Monthly Archives: October 2023

2023-10-28
Foreign exchange, Investments, Property, Shares

Economic War

War does not determine who is right – only who is left – Bertrand Russell

I’ll begin with my own speculative theory (an unverified assertion) regarding the decoupling of the United States and China. Prior to the Global Financial Crisis of 2008, China reinvested the proceeds from their exports into the United States. The crisis in 2008 disrupted their financial relationship due to reckless money management. We may recall the substantial losses suffered by a Norwegian investor in the U.S. mortgage market. Following the 2008 crisis, there was a mutual lack of confidence between them in managing financial resources. To illustrate this simply, let’s imagine they initially had built up $30 of mutual trust in terms of financial investments.

Now, let’s assume that $20 of this trust is dissipating due to this lack of confidence. In response, each of their respective central banks had to generate $20 (and of course some extra greedy money) to inject liquidity into the funds that were leaving the mutual investments.

Subsequently, the global economy was left with an additional $40 in liquidity (2 times the initial $20). The other $20 would likely gravitate towards a more supportive U.S. economic policy and a greater role as a global reserve currency, adding another extra liquidity on top of some extra and extra. Meanwhile, China would have to continue with monetary easing measures to compensate for the $20 exiting their systems and combating massive amount of real estate deleverage. This issue is further compounded with Emerging Market sensitivity issue to inflation. Notice the difference.

I’m working to navigate my current top fantastic four investment lieutenants within the context of the economic war dynamic and extra liquidity movement:

  • QQQ (Sustainable Energy and Artificial Intelligence)
  • Commodity (Copper and Iron Ore)
  • The Bill and The Bond
  • Property

Over the past year, we have scaled back massively on our investments in Property, and Bonds for various reasons. This has led us to engage in more active hands-on combat management between our holdings in QQQ and Commodities. It’s important to remember that each individual has their own unique circumstances and investment strategy, so what works for me may not be suitable for everyone.

In a December 2021, we accurately abstained from taking any positions in QQQ (after it was driven by too much extra liquidity) and correctly predicted the onset of high inflation. Inflation means there is too much extra money than economy can absorb in the foreseeable future. In my opinion is due to too much and long near zero rate easing and the decoupling money. Take note of the correlation between QQQ, liquidity, and inflation, regardless of which one is the cause. Six months later, due to the looming threat of high inflation, the Federal Reserve had to implement the fastest rate hike in history.

In a January 2023, we made a precise reallocation, moving nearly all of our commodity holdings and one-third of our property holdings into QQQ with substantial leverage. We believe it is excessively oversold and undervalued given the amount of available liquidity at that time. Our preference was towards the advancements in sustainable energy and Artificial Intelligence (AI).

Moving ahead to September 2023 and very early October 2023, in our current portfolio strategy, we decided to shift all of our QQQ holdings back into commodities (at a 15% discount) due to the following reasons:

  1. QQQ appeared way overvalued based on both fundamental and technical analysis. In the September article, we strongly believe that the Fed has completed the rate hike at 5.25-5.5%, indicating that there is less likely additional liquidity to fuel much further impressive QQQ rally. Of course, we both understand that there is still about 1 trillion dollars in RRP (Reverse Repurchase Agreement) and 1 trillion dollars in bank reserves in the ecosystem, which can have various unintended effects. We are also uncertain about how far the US and China will resolve their mutual trust and economic trade barrier issues, which could potentially provide additional momentum to QQQ.
  2. Previously (early October 2023) we held the theory that the U.S. 10-year Treasury yield at 4.2-4.7% was too low while other economists at that time believed it had peaked. Shortly after, there was a rally in the 10-year yield to near and above 5%. A rally in the U.S. 10-year yield may also indicate something is less supporting QQQ.
  3. However in my opinion, the rally in the US 10-year Treasury yield may indicate something is supporting commodities. While the prevailing common view attributes it to potential supply, I would like to consider it from this context, the perspective of China. Commodity positions seemed more appealing, especially given (in my own belief, others may disagree) the increased cooperation between the U.S. and China, following with higher economy activity in China, and may cause some degree of higher consumer price inflation in future.
  4. Due to that reasoning, also, on October 6th, 2023, we initially theorized that consumer-related inflation (CPI and PPI) might begin to show signs of a rebound, while others believed they would continue trending lower. Shortly after on October 11th, both CPI and PPI indeed indicated an initial rebound, and the US 10-year Treasury yield continued their rally from 4.2-4.7% to 5%. While people commonly attribute this to China exporting inflation, in my opinion, it’s due to the Chinese economy, which has undergone tightening over the past three years, suddenly consuming more resources and exporting more. If this is indeed the case, it should drive consumer prices higher.

