gas stock prices, especially on the large cap and mega cap side. And I think people forget that commodity prices other than the spot price are not predictive. The forward curve is not predictive. It’s terrible. It’s used as a hedging mechanism that’s used as a prediction mechanism. Equities are forward looking and they’re not perfect, but they’re one of the best prediction mechanisms that we have.
And so energy stocks, oil and gas stocks are telling us that oil prices are likely to be higher, similar to your analytics software and the pundits and what. The sentiment is terrible in saying that oil prices will be lower and the price has deviated in the short run with the equities. So it does look like the more likely scenario, just even using that heuristic, is that oil prices go higher again, ignoring all the fundamentals and whatever. And so the interesting thing is, if that’s right and oil prices go higher, it might send those oil and gas stocks even higher.
There’s sort of this sort of soros reflexivity that happens with those sorts of things. So I think it’s worth touching on. Many people are posting about it, talking about how they need to converge. And actually I just think you got to understand what they are and what they are.
Tony
That’s a good point. Tracy, what are you thinking about going in last two weeks now?
Tracy
That chart is everywhere. To be honest, I’m still looking very closely at open interest in the oil and gas mark, oil in particular. A lot of length has come out of that contract. People just aren’t interested. A lot of people took profits because it was one of the more profitable commodities. Right. Over the last year or two years, we haven’t really seen anybody actively short that market short.
Open interest has actually declined a little bit, but not as much as length. So if people get interested in this market again, there’s a lot of room to the upside if people jump in because that length has been taken out of the market. So I’m watching that towards the end of the year in particular, see what happens after the beginning of the year. See if this market find some more interest.
Tony
Okay, all three of you are being pretty subtle about your expectations for energy prices. Bob, why don’t you close out? What are your expectations going into the last two weeks of the year?
Bob
First of all, I agree. I think there’s almost I shouldn’t say this, but I think there’s almost no way energy prices continue lower on the crude oil side and natural gas is doing what natural gas is going to do. So I think overall energy prices go up. Electricity prices are going up. And given that backdrop, if the three of us are right, by the way, if I mischaracterize what you two think, please jump in. If energy prices go higher, there’s very little chance in my view, that of the three possible scenarios for the Fed that the right one can come true in the Fed’s view.
So I’m actually more looking at EPS estimates for equities need to come down, earnings estimates need to come down, and the Fed is either going to have to a admit to a higher inflation target or B accept a higher level of inflation without saying so, or equities have to make a new low. And when that low happens, if that low happens, I should say if it’s a very good opportunity for industrials and consumer staples to sort of get in and kind of ride the recession wave back up as the economy itself restrains inflation by us going into some sort of a shallow or deep recession.
The other two things I would say is there any way I can get an economist title without putting in the work that Josh did? If anyone knows how to do that, absolutely. Just put it on your bud, Josh, don’t let me do that. You actually worked for it. And then the last thing I would say, if anybody wants to send me a bottle of Blantons, I’m willing to give you a free trade that is guaranteed to either make or lose money.
Tony
Hey Bob, just kind of latch on to what you just said about energy prices rising and industrials. So we’ve seen through 2022, a lot of industrials and retail firms raise price. Okay. And consumers have accepted that price. But if you’re saying that commodities are generally going to rise yes. Does that mean that we’ll see margins compress for those industrials okay?
Bob
So in the short term, consumers are.
Tony
At a threshold where they can’t accept higher prices soon.
Bob
So if you guys remember, you look back to the Great Recession in 2008, the last thing people did was let their car be repossessed. That kind of shows you the inelasticity of energy demand in general. People were defaulting on their mortgages before they let their car payment go into default. So from that perspective, people might be overestimating how far demand for energy can drop even in a recession. I’m making a correlation that probably isn’t accurate, but just anecdotally that’s something that we’ve seen. And it’s the same thing with heating and cooling your home.
People are probably less likely to stop heating their home. They’re probably more likely to accept cooling at a little bit hotter of a temperature. So going into summer it may not be as apparent, but I do think that when we come out of it, industrial utilities, energies and consumer staples are going to lead us as most times coming out of recession simply because of the first things that people start spending again on and they’re the last things that people stop spending on. So I like those things coming out of what I expect to be a fairly decent drop and end of the first quarter, beginning of second quarter next year.
Tony
Very good, guys. Thank you so much. I really appreciate your time. This has been fantastic. So have a great weekend. And have a great weekend. Thank you.
This Week Ahead is a special episode because it was recorded live, with guests Albert Marko, Sam Rines, and Mike Smith, together with host Tony Nash in a face-to-face conversation. It’s also the first time that we had a Twitter Spaces, joined by a few people and taking their questions.
Gasoline prices have continued to decline here in the US. Since June, RBOB has been pretty much one way, sliding from ~$4.30 to $2.16. That’s half. Of course, lower crude prices are a huge factor, but over the summer we were hearing all about refinery capacity. Is there more to it than the oil price? XLE vs crude – XOM closing in on 100, etc. How much of an impact is this having to help affordability given the broader inflationary environment?
Inflation is proceeding unabated, as we saw in Sam’s newsletter this week. Some Goldman guy was out this week saying there may be a recession in 2023. Sam looked at the terminal rate in his newsletter this week. How would accelerated inflation or steepening of recession worries affect the Fed’s actions?
We had BOJ head Kuroda (who has been in the job for a decade) begin talking about Japan hitting its 2% inflation target. If that were to happen, how likely would the BOJ be to scale back its ultra-loose monetary policy? Impact on Japan’s equity market, govt bonds, etc.
Key themes 1. How low will gasoline go? 2. Inflation/Recession worries 3. The day after Japan hits 2%
This is the 45th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
I just want to say hi and welcome to The Week Ahead. I’m Tony Nash. We’ve got a couple of special items for this show today. First, Albert Marko is in Houston, Texas. So we’re doing a live in-person Week Ahead with Sam. Tracy will be on Spaces eventually. We also have a special guest, Mike Smith, who’s a partner at Avidian Wealth here in Houston. Second, this is our first Twitter Spaces, so this may be a little clunky and we may make some mistakes, so just bear with us, if you don’t mind.
So Mike, Sam and Tracy eventually, and Albert, thanks for joining us. I really appreciate the fact that you guys have come today.
We have a couple of key themes today. The first is how low will gasoline go? Gasoline prices I think nationally are around $2.99 are approaching that in the US. So we want to take a little bit of a look at that to understand what’s happening there. We also want to talk about inflation and recession worries. Sam will go into that quite a lot and we’ll try to figure out what’s happening with inflation.
And then we’ll talk about Japan post 2% inflation. So there have been some comments from Abe at the BOJ about Japan hitting 2% inflation, and we’ll talk about that a little bit.
Okay, so Albert just joined us. So let’s get started on gasoline prices. Guys, since June, RBOB has really come down from 430 to about 216. So it’s about 50% or 49 point something percent.
Of course, lower crude prices are a huge factor. We’ve seen crude prices come down in that time as well. So is there more to go on crude prices? On gasoline prices? Like I said, we’re waiting for Tracy, but she’s not joining. So I’m just going to throw it open to you guys. What’s your thought on gasoline? Because we’re entering the holiday season, it’s going to be a lot of driving. There’s a lot of inflationary pressures, which we’ll talk about in the next segment. But I’m just curious what your thoughts are on room for gasoline prices to fall.
Albert
Well, I think they guess some prices are going to fall because price of oil just keeps on going down. I think at the moment, whatever brokers, government entities or whatever we want to talk about is starting to drive down the price of oil because it’s beneficial to the political situation. So I think that oil, as it drifts down towards 60s, mid sixty s, the price of gasoline will also come down.
Tony
What are you hearing? We’re in Houston, energy capital of the world.
Sam
What are you going to yeah, it’s hard to make a call on the energy price kind of in its relation to gasoline for a couple of reasons. One, we really don’t know where any spare capacity can come from in terms of the ability to refine at this point.
You’re running at 96% utilization rates for refinery capacity, that’s pretty much peak. So if you have any sort of hiccup there, you’re going to have a problem on the gasoline front.
Tony
So hurricane season is over. Do you see any reasonable hiccups coming? Obviously may be unexpected, but when you’re.
Sam
Running at 96% capacity, it doesn’t take much to have a small problem. Right. And if you go from 96% to call it 90% because of an accidental outage, that could be something rather significant for the gasoline market. So while oil prices, you know, appear to be fairly volatile right now, it’s, it’s hard to translate that back into a gasoline price.
Mike
I know if 86 degrees here in Houston, but unpredictable winter can happen. I know it’s a little bit of a delay, but we don’t know. These weather patterns can happen. We could have a colder than expected winter and that could probably trigger as well.
Albert
Rail strikes is another issue. Talking about any kind of strikes in the transport industry, diesel prices making truckers, you know, trucking more. It’s not anything.
Tony
Right. I just saw Tracy pop in and then she popped out. So once she comes in, we’ll come back to her on this. Thank you. Okay, that’s great. And we’re seeing, we’ve seen XLE, the energy companies, the energy operators, we’ve seen XLE stay pretty elevated as crude prices have come down. There’s typically kind of a four to six month lead between crude prices coming down and XLE coming down. So when we look at some of these major operators, is there an expectation that those prices will come down? Or are we kind of I’m just inviting Tracy to co host. Okay. Hi, Tracy. Are you there? Sorry. Just back to XLE. Do we expect XLE, the traded operators like, say, ExxonMobil, those sorts of guys? ExxonMobile is about to break 100. They’re headed back down after topping out like 115, something like that. So do we expect their share price to follow the crude price directionally?
Albert
I would say no. Really? It’s tough. It’s a tough call, to be honest with you, because we just don’t know which way the markets are going to go. Crude prices is acting like bitcoin at the moment, just being up and down 10% per week. I can’t even give you an honest answer on that.
Sam
I mean, it’s certainly not going to be the same data that you would expect in a decade ago, but you’re likely to have the sentiment at least have some effect on XLE or XOP, whatever it might be. But the issue now is that you’re not going to have the same sort of capital expenditure catch up and overshoot that you did in previous cycles simply because investors have already said, we will punish you for that. And producers don’t want to be punished.
Sam
They’re making a lot of money at 50, 60, $70 barrel oil. I don’t think you’re going to see the level of beta to the underlying that you would normally expect.
Tony
Okay, great. So basically they’re using your old equipment at the current energy prices and they’re maxing it out. But when the capex cycle does come on, will it come on with huge force or will that trickle out? Like when will invest? Will investors decide at some point that they won’t punish these operators for capex?
Sam
No, they won’t. No. Okay. Why spend for something that has a five to seven year time rise? We’ve been told that the oil companies aren’t supposed to exist in a decade. So as a shareholder you want that return of capital. You don’t want that capital put back to the ground. And if you begin to see any sort of significant uptick in capital expenditures, you’re going to have it absolutely crushed from a stock perspective. Right. If Exxon announced that they were going to begin a significant capital expenditure program, that stock would get absolutely hammered and you can just go through any of the companies. It’s all about what are you doing for my dividend? How much stock are you buying back and maintaining output, not expanding because you talked about it.
Mike
We’ll be short or fast. I think it’ll be going to take a long time for that to happen unless some major catalyst happens that actually sparks that in.
Tony
When you think about how long it.
Mike
Is to legislate get permits, it’s a decade.
Sam
Yeah, absolutely.
Mike
So it’s got to be some major catalysts.
Tony
Tracy, are you there? I see you as a co host but I’m not sure if you can speak. Okay. Once you’re in Tracy, just speak up and I’d love to get you involved in this discussion. Sam, how much of an impact is having is say lower gasoline prices having on the affordability in broader inflationary environment? So basically are gas prices helping the inflation discussion much or is it just a relatively small thing since a lot of people are working from homes?
Sam
There’s kind of two ways to think about that. There’s the inflation dynamics, the actual inflation dynamics that lower gasoline does have that headline CPI narrative.
Tony
It’s a tax cut. I’m kidding.
Sam
The problem is that over time gasoline has become a much smaller portion of the wallet. The average person does not spend anywhere near as much on gasoline as they used to and that’s just a fact. So is it really helping people on the margin? Yes. Gasoline and groceries are the two things that you can kind of see and one you see in a big bull sign, the other you see every week when you go buy groceries. So gasoline, grocery prices coming down, it’s good for the consumer mentality. Is it good for the action and spending levels?
Tony
Okay, great. Okay guys, just so you know, this is a live spaces. We are recording this and we’ll upload on the YouTube channel probably tomorrow. Tracy has joined us. Tracy, if you’re there and you want to chime in please join. Okay, let’s move on to the next topic for inflation and recession worries. So inflation is proceeding pretty much unabated salmon, and we saw this in your newsletter this week and I’d love to talk more about that. We also had some Goldman guy, I can’t remember who it was yesterday, saying there’s probably going to be a recession in 2023. And all these people are coming out saying maybe back half of 2023 there’s a recession, which it’s a convenient time to say that right? Right now to say something’s going to happen in the back half of 23. So you look at the terminal rate in your newsletter.
So how would, say accelerated inflation, if that’s actually coming or the steeping of recession worries affect the terminal rate from the Fed?
Sam
I think you have to divide that into the first part. That is, what would inflation call it a deceleration in inflation pressures mean for the Fed? Unless it’s significant? Not much. Does a recession matter for the Fed? Not if it doesn’t come with disinflation. Does the Fed care if we have real GDP decline? No. I mean we have real GDP decline, q One, q Two. They got their mandate, they did not care. Right. You currently have north of 7% CPI and you have an unemployment rate of 3.8, maybe percent. It’s really hard for me to see which one of those metrics is comforting to the Fed at this point. So does it affect the Fed’s trajectory? Maybe it’ll take a 25 out of the terminal rate, but that’s about it. You’re simply not going to have this type of immediate Fed pivot with inflation at north of 6% and this type of unemployment rate, it’s just not going to happen.
Tony
Okay, great. Now for you guys on spaces, if you have a question or want to put up your hand, put a question in the channel or put up your hand. We’ll take some questions later on in the podcast.
Albert
That inflation is just so sticky right now. We spoke about it earlier for podcast about wage inflation just sitting there, you know, just rising every single month. Politically, it’s a great thing for people to wait 40 years to get wage inflation, but I just, I can’t see how all these consumer prices are going to come down and talk about this inflation or wage inflation is just going to stay elevated for the next 1015 years.
Tony
Yeah, that’s a good point. So I get that there’s this expectation out there where people expect prices to come down to say, 2019 levels at some point. And, you know, we were talking about this, Sam, that do you expect prices to go back down to 2019 levels? We’ve seen a dramatic rise in a lot of different areas. So do you expect that to fall back down to what it was two, three years ago?
Sam
No, I don’t even think that in the best of all possible worlds, that’s not one of the worlds.
Albert
The only people talking about that are the political people that are trying to sit there and trying to gain votes because people are struggling at the moment. But the economic guys exactly. It’s only what you want to hear, but the economic guys are looking at the numbers and, like, we have never seen I mean, why would why would companies bring the prices back down that much when they know they can get away with it?
Sam
I mean, Cracker Barrel expects wages in the coming year to be up five, 6%, right?
Tony
Those of you who aren’t in the US.
Sam
Year, right?
Tony
For those of you who aren’t in the US. Cracker Barrel is a very kind of middle America restaurant comfort food, right? It’s biscuits and gravy. It’s fried chicken, that sort of thing. And so this is not the high end yet. It’s not McDonald’s. It’s very much the middle market in the US. And so Sam’s done a very good job in his newsletter over the last couple of years covering price hikes at Pepsi, at Home Depot, at Cracker Barrel, at other places. So many of these companies have raised prices by, like, 8% to 10%, generally, or more. Who’s raised more?
Sam
So Campbell Soup this morning came out with earnings, and they divide them into two categories. They divide it into soup and kind of prepared meals type deals and then snacks.
So think Snyder’s Pretzels is one of the brands. The prepared meals, which include soup, they increased pricing, 15% from last year, and they increased on snacks, 18. And that was price that they pushed. Volumes were slightly negative, but negative 1% and 2%. Okay, you’re talking almost no budge on volume and a huge move in pricing, and that is for the most boring of all commodities. This is soup we’re talking about.
Tony
And I want you guys to understand what Sam is saying. Campbell Soup has raised their prices between 15 and 20%, and their volume declined 1%. So do we ever expect Campbell Soup to reduce their prices by 18%?
Sam
No. That’s the beautiful part if you were corporate America right now, is you get a free pass to really find the elasticity in the market for your product by raising prices until you begin to see pushback from consumers, and you just haven’t seen a significant pushback from consumers. And to the narrative of inflation peaking. Inflation is peaking. If you look at the last four quarters of price increases from Campbell Soup, it was something like 6%, 11%, 11%, 16. Right? So maybe the second derivative is negative, but the first derivative isn’t.
Tony
And it’s positive in not a small way.
Sam
Correct.
Tony
We’re not talking about 2% price rises. We’re talking about 18% price rises, which.
Mike
Is we’re seeing that for consumers, the biggest increase. But, I mean, I guess in future years, that probably somewhat levels off. And then on top of raising prices, I’m sure all of you have noticed the shrinkflation, the items have less in it and we’re paying more for it on top of everything else.
Sam
Well, that is part of the pricing element. Right. So when they take packaging down a couple of ounces that shows up in the pricing mechanism.
