Update On Macro-changes and Inflation 2.0

Planning for the next 6-12 months

I made a few predictions back in early April, and I realize we should discuss a little more about the foreseeable future.

Back then the predictions were essentially these:

1. Inflation is not over, because energy supply issues are not solved at all. In fact, capex is still half of what it should be, and even when backto normal, it will take years to go up again.

2. The banking crisis could create an issue and lower inflation, but it’s unlikely to happen.

3. De-dollarization is happening, yes. But the full consequences of it will take years.

4. A failure of the Ukraine War for NATO would spell a massive war of spending and renewed inflation.

While all this holds true, it did not give the fuller picture which emerged to me, a month later.

Regional Divergences

I think the most important part missing in the previous analysis is how the 2 hearts of economic activity in the world are diverging.

Asia

The first part is Asia. Economic activity seems to recover well, especially smaller purchases and travel/experience. Not surprising after very long and harsh lockdowns. People will first spend money on life, and later on cars, real estate, etc…

There are signs of a slowdown, notably with Chinese exports and industrial activity being very volatile and generally less strong than expected. Nothing dramatic, but we will see the cause below.

USA

A very schizophrenic macro environment.

On one side, you have low unemployment, not-so-low inflation, and reflating asset bubble. Year-to-date, Telsa is up 52%, Meta/Facebook is up 93%, and NVIDIA is up 94%. So we are still in a full financial party mood and the tech bubble is reflating happily.

On the other side, commercial real estate is going doooown. Like 80% compared to 4 years ago for some big office buildings in San Francisco. Massive layoffs by the same companies whose stocks are outperforming did not help, nor is the normalization of work from home and hybrid work.

We also have a little ongoing banking crisis, with another one biting the dust last Friday. Out of the 4 largest bank failures (by assets value), in US HISTORY, 3 happened in the last few months…

The root cause is massive unrealised losses on bonds, and that is before the commercial real estate really bites.

The thing is, the USA still owns the world’s printing press. And de-dolarization is nowhere far enough to limit that.

So no matter what happens, there will be another round of Friday Bank Failures followed by Monday Rescue Plans.

The Fed says they want a recession and they might get one. But it will stay mild, as everybody and their grandmother now know the Fed will never let a systemic crisis last more than an extended weekend.

Regional banks are kind of toast, but they will be progressivly digested in JP Morgan and other such big banks, the real controllers of the Fed. And the Fed will print money to compensate for the bond losses if needed.

In a perverse way :”buy the dip” and “don’t fight the Fed” is maybe, for now, the best advice to follow if you are only invested in S&P500 and US stocks.

Overall, I expect financial assets to stay inflated, while the real US economy (mom and pop shops, SMEs) take a hit.

Real economy depends on loans and credits from regional banks, which are dying. While the casino economy is saved again and again by the Fed.

Europe

Here the picture is a LOT grimmer. Just look at this data from Steno Larsen:

Or in my country, Estonia:

Retail trade fell 13 percent on year to March 2023

March's fall in turnover was most affected by stores selling manufactured goods, where turnover fell by 18 percent on year.

Meanwhile, French protesters are burning restaurants, building concrete walls on highways, and storming the EuroNext…

And the British should accept that sanctions against Russia have destroyed their standard of living, and learn to live with it.

Britons ‘need to accept’ they’re poorer, says Bank of England economist

Chief economist Huw Pill says workers and firms should stop trying to pass on rising costs by hiking prices or demanding better wages

“And what we’re facing now is that reluctance to accept that, yes, we’re all worse off, and we all have to take our share.”

I am sure top bureaucrats, especially Bank of England economists “take their shares”. One less glass of champagne a month AT LEAST, gosh, that’s rough…

German bankruptcies are rising, but with a serious lag and buffered by the warm winter that saved the EU’s bottom. This is more a slow train wreck than a crash.

I am also told that apparently, demand for diesel is so bad that most buyers do not take delivery of even the minimum amount they are supposed to according to their contracts.

So Asia has slightly slower growth and volatility, the US has a game of “keep the bubble inflated”, and Europe is entering a deep recession. Potentially a depression at this rhythm.

Still, Chinese stimulus and bank rescue should limit contagion out of Europe.

Cracks In The Narrative

Regarding Europe, the backdrop of the illusive Ukrainian counterattack does not help the mood.

Especially with truth bombs from US generals: “The Russians have strategic depth … The Russian army inside Ukraine today is bigger than it was at the beginning of the conflict“ being dropped here and there.

Not a surprise if you read me, but definitely one if you only listen to the mainstream “Russia is stupid and losing” story.

It also seems some large ammo deposit in preparation for the offensive got blown up… Not good considering the West’s apparent inability to mass produce ammunition.

Energy

This paints a confusing picture for energy.

• Depression in Europe is VERY bad.

• Booming travel in Asia is good.

• Weak demand for Asian industrial production is bad.

• Keeping US bubbles inflated is good.

• Persistent low capex out of a few like Petrobras is good.

• Russia struggling to keep oil production up is good.

