Strong Views Lightly Held

I’ll start by noting I don’t write anything here to be “right.”  Nor do I pretend to superior insight much less information.  I’m just writing to collect my thoughts in the vein of quite possibly wrong but hopefully thought-provoking.

So Putin went ahead and did the dumb thing.  2 days into invading Ukraine, he is already losing.   

• Militarily (for real):  The Pentagon and UK MoD have both noted the Russian Army likely hasn’t met its Day 1 objectives.  Which is their polite way of saying “If I were in charge of this operation, I’d be shitting bricks right now.”  They have also noted the Ukrainians are fighting well and their command and control has held up. Ukraine wins here by not losing.  Russian “wins” here by…. (I really have no idea at this point).
• Militarily (perception):  This is not the US’s brand of “surgical” video game warfare the world is used to watching on TV.  The photos and video show the result of bitter, ugly fighting leaving dead Russians and burnt out Russian vehicles in its aftermath.  As I noted before, if Putin wins ugly, he loses.  The US army has looked invincible in its wars.  The Russians look vulnerable.
• Hearts and Minds (Ukraine):  I have no idea if Putin thought he’d be greeted with flowers, but the Ukrainians clearly seem to feel otherwise.  Any who might have been ambivalent to start aren’t anymore – especially as the shelling and killing goes on.  This likely torpedoes a puppet government exit for Putin.  More important, that resistance will gnaw at his Russian support.  If you are a Russian soldier, you are not feeling the love right now.  And Ukrainian is close enough to Russian you are going to hear it in words you understand from people who look a lot like you.  If you are a Russian civilian, you are going to be seeing it and hearing it from (former) friends and family.  The uglier it gets, the more disheartening it will be (if you are Russian).  Especially if you are a Russian soldier who ends up tasked with propping up some puppet government against the wishes of “cousins” who very clearly hate you.
• Public Opinion (Europe):  Russia just got kicked out of the Eurovision song contest.  I laughed at first, but it measures the depth of popular response in Europe (who are getting a whole lot more news on this than we are).  Right now, Europe (OK, Germany mostly) is dragging its feet a bit on sanctions.  I would guess that another week of fighting, refugees, and horror will feed a groundswell of popular demands to get tougher with Russia.  Germany’s paid-for-politicians will find it increasingly hard to waffle their way out of something that hurts their precious client’s pocketbooks.
• Public Opinion (World): The ugliness of it all is not helping Russia anywhere else either.  At some point even the Chinese might finally start edging away.

So how does Putin get out of this?  I have no idea.

A few bullet point observations below.  And yes, I am playing armchair general and yes, I know I have no real clue.  The point of this blog is not to “be right.”  I’m also indulging in a little armchair general-ing with no illusions as to my qualifications.

• The recurring image of the war so far is a wounded blonde, bravely smiling woman who looks like (and might well be) one of those oddly healthy-looking senior citizens who feature in financial service commercials looking forwards to their comfortable, affluent, well oiled retirement.  Except her head is bandaged and she is covered in blood in front of a shattered building.  Wounded White People is not a good look for Putin.
• The Ukrainians seem to be doing to the Russians what the Russians usually do to the Germans and French.  Retreat into the vast interior expanse and then wait for chances to strike back viciously.  If they can cut off and destroy some Russian units (followed by heavy news coverage), it is going to get harder and harder for Russia to sustain enthusiasm for this war.  Especially among the poor guys fighting it against their “cousins.”
• It turns out the Russians export most of their gas to Europe via 2 pipelines.  One runs via the North Sea (Nord Stream 1).  The other runs via the Ukraine.  If some enterprising Ukrainian (or faux-Ukranian) were to figure out how to blow up a big, metal, multi-kilometer pipeline full of flammable gas that is admittedly running on the seabed, then Russia would be reduced to supply gas via a pipeline that runs through Ukraine!  This would seem to give the Ukrainians some pretty solid leverage – less over the Russians and more over the foot-dragging Germans.  No idea how practical that is, but…
• An obvious sanctions idea is to cut off all air travel links to Russia.  Not all global carriers would follow through, so the Russians could still take connecting flights to get most places.  But taking the big US and European carriers off the table (plus private jet landing rights) would send a fairly powerful and immediate message to ordinary (affluent) Russians.
• The Russian Army have a few weeks until mud season (which may have already started).  That is a depressing, wet, cold, and miserable time to be running around outdoors even without people trying to shoot you with bullets and/or dirty looks.

The Ukrainians are paying a terrible price here.  I need to end with that.  But Putin is already losing.