Albert
It’s incredible that Campbell Soup and all these other companies raised their prices by 16% to 19% because that is actually the true inflationary number. When you go back to what they used to do it in the 1990s, it’s 18 19%, not the 7% that the Fed tells you. CPI.
And on top of that, these inflationary numbers give you a tailwind for earnings. So all these companies that surprise earning beats, if you look at them, what inflation has done into their products, it’s not a surprise that they beat.
Sam
Yeah, right. And it’s somewhat stunning because if you think about it from a 23 24 perspective, if you have your input costs begin to move lower, or at least decelerate, and you’re holding your prices at these current levels, or even increasing slightly from here, or increasing from here, all of a sudden you begin to think about what that does to a bottom line. That is an extremely attractive thing for a business. As we begin to move into the latter part of the margin expansion that everybody kind of thought was over after COVID, that really might return to some of these boring, staid old stocks.
Tony
Right. So guys, just, just to be clear, what we’re saying here is prices are not going to go down or they’re highly unlikely to go down to what they were two or three years ago. We’ve hit an inflation level, it’s a stairstep. And companies are comfortable seeing reduced volumes, but they’ve compensated that with higher price and consumers are generally accepting higher price. Right. So as an aside, I’ll be shameless here and say complete intelligence does cost and revenue forecasting. If you guys need any help with that, let us know. Okay? So, terminal rate, you’re still looking at five to five to five somewhere in there.
Sam
Well, I think it’s probably closer to five and a half to somewhere between, I would say five and a half to six because you have the stickiness in wages, right? And the stickiness in remember this is important, that Powell, week ago at the Brookings Talk pointed out one thing, and that was Core Services Ex shelter. In other words, they, they are already throwing shelter out. Even when shelter decelerates, they’re not going to pay attention to it. And he also made it very clear that Core Services X Shelter, the main input cost for many of these businesses is wages and personnel. So while you have these wage pressures, building the Fed is not your friend in any meaningful way. So I’m much more on the give it five and a half to six. There’s this idea maybe we get 50 50 25 then done. Or 50 50 done. It’s more like 50 50. 25 and 25 and 25. It’s just slower.
Tony
You said this a month or so ago. It’s a matter of the number of 25 that we get.
Sam
Yes, it’s 25 delays.
Tony
Okay. So it’s not over, guys. We’re going to continue to see the Fed take action, and they haven’t even really started QT yet. And we’ve talked about that for some time. And when they start QT is really when markets feel is that fair to say? Yeah, depends on the market, of course.
Sam
Yeah, they’ve started QT It’s just a small 200 billion or something that’s still QT. They’re not going to sell them.
Mike
I think one of the things he said is the Fed is not your friend. And just think about that statement for a minute. For two decades, all investors we’ve all come to known as the Fed is our friend. Anytime the market was down, they’re out there doing press conferences. But I think it’s critical for people to understand we’re not going to see a return of that for a significant amount of time.
Tony
Right. You’re not public servants. Right. Exactly. They don’t like you.
Albert
It’s important that as Sam mentioned, that 50 50 and then the repetitive 25s correlates with their rhetoric of soft landing that they keep talking about whether they can actually achieve a soft landing. Well, that’s another debate that we talk about. But that’s exactly what their intentions are. Those are 25 US to the end of their they get to where they want to be.
Tony
Right. Okay, very good. Let’s move on to Japan. Bank of Japan Chairman Corona was on the wires this week talking about Japan hitting the 2% inflation rate, which they’ve been trying to hit for 30 years or something. And then they made a policy with Avionics in 2012, and they still have been able to hit it. And now that we have crazy inflation globally, they’re going to claim the win. Right. And they’re going to say, we hit it and abe nomics. Although Avi is not empowering where it was ultimately successful. So, Albert and Sam, I’m just curious, what does that mean if Japan hits 2% inflation and they tail off their quantitative easing, their kind of QE infinity and they stop buying government bonds, all this stuff. First of all, do you think that’s going to happen? Okay. And second, if that does happen, what did Japanese markets look like? And then what does the yen look like? I realize they just threw a bunch of stuff out there, so just take it away. So you might like jump in here. Sure.
Albert
The fiscal monetary setup is quite favorable, right. If they do whatever they’re going to say they’re going to do quite favorable. There are only headwinds that I can see is the US. Stock market equities. If the US equities fall, without a doubt it will affect the Asian market, specifically Japan. It’s a tall order for them to sit there and get their 2% inflation target. So I don’t even know if that’s even a valid discussion, but I guess we’ll sit there.
As much as a set up as favorable for Japan, they’re combating China. And I still think that China, because they don’t have as much connection to the US. Equity market, is a little bit more favorable. I would go China over Japan right.
Tony
Now, yes, but I’m tired of talking about it.
Albert
I know not to talk about China when Japan is so interconnected with China, so everything is interconnected in that region. But I do think that the fiscal monetary set up for Japan is favorable.
Tony
Okay, sam, what do you think?
Sam
Like Albert said, theoretically, it’s really interesting. It’s intriguing. The one thing that I think is important to remember about Japan is that every time they seem to have the monetary policy setting correct and they were heading to actually hit their 2% target, they always seem to raise taxes or do something to make sure that they missed it. Was MMT on steroids? Very good example of MMT actually working. Right. You can do as much monetary policy as you want as long as every time you’re close to an inflation target, you just race to that or taxes. So I think that’s something that I’m always somewhat skeptical of Japan doing. If they begin to lift yield curve control on Japanese government bond yields, I think it’ll do two things. One, it will make for an interesting market in Japanese bonds. The BOJ owns such a large amount of that market that is almost difficult to fathom that it actually has a functioning market. It doesn’t really have a functioning yield market. So that’s kind of the first thing is we’ll finally get a feel for how that market actually functions. The second one is that you’ve had a 2% inflation win with the yen sitting between 130 and 150, a very weak yen.
That’s a tailwind to inflationary pressures. If they do lift YCC, it doesn’t matter what else they do. If they raise interest rates, whatever it might be, the yen going back to 120 is going to undo a lot of that inflation pressure in and of itself. You’re going to really bring that in. It’s also probably a positive. Having a stronger yen in this environment when you’re at an energy shortage globally is a positive for the Japanese economy because they import so much energy. Having that stronger yen makes it cheaper in domestic terms from that perspective. So I think there’s a number of things that could line up pretty well, and there’s always the opportunity for the Japanese government to mess it up somehow. Of course, I do think that it’s a very interesting market, particularly if you can do it on a call it an outright basis investing and get some of that currency dynamics mixed in with your investment, that could be a very interesting opportunity going.
Albert
You know, what’s interesting is what you’re saying about MMT on steroids. It’s like, you know, you’re making all these descriptions of what’s going on in Japan, and I just look at the fed, and I’m just like, well, oh, my God. We’re starting to be on the verge of Japanification at the moment right now, because the 30 year bond from who I talked to the 30 year is.
Sam
Completely controlled by the federal government.
Albert
And at the moment, it’s completely controlled. And if they can sit there and pump those bonds and pump the markets, you got Japan right here in the United States with MMT and Leil Bernard and yelling, doing whatever they want to do.
Sam
You just have to raise taxes.
Albert
Yeah. So so masters at that. Yeah.
Tony
So I used to go to Japan a lot, and in the late, say, 2010, 2011, when the yen was at, like, 75, when I would go to Tokyo and I would go down to breakfast in the hotel, I was the only one there. And I remember when Abe was elected and even pre election, the yen started to weaken him taking office. The yen started to weaken. Right. And I remember the first time I went down to the hotel lobby and there was a line to get to breakfast rather than just it being wide open for me. So a devalued yen means a huge amount of power for the Japanese economy. So when you say JPY going back to 120, I remember in 2010 eleven. When people would say, gosh, if we just had a yen at 95, we’d be happy. Right. And now it’s at 145, or whatever it is.
Sam
I haven’t 130 yet.
Tony
136. So, you know, it’s you know, it’s a completely different environment and puts the Japanese economy in completely different context. But you have nationalization of bond markets, you have nationalization of ETF markets. Is it really an open, competitive economy? It’s certainly a highly centralized economy. Right. And that’s really dangerous. But they love to use demographics as the justification to intervene in markets, right?
Albert
Yes.
Tony
Okay, guys, if anybody has a question, raise your hand. Or I’m not exactly how this works. Again, this is our first time to do a spaces. So put something in the messages or raise your hand or do whatever, and we could potentially have you come on and ask your question. I’ll be very honest. If you have an anonymous Twitter handle and we don’t know you, I’m not going to let you speak. So don’t waste your time. But if you’re someone we know, then we’re glad to have you on. So I guess while we wait for people to come in with questions, we’re pre Christmas holidays here in the US. We’ve got a Fed meeting coming up, the expectations for a 50 basis point hike. What do you guys expect? We’re seeing equity markets really kind of gradually move lower. What do you guys expect for the next week? Or so in the US before the Christmas holiday.
Albert
I think the CPI is actually going to be a little bit less than consensus and probably get a rally going to the end of the year, to be honest with you. I think everybody knows it’s going to be 50 basis points. The question is what’s the guidance after that? What do they say? If it’s a good CPI number, well, then you can have this dough stock for another month.
Mike
Sentiment has been so low and kind of got your seasonality right now. I think that probably prevails here.
Sam
If you think about it, a few.
Mike
Months ago everybody was kind of in this panic, Seymour. People kind of there’s this nice little calm right now everybody’s just kind of floating around waiting to see what’s next. And what’s your point? I think everyone expects to raise another.
Albert
50 basis point, which is amazing, because 50 basis points is not dovish. I guess everyone’s expecting 75 or 100 about a month ago, you know, their.
Mike
Condition as to.
Sam
No, I would say there’s there’s a couple of interesting things about the Fed meeting it into the back half of the year. One is what does the dollar actually do here? Because if you begin to actually have a significant move in CNY stronger right lower on this chart. But if you get a significant move back towards the 650 area on CNY, that is going to have a spillover effect. To a stronger Euro continued strength in the British pound you could begin to have a number of dynamics that are somewhat negative dollar and therefore pretty bullish on the risk asset front that I think could catch some people off guard simply because of the spillover effects. But the Fed, the one thing to remember about this meeting is it’s not just a 50 basis point height. It’s also that stupid dot plot that they do that actually has some pretty serious potential consequences because if 23 comes out with higher than expected dots and 24 dots move higher, the terminal and the long term rate begins to creep a little bit higher. If you begin to have that hawkishness, I kind of want to say this, so going to, if you begin to have the hawkishness become less transitory in the dot plot, that could become somewhat problematic for markets that could take some of the sales out of what we’ve seen to be a moderating dollar effect.
So I think, I think it’s worth being a little careful until we see that dot plot and begin to hear how Powell is approaching 2023 because I think they’re somewhat aggravated about the way that the Brookings Institution, the Brookings speech was received by markets they did not want a significant asset rally going out of that right. That was counterproductive to what they want. So I think they’re going to be very careful about the rhetoric into the.
Tony
Back half of the year because they would just. Not be so jerky in their communication. They’re super bearish. They’re bullish. They’re super bearish. They’re bullish have a consistent message.
Albert
Yeah, but it depends on what’s going on behind the scenes, what data they see. All this data, they see all the CPI and the jobs numbers a week or two heading for anybody else. Don’t kill yourselves.
So I guess it comes down to what is going on behind the scenes and what they don’t want to break. I mean, Blackstone came from what I heard, blackstone was $80 billion in the hole and having problems, and they went to the Fed, and that’s what triggered Powell to be slightly dovish.
Tony
And I thought they were the fed.
Albert
Well, whenever you guys Powell’s portfolio sitting there in your grasp, you are the.
Tony
Fan of that one.
Albert
But I guess it goes down to what is happening behind the scenes and what could potentially break is why they’re coming on this roller coaster ride of rhetoric.
Tony
Yeah. Okay, I’m going to see if Valena wants to come in she’s attending. And see if she wants to come in to see what? Invite her to speak and see if she wants to Valena, are you there? If you want to come in and let us know what you’re thinking is going into the end of the year and 2023, you have an invite to speak. You’re welcome to.
Albert
Molina is sitting there in Austria, vienna, Austria. And I know the European markets are now looking quite interesting to me. A little luxury market in Europe is absolutely exploding, and it’s just unreal that. It’s just so resilient. I mean, there’s two brands that I personally liked, laura Piano and Brunello Cucinalli, which I have a tremendous amount of polls. Brunello Cucinalli didn’t care anything about the Russian sanctions or anything. Just kept on selling, and they just blew out earnings yesterday or as of today, they were up like 7% this month. Really, the luxury retail market, luxury jewelry market is just it doesn’t stop great. And it’s counter to what everybody is saying. Recession this, recession that. You go to gucci stores, lines out the door, Louis. The time you need an appointment, it’s just resilient. It’s just actually quite amazing.
Sam
It is really similar to if you look at our markets, right, particularly the masters plotted against the price of oil. If you do a six month delay, guess what? It’s almost it’s a really interesting kind of windfall type chart. You can kind of see the oil money flowing in there. And you even had China relatively shut down, and that was a huge driver, a tremendous driver of European luxury, particularly for LVMH. Even with China shut down and not really having the tourism, you had a lot of tourists from Middle East, et cetera, really put in some of the South American countries that are doing fairly well, particularly at the higher end. A lot of that is driving this kind of underneath the surface. You had tech, then you had energy. And the question is, now you have the China reopening. Is that the next leg for a lot of these lectures?
Tony
Okay. So let’s talk China.
Albert
I wasn’t going to do that.
Sam
Tracy.
Tony
You’Re as a speaker as well. So if you want to come in, you can come in any time. Okay, so let’s talk about China, even though I didn’t want to COVID that. So let’s talk China. What’s happening, Albert, with the reopening? Like, what do you see the next two months happening with the China?
Albert
Just as we spoke about a week ago on China, those riots and the reason the Chinese even let you see these riots happen on the social media was a signal that they were going to reopen, and in fact, they did. Days later, we’re reopening in stages. And that’s just it. And get your house in order, everybody, because inflation is going to happen. I think I think copper was up, like, two and a half percent this morning. And this is this is it just barely reopened right now, manufacturing, because the odors were down I think Western odors were down 40%.
Tony
But kind of everyone told me on Twitter that democracy came to China.
Albert
Yeah.
Tony
Okay.
Albert
Those are people that have never been to China or stayed at five star hotels or actually step foot outside of Beijing.
Tony
So let’s go there a little deeper. And Xi Jinping is in the Middle East either today or over the weekend at an Arab China summit. Right. And so, first of all, him leaving China right after there were protests, what does that say to you, Albert?
Albert
Safeguard, he’s done any kind of opposition that was pushing against Xi’s Party congress moves eroded, and then these street protests are just street protests. I get it, people are upset and their livelihoods and check down the list of whatever you want to say, but realistically, they never work unless they get violent. And they never got violent.
Tony
Right. So you kind of have to let the steam come out of that valve, I think is probably what you’re saying. Right? The CGP is saying that now with CGP going to the Middle East, sam, they are the premier buyer. China is the premier buyer from OPEC clubs now. Right. It’s not the US. And this isn’t new for people who have been paying attention. The Saudis and other people in the Middle East have been spending a lot more time in Beijing for probably six, seven years. And so and and it’s been longer, but it’s been really, really visible for the last six or seven years. So what does what does that tell you about, let’s say, OPEC’s desire to, please say, a US president going to the Middle East to try to bully them, to pump more? Is that effective anymore?
Sam
No, not at all.
Tony
Hi, Tracy.
Speaker 5
Hi. Sorry, I was having technical difficulties, and for some reason I couldn’t all gone earlier.
Tony
Welcome. No apology necessary. We’re just talking about China and with Xi Jinping in the Middle East for a summit with the Saudis and the GCC members and what that means for the ability of say, a US president to kind of bully OPEC into reducing oil prices going forward. Is there really any strength there? Do you see.
Speaker 5
That’S? Absolutely done. What I would expect she landed in China today. I would expect him to get the full lavish welcome. Right. And we want to be looking at who he brought with him as far as national heads of corporations. And I would expect this to be completely opposite of what we saw the Biden meeting with and more akin to what we saw the Trump meeting with, where they I would expect that.
Tony
So they’ll touch the crystal ball.
Speaker 5
Maybe they might bring out the ball. Yes. And I expect billions and billions in new deals as far as economic, military, energy in particular, et cetera going on at this point. Again, they’re having a conference where they’re going to have multiple leaders in the Gulf nations in Saudi Arabia. So I mean they’re really going to try to rue China on this trip big time.
Tony
Right. So when you talk about military deals, what do you think about that? Albert?
Albert
I’m not really sure Saudi Arabia will.
Tony
Do major military deals with China.
Albert
I mean maybe a few just for show up for optics theatrics but the US military hardware is the best in the world and realistically Saudi Arabia is under the US defense umbrella. Whether the left or the right likes it or not, that’s just the reality of it. And as long as Iran is not poking or poking trouble from the east and Yemen not from the south, southern regions have an easy ride. So their military deals aren’t really they’re not at the forefront at the moment. But anytime that Russia wants to string that relationship, they can certainly call up Tehran and say lob a few missiles over and things go right to elegant.
Sam
To Albert’s point, I don’t think Saudi is going to work. KSA is going to become the next India where they split their arms deals among the three major powers of arms anytime soon. I mean that’s just not going to happen.