Our top two picks in commodities are copper and iron ore, as we believe these two materials have the highest volume in economic growth and renewable evolution. Please note that we are not endorsing direct investment in commodities, ETF, or any specific stocks or investment vehicles. We leave that to the financial advisor. Our purpose here is to focus solely on discussing the thesis and theory that can closely predict the future and not according to popular opinion.

From our perspective, iron ore continues to be an attractive prospect considering its favourable price and substantial volume. If the current volume keeps increasing, the unit cost could potentially dip below $20. Furthermore, when factoring in the Australian Dollar (AUD) sale cost, it logically provides a 22% higher profit margin.

As for graphite and rare earth, we have reservations due to:

  • A high level of uncertainty regarding their production and market control.
  • Limited profit margins.

Regarding lithium, we are cautious due to its price volatility, which presents a higher risk to our risk management. In fact, we believe that the current price of lithium is still overvalued after the recent “tulip mania” event, similar to the situation with copper after the technology boom in the year 2000, and it may take a few more years to normalize.

We are still navigating a very complex yield curve dynamic and its associated liquidity challenges. However, as indicated in a previous article, we would like to concentrate on the short-term US10Y. Our position in commodities is also influenced by our suspicion that there will be a continuing imminent shift in $TNX, backed by the just recent more stability of $TLT.

What do we think will happen IF the U.S. and China had real issues in the past and are now genuinely moving towards better economic cooperation? Would there be better resolution of US liquidity? Would there be increased of commodity consumption? Would there be higher consumer price? We leave that up to each individual’s superpower skill, imagination, and portfolio strategy.

The outcome of a global economic war is not a measure of which side was morally or ethically justified in their cause. Instead, it emphasizes that the side with superior resources, and strategic advantage often emerges as the victor, rather than the righteousness of a particular cause. Furthermore, the phrase highlights the tragic and devastating toll that war takes on both sides, leading to high inflation, high mortgage rate, costly living cost, volatility and investment loss. Overall, this saying underscores the futility of resolving complex economy issues and encourages the pursuit of alternative means, such as diplomacy and dialogue, to achieve lasting and just solutions.

Please note that all ideas expressed in this blog and website are solely my personal opinions and should not be considered as financial advice.

2023-10-06
Bonds, Foreign exchange, Investments

Acceptance of The Inevitable

“When the fierce, burning winds blow over our lives-and we cannot prevent them-let us, too, accept the inevitable. And then get busy and pick up the pieces.”

Dale Carnegie – Stop Worrying and Start Living.

In my previous articles, I have argued that current economic systems should accommodate a 5.5% growth. This is a straightforward concept, and I would employ 5.5% as the fundamental standard throughout my entire thesis. Since 2020, the US debt has been consistently increasing at the same rate of 5.5%. I anticipate this trend to continue until next few years, at which point after, it may accelerate even further faster. Unless the largest economy in the US experiences a significant deviation from its trends spanning decades, we should acknowledge my inevitable economic thesis: (1) higher debt (2) faster debt, coined as “higher further faster.”

The current pace of growth has exceeded that of the previous cycle and is anticipated to rise further in the subsequent cycle (after the next Global Financial Crisis). During this period, the global landscape has been notably demanding due to elevated levels of debt growth. The earlier 2020 CoVID crisis necessitated low interest rates and fiscal support measures to steer it back onto its 5.5% trajectory. I would anticipate policymakers to maintain their commitment to this debt-driven growth. Ultimately, they would have little choice but to align with this trend, lest they risk jeopardizing the entire economic framework, which amounts to hundreds of trillions in human history.

In prior articles, I contended that a 5.5% increase in debt might lead to significant economic challenges:

  • Firstly, a 5.5% increase in debt will drive asset growth at a rate of at least 5.5%. This will lead to a swifter expansion of assets in the market and among participants. We can anticipate the following:
    • Wealthy individuals with significant assets will experience even greater wealth accumulation.
    • Major corporations will demonstrate resilience, maintaining stable revenues and continued hiring.
  • Secondly, historically, wage growth has not exceeded 5.5%. This could pose a challenge as most workers may struggle to keep pace with inflation.
  • Thirdly, individuals fortunate enough to possess substantial and rapidly appreciating assets may face a decision between continuing employment or opting for retirement. I suspect this may be a minor contributor to the lower unemployment rate, owing to workers choosing earlier retirement. Over time, they are likely to receive enduring support with returns sustaining at 5.5%.
  • Lastly, there should be an adjustment in yields. Assuming policymakers remain steadfast, I would contend that long-term yields should at least approach 5.5%.