If Putin is rational, he’d played this mess out to the most face-saving “win” he’s going to get.

It “feels” like the point where the whole Ukraine drama comes off the boil (returning to a simmer) or we’re going to have a major land war in Europe.  Not sure how it resolves, but if we are going to have a standstill this is likely when it happens.  Just thinking this through on paper here.

In retrospect, it was obvious Putin would choreograph his point of maximum tension for today.  Why?  Because the Winter Olympics ended yesterday.  Why piss off the Chinese?

At this point, he’s gotten about all he’s going to get short of outright war.

• Fully occupied and effectively re-absorbed Belarus.
• Occupying the “breakway” regions of Ukraine.  With useful ambiguity if that includes Ukrainian land (across the current front line) claimed by those regions.
• Looking tough in front of the Russian people and the world.

Note that the first 2 “wins” aren’t really much of a change from where we were a few months ago.  Although Belorussia’s now-gelded dictator Lukashenko might disagree.  Actual Russian troops on the Polish border is also a little more scary.

Putin has also lost a lot already.  His initial calculus was (probably) Biden is a wimp and Europe is easy to split apart and I can extract concessions from them if I press hard enough.  That has proven wrong.

• No concessions gained.  If anything, his actions have served to unite them.  Germany putting the Nord Stream 2 gas pipeline on the line was a big loss for Putin.
• Pushed Ukraine farther away (today’s speech claiming it for Russia will only exacerbate that).
• Set off a likely for-real effort by German/Europe to diversify away from energy dependence on Russia.
• Repelled everyone that really doesn’t like the idea of old-school wars of conquest, which is “most people in the world” these days.
• Given “everyone” a lot of reasons to avoid investing in Russia.

If Putin goes forward with war, he risks losing more and I still can’t see what he gains?  Maybe I’m not seeing some halfway move that gets him more out of Ukraine with the long-term war-of-occupation pain. Otherwise, he stands still here.  The rest of the week is about everyone finding ways to normalize the situation.

In bar fight terms, the bully making all the noise gets to stomp out looking tough, but the other guy doesn’t actually get punched.  And we all sort’ve know the bully was bluffing, but we do him (and the other guy) the favor of not pointing it out.

If he isn’t rational?  Or if there is some benefit I’m not seeing (very likely)?  Or some internal threat pressing him forward?  Then we’re going to war.  But it likely resolves this week.

He can’t keep the troops out in the field forever (ran into a good Twitter thread about how they are getting drunk, cutting down all the trees for firewood, and selling off their rifles in Belarus).  Also the mud makes the whole area impassible as we get into March.

So we’ve hit the likely point of maximum panic and uncertainty.  We have learned that.  We don’t know (yet) how it resolves.

From a market/economy perspective, I’d note that a land war in Ukraine actually doesn’t change much for most things.  OK, energy prices will stay high (but they are already high).  Europe will have a freak-out.  It does increase the (small) risk the Russians blunder into a confrontation with NATO.  But mostly the world will just keep going about its day.  Provided you don’t live in the Ukraine.

More reasons why Putin’s best interests lie with avoiding war.  Does he understand where his best interests lie?  I have no idea.  He wouldn’t be the first leader to do something stupid and ill informed.  But we do know it would be stupid.

If Putin “wins ugly” in Ukraine, he loses.  The world has gotten used to the “surgical,” low-casualty, effortless ease of the United states invading Afghanistan or Iraq.  Putin would have to match that apparent ease militarily.  He is almost certain to fall short of that bar.  Just one lost battle risks making Russia look like a 2nd rate power. In basketball terms, never get into a 3 point shooting contest with Steph Curry.

Militarily, the US has set a ridiculously high bar that “everyone” just expect all top-tier nations to clear.  We will benchmark Russia against the seemingly effortless US war-fighting playbook.  Cool videos from precision missiles.  A few unlucky American dead and wounded.  Confusion and abject terror on the opposing side.

The US has picked on weak targets.  The Ukraine is a pretty well guaranteed to win a few battles along the way.  It has the latest anti-tank missiles.  It will have the best satellite and signals intelligence NATO can offer.  Against that backdrop, consider this imaginary news piece.

Reuters Feb 28, 2022:  Russian public opinion is reeling from viral TikTok videos after a missile ambush incinerated all 31 tanks and 93 crew of the 6th Tank Brigade.  Unexpectedly high casualties overall are casting a pall over the Kremlin’s efforts to portray the invasion as a success.  It is also raising questions about the true competence and capabilities of the Russian Armed Forces.

Just a few “lost” battles and Russia ends up looking like a 2nd rate power.  Even if they win the war overall.   The Ukrainians, the US, and (hopefully) Putin know this.