Albert
No, there will be a little bit, yeah. India is a completely different ballgame. India has got counterbalance, they need to counterbalance Russia with China and Pakistan and it’s the old mess over there and they need to do what they’re doing.
Sam
Well Nksa is also trying to hold together their market share in a world of Russia really having to begin sending almost all their stuff to call it China India.
Tony
Right.
Sam
So if you had were the two largest pieces of growing market share for Saudi Arabia over the past decade, that was India and China. And now you have the other major energy player in the region coming after your market share. There’s got to be a little handshaking here to keep everybody happy and selling at $55 a barrel.
Tony
You don’t hate that, right?
Sam
If you’re trying to. I mean, it’s the perfect time to reopen. You’re getting cheap energy. You have supply chains that have fixed in the rest of the world. So I think this is very much a visit to make sure that they can continue reopening, get those long term energy deals in place, and then move forward.
Tony
Right. Okay, so we do have a question for Tracy, and you guys jump in. So, Tracy, there’s a listener named Rasul, and he’s asking, when China opens up, is it possibility that it could use its own SPR, like in November 21, to reduce its oil cost? Is that something they would consider doing?
Speaker 5
I think not at this juncture, right now, because, first of all, they’ve already drawn it down. Right. And they’re still worried about long term energy security, as is everybody right now. In addition, they’re also getting really cheap Russian oil, so I don’t think that would be something that they would do right now.
Tony
Okay.
Albert
No, they wouldn’t do that.
Tony
Right.
Albert
There’s no absolutely no need to do that. The US. Only did that because of Midterm economics, and that’s just that China had no intention of doing that.
Tony
Great. Okay, good. All right. Well, guys, I think we’ve covered it. We’ve been here for about 40 minutes, and the hotel we’re in has threatened to call the police if we don’t leave. So I want to thank you all for joining us for this week ahead, and we’ll get this posted on our YouTube channel within a day or so, okay? So thanks for joining us, and look forward to seeing you on the next one. Thank you.
The released Fed minutes show that most officials are backing a slower pace of interest rate hikes. Markets reacted positively but this is false optimism as the terminal Fed Funds Rate may eventually be higher. The 3Q reporting in the US is also coming to a close and 75% of corporates experienced downgrade in earnings. Have the cut in earnings by analysts been adequate or will there be further downside, with 2023 outlook still uncertain? For answers, we speak to Tony Nash, CEO, Complete Intelligence.
Transcript
BFM
BFM 89 Nine. Good morning. You’re listening to the Morning Run at Thursday. It’s Thursday, the 24 November November Friday, junior, as we like to call it. Here. I’m Shazana Mokhtar with Wong Shou Ning and Chong Tjen San. As always, let’s kickstart the morning with a look at how global markets closed overnight.
All key US markets showed gains as most members of the Fed said the pace of rate hikes will slow down. So the Dow was up 0.3%. The S&P500 was up 0.6%, and Nasdaq was up 1%. In Asian markets, the Nikkei and Hang Seng was up by 0.6%. The China Composite was up by 0.3%. The Straits Times Index was down by 0.1%, and our very own FBMKLCI was up by 0.2%.
Joining us on the line now for more on what’s moving markets, we speak to Tony Nash, CEO of Complete Intelligence. Hi, Tony. Good morning. Now, let’s start with just some reactions on the Fed minutes that were released. It showed that most officials are backing a slower pace of interest rate hikes, but that the terminal rate might need to be higher. What do you think? Are we seeing a relief rally? And is that sustainable in the short term?
Tony
Yeah, I think the ultimate destination is probably the same, but the pace of getting there is slower than many people thought a couple of weeks ago. So I think what it means is we’ll see more, say, 50 and 25 basis point hikes. That’s the expectation. It’s still possible we’ll see a 75 if Powell really pushes hard for December, but we’re still going to see a 5, 5.5 terminal rate, depending on really how things end up for CPI and PPI next month. But it’s just the pace and markets are more comfortable with a gradual adjustment to higher rates than the continued kind of shock treatment.
BFM
And Tony, the US reporting period is coming to a close. How would you assess the quality of corporate earnings release so far? How well have they tracked market expectations?
Tony
They’re OK, they’re pretty weak, actually. Compared to 2021, we had, I think, 25% earnings growth in ’21 about this time last year. They’re just over 3%. So it’s not even near where it was last year.
Something like 75% of companies are seeing estimates for their downgrade. So people expecting inflation to endure longer than they thought. If you remember a year ago, people were saying inflation was transitory, so they’re saying inflation will endure longer and rate hikes will continue.
So with credit tighter, businesses and consumers are not expected to spend as much.
So going forward, there is a fear that wallets will be more closed than they are now and earnings will continue to be tight.
BFM
Which just confuses me, Tony, because if the Fed stops their rate hikes at least decelerates the pace of it. And at the same time, corporate earnings aren’t going to be as robust as ever. Then why is the S&P500 above 4000 and the Dow Jones at 34,194 points? I mean, they’re just in fact, the Dow is only down 6% on a year to date basis and the S&P down 15%. Shouldn’t markets be actually more bearish than they are now?
Tony
Well, I think there are a couple of things happening there. I think first, there really is consumers have continued to spend and businesses have continued to spend in the US. Although we’ve seen economic growth slow dramatically, we’ve had spending continue to push forward. So if the Fed slows its tightening cycle, and keep in mind, they haven’t really started quantitative tightening, meaning getting things out of their balance sheet. They’re only, I think, $200 billion off of their high.
But if the Fed continues to tighten at an accelerated pace, then markets are worried. But again, if they slow it down, the feeling is that spending will move in stride. It won’t necessarily be too shaken up.
Also, on inflation, don’t forget inflation didn’t really start on an accelerated basis until November of ’21. So we had inflation, but fairly muted inflation then. And so what we get after November, well after this month, is what’s called a base effect.
So we’ll likely continue to see inflation rise, but not necessarily at the pace that it’s been over the past, say six to nine months. So does that mean inflation is peak? No, not at all. But it means the pace of the rise of inflation is likely going to slow on base effects.
So if that happens, we’ll have a lot of people declare victory over inflation, but I think that there is an expectation that that rate will slow as well.
BFM
Can you look at the prospects of retailers like Best Buy? We see Abercrombie and Fitch. These names are defying inflationary trends and higher rates to post better results than expected. So why has this sector been the exception to the norm?
Tony
Yes, the quick answer is most of those guys have been pushing price. So they’ve been passing along their higher labor and goods costs onto consumers.
Now they’ve been pushing price while sacrificing volume. So they’ve been pushing 8 to 10 to 15% price hikes in many cases. But they’ve had fewer transactions between one and say 6% fewer transactions.
Regardless, they’re earnings have risen. So they’re not as worried about fewer transactions. They’re focused on keeping their margins up.
And so when you look at retailers like Walmart, which has mixed, say, general goods and food, they’ve done very well. They had a very difficult Q2, but they did very well this past quarter.
Home Depot, which is a DIY store, has done very well because they pushed price Cracker Barrel has done very well.
Cracker Barrel. These are not these are not retailers that are at the high end of the market either. These are mid and even, say lower end companies, but they’re pushing price on the middle and lower end of the market.
Higher end of the market? They’re doing great. So it’s tough to be a consumer in this market because price definitely continues to be pushed and we expect price to continue to be pushed through probably Q2 of next year.
BFM
And Tony, with potentially slower pace of interest rate hikes, how do you expect the technology sector to do? Is there more pain to come for the likes of Amazon and Meta?
Tony
For sure. Amazon, Meta and technology companies generally do very well in very low interest rate environment, where the money is effectively free or negative real interest rates.
As you have to pay for that money, it becomes tougher for those companies to do well because their core investment is in technology. And we had things like Mark Zuckerberg at Meta really went off the rails with some of his spending and investment.
It’s not to say that the Metaverse investment is not ever going to happen, but much of that stuff really went way overboard. Same thing with, say, Amazon with some of their infrastructure investments and delivery investments.
So we do expect HP today, I think announce 6,000 jobs to be lost over the next, I don’t know, twelve months or something. So we do expect much more pain in tech. We expect that to continue until at least the end of Q1, if not a little bit further.
BFM
And Tony, let’s talk about oil because WTI for futures delivery in January, $77 a barrel. And we know that there’s an upcoming OPEC meeting in December. What are your expectations in terms of oil price then?
Tony
Yeah, it’s tricky, right? Because oil prices are kind of in that zone where a lot of people are comfortable. And so the question is, is this acceptable to OPEC members? So Saudi Arabia, UAE, Iraq and Kuwait have already come out and said they’re going to stick to the current plan, the current cuts that were already announced last month.
But we have things like the Russian price caps coming into play. And you know, our view is the price caps are pretty meaningless actually, because Europeans are pretty good at circumventing the kind of emotional embargoes they put in place.
I’m sorry to put it that way, but they put these laws in place and then they circumvent them pretty well. A lot of this is theater. So that’s not the price caps are not going to have as much of an impact as many people thought. So it’s possible if we get into next week and crude prices start coming back pretty strongly, or sorry, if we get into next week and crude prices are as weak as they are now, we may see a 500,000 barrel per day cut. I think that’s a possibility, but it’s likely they’ll stay on what’s already been announced.
BFM
Tony, thanks very much for speaking with us. And since it’s Thanksgiving eve. Happy Thanksgiving to you. That was Tony Nash, CEO of Complete Intelligence, giving us his take on the trends that he sees moving markets in the days and weeks ahead.
All eyes, of course, on that all-important inflation number and how that will affect how the Fed raises hikes moving forward.
I think the key takeaway for me was he mentioned that 75% of corporates in the US had downgrades, which I feel it’s a good thing as it brings expectations lower and more in line with future expectations and it also gives perhaps some room to surprise on the upside.
Yeah, well, markets seem to be at crossroads, but a little bit cheered by the fact that the Fed isn’t going to raise rates as aggressively as they have in the past. But I want to keep my eye on corporate earnings. I think that if you see continuous downgrades by the analyst community, you see the messaging coming out of US corporates that things aren’t looking as rosy as they are, then it’s just going to be hard for the Dow, S&P500 to actually break through their current resistance levels. So I think it’s something we have to keep an eye on.
Emma Muhleman, Boris Ryvkin, and Albert Marko join us for this Week Ahead episode. We talk about FTX and why it happened. FTX transferred about $8 billion of customer deposits to a trading arm called Alameda, and they lost it. FTX was assumed to be a regulated institution. It wasn’t. So customer deposits evaporated. There was a desperate attempt to merge with Binance. That didn’t happen. FTX filed Chapter 11 on Friday, and then Sam Bankman-Fried apologized as if that just absolves him and makes everything better.
Albert, Emma, and Boris help us understand what happened here and what it means not just for FTX executives, but for markets in the week ahead.
We also saw some selling in crude markets as FTX collapsed. Emma talks us through that and tells us how long the crypto unwinds will impact commodity markets.
Based on the market reaction to Thursday’s CPI print, you may think inflation is solved. CPI seemed to override FTX worries and there was this huge sigh of relief in markets. Not so fast. Boris, Emma, and Albert talk us through the CPI print and where we’re seeing persistent inflation (diesel, food, etc). Will the Feds raise by 50 in December followed by some 25s? How will this affect layoffs across the economy?
This is the 41st episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Tony Nash: Hi, everyone, and welcome to the Week Ahead. I’m Tony Nash. Today we’re joined by Emma Muhleman. She’s a macro strategist and if you don’t know her, you’re not on social media. We’re also joined by Boris Ryvkin. He’s with Montefly Holdings. He’s also a former M&A attorney with Skadden and a bunch of law firms, and he was National Security Advisor in Capitol Hill. And Boris has an amazing perspective on macro, on history, on markets. It’s really great to have both of you guys. And we have Albert Marko. You guys know Albert. So it’s just great to have you guys. Thanks so much for being here.
Before we get started, I’m going to take 30 seconds on CI Futures. Our core subscription product. CI Futures is a machine learning platform where we forecast market and economic variables. We forecast currencies, commodities, equity indices. Every week markets closed, we automatically download that data, have trillions of calculations, have new forecasts up for you Monday morning. We show you our error. You understand the risk associated with using our data. I don’t know if anybody else in the market who shows you their forecast there. We also forecast about 2000 economic variables for the top 50 economies globally, and that is reforecast every month.
So we had a lot going on this week, particularly kind of in the second half of the week with FTX. Unless you’ve been kind of on vacation or away, you probably know about this already, but I’ll recap a little bit.
FTX transferred, I think, something like $8 billion of customer deposits to a trading arm, Cart Alameda, and they lost it. FTX was assumed to be a regulated institution. It wasn’t. So the customer deposits evaporated.
There was a desperate attempt to merge with Binance. That didn’t happen. FTX filed Chapter 11 on Friday, and then Sam Bankman-Fried apologized. We’ve got his tweet from Thursday on the screen. He sent another apology out today. And if that just absolves him and makes everything better.
So, Albert, I know you’re a huge fan of crypto, so can you help us understand kind of what happened here? And really, what does it mean not just for Sam, but what does it mean kind of for markets going into next week?
Albert Marko: Well, for Sam, you can look at my shirt. That’s I purpose wore stripes, because that’s where he needs to go to. He needs to go to prison. The crypto space has been just littered with fraud. I mean, just incredible fraud. This guy had the nerve to go up into Congress and talk about transparency and central banks are illiquid and there’s no transparency.
Meanwhile, he’s taking customer deposits, not only just setting it to Alameda, right. But then now there’s a political component of it because he was spreading it around to super PACs for the Democratic, for Democrats.
This is a bigger story than people are alluding onto. On top of that, you had a bunch of Republicans come out and say, why was Gary Gesler helping him get through loopholes in the system?
TN: Was that actually happening? Because I saw that gossip on Twitter, but I’m just not sure if that was actually happening.
AM: Well, yeah, this is political season, so I’m not sure if it actually happened. But you don’t just come say something like that, right? You don’t just make those kind of accusations out of nowhere.
So there’s definitely going to be congressional hearings on this. SBF could be in jail at some point in time.
Concerns of where the customer’s money is. This is not funny. As much as I just absolutely despise crypto, this is not funny when you take people’s hard earned money and put it into different outfits without
any transparency whatsoever.
TN: I hear a lot of comparisons of this to Corzine from, like, 15 years ago. Are there similarities between what Jon Corzine did and what Sam did?
AM: That’s a really good question. I don’t think I can really answer that because we know exactly what FTX actually did with all these funds, where they’re at. Because there are stories that there’s penthouses and condos all over the Bahamas and the Caribbean that they can’t even touch yet. We’d have to find out a little bit more detail of what went on, what transpired into FTX.
Emma Muhleman: Because a lot of the deposits don’t invest in them in illiquid private equity investments, including VC funds that were invested in FTX.
AM: Like Sequoia put in a little bit of money and then they get 500 million back.
EM: Sequoia put in like $420 million that they wrote down to zero.
TN: And they got 500 back? It’s a great deal.
Boris Ryvkin: What was interesting was that Kevin O’Leary, he had a Jim Cramer moment with FTX. He said, if there’s one place where I could feel totally safe and fine, it’s FTX, apparently, because he was confident in their compliance capabilities. Because apparently the CEO was like his parents were like compliance lawyers or something. And he’s probably that’s not one of Mr. Wonderful’s more wonderful calls, I think.
AM: Well, when your parents are compliance lawyers, it just means that they’re going to teach them how not to be compliant and not get caught. That’s what happens when that occurs.
TN: Okay, so what does this mean for crypto generally? I know you’ve been not been a crypto fan for a long, long time. So is this an FTX issue or is this a crypto issue?
AM: This is a crypto issue. This ruins the credibility of any crypto that’s even valid in people’s eyes at the moment. Even Bitcoin is the 800 pound gorilla. There’s other cryptos that are trying to be stable and compliant and everything, and it kills.
TN: Do you know how many crypto pages we’re going to get in the comments to this?
AM: I bring it on because I’ve been telling these people for years that the space has been just a positive scheme after another.
TN: So does this permanently kind of impair crypto, or do you think there’s a time that two or three months from now, everyone forgets about it and people are back in and crypto is back on?
I just think that the crypto excitement is so persistent that I’m just not sure that this hurts it for the long time. They haven’t had that moment yet.
AM: No, not yet. It doesn’t hurt it. Actually, I want to say it actually kind of makes it better because it is weeding out the real problems and showing the problems that are in the space.
But the bigger problem that they have now is one side of credibility is getting retail money into the space. Retail money is just not going to get into the space, and even institutional money is going to have to think ten times more about getting an investment in the future.
TN: So what was it, thanksgiving of 2019, I think, when all the retail money went into the space Something like that, right? We got Thanksgiving coming up here in the States, and we’re probably not going to have the same effect this year.
AM: Oh, God, no.
TN: Are there any other players, do you think, that are likely to fail as spectacularly as FTX has failed?
AM: I don’t think so. At this point, I think that the FCC is going to have to really crack down on the entire crypto space and really force these guys to be compliant with, your know your customer rules and whatnot. So that’s something, actually, Boris could talk about, but I think they’re going to have to do something drastic here with the whole space.
TN: Boris, I guess from a legal perspective, how much do these guys have to worry? Do you think Sam can get away with this?
BR: I just don’t. No, I don’t. I think that, you know, the issue, of course, is just going to be the chain of ownership, first of all, of all, these shell companies. Where’s the money? Where did the money go? Because the money’s gone. I think it was something I know that there were a lot of jokes. He went from 16 billion net worth to a dollar, and he can’t afford his verification badge on Twitter now.