We are witnessing evidence supporting my fourth argument here. Over the past few weeks, we have observed disruptions in both $TLT and $TNX. I stand by my thesis that they should reach a minimum of 5.5%, and possibly even higher on the longer end. While some economists have been suggesting that TLT may have hit its bottom in the past few weeks, I would argue that it has not yet done so. The 10-year yield has not yet reached 5.5%. I firmly believe that the 10-year yield is strongly linked with inflation. Therefore, given that the 10-year yield has surpassed its previous high of 4.2%, we should anticipate:

  1. A prevailing narrative of heightened inflation.
  2. A new normal of 5.5%.

I suspect that this shift in narrative, which has taken us halfway through the cycle, where we’re beginning to see a rise in both inflation and yield, has contributed to the recent bout of volatility. From my perspective, policymakers are standing firm in their commitment to achieve a 5.5% growth through a combination of deficit spending and monetary measures. It’s worth noting that not all economists endorse these policies, with some deeming them as risky due to their potential to excessively stimulate the near term, possibly jeopardizing the long term.

I contend that the world has entered a new paradigm, and in my view, 5.5% represents a new normal. Market participants should be prepared to embrace this change and acknowledge its inevitability.

However, it’s important to recognize that this acceptance is not without repercussions, as elucidated in my second and third arguments. While major corporations continue to generate substantial profits, the same cannot be said for smaller enterprises and the average individual. Unless wage growth experiences a substantial acceleration, we may continue to face challenges in the market. We must closely monitor whether individuals can sustain their spending, if major company revenues will continue to surge, or essentially, if key economic indicators will remain robust.

I understand that some advocate for a focus on the average economy. Yet, in my perspective, policy tends to lean towards the larger economic landscape rather than the average. If these significant economic indicators were to falter — for instance, if major corporations were to significantly reduce employment — the new ecosystems might face difficulties. However, as we have observed, the major economic metrics remain solid. Therefore, in my view, policymakers will stay the course, using front-end deficit measures.

Given the stability in economic metrics, I don’t see any reason for policymakers to alter their approach until long-term yields reach a 5.5% growth (which has not yet been achieved). I believe they will remain steadfast in their strategy and avoid making significant disruptions to the long term until this 5.5% objective is met.

I maintain my thesis that a 5.5% front-end Fed rate represents the peak or upper limit for the Fed rate. As of August 2023, this remains my peak rate thesis. My argument is straightforward and is rooted in the observed debt growth. Raising the rate beyond 5.5% would likely lead to a stagnation in the economy and a contraction in liquidity, thereby tightening the market. Conversely, reducing the rate below 5.5% would likely only spur inflation, which has been trending upwards over the past half of the cycle. The longer policymakers adhere to a 5.5% rate in the front end, through the use of fiscal deficit, the more entrenched it will become in the long end.

There is a discussion surrounding the potential limitations of fiscal deficit supply. If over the next 4-5 years we do not observe any improvement in market resilience, we may unfortunately face a significant new challenge where increasing long-term yields could escalate beyond control. My contention is that supply allocation should no longer disproportionately favor short durations and must begin to exert pressure on longer durations. In this scenario, Treasury buybacks (which would be implemented gradually starting in 2024) could emerge as a dominant policy to prevent an uncontrolled surge in long-term yields, which the global economy may not be able to sustain. We’ll deal with this later.

To avert such a situation, as I argued in my articles over the past two months, cooperation with other countries, particularly China, should improve. I still believe that China has not yet substantially reduced its holdings of US Treasuries. There will be debates regarding duration and potential reallocation, possibly involving Europe.

In contrast to some other economists who may anticipate a cooling down of inflation, I adhere to my thesis that we will start to witness a resurgence of inflation, and it will likely persist at elevated levels. This is why I have begun to reacquire quite significant amount of leveraged commodities. In the next few years, I anticipate a potential (restrictive) cycle in commodity growth. I cannot predict whether there will be a definite recession next year. We should closely monitor the global market’s resilience during this period.

Given the considerations above, and in light of the increased yields’ impact on resilience, we have decided to re-enter the market, albeit without employing much leverage. In previous years, we consistently maintained leverage ranging from 200% to 300%. However, for this half of the cycle, we are beginning to allocate a portion of our previous leverage into fixed incomes (though not yet long-term bonds), and we have not yet introduced significant leverage. If long-term yields were to surge above the 5.5% trend, I may then reallocate fixed incomes into long-term bonds. I believe it is a prudent decision to introduce fixed income into my portfolio, which has primarily consisted of high-risk assets with high leverage in the past 3-4 years, lacking lower-risk assets.

Please note that all ideas expressed in this blog and website are solely my personal opinions and should not be considered as financial advice.