Putin’s other problem is best said plainly.  Putin’s forces would be be killing, maiming, and displacing White People –   “people who look like us.”  Not only in US/European eyes, but in the eyes of ordinary Russians.  The US’s lopsided wins on the battlefield didn’t come with a sympathetic (to the West) counter-narrative.  The other side’s view was ugly – thousands maimed, killed suffering, and displaced.  But the other side’s view was obscured by brown skin, turbans, and other marks of foreignness that gave “us” license to de-humanize the suffering of those “others.”    It will be a lot harder for viewers to deny the humanity in the Ukranian TikTok videos…

The last 20-30 years of conflict have hid behind a long history of “colonial war” narratives.  People of a certain age (like me) have seen all those movies.  A few hundred plucky British or French troops with Maxim guns mowing down thousands of howling  Brown-skinned “turbaned natives” – with colorful costumes and heapfuls of overt racism served to accompany.  A lot of US “War in the Pacific” and “Cowboys and Indians” movies fit this trope.  Russia has is own “War in the Caucuses/Asia” equivalents.

Unfortunately (for Putin), the Ukraine is largely made up of… White People.  They don’t wear turbans.  The viral TikTok videos of tearful refugees and sobbing children will all be White People wearing normal White People clothes driving normal White People cars in normal White People settings. People with family and personal ties to Russia and the (huge) Ukrainian community in the US.

Those videos will be seen and the humanity will stand out. Their stories are likely to be “heard” in a way that dying, desperate Afghan/Iraqi stories were not.  This is an ugly truth.  But lets hope Putin understands it is true.

As a thought exercise, ask what Putin would actually get from invading Ukraine?  What would define “victory” in his terms?  A few more chunks of the Eastern Ukrainian Rust Belt?  Uneasy control of Odessa?  A long land corridor to the Crimea that he’d have to defend?  He’s definitely not getting the NATO climb-down he keeps asking for.

A final note.  I think a lot of (traditionally Republican) investors are investing their politics here.  They see Biden, the Democrats, and the Europeans as wimps.  They see Putin as “strong” and they secretly – shhhhh! – admire him for it.  So the markets are over-weighting the likelihood of invasion.  We may well get an invasion, but the weightings of the bet seem wrong.  Every day that drags by without an invasion is also going to make the current market negativity seem less and less reasonable.

If forced to guess, my bet is Putin doesn’t invade Ukraine (see last bit below).  But I have no real idea what Putin’s plans are for Ukraine.  The US doesn’t either.  But the back-and-forth of the past few days confirms the US’s game.  It is, I think, well played.

• If Putin wants to invade, he’s going to.  We aren’t going to send in troops.  But we are going to make it hurt economically.  The Pentagon is also clearly salivating at the prospect of bleeding an occupying Russian army while trying out all its new toys.
• If Putin doesn’t want to invade, we are not going to let him off easy.  We are going to keep shouting “invasion” until he climbs down publicly, loudly, and un-equivocally.  There will be no face saving exit.  We’ll keep shouting invasion until we can show clear “then vs now” satellite pictures of abandoned forward bases on TV.  Pictures which will find their way into Russia…
• Note “we” announced “his” invasion date for when the Olympics are going on (never actually likely)  rather than next week.  If he invades next week or after, he already risks looking like a lame-o loser.    The goal has always been to make him look off balance.

The strategy is either

• “no gains from bullying brinksmanship.”  Which is how you deal with a bully.  Well played.
• …or “no gains from starting a war, but also no global war” which was always how were going to respond to an actual invasion.

In the meantime we’ve already won a lot.

• Ukraine is going to that much less interested in “friendship” with Russia.
• Europe is forced to confront their dangerous energy dependency on Russia.  That will come in handy if/when tensions with China heat up (where Europe has also put immediate commercial interests over self-interest).
• Putin looks unstable and dangerous.  Russia ends up increasingly isolated on their own continent.  Which eventually might just flow through to your average Russian deciding (post Putin) that “joining” Europe is a better idea vs attacking it.  Which might also come in handy when the China conflict heats up.

Why I’d guess Putin is bluffing. This is just a guess but… Point in bold below is particularly convincing to me.

1).  In a negotiating dynamic, the party making the most specific demands has the most at stake (and the weak hand).  The party who is willing to walk away has the strong hand.  The US has already “walked away.”