I think there was specifically because he’s now requesting, what, 94 billion as a rescue package. Once you’re already, and today he officially announced today was that they were filing for Chapter Eleven. So that was the official name today after requesting 94 billion, which was already I mean, when you’re already at that point, it means that nobody’s keeping the book.
So first of all, just in terms of any kind of account, whoever the accountant is, if there even was an accountant tied to this, whoever was signing off on this needs to worry a great deal. It’s not just Sarbanes Oxley and everything related to that, but it’s just simply who are these accountants and who was actually keeping these books? Because these numbers that were being thrown out, putting aside that it was impossible for him to get any kind of rescue package that quickly. But that number, it’s a number that is simply not credible.
TN: I’m going to get really boring on you for a second. Most companies have a DOA delegation of authority, right? And so I would think that to transfer $8 billion, the delegation of authority would go up to the board level. Is that fair to say?
BR: Well, I mean, it should, because again, it depends how these companies are actually managed, right? Because these could be not under US law managed, board managed, or there could be LLCs involved here which are member managed or have separate managers or what have you. It should go to the board level.
And in any event, you should have the senior management sign off on the accounts, not just the account. Even though that’s the position with public companies now since Starbucks and everything else. But even when it comes to private companies, to have for sufficient transparency, to really have investors comfort, you would need to have that chain of control.
So the DOA would have to come depending on who actually the board would have to authorize the management to give the DOA either broadly upfront or specifically for a specific transaction as it would happen.
TN: Because of $8 million, that’s still a fair bit of money, right?
EM: There were several acquisitions that he made that were private companies with the tune of over a billion each. So I guess you got like two $1.5 billion private investment, 500 million here. So I guess that’s how that all works out.
TN: You would guess that those have to have board approval at some point, I would think.
BR: I’ve done in the past very discreet deals where it’s sort of like, we’ve already transferred 100 million for this property. Please paper all of that over retroactively.
I’m sure that that’s what happened here. In other words, there was a lot of money moving around, nobody papered over what they needed to paper over. And I would be surprised if there’s actually a chain where all of the documentation that was needed at each stage of the transfer was actually put in place.
I’m certain that money just moved around all over the place, which makes it now very hard to track because there’s going to be a very limited paper trail to find, which is going to be a problem for him and everybody who’s authorized per the corporate documents of these companies for having to move the money around. So it’s going to be multiple levels of potential liability.
TN: Okay, so I would guess also that everyone in every crypto company is probably also coming up with their policies, if they didn’t have them already.
BR: So what are the investors are going to start calling to talk major policies. But I think the bigger issue, and Albert sort of touched on this, is the fact that this is an exchange, fundamentally.
So the issue isn’t we’re talking about Bitcoin as a currency, but if you can’t trust one of the largest exchanges and I forgot that was it, it wasn’t Coinbase, it was one of the others that pulled out of an attempt to that’s a last minute shotgun. Binance. And that has a second and third order effect. So not only did this huge exchange fail, it was such a disaster that the Binance, which is one of the more credible exchanges like Coinbase and what have you, just simply said, you know, this is beyond saving.
So it could really have a cascade effect. I know some are calling it the Lehman moment for crypto, although Albert would say there have already been five or six of those.
TN: Right, well, and before we get too critical of FTX as an exchange, let’s look at the LME and the credibility of kind of traditional exchanges. So, I mean, it’s easy to point the finger at crypto exchanges, but the LME has done some pretty screwy stuff over the years. So I think we need to be really careful
of just saying, well, I know you didn’t say this Boris, but crypto exchanges do screw things. Other exchanges do screw things as well.
EM: might I mention, though, with the LME, they are now under the control of the Communist Party of China via HVX. Great. Who is running the show? Real competent folks at the CCP. Binance is even shiftier if you ask me, but we’ll see.
TN: Speaking of markets and crypto, Emma, can we talk a little bit about kind of markets and correlations? How are we seeing this crypto activity and how do we expect this crypto activity to kind of flow through into other markets, equities, commodities, other things? Obviously it didn’t hit equities yesterday and today, but it seemed to be hitting earlier in the week.
EM: Yeah, just as it was all falling apart, we saw a big risk off move in equities. We saw the Nasdaq coming down, we saw some weakness in oil that may have not had anything to do with the
fundamentals in the oil market. I would venture to guess or argue that it had more to do with the FTX sell off because there were several companies, including pension funds, that had significant exposures in FTX. So that oil related selling around the time that FTX all this broke. It may not have to do with the report, this actual EA report.
TN: So I’ve got a graphic from Tracy’s newsletter earlier this week where she talks about the funds and the investors that were deleveraging in oil because of FTX. BlackRock, Ontario Pension Fund, Sequoia, Tiger Global, et cetera, et cetera.
So there were some big players impacted by this and I can’t believe that it just impacted oil. I also have a hard time believing that it was a one time, say, 48 hours event.
EM: Yeah, I would think that. Not having done any diligence for a pension fund, Ontario Pension Fund,
like for BlackRock. I mean, I don’t want to call out too many names. We all know what SoftBank is about. They were intimately involved. There’s going to be a lot of problems and a lot of spillover that we’ll just have to wait.
TN: At the end of the day, I hate to say “only”, but in terms of global fund flows, it’s only $8 billion of retail money that was lost. It’s I say “only”, but, you know, it’s not a huge amount in terms of flows, but I just don’t know how much is in these funds themselves.
AM: Yeah, you don’t know how much the funds have lost and what they’re trying to make up and like yeah, sure, 8 billion doesn’t sound a lot, but in a market that’s so illiquid with a lot of these funds blowing up right now, it can be a lot. You don’t know what they’ve leveraged off of it.
EM: And what they might be being forced to sell as a result.
TN: So we probably haven’t seen the end of that. Fair to say?
EM: We’ll see a long restructuring or not restructuring Chapter Eleven. Not a restructuring, but a liquidation.
TN: Yeah, it’ll be liquidation.
AM: Discovery will be fun. See where all this money went to.
TN: Great, that’d be great. Okay, perfect. Anything else on markets and FTX and crypto? Are we looking at is this impacting, say, European markets or Asian markets? Since crypto has been so big in Asia, are we seeing impacts in Asian markets, like in China?
AM: I don’t think so. I think that’s really Binance’s territory at the moment. Right now, I think FTX was solely the US and Western Europe.
EM: I would think you would see an impact on Japanese investors as well, who own a lot. But just like, not the kind that puts out life insurance companies or puts you a lot of business, but more like retail investors getting screwed.
AM: retail investors have just been taking it on the chin for the last 18 months. It doesn’t stop. 30 years.
BR: Except for Warren Buffett and those who invest with him because yet again, everyone’s underwater, he’s up like 2.3%.
TN: Boris, say, can you talk us through the CPI print this week? Because it seems like CPI, the rate of rise of CPI slowed. CPI didn’t slow, but the rate of rise of CPI slowed. And so it feels like it kind of overrode the FTX worries and there was this huge cyber relief in markets for the past couple of days that we’ve kind of conquered inflation. And the Feds only going to raise by 50 in December, and then after
that we have some 25s. What’s your sense of that? Do you feel like kind of inflation is conquered? Is that base effects? Is that kind of core inflation coming down? What does that seem like to you?
BR: Yeah, I don’t think that it’s conquered. I mean, what’s interesting to me is sort of the degree to which all that matters is what the Fed may or may not do and trying to price in factional differences within the Fed. That’s how granular it’s now become. Because I think the markets were waiting for any reason, anything, to cling onto for Powell to reverse course and to after his very hawkish last meeting, where he said, ignore all of the pivot talk.
Essentially, you know, we’re going to continue to do this as effectively as long as it takes to see a sustained reduction in inflation over that’s defined. So he essentially was very angry and Albert and I were talking about this as well, that he was very angry by some of the Pivot talk from brainer than some other people yelling, was saying certain things. It looked like some of the more devastated member. And then Powell comes out and basically says, I don’t know what you’ve heard about any Pivot talk, we’re going to stay the course until we see more evidence of multi quarter reductions and declines in inflation.
But it looked like the market really was desperate to find a reason to not believe them and to hope that anything that might persuade him to in other words, the market is looking for anything to latch onto to have a pivot, even if we don’t actually get one.
So initially it was the official position, if you were even to read the kind of the superficial financial media was they were worried if we focused on the red wave, that was what was going to get the relief rally. Then we forgot about what was happening with the midterms. And now we have this softer inflation report that as you said, to slowed the rate while most of the slowdown was because of on energy, used cars and a couple of these other, in my view, short term fluctuations which are, I mean, to the extent that CPI has already been massaged to death.
Obviously the listeners of this podcast of course know that very well. If we measure inflation how it used to be measured from the 1970s on, we’d be in double digits. I mean, that’s just a fact. So taking even to the extent that they were able to massage it, what I saw here was the market latching onto the top line figure, hoping that this would block the Fed into doing what the markets want the Fed to do, rather than actually looking at what’s happening to the core and actually looking below the hood and the underlying trend.
That’s what I’m seeing. You also can’t have to take into account biden’s political depletion of strategic petroleum reserve. You have to take into account the unseasonably milder sort of late fall that we’ve been having, I think that’s been having an impact on natural gas prices which have this very sharp decline and now have rebounded a little bit.
Certainly that’s coming out of Europe as well, but I’m not seeing anything fundamental that would actually allow us to conclude peak inflation and sustained reduction inflation has been achieved. So I’m not saying that when it comes to energy, I’m not seeing that when it comes to food, I’m not saying that. I mean, the housing market is not doing well. I’m not seeing any fundamental changes in the housing market. Really. This to me seems like a short term story and the market overreact, in.
TN: My view at least, this is that’s great. So I’ve got on screen Sam’s from Sam Rines newsletter, the core CPI and all CPI items, just showing a bit of turnover there. So it could be encouraging to people who like lines. Right.
But if we look at the target rate probabilities for the Fed, which is the second item on the screen, it does look like we have from a 4.5 almost to a 5.5 target rate.
So that shows there may be ongoing tightening, say maybe into Q one, if we don’t see a dramatic continued decline in the rate of rise of inflation. Is that fair to say?
BR: Yeah, I think so. I think that it seems that the growing chorus is shifting from do what continue as long as it takes to fear of overtightening, at least outside of Powell and maybe one or two other people. And Albert really, I think, is the resident expert on FOMC, inside of baseball on that and sort of thinking, et cetera.
But once that rhetoric shifts to fear of overtightening, that tells me that they’re looking for any excuse to stop and to begin moving back. And that will just bring the inflation genie back out. Because again, these policies are being set by people who don’t fundamentally understand what inflation is and isn’t and what’s causing the inflation. So they’re looking at the wrong things still, in my opinion.
So none of the fundamentals that I’m seeing, as I said, that would really drive a sustained reduction in inflation have changed in that direction. And once if they do decide, as you said, Tony, if they do continue to tighten into the first quarter and then decide to do a sharp 180, that’s going to just bring everything back, if not make the situation even worse.
So they’re in a very difficult position and I think, as I said, there’s a lot of political pressure for them to move back, especially given what’s happening with these midterms, certainly on the part of Yellen and the bike administration. But I think maybe Albert can also chime in.
TN: Let’s talk about the Yellen Fed factor and also since she’s a labor economist, Albert, let’s wrap some of these layoffs that happened this week into that discussion.
AM: How coincidental that these layoffs come right after Midterms and after Yellen has done everything in her power to keep equities up so they don’t have to have layoffs until now. Well, now all the layoffs are coming. Like we’ve talked before, they’ll do this right before Christmas.
But also on the CPI and the inflation front, there are two glaring problems that they’re staring at the moment right now. How’s y’all going to deal with the Chinese reopening in March? Because that’s going to be really announced in February. They did a little bit about real estate today. They talked a little bit about real estate supporting the real estate market. And every Chinese name that was on my screen was up by 7%.
And then you talk about oil and then we have a big diesel shortage in New England at the moment and it’s leaking down all the way into the Southeast. And those are just going to add to costs across the board. And I don’t think that they understand how bad inflation can really get. They can only suppress it for so long with SPR releases and whatnot. But it’s coming to a head and I don’t think that Paul is going to be able to release. I think he’s going to have to do another 75 again.
EM: The thing that’s just disturbing to me about that is that, like, for instance, we are going to have a serious diesel shortage coming here currently and it’s only getting worse. Powell cannot fix that problem. So let’s just shoot the consumers even more like his policies. They’re not helping. Unless you want to completely destroy the economy and have a complete disaster blow up with Deleveraging and the whole shebang.
TN: Default rate in auto loans this week. Right. I can’t remember the percentage of people who were two months behind in auto loans.
AM: Skyrocketing wastelouses start kicking into that, too. Started kicking in. But just to touch on what Emo is saying about Powell trying to kick the teeth into the consumers from his perspective, he’s trying to do the right things, but he’s just not getting any help from yelling or other members coming out there talking about pivots.
TN: What would that look like? Help from Yellen. What would that look like?
AM: Well, she can drive the dollar down to Dixie. That rallies the markets pretty easily.
EM: Well, he doesn’t want a market rally, right? She can help.
AM: Powell does not want a market rally. Brainer and yelling did want to market rally for the midterms. So this is the problem that they have. There’s a civil war within the Fed and treasury that is just making these policies look even stupider than usual. And I know Powell is going to get the brunt of it because he’s the Fed chair, but he only has two other members that are on his side. The rest of them are against them. So he doesn’t really have much of a choice. He’s going to have to do 75 in December.
TN: Well you say he’s going to have to do 75 in December.
AM: He’s going to have to do 75 because we have a CPI print coming out December 14. It’s probably not going to be as nicely massaged as this one was. And on top of that he’s running out of time because the Chinese look like they’re going to stimulate in February, March.
TN: Yeah, you’re right. I agree with the timing on China opening and Chinese stimulus in the meantime is going to be really ugly in China. Do you think that it’s possible that there’s some sort of regulatory relief especially for energy that allows, eventually allows more US. Supply, this sort of thing? Or are we too far down that path with the current administration?
AM: Me and Boris are bred from DCP, the Beltway guys, we’ll just laugh at anyone with the notion that think that anything is going to get done legislatively in the next two years.
TN: Okay, but nothing getting done legislatively is not terrible, right? At least we know the rules of the game and their content.
AM: Yeah, it’s not if there wasn’t problems but there’s glaring problems everywhere and things need to get fixed. So you need something from progress.
TN: Okay, let me throw this out to you guys. We have seen a little bit of move on CPI, whether it manipulated or not. We all kind of know it’s always in there a little bit. But what’s the timing on inflation coming back into a reasonable area? Let’s say five to six, I don’t know. Are we a year, two, three years from that, six months from now? What do you guys think? Emma, what do you think?
EM: If we’re ignoring energy and then we’re ignoring fertilizer prices and food prices, we’re looking at goods, those we may see services come down and wait the wage issue come down a little bit. Just like we’ve seen with auto delinquencies, used cars, these sort of things. You see numbers starting to roll over as demand destruction and liquidity has been pulled.
But I think you’re going to see the opposite in energy and you’re going to see diesel shortages which pushes goods prices up. Right. If every trucker in the nation has to spend a time for every time they fill up with diesel and they can’t even fill up enough, then there’s going to be not only a shortage of goods but goods prices will less go up.
I don’t see how we fix that situation. We only have extra finding capacity. It takes like 30 years to build a new one so I don’t see how that gets fixed. So that’s something that really looks like it would push inflation upwards. So if we add all that together, I’d say we’re going to have a problem with inflation for good at least another year if we include energy and food.
TN: OK, let me ask this. That’s a great answer. Let me ask this divorce, because I know I’m going to get an answer that doesn’t agree with what I think is there pressure to broker a Russia Ukraine piece? And if that happened, would that alleviate some of these diesel price issues?
BR: I think that there is. I know that Orban, for example, and Erdogan met and basically said to Zelensky’s, time to use this window of opportunity to start negotiating. So they liberated Kirstan today, which was.
They liberated Kirsten today, which was the one major city that the Russians were able to occupy and they were offensive earlier the year. So this is kind of a huge move with the Russians on the back foot. And these are people who are everyone is playing all sides.
And Orban, of course, is more kind of the one European leader that’s closest to Putin major leader. But I don’t think that the US is. I know that there was some discussion from the Biden administration about don’t be so categorical about Zelensky, about saying you’re not going to negotiate with Putin. It’s irritating African countries, South America, et cetera.
You have to start taking advantage. I don’t think there’s any pressure and will be in the near term, and especially after these midterm results, I think that the risk of any major, immediate cutoffs in military economic aid from the US to Ukraine are going to be somewhat subdued now, given the kind of the risk from right and left. So I don’t think there’s going to be any nearterm pressure on the Ukrainians right now to start looking at essentially trading land for some kind of an intermediate piece.
But as a side issue, there was some in terms of alleviating the diesel and the gas problems, especially in Europe, there was some discussion about Erdogan purchasing Russian gas at a discount and essentially creating an alternative for the Europeans through that pipeline that was being built basically through the Black Sea, et cetera.
And there was a lot of kind of talk in the US and some European capitals like Erdogan is going to save us because he’s playing everybody and he’s going to create a new gas hub in Turkey, as he declared with the Russian gas. What he’s actually going to do, and Albert and I were talking about this too, in my opinion, is because of Turkish elections next year, he’s going to keep the discounted gas, sell it at home, domestically cheaply, in order to drum up support for his reelection next year. He’s not going to resell that to the European.
