It has been our central operating thesis since the Great Financial Crisis that low interest rates + low volatility + larger central bank balance sheets would = higher asset prices. We are now entering an environment where we are seeing higher interest rates + higher volatility + smaller central bank balance sheets. We surmise that will = lower asset prices. It's just math.
The big news this week was probably Trump's trade policies and tariffs on steel. On that subject we do not believe that those tariffs will see the light of day. He will lose when he goes to the WTO and will be forced to retract them but, then again, we think that his threatened imposition of tariffs is probably only a negotiation tactic.
We had several discussions this week on tariffs with people we respect. They made several interesting points about trade and steel and tariffs. My contention is that none of that matters. Wall Street and investors see tariffs and they think trade war. They think trade war then they think about the Great Depression and Smoot Hawley with a shooting war to follow. When it comes to trade wars investors will shoot first and ask questions later. A trade war = lower asset prices.
This week we saw the new Fed Chair go in front of Congress and act hawkish on inflation. Markets reacted negatively. The very next day he seemed to walk back his earlier comments. This is precisely why, as investors, that we need to prepare for inflation. No one wants to fight it. It is not politically acceptable until it is too late. No Fed chair will have the political will to fight inflation until it is raging and it begins to hurt Main Street. The biggest beneficiaries of inflation are the largest debt holders. Who are the largest debt holders? Governments. They need to inflate away their debt. They want inflation because it allows the very existence of bigger government. The political will to fight inflation will not be there until it hurts and hurts Main Street badly.
"CONFIDENCE ON INFLATION GETTING STRONGER." - "Hawkish" Fed Chair Powell
"NO STRONG EVIDENCE OF DECISIVE MOVE UP IN WAGES, MORE LABOR MARKET GAINS CAN OCCUR WITHOUT CAUSING INFLATION." - "Dovish" Powell
By far, the most interesting part of the week for us was an interview from Goldman Sachs of Paul Tudor Jones, a legendary hedge fund manager who called the 1987 crash. He has run a Global Macro hedge fund for over 30 years investing in stocks, currencies and commodities. Check out the whole interview if you can. Here are some of the highlights (emphasis ours.)
Interview with Paul Tudor Jones
Allison Nathan: Is the market underestimating commodity-related inflation today?
Paul Tudor Jones: Absolutely. The S&P GSCI index is up more than 65% from its trough two years ago. In fact, relative to financial assets, the GSCI is at one of its lowest points in history. That has historically been resolved by commodities putting on a stunner of a show, stoking inflation. I wouldn't be surprised if that happened again.
Allison Nathan: Does all of this just boil down to the Fed being behind the curve?
Paul Tudor Jones: … The mood is euphoric. But it is unsustainable and comes with costs such as bubbles in stocks and credit. Navigating these bubbles will be one of the most difficult jobs any Fed chair has ever faced.
Allison Nathan: In this context, what do you want to own?
Paul Tudor Jones: I want to own commodities, hard assets, and cash. When would I want to buy stocks? When the deficit is 2%, not 5%, and when real short-term rates are 100bp, not negative. With rates so low, you can't trust asset prices today.
Allison Nathan: You are well-known for calling Black Monday. Is the recent surge in volatility behind us?
Paul Tudor Jones: In my view, higher volatility is inevitable. Volatility collapsed after the crisis because of central bank manipulation. That game's over. With inflation pressures now building, we will look back on this low-volatility period as a five standard- deviation event that won't be repeated.
If you are a regular reader you know that one of our biggest concerns is rising bond yields. By way of our friend, Arthur Cashin, comes some insight on those rising bond yields. Barry Habib is quoted from time to time in Arthur's Daily Letter and his track record is nothing short of amazing.
We are going to see 3.04% on the 10-year within the next couple of weeks. That will be the moment of truth. The level of 3.04% matches the top of the 30-year downtrend in yields, as well as the 0% retracement from the highs 4 years ago. In other words…it's a big deal if this is convincingly broken to the upside, and strongly suggests that the 10-year will hit 3.80% before summer.
Interestingly, Paul Tudor Jones spoke of rising bond yields in his interview. His thought is that the 10 year goes to 3.75% by year end and that was a conservative target. We thought that the S&P 500 would make a run to the old highs but it seems that talk of trade wars has aborted that attempt. The struggle between the bulls and bears is a push right now. Either could take over. Markets are a bit oversold here which gives the edge to the bulls but the failure to trade to old highs and trade war talk tilts things in favor of the bears. So much to say in such a small space. We are looking forward to our quarterly letter where we will get more in depth in some of these issues.
From the Back to 1987 Department:
Gluskin Sheff's David Rosenberg summed it all up nicely…
"Hmmm. Let's see. Tariffs. Sharp bond selloff. Weak dollar policy. Massive twin deficits. New Fed Chairman. Cyclical inflationary pressures. Overvalued stock markets. Heightened volatility. Sounds eerily familiar (from someone who started his career on October 19th, 1987!)."