Can several goods compensate for a few big bads?

The regional disparities show in oil. US inventories are declining by 1-2 million barrels per weeks (thanks to SPR releases) & “the EIA reported the highest demand for the 3rd week of April *ever*.”

But Europe seems to be managing low supplies fine, even with most of the French refineries on strike.

This is the likely reason why the OPEC has cut production, demand is more than a little soft.

They had to because European demand is THAT bad it is canceling the boom in both US and Asian demand.

Short Term Outlook

In the short term, I expect somewhat of a short-lived panic to happen. Either triggered by an expansion of the banking crisis due to more bond-related failure, commercial real estate, or both.

Could be from the US or the EU, but more likely the EU, as they are more likely to have more dysfunctional, disunited, and slow policy decisions.

Also, the ECB is led by Lagarde, and as a Frenchman who saw her as minister of economy, she is the poster child of the “failing upward” method of the EU managerial “elite”. Maybe she can lead the IMF next, who knows…

Expect lower oil, gold, and commodities for that mini-panic.

Depending on your strategy you might want to just raise cash and wait.

Personally, I am not very good at such short-term timing of the market. I think I will just sit tight and collect Petrobras dividends, and ignore Transocean stock's crazy volatility. Business as usual.

Better for my nerve, even if this means leaving some money on the table. Besides, at a yield of 10%-20%, this is a pretty decent return even if stock prices suffer.

Long-Term Outlook

The longer term has not changed much.

Black Swan?

Case 1 is the EU recession/depression and Ukraine war triggering a global Great Depression 2.0.

Possible but unlikely for now. Again, no Great Depression when the government goes heavy on the printing press. Just short-term pains and inflation.

No idea where to hide for that if I am wrong, except maybe cash and bare necessities. Kind of like a hardcore survivalist checklist minus the gold.

Combined with the low probabily, I would keep it as something just to get a cheap insurance policy against.

Depending on your sophistication, financial hedges or just a house with a good veggie garden will do.

Gardening is good exercise too :) I am going to do a bit of weeding after this article.

Staying On Track

Case 2 is turbulence and short-lived panic, but not much has happenned in retrospect. I expect a continuation of the existing trends:

1. Growing defense spending and rising international tensions, hence why my new report covered 2 Anglosphere military shipyards.

2. No true asset deflation in the US. A true end of market and business cycle mandated by the central bank.

   1. It might hurt the dollar. Or only do so in 5-10 years. Impossible to tell.

3. Europe is in trouble.

   1. The failing Ukraine war, which will result in permanent high energy costs and inflation.

   2. Rising social/political tensions from countless unresolved issues. Economic, but also immigration, generational divide, South vs North, East vs West.

   3. France, the eternal basket case of protests, might be okay due to nuclear power in a sea of shortages. Or get a 6th republic, to add to its previous 5th republics, 2 emperors and several kings it had since the French Revolution.

   4. Poland could be re-emerging as the industrial leader of central Europe if it does not go adventuring alone in Western Ukraine.

My Strategy

I insist on the “my” part.

This is really not investment advice, as I have a very rare profile in risk & volatility tolerance.

Stick to oil for another 6-24 months

Poor production levels and declining inventory compared to demand are here to stay short of WW3 or a global Depression. China is likely to boost domestic consumption through various stimuli.

OPEC will not let oil prices go too low if they can manage.

Dividend-gushing stocks are better, as they bring some cash to buy more during volatility.

Inflation shielding stays priority number 1

We are still very much in a stagflation scenario.

Deglobalization and trade wars are inflationary. So are energy shortages, and commodities shortages. And re-arming, rebuilding industries, and spare capacity.

A bit of gold insurance (physical in hand and/or gold miner) is welcome. Commodities will do fine if you navigate well the muddled water of jurisdiction risks, management quality, and picking the right ones.

Localized and de-correlated opportunities

Not everything needs to be tied in macro. There are quite a few other themes I can see having their time in the sun in the next 5 years.

• Fertility. The realization that demography matters is growing. Plus a secular trend of people marrying too late (I know this problem personally). Most countries will soon subsidize making babies like they subsidized EVs and solar panels.

• Cannabis. The industry went down 90% and is left for dead. Difficult to make good picks with scummy management, custodial issues, etc… Still, a 90% fall in a sector basically selling addiction must be playable somehow. Just not sure how yet.

• Sri Lanka. The country was left for dead in 2022, and forgotten since. Another theme on which I need to do deep research to find anything investable.

• Frontier markets: I covered Kazakhstan, Georgia, and Guyana so far. SE-Asia, more South America, or Central Asia probably has some hidden gems I need to find.

• Tech innovation.

  • AI for movie making and animation might become a real thing stunningly soon

    • and I already have a company in mind, might be the report in 2-3 months.

  • Progress in genomics is astonishing.

  • Nuclear power is finally making great progress with SMR, thorium, etc…

  • The new space race is accelerating.

Again, this needs more research, but I think a mix of cyclical, geopolitical, and relying on making technological innovation is healthy.