So that life raft is not going to be sailing. So therefore, I think that unless there is some relief from the weather, I’m not seeing any, because I know that at that moment, because the weather was unseasonably warm to a large extent, you have this natural gas flood in Europe now, which has driven down natural gas price, at least in the short term.
Dutch and et cetera, the benchmark. But I don’t think that’s necessarily going to sustain. I think we could have a colder winter and Erdaman is not going to provide that relief. I know the Ukrainians are looking at alternatives themselves, but the Ukrainian economy doesn’t exist anymore, really.
Right now, we’re basically balancing their budget through direct cash transfers at the moment. I think it’s only going to be bad news and it will reinforce what Emma has said about her predictions about the diesel shortage and about just energy in general and how that would impact inflationary changes. So I’m not seeing any major improvement.
And also, in terms of the broader discussion on inflation, I also agree that, again, kind of what I said before to dovetail off of that, like, none of the fundamentals to reduce inflation have improved, have changed markedly. So we could be, it’s really, to me, a risk tolerance for recession on the part of the Fed.
When will the Fed decide that if they’ve given up on a soft landing, then we’re going to have one projection in terms of when inflation is going to start coming down dramatically. If they still are insisting on the fantasy of a soft landing, then there will come a point where they might decide.
Regardless of what happens with inflation, recession is a much bigger problem. And we’re going to have to, sooner than we had hoped, begin to pivot, which is probably not something that Powell would want to do, but that’s a recession versus a soft landing versus hard landing balancing act that they’re, I think, going to have to perform over the next couple of quarters.
And I think that’s sort of their near term focus and to kind of close that point off. Right. I mean, I think that the layoffs and I mean, the fundamentals are cooling, the economy is slowing. We’re seeing that with the layoffs, the housing market is going to get worse, in my opinion. Oh, yeah, it’s a disaster.
TN: Look at the MBS holdings at the Fed. They’ve just started to tighten them. They’ve just started. Right.
BR: But then you also have to take we talked about you said auto defaults for auto loans. What about credit card debt, consumer credit card debt? And also, what about the leverage that’s on the books of these companies? Why is the tech, which is tech at the tip of the spear? Why are we seeing all of them down 70%, 60, 70% on the year? Why are we seeing the layoffs hit tech massively? First, because they grew too much too quickly and are over level.
EM: They did refinance in 2021 when they had a chance. So they’ve got like a couple of years.
BR: I don’t know who’s advising Zuckerberg here and his colleagues. I think what we’re going to do is we’re not going to refinance, we’re going to double down on Meta, which we don’t really know what to do with and we’re going to double up on the head count dealing with Meta, on the Metaverse thing, that isn’t getting adopted the way that we would want it adopted. It’s like everything, every mistake that could possibly have been made from the financing to the head count to the rollout, and that’s happening across the tech sector, but we’re financing.
TN: Would you have done differently? I would have taken on all that too, because it was fun. I’m kidding. But I actually think that there are more rounds of layoffs in tech coming. I don’t think this is the only round. I think that in the auto sector, tony and auto and other guys.
So I think I was in Silicon Valley in 1998 to 2001. I know that’s ancient history, but my company went through six rounds of layoffs. I didn’t know when I say my company, the company I worked for, they went through six rounds of layoffs.
So I think all these stories about people at Meta thinking they were going to dodge it and all this stuff, I don’t think that I don’t think this is the only one. I think they’re going to have to do more in three to four months.
I think you’re going to see more companies bandwagon on top of this to say, hey, Meta is doing it and Stripes done it and all these other guys are doing it. So let’s use this opportunity to become more productive and we’re going to see a flood of these before the end of the year. Just a flood. I think the tech sector is going to be wrecked in terms of employment.
AM: Oh, yeah, without question. Even going back to your previous point about the Ukrainians and the Russians getting some kind of peace agreement, even if they did, that would solve the diesel problem overnight.
Even if they did that today, it would take a year, maybe 18 months until all that got rolling in again if they looked at the sanctions, because they still have to go through that whole process for all the countries.
EM: Russia doesn’t send us diesel heavy crude and then we have to process it at refineries, which are running at max capacity. Hence the crack spreads being so wide, we can only convert so much crude into distillates, which diesel of which is one of which jet fuel for planes is another, but both things that cost a lot of money when the prices of the input key input goes up.
TN: Okay, great. Let’s do just a really quick round the week ahead. What are you guys looking for for next week? Albert, you go first.
AM: I’m actually going to look at to see what the House majority and Senate majority makeup comprises of and whether the markets are going to react negatively towards it. Because if the Republicans, I know they’re going to take it, but when they get announced that they take the House, the stimulus packages all but die at that point for two years. So I’m very curious to see how the markets react to that.
EM: I’ll be continuing to watch what’s going on in Crypto to see if anything’s happening with Bitcoin ethereum, because we’ve already seen a lot of other tokens just literally, basically go to zero. So just see how that continues to play out.
TN: Great. My $20 a DOJ is still at, like, three times where I bought it at, so I’m just holding on to it just to see where it goes.
EM: And then I’ll also, obviously, as usual, be watching China and certainly the bank of Japan and just the end period.
BR: Yeah, like Albert, the makeup in Congress and also going to be looking at some of the emerging markets. I think maybe if we’re going to get more evidence out of China as to when they’re still pursuing COVID Zero, I think they’re now recording again, like, a record high number of cases from April. It’s not working yet. They’re continuing to double down and reward everybody who’s pursuing that.
So I want to see if they’re going to continue with that and they’re going to be on track for what Albert said to reopen early next year or if it’s just going to get worse. So that’s what I’m going to be focused on.
TN: Yeah. You’ve heard of the great league forward, right? I mean, these don’t really take sound policy advice. When they get their mind on something, they just push it and push it and push it until it harms everybody they can.
EM: I often when you’re trying to when you have, like, the worst debt crisis ever and the population that’s, like, you know, put the equivalent of $50,000 down on apartments, like, millions of people have done that, and they’ve got nothing to show for it, and you want to keep them from acting out and protesting in the streets. It’s pretty convenient to have them all segregated where they’re not communicating. I wonder really what the motivation behind COVID Zero is. And so I don’t know if I buy that it’ll ever end until it’s convenient for it to end economy wise, where she feels no threat.
TN: I don’t necessarily disagree with you. I think things in China don’t necessarily end until they want them to end. Right. And if you look at exports from China to the US. They’re back up to preCOVID levels now. So in terms of that export machine in China, it’s humming, right? So there’s not feeling economic pain, at least in terms of trade.
So if they’re comfortable feeling the domestic economic pain, then why would they stop? So I think what Albert talked about is Code Zero ending in March, and he and I’ve talked about that a couple of months ago as well. I think that’s the best case. So I think there’s a best case that they end it and they stimulate in March, but it’s quite possible it continues going on because there may be social reasons, there may be other reasons to not open up.
So I don’t think, as westerners, we can look at the Chinese government necessarily and understand the perspective they have on policy and the reasons they have for policy. There is so much inside of Jungkonghai and all of the different things that happen that we just can’t look at it rationally and say they should do A, then B, then c, and very few Americans can look at that and understand why and how it’s happening. You may be exactly right.
EM: Yeah. It’s not a logical I mean, it’s more like if I’m she or if I’m trying to do this, it’s not really like what westerners typically associate as logical things to do economically. It’s more like it’s possible.
TN: Yeah. Anything’s possible. Guys, thank you so much. I really appreciate the time you took to talk through this. Have a great weekend. And have a great weekend. Thank you so much.
In this episode, we’re joined by Isaac Stone Fish, who is the CEO of Strategy Risks. He’s the author of a book called America Second, and he lived in China for seven years.
We talk about how are foreign companies dealing with the political changes in China? Or what should they be paying attention to? We’ve seen changes in Xi’s team that, to be honest, weren’t all that unexpected, but seems unexpected anyway. It’s certainly a hard turn to the CCP’s commie roots. This tweet really underscores how desperate Xi is to set an old school tone.
Markets have seemed a little spooked this week, so we saw orders from Beijing to prop up the CNY and Chinese equities, which didn’t work all that well. But with all the political and market backdrop, what does all of this mean for US and other foreign businesses? Are foreign employees at risk? Do we expect direct investment to slow down?
On the risk side, we look at tech earnings, which are super bad. Hiring is a huge issue and tech firms seem to have been hiring based on their valuation not based on their revenues. When will we see headcount reduction announcements? One of Meta’s investors was saying they should cut 20%. Albert shares his views on this.
And we’re also looking at crude oil inventories and refined product inventories. They’re way below averages. We saw another draw on global inventories this week. As OPEC supply is contracting ~1.2m bpd. Russian crude sanctions start soon. And US exported 5.12m bpd last week, making it the 3rd largest crude exporter. We know global inventories are low, but when will it start to bite? Tracy shares to us what’s going in.
Key themes
1. China risk for Western companies 2. Tech earnings & China 3. Crude inventories & Asia stockpiling
This is the 39th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
0:00 Start 1:00 Key themes for this Week Ahead 2:52 What the news about China means to Western businesses 6:38 What has changed around the concept of Communist Party membership over the last ten or 15 years? 8:20 Anybody who’s overseeing a business in China has to understand modern Chinese history 9:31 Risks for foreign staff in China 12:34 Congress does not want US companies to do business with China 14:14 Danger of a rush to the exits in twelve months 17:58 Tech earnings are super bad – how bad will layoffs be? 21:10 Is it possible to cut 20% of Meta’s workforce? 22:44 China and US competition in India and other countries 24:52 Crude inventories – when will this start to bite? 28:31 Japan is stockpiling crude – is it because of geopolitical concerns? 29:47 China stimulus – will they do it in February? 31:55 What happens to the crude demand of Covid Zero ends? 34:27 Will oil prices raise by 30% before 2022 ends?
Transcript
Tony Nash: Hi, everybody, and welcome to the Week Ahead. I’m Tony Nash. Today we’re joined by Isaac Stone Fish. Isaac is the CEO of Strategy Risks. He’s the author of a book called America Second, and he lived in China for seven years as the New York Times in New York Times bureau. So we’re really lucky to have Isaac with us. We have Albert Marko, of course. And Tracy Shuchart. We’re very fortunate to have them again today with us.
So, Isaac, welcome and we’re really happy to have you.
Our theme today that we’re going to talk through first is how are foreign companies dealing with the political changes in China? Or what should they be paying attention to?
On the risk side, we’re looking at tech earnings and the impact that tech earnings will have on other earnings and headcount reductions and other things over the next few months. And we’re also looking at crude oil inventories and refined product inventories. They’re way below averages.
And we want to hear from Tracy as to what’s going on.
Please take a look at our product, CI Futures. It’s a forecast subscription product. It’s $99 a month. We cover a few thousand assets over a twelve month horizon. Economics, currencies, commodities, equity indices. So please take a look at that. The URL is on the screen. Thanks a lot for that.
So, Isaac, welcome. Would you give us a quick overview of what Strategy Risks does?
Issac Stone Fish: Strategy Risks works with corporations and investors to help them manage and reduce their China risk. And with increased tensions between the United States and China, and growing awareness of the liabilities in both China and the United States of working with the People’s Liberation Army or the United Front or the Ministry of State Security or the Chinese Communist Party more broadly, it’s been a good couple of months for us.
And so excited to be joining you and chatting with you on these issues.
TN: You must be working 24 hours a day. I have no idea how you stay, how you get any rest right now with all the stuff that’s going on in China.
ISF: Under drugs right here.
TN: Isaac, I’m curious, with all of the political changes announced this week, of course, that’s been way analyzed, a lot of different perspectives on things. I would warn people as they read through that analysis, just be careful of kind of some anti China bias, but we have to kind of read things for what they are too.
We saw changes in Xi’s team that, to be honest, weren’t all that unexpected. People have talked about this for months, but the fact that he actually carried through with it, I think made people feel like it was a little bit unexpected.
But it’s certainly a hard turn to the CCP’s communist roots. I’m showing a Tweet right now looking at Xi taking his team to pilgrimage where the long march ended during the Communist revolution. And so he’s just the optics around the hard turn to the party’s communist roots are front and center.
So Isaac, markets were spooked this week. Of course, we saw orders from Beijing to prop up CNY and prop up Chinese equities. Obviously didn’t work very well. But with that backdrop, what does all this mean for US and other foreign businesses? I know it means a million things, but if you had some top level takeaways, what are the things that you’re seeing that it means for, say, US and other foreign businesses in China?
ISF: Have a really good understanding of leftist ideology. If you decide that you want to stay, which oftentimes we discourage, and if you decide that you don’t want to reduce your exposure, which we always discourage. Have a really good understanding of how Communism works, and read the tea leaves. Spend a lot of time on analysis. Understand that every Chinese company or every company in China that has at least three party members has to have a party cell. And for a long time people overlook that law.
But companies like Alibaba have tens of thousands of party members. So understanding that you’re partnering with the Chinese Communist Party and things that you used to be able to get away with, you can’t anymore. I think the other high level take away is with increased media, consumer and congressional scrutiny on China.
What happens in China doesn’t stay in China. So the work that you do with a major Chinese charity which does say party building exercises in Chinese orphanages, aka Brainwashing Chinese Children on Party ideology, we can get that information here. Congressional staffers can read that, journalists can pick that up, and you’re going to have to start dealing with the liability of that from a PR perspective. The final highlevel takeaway, the more Xi marches to the left, the more draconian things get. And the more saber rattling we see with Taiwan, the more likely it is that the US and China go to war over Taiwan.
Right now, I would say that’s still not the base case. War is very avoidable. It probably won’t happen. But it’s a very concrete risk and investors and I would argue especially boards of major corporations, need to be discussing this risk. And perhaps the best thing to do with the risk is to say, okay, we know this, we’re not going to change.
But I think if there is a war, companies are going to have to face some pretty serious shareholder lawsuits because it’s a viewable risk and you didn’t do anything about it.
TN: Right. So let me ask you, take two questions. First is, in 2010 or ’11, I spoke at the Central Party School in Beijing, and the person who drove. I was giving an economic update. I was working with the Economist at the time, and it was so surreal for me. The person who drove me to that event was a venture capitalist. And so I think the view that many people have of Communist Party members is, oh, you know, they’re these soft guys, they’re capitalists like us too, you know, that sort of thing. What has changed around the concept of Communist Party membership over the last ten or 15 years?
ISF: Think of the perception. So when Rupert Murdoch in early 2000s was going into business in China, he would downplay the importance of the Communist Party and say things like, oh, they’re just like us, there’s really no difference. And some people just join the party for opportunistic reasons, and some people do it because they believe, but they’re fairly soft spoken and gentle. And then there’s the very hard security element of the party.
And I think people are realizing that for every venture capitalist, there’s also the PLA secret agent or the MSS agent or the public security agent in that these people are increasingly important in the Chinese system.
And the other piece of it is that it used to be seen from a Western context, both PR and regulatory, relatively benign to be working with party members in the Communist Party. But after the genocide in Xinjiang, after Xi’s increasing authoritarianism, people are not getting the pass that they had before when you and I were out there.
TN: Right. And so I think it’s really critical. Anybody who’s overseeing a business in China has to understand modern Chinese history. You have to start from the great famine, really. I mean, start from the revolution, but really the great famine through the Cultural Revolution, through the 70s, through Deng Xiaoping, through… That era is really critical to understand what’s happening today. Right. Because that’s when Xi Jinping grew up and that’s when his ideologies were formed. Is that safe to say?
ISF: Good is safe to say. I think the other thing that we have to understand is we do have to be incredibly humble about our ability to understand what’s going on at the top of the party. We have very little idea. People are going to keep speculating about that crazy video with former Chairman Hujing Tao. We probably won’t know what happened there for decades, I would guess.
And I think when we talk about war with Taiwan, we talk about what’s going to happen between the US and China, we have a lot of insight into how Biden thinks and almost none into how Xi Jinping thinks. We just need to bake that into our predictions.
TN: Yeah, that’s absolutely right. And I cautioned on that earlier this week about the Hoojin Tao exit. It could be health, you don’t know. Right? It could be intrigue. You don’t know. So none of us know.
So let me also ask you, when you talk about you had a tweet about potential China-Taiwan war earlier this week, and you talked about Chinese staff for American companies or Western companies, sorry, and you talked about Western staff in China. So can we talk about some of those risks, like the real people risks for multinational companies who hire Chinese employees. And none of this is intended to be Xenophobic.
This is intended to be purely practical in understanding really what the risks are. And also with those foreign staff in China. Can you help us understand some of those risks?
Tracy Shuchart: Yeah, I was going to ask something along that line, if I can just tag on my question to that one. We saw a bunch of people who are Americans pulling their staff from Chinese chip companies right, lately. So I was wondering if you saw that, see that trend continuing and bleeding into other sectors besides just the tech sector.
ISF: I very much do, and I think there’s two ways to think about this. One is the economic and regulatory so increasing difficulty doing business in China, desire for localization of staff, Biden regulations that restrict the ability of Americans to work at certain Chinese chip companies. And then you have the potential for war.
And the idea is that if the US and China go to war, American staff in China and also Chinese staff for certain American companies could be seen as enemy combatants. And we saw this with Afghanistan, we saw this with Ukraine. There’s orders of magnitude, more staff for Western companies in China than in these places. I mean, it’s not even comparable, the numbers.
And I think from an ethical perspective, I get really worried that people don’t talk about war because then war could just be on us. And the United States has a terrible history of interning Japanese during World War II and harassing Germans during World War I. I think with the dynamic with Chinese people here, we need to have a concrete conversation about it so that we can defend the rights of Chinese and Chinese Americans in America if we go to war.
And from a corporate perspective and from a risk perspective, companies need to have exit plans for their staff in China because they’re going to be dealing with major, major ethical and insurance risk issues if this happens. And they can’t just take the foreign staff out to Hong Kong anymore. Because that’s not like a free zone anymore. And you hear stories of people being smuggled out now, and I think we’re going to hear a lot more of those, and that’s going to be more and more common.
TN: So, Isaac, what are we missing when you see the discussion about China right now and with American businesses, what are we missing? What’s not being discussed that you’re like, Gosh, I can’t believe people don’t see this.
ISF: Congress does not want American companies to do business in China. And with the UFLPA, the Uighur Forced Labor Prevention Act, we talked to a lot of corporates about that, and they don’t seem to understand how to comply with the law. And that’s the point. It’s a law that’s meant to deter behavior as opposed to shape behavior.
So it’s okay, we can’t invest in Xinjiang, but this company that we work with, has a branch of Xinjiang. Well, don’t work with that company. And I think the American political calculus of this too.
People don’t really get Pelosi’s trip, I think didn’t really bake into corporate behavior in the way that it should have because people think this is a Republican issue. They hear Marco Rubio, they hear Ted Cruz, they hear some of the awful remarks that Trump made, and they don’t realize that Nancy Pelosi and Chuck Schumer sound almost exactly like Rubio and Cruz on these issues. They think it’s a Republican issue. It’s not a Republican issue. There are holdouts on the progressive left, there are holdouts on the libertarian right. But the US is pretty united about this from a government perspective.
It’s just not from a business perspective. And that’s fine. You can have that discordance. But businesses need to understand main street and Congress feel very differently about these issues than they do.
TN: Yeah. So one last question on this. Unless Albert, Tracy, you guys were going to come in, but do you think we’ll see publicly traded American companies disposing of their China units with say a Hong Kong IPO?
I mean, I know this is an old idea, but better than nationalization, at least they can get some value of it. And I think of like a GM or something like that, right? It’s a huge business for them. So they could potentially either have that nationalized or they could make it public on the Hong Kong stock exchange or something.
So do you think we’ll see more of this? Young Brands is the one that everyone knows about from ten years ago or whatever, but do you think we’ll see more of this? And if people don’t do it now, is there a danger of a rush to the exits in say twelve months?
ISF: I think that’s an excellent point. Ping on, which is a major shareholder of HSBC, suggested HSBC break up into two different banks, one headquartered in Hong Kong to focus on China market and one of the rest of the world.
And companies like Boeing, which has an airplane business that I think it’s something like 14% to 18%, goes to China, specifically the Chinese Communist Party and then has a very important government contracting business which is increasingly at odds with its relationship with the Chinese Communist Party and need to start considering these issues.
I think you’re right also on the timing, these things take a lot of time and companies are very private with them for obvious reasons. So if they’re considering them now and we’re going to see announcements on it and it doesn’t require that much scrutiny from Cyphius or the Beijing’s regulatory Agency or other Beijing other Chinese agencies, I can see these things happening.
I think if companies are starting to think about it now, it’s probably too late. I think years process. But in the same way that nobody wants to talk about war, nobody wants to talk about spinning off their China assets.
TN: Right. But you either do it now or it gets nationalized. Or you do it for $0.10 on the dollar in a year or two years.
ISF: I think you’re exactly right. And Tony, we should write something on this, and I think this is a good time to talk about this issue.
Albert Marko: Okay. There are other issues. Capital flight out of China, even if you decide to list in Hong Kong, is like, where’s the money going to come from? It’s not going to come from the west. Even the Chinese are starting to take their money out into Singapore and Macau and anywhere else they can get it out of at the moment.
But I agree with Isaac on 90% of what he’s saying. I don’t think that war, Taiwan is even a remote possibility in the next ten years, to be honest with you. The pilot bureau, Xi is inspired politburo. It looks scary. There’s no question about that. And the Western companies need to take a look at that because it reminds me of the Nazis from the 1930s.
Now, I’m not talking about what the Nazi crimes were, but just the mobilization of the country and the nationalization of corporations and then starting to boost the economy internally. It’s most likely going to start happening, and they will nationalize companies that they see are instrumental for their vision going forward.
TN: Yes. I mean, honestly, I don’t know why anybody related to SAIC Shanghai automotive. Why would that not become the property of SAIC? If they’re really taking this nationalist bent, that’s a real risk, right? I think so. Any of these guys really need to pay attention and really start to evaluate what is their path going forward? What is their path for Chinese staff? What is their path for foreign staff there? What is their path for IP that’s shared between those units? These are real head scratcher questions.
Okay, Isaac, thank you so much for that. This is so insightful. I’d love to spend 2 hours with you on this, but we’ve got to talk about tech earnings.
So, Albert, tech earnings are super bad, right? Super bad.
AM: Super bad is an understatement.
TN: Yeah. Horrific. It’s a tech wreck, all that stuff. So we can talk about what missed and kind of we all know what’s missed. That’s been analyzed over the last 24 hours or say a few days or whatever. But I guess what I’m most interested in tech is staffing.
So the vacancies in the US. Workforce has been a big issue for the Fed. Okay. And I’m showing right now on the screen that the Meta’s stock price from $350 all the way down to I think it was $97 yesterday, just over one year. It’s incredible, right?
So a lot of these tech firms have been over hiring. They’ve been putting out job wrecks for things that they where they just want to target one person and they don’t really want to target the job and all this stuff. They’ve almost been hiring based on their valuation rather than their revenues. So in terms of those productivity metrics, do you think we’ll start to see headcount reduction in tech? Or they’ve been saying, hey, we’re just going to slow down our hiring.
So do you think they’re going to stick to only slowing down their hiring? Or do you think we’re going to see this kind of tech halt and kind of shrink the tech workforce?
AM: Oh, absolutely. You got to shrink the tech workforce. But that’s not going to come till after midterms. I mean, nobody wants to be in the line of sight of Biden’s firing squad over firing 10 thousand people just before midterms happen. But afterwards you will. Probably after Christmas, you’ll actually start seeing quite the number of job layoffs in the tech industry.
TN: Every time I’ve worked with a tech related firm, the pink slips come literally the week before Christmas.
AM: Yeah, you know what I mean? I don’t think that people understand how bad these tech earnings are. Right. We can note Facebook and Amazon and whatnot, but they had tailwinds of inflation of an extra 10% because CPI, they say 8%. It’s really like 20%. So they had an extra 10% baked into their earnings that people don’t really catch. Right? And even with that, they’re down 30, 40%.
Amazon lost 25% in two days. Amazon. These are just astronomical. Which is a solid company. I love Amazon. I don’t have any… Company. Yeah, it is a solid company. And I like Amazon, I like the tech, I like the delivery service. And everything they do is correct. But I mean, realistically, they were, them and along with another dozen tech names were so over inflated for the last two years because the market just kept pumping up to just the high heavens that this was just I mean, it was an easy call that tech had to come down.
And on top of that, tech is based on zero rates. We’re not going to see zero rates for years.
TN: Right, that’s fair. Okay, so, you know, one of the hedge funds, I can’t remember who, was pushing Meta or Facebook now, I guess, again, to cut 20% of their workforce. Do you think something like that is possible?
AM: And it sounds like a lot, but given what’s happened with their valuations, do you think a 20% cut is possible? Do you think more or less is possible? And 20% is a lot. Usually when you have over 12%, you start looking at a company as going into bankruptcy. That’s one of the signs that you look at. So 20% is way too much. I don’t think that’s going to happen. Maybe seven to 10% staggered over the next few years.
TN: Okay, that’s fair. But I mean, they hire a huge number of people. What that would do to wages in tech would be immediate, right? $300,000, 22-year-old dev, that would be gone.
AM: Well, yeah, that cuts into the state’s budgets also because they take those tax revenue and whatnot. The other thing that we should talk about is China’s mix with the tech industry. I mean, now that the US congress, like Isaac was saying, is actively trying to prevent companies to go over there, I don’t know where tech earnings are going to come from. I just don’t see it. They’re taking away massive market share. They’re taking away supply chains and semiconductors and everything. I don’t see any silver lining in tech for the next two, three years.
I think they need to run size their organizations and really focus. Plus there’s more competition in the ad market, so you’re not going to see ad rates necessarily rise from here for some time.
So, yeah, I think there’s a lot of headwinds. I actually have to get Isaac’s opinion on this one is no one is talking about the tech industry in China competition with American companies in countries like India. Right? Because you have Chin Data and a couple of other countries that are massive and makes generate a ton of cash out of there.
And nobody’s talking about the competition level in India between the two. And I don’t know if you’ve heard anything, Isaac, but like, that’s something that I wanted to start looking into.
ISF: I think that’s an excellent point, is it doesn’t get nearly enough attention. And the market for the rest of the world for most of these companies is larger than the market for the US and China combined. There are a lot of contested spaces, especially in countries like India, Brazil, Indonesia.
And I think the lens through which we should see it is the political battle between the US and China because both countries are really pushing all of these third countries to be more sympathetic towards their way of view because so many of these tech companies can be hobbled by regulations. We see that with Huawei. We see that a lot in India where there’s a lot of distrust for Chinese tech companies, a lot of restrictions on the ability of Chinese tech companies to operate.
And so it’s protectionist, but it’s good political warfare for both sides to be making these arguments in countries around the world. And it is good business for these companies to be spending heavily on government affairs in all of these companies, in all of these countries and figuring out how they position their relationship with the government, whether it be the Chinese government or the US.
AM: Yeah, and that’s something I actually criticized the Biden administration that they’ve been so hard on India about using Russian tech and Russian oil. It’s like, come on, you guys got to be a little bit pragmatic here. You know what I mean? They’re stuck between a rock and a hard place with China and Pakistan.
TN: True.
ISF: I think that’s a great I mean, they buy huge amount of weapons from Russia, and they buy those in large part to defend against China.
TN: Yeah, very good. Okay, great. Thanks for that, Albert.
Now, Tracy, let’s move on to crude inventories. I’ve got a Tweet up where you talk about there was another draw this week.
And we saw a draw on global inventories. As we have inventory drawdowns, we have OPEC supply contracting by what, about 1.2 million barrels per day, something like that. Russian crude sanctions starting. We also have with the SPR, it was interesting to see the US became the third largest exporter of crude, I think last week or something, with over 5 million barrels per day because of the SPR draw.
So we know global industries are low, but when does that start to bite? I feel like the easy answer is well, after the SPR stops, right? What more to the story is there?
TS: I mean, I think it really depends on where you are. I mean, we’re already seeing the SPR. Those draws are kind of dwindling down, right? We’ve gone from about seven, 8 million barrels per week to 3.5 million. Even though that’s still a lot. That’s been part of the reason why we’re exporting, because we kind of, first, we were drawing down sour crude because that’s really what US refiners need. But at some point, that’s almost gone, so we had to start releasing sweet crude, and we can’t do anything with those barrels. And so they are making their way to China, they are making their way overseas.
And that’s why our exports have increased over the last few months there. In particular, we’re kind of seeing an uneven balance where we’re seeing global inventories are drawing, still drawing, right? US inventories are drawing, by all intents and purposes. I mean, we had, what, a 2.8 million build, but we also had a 3.5 million SPR release and an adjustment factor of 15.8 million barrels. Technically, we are drawing. And really, if you include the SPR, we had a draw of 5.9 million barrels total crude plus products this week.
But we are seeing what’s interesting is we are seeing Japan. Their stocks are actually going up because they’re stockpiling mad right now. So they’re buying everything from everybody. It’s stockpiling, and they were giving subsidies for companies to buy that in their SPR. So Japan kind of had a different kind of way of looking at things and the rest worlds just dumping. But they’re literally stockpiling.
China did stockpile for a while, but really their SPR is down, obviously, from the 2020 highs. They’re not stockpiling as much. But with China, I know that there are many problems going on there, but if they increase those import quotas for the Teapots, then we’re going to start seeing them by a lot.
TN: By Teapots, you mean the small refinery?
TS: Is just correct, because they’re talking about possibly raising those import quotas. But we won’t really find that out until December, and that’ll be for into 2023.
TN: Okay, so just a question on both, well, in Japan, first of all. With the yen at these dramatic lows, they’re stockpiling and it’s hugely expensive for them. It’s not just kind of incidental decision, this is a really intentional decision for them to stockpile. So are they partly, do you know, are they partly stockpiling
on geopolitical concerns?
TS: Yes, absolutely. I believe so. And all around, because we really saw them that sort of started to kick off in March after Ukraine invasions. Same with LNG, right? They’ve always been huge importers of LNG, the world’s largest, but they’re importing even more because they’re kind of seeing what’s happening in Europe right now and they don’t want that to happen to them.
AM: I think it’s a little bit more than that. Also, I think that they see that we’re probably even got cues from the US that Japan is going to be a manufacturing hub to try to pick up the slack from China. So I think they’re preparing for that in 2023, 2024. And on top of that, the price of oil right now, that’s still discounting China not stimulating because once China stimulates, the demand is just going to skyrocket.
TN: Okay, all three of you guys want to ask about that China stimulus. So you guys all know China Beige Book, and they’ve been saying everyone’s really foolish for thinking China is going to stimulate, and they’ve been saying that for something like six months. Right? And I hear a lot of people say, oh, they’ll stimulate after the Party Congress. I said that too, and we still haven’t seen that. Do we think that we’re going to see stimulus in China, say, before Chinese New Year, which is what, February?
ISF: I would say absolutely not. I think the real stimulus for the Chinese economy, too, will be less a government led infusion of capital and more a relaxation of COVID concerns.
And I think that’s going to be a lot more likely after Spring Festival than after the March Congress because, A, you have the appointment of the premiere, you have some important events there, but you also don’t have to worry about mass contagion with hundreds of millions of people wanting to travel.
So I think the base case for the opening of the economy and then potentially economic inflation is after the Congress, after Spring Festival. And who knows, it’s very hard to predict, but that would be my best guess for that.
TN: I think that’s really solid. What do you think about that?
AM: Yeah, I think COVID Zero policies are going to be still in place until March. There’s no question about that. I think stimulus happens around the same time that they think that inflation is under control. I think that’s pretty much their driver at the moment, because if they stimulate price of copper and oil and everything in the country is going to go to the moon and they know this. So I think it really depends on inflation. What the US can do to tame it.
TN: So when do you think they’ll think that inflation is under control?
AM: I think close around March after the US. And also the end of quantitative tightening and whatnot. So it’ll probably be a coordinated effort.
TN: Okay, so Tracy, if they just let go of the lockdowns, what does that do to crude demand?
TS: Well, definitely we obviously start to see that rise because they’re locking down millions of people at a time, you know what I’m saying? An entire city, and not for a couple of days. We’ve seen some cities lock down as long as two months.
So I think as soon as they start relaxing that we’re definitely going to see demand come flooding into the market.
And again, China hasn’t really been stockpiling this whole time during this, which they have a little bit from their lows, if you look at their SPR, but not a lot. Not as much as everybody thinks they are. Everybody thinks they are because oil prices are lower and they like lower oil prices. But really, comparatively speaking to how they purchased in the past, the SPR hasn’t been as much as most people think.
AM: Okay, do you think that they could be? First of all, I don’t trust the data of China. I don’t have anything.
TS: Well, what we can see from satellite systems, right? We have no idea what their underground storage looks like or anything of that nature. But what we can tell and what we can track, what’s actually going into the country.
AM: Do you think that they can hide that in tankers on the sea for a while?
TS: Yeah, absolutely. I mean, they’ve been known to do that before. Absolutely. They’ve used Myanmar,
AM: Singapore also, I believe.
TS: Well, Singapore is a little bit harder to hide just because it’s so huge and so many people are tracking vessels there. So they kind of like to kind of stay away from there when they’re kind of trying to hide stuff.
But definitely, I mean, they’ve, you know, hidden purchases from Venezuela through Singapore, through other ports in that area. From what you can see from the best guess. From the best guess, what you can see, what you can tell what satellite services have picked up, like Kepler or whatever.
TN: OK, let me kind of close up with this question. So I just filled up with gas in the US last night and I posted this price in Texas is $2.95. So I’m sure you’re all jealous. I said, will this be 30% higher by the end of the year? Because post election, SPR releases stop, other things? Do you expect gasoline to rise, say, as much as 30% before the end of the year since SPR release and other things are stopping? Or do you think we’re kind of in this zone that we’re going to be in for a little while?
TS: Well, I think that generally this is kind of lower demand season anyway, right? I mean, usually typically we don’t see prices really start to rise again until about mid December, just seasonally speaking, right before the holidays. Christmas in particular, and everybody goes on vacation, et cetera, et cetera.
But I think, I don’t know. 30% might be a lot for this year, but definitely for next year we’re going to have some problems because they took that last 10-15 million barrels and they pushed that out for December, so we’ll still have some releases then.
So I think they did that it was actually 14 million barrels that are left and so they did push those out until December. So they’re kind of going to triple it out in order to kind of control prices.
TN: Okay, so the selection bias for people telling me that I was right is wrong.
TS: I think it’ll probably depend on where you are in the country, you know, depending on the state. Yeah, absolutely. I mean, if you’re in the Northeast, you’re going to have a huge problem, right, because they have the same issues going on that Europe. They don’t have any pipelines, they don’t have any storage, and they don’t have any refining capacity.
So this winter, especially with the diesel shortage, you’ll probably see the highest gasoline prices, obviously in California and then the Northeast will be the next higher.
TN: And I just want to say to everybody, I’m not promoting the gasoline price as a reason to move to Texas. I mean, it’s all scorpions and rattlesnakes and really terrible bagels here, so please don’t move here. It’s just an incidental benefit of living in a place that’s a pretty rough place to survive.
So anyway, guys, thank you so much. Isaac, really invaluable. I don’t think we’re going to gotten this perspective from anybody else on earth, so I really appreciate the time that you spent with us.
Albert. Tracy. Thank you, guys. I always appreciate your point of view. So thanks very much. Have a great weekend. Thank you.
It has been a terrible week in markets. It is not looking good for anybody, at least on the long side. A lot of that seemed to change when the CPI number came out. It’s like people woke up and terminal rate is going to be higher and just everything flushes out.
We talked through why the dollar is where it is and how long we expect it to stay there. Brent Johnson recently said that the USD & equities will both rise. And so we dived a little bit deep into that. We also looked at crude.
Crude’s obviously been falling. Tracy discussed how long is that going to last.
We also did a little bit of Fed talk because the Fed meets this week. And we want to really understand when does the Fed stop? After last week’s US CPI print, the terminal rate rose from 4% pretty dramatically. Does QT accelerate?
Key themes: 1. $USD 🚀 2. How low will crude oil go? 3. When does the Fed stop? 4. The Week Ahead
This is the 34th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Time Stamps 0:00 Start 1:20 Key themes for this episode 2:24 What got us to stronger USD and will it continue to rise? 8:29 Dedollarization 10:23 Intervention in the dollar if it gets too strong? 12:22 Both the USD and US equities will be rising? 14:18 Crude: how low can it go? 18:03 Look at the curves for crude 19:17 Slingshot in December? 20:18 How India and China buys Russian oil and resell 21:33 Restock the SPR at $80?? 22:57 When does the Fed stop raising rates? 29:33 What if Russia, Ukraine, and China don’t lock down anymore? 32:08 What’s for the week ahead?
Listen to the podcast version on Spotify here:
Transcript
Tony Nash: Hi everybody, and welcome to The Week Ahead. My name is Tony Nash. We’re joined today by Tracy Shuchart and Brent Johnson. So thanks guys for joining us, really appreciate the time to talk about what’s going on in markets this week and next week.
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So, Brent and Tracy, it has been a terrible week in markets. It is not looking good for really anybody, at least on the long side. And so a lot of that seemed to change when the CPI number came out. It’s like people woke up and we’re like, oh no, the term rate is going to be higher and just everything flushes out, right. And earnings and a bunch of other stuff. So we can go into a lot of specifics. But one of the items that I’ve been really curious about for weeks, if not years, ever since I met Brent in 2018, 19, is the dollar. So we’re going to go a little bit deep into the dollar today.
We’re also going to look at crude. Crude’s obviously been falling. So we’re going to ask Tracy kind of how long is that going to last? And then we’re going to do a little bit of Fed talk because the Fed meets in the week ahead. And I want to really understand kind of when does the Fed stop.
So those are our key themes today.
So, Brent, welcome. Thanks again for joining us. I’d really like to talk through the dollar and we are where we are, which is amazing. And you have seen this years ago. On the screen, I’ve got a chart of our CI Futures forecast which shows a dollar continuing to rise over the next year. We’ve got some bumps in there, but for the most part we see a persistently strong dollar.
CI Futures provides highly accurate commodity, equity, currency and economics forecasts using advanced AI. Learn more about CI Futures here.
So I’m curious what got us here and what will continue to push the dollar higher?
Brent Johnson: Sure. Well, first of all, thanks for having me. I always enjoy talking to you, Tony. The reason I like talking to you is you’ll talk a lot about Asia, but you’ve actually lived there and you actually know what you’re talking about rather than people who’ve just read it in a book. And same with Tracy. So I’m happy to do this and happy to do it anytime you invite me.
But anyway, what’s really going on with the dollar is a function of the fact that it’s not only the Fed and it’s not only the US that has, for lack of a better word, idiotic leaders. The rest of the world does, too.
And I think over the last several years. At least in the retail investment world. There’s been this theme that the Fed is out of control. The government’s out of control. They’re going to spend all this money. The dollar is going to pay the price. And it’s going to get inflated away and go to zero. And the rest of the world is going to do great and we’re going to do poor.
And I understand that view if you just analyze the United States. But the problem is you can’t just analyze the United States because it’s a big world and everything is interconnected. And all of the problems that people have forecast to fall upon the US.
Dollar are currently happening to a greater extent in Europe and Asia. And the budget deficits, the printing of the money, the central bank support, the holding down of rates, all of that applies even more so to Japan and Europe than it does the United States. And that’s really what you’re seeing.
Over the last, let’s just call a year, you’ve seen the yen fall 20% versus the dollar. That is an incredible move for any currency, but it is an absolutely astonishing move for a major currency, specifically the third biggest currency in the world, or some would even argue the second biggest currency in the world. And then you’ve seen the euro over the last year is down 10% or 15%.
So these are very big moves. Again, the reason is because the Fed is raising rates. So on a relative basis, we have higher rates than those two big competitors. And on a relative basis, those two big competitors are doing more monetary stimulus or QE or extraordinary measures, however you want to define that central bank activity.
And you always because the globe runs on the dollar, there is a persistent and consistent bid for the dollar globally. And so it’s really a supply versus the demand issue. Now, everybody always focuses on the supply. Central banks are increasing the currency in circulation. They’re going to print all this money and so therefore the dollar falls or the currency falls. Well, that’s just focusing on the supply side.
But again, you have to remember that all central banks are increasing supply, but the demand is what makes the difference and that there is global demand for the dollar. Now, whether you think there should be, whether you think it’s the right thing, it doesn’t really matter. It just is. That’s the way the system works.
But there is not that same global demand for yen. There’s not that same global demand for yuan, there’s not the same global demand for euros or Reals or Florence or Liras or anything.
And so what you’re really seeing play out is Trifan’s dilemma. And so I’ve spoken about this before. But Trifon’s dilemma is an economic theory that states that if you have a single country’s currency that also serves as the global reserve currency, at some point the needs of the domestic economy for that global reserve currency will come into conflict with the needs of the global economy. And that’s what we have.
We have an inflationary pressure problem in the United States. The Fed is very embarrassed about it. They got it wrong and now they need to do something about it. And they’re bound and determined to try to bring it under control. And so they’re raising rates to counteract that. Well, when you raise rates, you’re tightening the monetary supply. And that’s happening. That’s fine for the US. But there’s many countries around the world that cannot handle that right now.
But that’s what’s happening. And so the needs of the domestic economy are in conflict with the needs of the global economy. And it’s going to be the global economy that suffers more than the domestic economy as a result. It doesn’t mean that the domestic economy won’t be hurt. It just means on a relative basis, you want to be closer to the money than far away from the money. And because we have the global reserve currency, we’re closer to the money.
TN: So it’s interesting when you talk about the dollar versus other currencies, and we often hear people say, oh, CNY is rising as a share of spend, which that’s debatable. But from my perspective, it’s not the dollar that’s kind of in the gladiator ring of currencies. It’s the yen, it’s the euro, it’s the British pound, it’s the aussie dollar, it’s these secondary currencies. They’re going to lose share before the dollar does. Is that wrong?
BJ: No, I think that’s absolutely right. And again, that’s a very good way to put it. I know gladiator walks into the ring and thinks, I’m not going to at least get a few scratches. It’s going to hurt. That’s just the nature of being a gladiator. But what matters is who’s standing at the end of the day, right? And so I think it’s these other currencies are getting hurt by the battle more so than the dollar. It doesn’t mean that we’re not getting hurt. It doesn’t mean it doesn’t sting. It doesn’t mean there isn’t going to be any pain involved. But at the end of the day, if you’re at war, you want to be the last man standing because of the way the system is designed, I believe that that will be the US dollar.
The other thing that I would just quickly point out is a lot of people say, why can’t you see it? It’s very obvious. The rest of the world wants to de-dollarize. They’re putting all of these trade deals in place, the dollars falling as a percent of reserves, etc. And the point I would make is, yes, I do see it. I agree with you the world would like to dedollarize, but it’s much harder to dedollarize than just saying, just because you put an announcement out there doesn’t mean you’re actually going to be able to do it.
I’d like to make the analogy that I’ve said I want to lose weight and get in great shape for 20 years. It doesn’t mean it’s going to happen. It hasn’t happened yet.
But that’s the headline versus reality, right? I just think that’s where we’re at. And the dollar, for better or worse, it’s a rigged game in favor of the dollar. And the US set it up that way is the global hegemon. They set it up that way. Now, it doesn’t mean they’re not trying. It doesn’t mean that the world doesn’t want to get away from it. It’s just very hard to do it.
The last thing I’ll say and I’ll shut up, but the other thing I would say is the process of de-dollarization, even if it is successful, will not be a calm transition. And the process of dedollarization is not necessarily, and in my opinion, not probable to be negative for the price of the dollar. I think the volatility and the lack of liquidity in dollars that would go along with de-dollarization would actually squeeze the price of the dollar higher.
And so it doesn’t matter to me whether de-dollarization happens or not. I think the dollar is going higher for all of these reasons.
TN: I think what’s funny there is people always put de-dollarization in this almost moralistic language. It’s a good or a bad thing. And it’s just not. It just is.
Tracy Shuchart: I just had a question for Brent. I mean, do you see at any point that there’s some kind of intervention on the dollar? The dollar gets too strong because it’s going to crush emerging markets? Do you think there’s any point in which Yellen kind of backs up?
BJ: I do think they will. And that’s why I think the dollar is going to go back to all-time highs before this is all said and done. I don’t think it’s going to be a straight line. It can’t be a straight line without absolute devastation. Doesn’t mean it can’t happen. But I think this is going to play out over several years rather than several weeks. It could play out over several weeks, but I think it will take longer. And the reason I think it will take longer is I think that they will interact or they will get involved, as you’re suggesting, Tracy.
I actually think right now the Fed and the Treasury want the dollar strong. I think they’re using it as a weapon or as a tool. It’s something that can be used very effectively. Again, whether you think it should be used or not, I don’t care. I just think it will be, and I think it is being and so I think that will continue.
But I think the Fed and the treasury, they want the dollar higher, but they want it done in a measured fashion that they can control. If it starts to get out of control, I think that they will rein it in. I think they want some of the other parts of the world to be an economic pain, but I don’t think they want the whole system to collapse. And so my guess is that we’ll get the dollar higher, maybe it goes to 115, 120, and then they’ll do something, it’ll pull back for six months, three months, whatever, and then it’ll get higher again and they’ll come out and do something.
So I think this will be a process, a little bit of a roller coaster, up and down, but I think that the general trend is higher and I think there’s more pain to come for the global economy as a result.
TN: Brent, real quick, before we get onto oil. You sent out a tweet earlier this week that said you think that we’re going to come to a point where both the dollar and equities and US equities are rising. Can you walk us through that just real quickly? I know there’s a very detailed thesis behind that, but can you walk us through that very quickly so we understand kind of what you’re talking about there?
BJ: Yeah, so the first thing I’ll say for anybody who’s just kind of passing through this conversation is that I don’t think this is happening right now. It could happen right now. In the short term, I expect US equities to go lower. I think that’s just kind of where markets are headed.
But as the pain develops throughout the global economy, I think we are going to experience a global sovereign debt crisis. And when the world, the US included, starts selling sovereign debt rather than buying sovereign debt, I think that money will have to go.
Now, some of the money will just be, it’ll just go poof. It’ll be gone. And so that money won’t have anywhere to go but the people who start selling the bonds looking for another place to go, I think the next best place to go will eventually be US equities. And I think US equities will be seen as the new… I don’t want to say new Treasuries.
That’s a little bit hard to say. But on a relative basis, the place where big global capital can go, that is the most advantageous to them. And so I think we will get into a point in the sovereign debt crisis where US equities will get safe haven flows and I think the whole world will potentially be printing more money, right.
So be sending more liquidity out there. And so I think that liquidity that is generated with little liquidity there is, I think we’ll find its way into the US and the US Dow, big blue chip stocks and I think they’ll go higher. I might be wrong on that, but that’s my working thesis as of right now.
TN: Let’s move on to crude oil. Obviously we’ve seen crude take some hits over the past few weeks and we’ve got a WTI chart on the screen right now.
So how low will crude go? Are we almost there? Are we headed to 65 where it was for a while? And what then pushes it higher?
TS: I don’t really want to forecast exactly where crude is going to go. I definitely think that we could see some more downside, but we have to look at what is weighing on price and sentiment right now. One, there’s more Russian barrels on the market than everybody anticipated.
Two, you’ve got never ending zero Covid China lockdown that haven’t seemed to let up yet. We also have EU recession, right? And then we had 160 million barrels of SPR thrown on the market. And so that’s really weighing kind of on the front end of the curve. Those are the things kind of weighing on sentiment right now. That’s why we’re seeing a lot of weakness.
That said, if we look at the fundamentals of the market, the market is still very tight. We’re still drawing globally. We definitely have a diesel problem that is global. And I think where we start to see kind of a change in this, I think when it comes to the end of October, when the SPR is done this with kind of been looking over the last couple of weeks, had we not had such large SPRs, we would have actually been drawing a regular stock.
So it’s not as if that oil is going piling up anywhere. So I think as soon as the SPR stops, I think after Midterms, because I think this administration is trying to do whatever they can to suppress the price of oil, thus, gasoline. And I also think that we have to see kind of what happens in China after the People’s Party Congress in the middle of October and trying to see what their policy is going to be moving forward.
Are they going to open up? I mean, they’re looking at they want 5.5% YoY GDP by the end of the year,
which…
TN: They’ll hit it. On the nose, we can guarantee that.
TS: But I think they’re going to have to start stimulating the economy a little bit more. And we kind of saw announcement Evergrande is going to start financing more inspection projects and whatnot going into starting at the end of September. So I think we’ll probably see the last quarter if we get a little stimulus and if they back on their policy because, that’s the big thing for oil right now, is that if that demand comes back because they’re down about 2.7% on the year and as far as consumption is concerned.
So I think if that demand comes rushing back, know that’s going to be a huge upside surprise for the market. I think over the long run, oil is going higher, but out looking out into 2023, I just think that’s just the trajectory of it. I’m not calling for $200 oil, anything crazy like that. I just think that we will see higher oil, and I think we’re poised to see higher for longer than the functionality of the market and the fact that we have no capex for the last seven years.
TN: So last month you said to look three to four months out, look at the curves three to four months out to understand kind of what the real oil price was or is going to be. And so that would be two to three months now. So that’s November. December.
TS: Look at those spreads are widening out or not, right. You want to see if we’re moving into more backwardation and even more backward dated market, right? So you kind of want to look at that.
TN: Okay, so I paid $2.88 a gallon for gas at my local last night. We’re the energy capital in the world. Yeah, I’m going to show it off. Anyway, that is kind of coming down. And energy has been the biggest upward factor in some of the inflation issues. That’s good news, at least until the election. Hey, I’ll take it while I can get it, right? And if it heads back up after the election, I think we’re all prepared for that on some level.
So I guess SPR, as he said, election happens, there’s no political reason necessarily to suppress these prices and so on and so forth. So do you expect to see almost a slingshot in, say, December, where things trend higher pretty quickly?
TS: I don’t think we’ll have… I don’t want to call it a slingshot because anything can happen in the oil market. I mean, we’ve seen $7 to $10 in a day before, so that’s not unheard of. But I do think we go higher, especially if you’re looking into the market, is going to get even tighter in December because of tax reasons. December 31 is the tax assessment date for the barrels that you have on hand. So they tend to pull back on production so they can move out inventory as much as they can, so they’re not taxed at the end of the year.
Usually we see a little decline in production anyway in December and the second half of December, we do see prices start to rebound off the seasonal for regular seasonal trend low. Okay, so that would be normal.
TN: Brent, I think you had a question for Tracy on crude markets as well.
BJ: Yeah, I actually had two quick questions. One, I wanted to get your thoughts on the fact that India and China are buying oil at a discount from Russia. And then there’s lots of stories about them selling that oil
on to Europe or other places. And so they’re making that spread. I just wanted to get your thoughts on that and logistically how that actually takes place.
TS: So if you’re looking at India, definitely they are buying discounted crude. What they do is they don’t
resell that to Europe. What they do is they blend it and they sell fuel. So that’s refined. So it’s really hard to trace what’s in… They don’t trace those barrels that way.
So that’s how that oil is kind of emerging back in Europe. It’s really by way of refined products. Now when we talk about China with the gas, really what they’re doing is they’re buying gas right now, literally half off from Russia, and they’re turning around and selling their own gas to Europe for the higher marked up. The gas they already have. So they’re selling the gas they already have? So that’s kind of how that’s working.
BJ: And then the other question I have for you quickly is I was surprised this week when the rumor was floated by whoever floated that they would restock the SPR at $80. It seems like they’re doing everything they can to get the price lower. And then to have that rumor come out and put kind of a floor under it was kind of surprising to me. So maybe nothing more than just the speculation, but did you have any thoughts on that?
TS: Yeah, I mean, basically they put a floor on it. Everybody’s calling it, the Biden put now. But the thing is that it’s all nice and well if they want to do that, they still got enough 60 million barrels that they need to release. And then by the time those contracts go through and you want to refill the SPR, I mean, that’s months away. We’re looking at months and months down the road. And who knows what oil price would be? To me, it was just another try to jaw bone market down lower.
BJ: It kind of reminded me of the ECB where they’re raising rates on one hand, but they’re buying bonds with the other. Biden wants his cap. He’s like got a collar on it. He’s trying to put a cap on it and a foot on it.
TN: Strategy. Let’s move on to a little bit more of kind of the Fed kind of Fed talk. There’s a Fed meeting next week, and when CPI came out this week, the terminal rate really rose very quickly. And that’s when we started to see equities fall pretty dramatically. And we’ve got on the screen right now expectations for the rates coming out of each meeting. So 75 in September, 75 in November, and another 50 in December. That has accelerated the expectations for the Fed by about 25-50 basis points?
When does the Fed stop, basically from where you are now, do you think this continues to accelerate in 2023 or given, let’s say, CPI? Of course on a year-on-year basis it looks terrible. But once we get to November, when CPI really started to accelerate, November 21, do we start to see some of those base effects in a year-on-year basis and the Fed starts to pull back a little bit and go, okay, wait a minute, maybe we’re okay with the plan we have when we stop at say 450 or whatever as a terminal rate.
The other complicating factor will add in there is University of Michigan came out, University of Michigan survey came out on Friday and it’s a bit lower than what was expected. And the Fed has really been looking to University of Michigan, which is kind of a semi-serious survey, but they’ve really used that to justify some of their decisions.
So we obviously have a mixed environment. But I’m wondering, with all of this stuff coming out this week, do we expect the Fed to keep marching pretty aggressively into 2023?
BJ: I’ll take that first. So I actually do expect them to keep marching higher into 2023. And I say that for a couple of reasons, and I’m going to qualify this and say that they will pivot when they have to pivot, but I don’t think they’re going to pivot until they have to pivot. And so I think a lot of people that are predicting the pivot are misunderstanding the Fed’s intentions and perhaps for a good reason. They’ve done a fantastic job of ruining their credibility. So it’s understandable not to believe them.
But in this case, I think you kind of have to believe them. And I’ll tell you why I think you have to believe them. Number one, I think they don’t mind the dollar being stronger. Again, I think that’s kind of policy that I spoke of earlier in conjunction with the treasury.
Number two, I think they want asset prices lower. So the fact that the stock market goes down I don’t think would bother them. I think if the Dow was at 28,000 and the S&P was at 3600, I think they’d say that’s totally fine. I don’t think they have a problem with that as long as it’s not collapsing. Right? Now, if it collapses, then they have to come in. And they will come in, but I don’t think they mind if the stock market is 10% or 20% lower than here.
The third thing I’d say is the Fed central banks in general, they’re always lagging. They’re a reactionary agency. They’re not a predictive agency. We all know that. They can’t predict anything anyway. I’m not sure I want them predicting things, but to me they’re always behind the curve because they always wait until they see it and then they react, right? They come in and they try to save the day. So when things get really bad, then they’ll eventually come in and provide support.
And when things are always too late to tighten as they are now, and then they try to make up for it. So I think they’re going to despite, like you said, the Michigan number starting to come down, Atlanta Feds already slash their GDP. So even though they’re getting these signals that things are slowing down, they’re not reacting to it yet. They will react to it late.
And then the fourth thing I’d say is that I think Powell is mad and he’s pouting, right? Not just Powell, but mainly Powell, but he got all this advice from all his staff and however many staff, PhD staffers they have at the Fed, and they all said inflation is transitory and it’s going to be fine. And then it wasn’t. Right? Now he’s mad.
TN: He’s a lawyer, not an economist.
BJ: And I’m going to do something about it. And if you don’t think that I can bring inflation down, well, then you just watch me, right? And I’ll take my ball and go home. And his ball is interest rate. So he’s taking them higher, and he’s taking them home, he’s taking them higher. And so it come hell or high water, and after the, I don’t know, the chink in their armor or the threat to their credibility that they’ve had over the last year or two, I think the last thing in the world that Powell wants to deal with is the fact that he slowed down or, God forbid, cut rates and then inflation kept going higher.
That would look even worse than waiting for it to crumble, right? So I think for all of those reasons, you kind of have to take them at their word. Again, I’m not saying not unless the markets force them to do it
and the markets might force them to do it. I’m not saying that that’s out of the possibility. The only thing I don’t like saying about this is this is the hole they’re going to hike until it breaks theory, right?
And I agree with that. The thing I don’t like about it is everybody else seems to agree with it now, too. That seems to be the common refrain, is that they’re going to hike until something breaks, and everybody says, yeah, that’s kind of what’s going to happen. Usually when everybody thinks something, it doesn’t happen that way. But as long as equity prices are higher and as long as inflationary prints keep coming in high, I think they continue hiking.
And think about it, inflation could fall by 30%, and it’s still at five or six, which is still two or three times higher than their goal. So is there a path to a pivot? Yes, I think there’s a path to a pivot, but every week, when people come out every week and, oh, they’re going to pivot, they’re going to pivot. I don’t think they’re pivoting next week, and I don’t think they’re pivoting in October unless they have to.
TN: Okay, Tracy, what do you think of that?
TS: Yeah, I absolutely agree. All the data coming in, there’s no way they’re not doing 75 next week. In my opinion. I could be wrong. Somebody will come back. I think that’s pretty much a lock.
TN: Yeah, I think short of, let’s say sometime in Q4, Russia, Ukraine ends, and China says we’re not going to lock down anymore, that would fundamentally change the Feds calculations, right?
BJ: Well, if they weren’t locked down anymore and it pushed demand higher and it pushed prices higher as a result of demand increasing, then to me, that would keep them on their path to hiking. The flip side. And the flip side is that if something breaks in China, and China has to devalue or revalue the yuan in order to deal with the real estate collapse or the internal problems, whatever it is, that could send a deflationary wave to the rest of the world.
So I’m not going to sit here and deny the inflationary pressures that we’re seeing, but I think to a certain extent, people have again dumped themselves into the inflation camp or the deflation camp, and I think we’re going to have periods of both.
I think if you fundamentally understand the design of the monetary system, the threat of a deflationary
wave is always there. But if you don’t admit that the inflationary pressures are here, I think you’ve also got your head in the sand. I’ve said this several times, but I will admit to a big mistake, and that is, for several years, I hated the term stagflation. I thought it was a cop out. I thought it was for people who just couldn’t decide if they were in the inflation or deflation camp. But I think that’s what we have, and I think we have it in spades. I think some assets and some prices are going to continue to rise and be higher, and I think others are going to collapse, and that’s what makes it so hard to deal with.
So to anybody I ever took a shot at for them using stagflation as a cop out, I apologize. I’m with you now. I got that part wrong.
TN: Brent, one of the things I admire about you is you’re not afraid to say you were wrong, right?
BJ: No. I mean, do you mind if I just make a comment on this really quick? I think too often in our business, people will make a call and then they’re just so afraid to change it. Or you’ll make a call, and then somebody else will call you out on it if you got it wrong. At the end of the day, our job is sort of to predict the future. And so anybody who thinks that they can accurately predict the future 100% of the time has the biggest ego in the history of the world.
The reason I don’t mind making predictions is number one. I don’t mind being wrong because I don’t think I’m the smartest guy in history. And if I get something wrong, then I’ll have to deal with it. But this idea that we’re always going to be right and we know everything, it’s ridiculous. So anyway, we’re all speculating at the end of the day.
TN: That’s right. Okay, real quickly, guys, what are you looking for in the week ahead? More the same. More the same disappointment, difficulties, headwind, all that stuff. Until the Fed meeting? Is that what we’re looking for until the press conference?
TS: Yeah, I think we’re the markets will be in limbo, definitely until the Fed. I mean, everybody expects 75. We get 75. Maybe we see a bounce in equity, actually, because it’s already done with, right. There’s no question anymore. So maybe we get a bounce after that.
TN: Slightly less hawkish language than is expected, right?
BJ: I think that’s right. Now we’ve got the potential of maybe 100 basis points, right. So if they come in a couple of weeks ago, although now there’s a path to pivot, they’re probably only going to do 50 basis points in September.
Well, then we got the CPI print and it’s 75. That’s 75 is going to happen. Then a couple of people go hundreds now on the table, right? So now if they only come out and do 75, maybe the market kind of breathes a little bit. At least it wasn’t 100. So my guess is that we would have some volatility leading up to the meeting. Maybe they do 75. Perhaps things get a little bit of a bounce as a breather.
But I don’t think markets are going to change a whole lot between now and the election. I think they’re going to be volatile. I think the Feds are going to keep hiking. And I think Market Powell said it himself. We had the boom and now we have to deal with the pain. This is the unfortunate side effect of what we have to do. So he’s telling you he’s going to cause pain. He just doesn’t want to collapse. So if it starts to collapse, it’s the sad truth.
TN: Guys, thank you so much for your time. Thank you so much. Have a great weekend and have a great week ahead.
Can the Federal Reserve engineer a soft landing for the US economy? Are the odds stacked against them especially if consumer spending stops suddenly. Tony Nash, CEO, Complete Intelligence gives us his views.
Transcript
BFM: The business station BFM 89 Nine is seven. 6th Thursday, the 1 September, and we are in the final quarter of the year. But nonetheless, we don’t need to look so far ahead because in the next half an hour, I’ll be speaking to Hannah Pearson of the travel consultancy Pet Anderson on Asian tourism recovery.
But in the meantime, let’s recap how global markets closed yesterday. So the Dow was down 0.9%, S&P 500 down 0.8%, while the Nasdaq was down 0.6%. Meanwhile, in Asia, Nikkei was down 0.4%, Hang Seng was up very marginally by 0.3%, Shanghai was down 0.8%, Singapore Street Times was up 0.6%, and our very own FBM KLCI was of course close due to the medical holiday.
But for more in terms of where global markets are heading, we have on the line with us Tony Nash, CEO of Complete Intelligence. Good morning, Tony. Now, the S&P 500, in fact, the US markets continue to slide, but the S&P 500 we know, is down by 4.2% on a monthly basis, even though US jobs and consumer numbers released this week were largely positive. So why is this bearish sentiment in the equity markets persisting?
TN: It’s pretty easy. Equity investors weren’t prepared for Powell to have the conviction to fighting inflation that he showed in last week’s speech. So everyone else, bond vestors, commodity investors and so on, understood Powell’s conviction.
But equity investors had expected the Fed to pivot. And by pivot, maybe coming close to loosening and maybe coming close to ending rate rises. But the Fed was never going to pivot. If anything, the pace of rate rises may slow, but the Fed’s ultimate destination is 4%. And they’ve said that for months.
So there really shouldn’t have been any surprise with that. But equity investors just didn’t want to believe it. And so they’re in price discovery, continuing lower now. So once they hit the valuation that will reflect getting to 4%, I think we’ll be back in decent territory. But until then, we’re in a downward price discovery mode.
BFM: Okay, Tony, the other thing that’s going to happen in next few weeks is of course, the Fed going to reduce their $9 trillion balance sheet. What kind of impact do you think this will have on markets?
TN: Well, it’s tighter. So it’s going to be more difficult. So in September, the Fed will double quantitative tightening. So they’ve been tightening at about 47.5 billion dollars per month. They’re going to more than double that to 95 billion in September. So it will definitely add upward pressure on interest rates.
And when there is upward pressure on interest rates, that means the cost of money is higher and the cost of buying a house is higher, and so on and so forth. And with respect to buying a house, the Fed is about $50 billion behind on shrinking their mortgage-backed securities portfolio. So they do have some catching up to do, but they’ve got time on their side. They can do it at whatever pace they want.
BFM: Okay. In the meantime, right, let’s look at the US consumer. Super important in the US. Economy, but at least 60% of GDP. Do you have a sense of what’s happening there? Are they still very confident? Are they still buying, especially discretionary spending? Has it been robust?
TN: I don’t necessarily think. You have a separation. You have luxury buyers who are very confident. But I think your average buyer, I don’t necessarily think there’s a lot of confidence behind their buying. I think they’re just trying to maintain their pace of spending.
So spending continues to grow, but consumer credit has also expanded. Visa, I think, two days ago said that their payments volume grew by 11%. So that’s not the value. I mean, you could say with inflation, of course, the value is going to go up, but they saw their payments volume go up by 11%. Part of that is due to things like back to school here in the US. The school year starts in late August, early September.
But until consumers stop growing their spending, the Fed will keep raising because the Fed, part of what they’ve been trying to do is what’s called demand destruction. And until consumers and businesses stop raising the pace of their spending, the Fed will continue raising interest rates in tightening conditions.
BFM: But doesn’t this then just mean that the US is officially in a recession? Because you’re basically sending out signals to the market that the economy needs to slow down. And if we continue to do so, we’ve already seen two-quarters of it, right, which means it’s a technical recession. How bad will this recession really be? I mean, it will be official at some point.
TN: Yeah, I really honestly don’t care if we’re in a recession or not. If two quarters is the rule of thumb, then we’re in a recession. And we’ve been in a recession since Q1. So it’s really just a matter of labeling.
I think the difficulty is, as you say, what’s the impact on, say, business growth, job growth, spending growth? And we’re seeing that the job market has remained pretty strong, spending growth has remained pretty strong. And the concern is, will that stop? When will that stop? And I think we have seen things slow down, at least in terms of economic growth, but a lot of that has been around government spending as well.
So things will likely become dramatically slower in 2023 if the Republicans take over the US. House of Representatives, which controls the budget. So if Republicans take over the House, they will put a stop on a lot of the spending bills that the Biden administration continues to want to pass, and they’ll be more budget conscious. So government spending may not necessarily decline, but the pace of the rise will stop. And so government spending has been what’s been keeping, say, GDP and other things moving, but that will likely stop if Republicans take over Congress.
BFM: Okay, but what about the Fed, the actions of the Fed? Because so far it seems like markets are looking to them for engineering a soft landing in the US. Do you think they’ll succeed, though, or are we going to look at the politicians for doing so?
TN: It all depends. Well, not all. A lot of it depends on the Fed’s actions this month, in September. So if the Fed slows the pace of rate rises, let’s say to 50 basis points instead of 75, they’re signaling that they’re willing to slow down a bit with the destination remaining 4%.
So if the Fed were to come and say, a 25 basis point rise, then that would be a real signal that, yes, they’re definitely committed to getting to four, but they’re willing to slow down to get us to four by, say, Q1, maybe late Q1 of ’23. And I think that would be a signal to equity investors that the Fed understands and they’re okay if some of these valuations continue to be stretched.
If we see a 25 basis point rise, which I don’t think anybody is really calling for in September, then that would be a real kind of green light from the Fed. I think we’re likely to see 50. 75 is also likely, but I think 50 is slightly more likely. So we’ll likely see 50 and then a few 25s. And that’ll get us to four in, I think, December or January. And at that point, the Fed is just going to reassess and figure out kind of which strategy to pick after that.
BFM: So is it too optimistic to say that maybe we might have a year-end rally for US. Markets? What do you think?
TN: It’s possible. I wouldn’t necessarily count on it. Again, I think the upside is capped for a period because of the uncertainty of the Fed, at least until we have clarity on the September signaling. So if they do raise 75 in September, then that likely means we have a couple of 25 rises in October, November, something like that. But it doesn’t necessarily mean they’re going to stop. All it means is that they’re going to reassess and the beatings will continue effectively.
BFM: What about oil, though? It’s now $89 a barrel for WTI. Why have prices come under pressure so much?
TN: Well, the Saudis came out with a statement last week around the gap between the paper value of oil and the physical market. And they have been talking about cutting their output because of the difference, the broad difference between the physical market and the paper market. And so I think when we see falls like this, it just convicts the Saudis more. Unless there’s political pressure put on them, it just convicts them more to cut their output.
The Saudis, the Emiratis and others have come together and said we’re likely going to slower output. Part of this is also putting pressure on the Iran deal, assuming that there’s more capacity from Iran. So if exports from Iran are normalized, then that could put downside pressure on the price. So the Saudis are just trying to keep the price up.
Within that context, we also have to look at the Strategic Petroleum Reserve releases in the US. So that will end in October unless they slow down the pace of the SPR release, but that effectively cuts off supply to the market. And so when the SPR release ends and if the Saudis cut their output, we could have a spike in crude prices, say in Q4.
That’s kind of what we’re expecting is for crude prices to rise into the end of the year. The US midterm elections will be passed as Saudis will likely cut their output. Other OPEC countries will likely cut their output. And the US SPR release will be done. Unless the Russia-Ukraine war ends, which would put crude in the open market, we do expect to see crude price rises towards the end of the year.
BFM: All right, thank you for your time. That was Tony Nash, CEO of Complete Intelligence, telling us that we can expect Brent crude prices to actually perhaps go up for the last quarter of the year as there are more output cuts despite some of the demand destruction we are seeing because of the global economic slowdown.