• Putin has made increasingly specific demands centered on an assurance Ukraine won’t join NATO.  He has also insisted on bilateral talks with the US (bypassing Europe).  He wants that “no NATO” commitment to come from the US directly.  He is threatening to invade Ukraine if the US doesn’t do what he says.
• The US has replied with “Be my guest.  Go ahead and invade Ukraine.  We won’t do talks and we won’t give you those concessions whether you invade or don’t.  I’ll just keep putting out the grim warnings so you have no face saving exit and wait for your next move.”  The US has walked away from the table leaving it up to Putin to follow through (or not) on his threat.

2).  Putin loses in most (or all?) invasion scenarios.

• Even the Germans will have to re-think the Russian Nord Stream 2 gas pipeline and their overall energy strategy.  The US will end up selling a lot more LNG to Europe as a result (another reason The US is OK with him invading).
• A “big” invasion will leave him occupying a lot of territory with the US gleefully shipping in anti-tank missiles and sniper rifles to the resistance.  Any puppet regime he installs will collapse the day the troops go home.  And the troops will be increasingly miserable with occupation duties as they rotate home.
• A “small” invasion that strips off Russia-friendly territory in Western Ukraine sounds more palatable.  But that leaves a smaller Ukraine concentrated in the Eastern regions where they like the Russians the least.  The first chance they get, that smaller Euro-centric Ukraine is going to apply to join NATO.  And NATO will find it very hard to say no after that “Russian invasion” thing.  Meaning that Putin’s “invasion to push back NATO” will actually end up moving NATO that much closer to Moscow.  And Putin doesn’t want to go to war with NATO.  Even if Ukraine doesn’t join NATO,. it will “join” Europe culturally and economically.  Putin’s economic/cultural/military border moves East towards Moscow, not West away from it.
• There are all sorts of terrible. tragic industrial accidents that might befall Russia’s shiny new Nord Stream 2 pipeline running under the Baltic.    Who will ever really know where those frogmen and submersibles came from?  Brave Ukrainian freedom fighters?  The US can do “little Green Men” too….
• Putin ends up looking like a class A jerk.  Even the most cash-register driven Europeans will figure out they can’t rely on him.

PS – A lot of Ukrainians really don’t like the Russians.  With a few million good reasons – see https://en.wikipedia.org/wiki/Holodomor.

Has it occurred to any of the inflation doomsayers they might just be getting played by the Fed?  The Fed is going to look like a bunch of geniuses as the headline YoY inflation numbers mechanically come down over 2022 🙂

We KNOW that headline inflation is going to plummet in the next few quarters.  Why?  Because we will stop comparing prices today with (hideously depressed) prices 12 months ago that reflect a freakin global pandemic!  Auto prices are up 40% year over year right now, but that is comparing January 2021 with January 2022.  By the time we get to say August ’22 vs August ’21, the YoY change percentage increase is MUCH smaller because prices in August ’21 were already much higher

So, this was always a risk free way for the Fed to burnish its reputation, credentials, and “inflation fighting credibility.”    Powell already knows the trajectory of headlines over the course of 2022 – “Reported Inflation Numbers Fall From Record Highs“.  All he is doing is scooching in to take the credit. “Decisive Fed Action Reduces Inflation” has a much nicer ring to it (if you are the Fed).  

Responsible adults can (and do) differ on whether inflation settles back down at sub 2% (where it was pre-pandemic) or in the 2%-3% range.  Here, we should probably pay attention to what the Fed was saying 6 months ago.  They WANT inflation to overshoot their 2% target.  They were very clear on that.

My guess (and my inflation forecast) is probably inflation in the 2% to 3% range and risk-free treasury interest rates close to 2% BELOW inflation. Meaning people looking for a risk-free return will end up paying for the privilege.  Which is where I think the Fed wants to end up.  Why?  That’s for a later post.

For more of the data, I’ll just pull this quote from NYTimes

Mark Zandi, chief economist at Moody’s Analytics, which conducts economic research and risk analysis, put it clearly in a conversation on Wednesday. “Inflation has already peaked,” he said. “It peaked in October.”

How is this possible?

A close look at the numbers shows that the annual C.P.I. inflation rate reflects the very low base levels of one year ago, when the pandemic had suppressed demand and prices were low. The month-to-month numbers support a different narrative.  Consider that monthly C.P.I. rose:

.09 percent in October.
0.7 percent in November.
0.6 percent in December.
0.6 percent in January.

It’s true that this has been the worst year for inflation in more than 40 years, but we’ve known that for months. What these numbers show is that although inflation is high, it has also been fairly stable on a month-to-month basis. Mr. Zandi, who says he takes “a sanguine view,” expects that the annual C.P.I. numbers will start to decline in several months, whatever the Fed does. And much as annual corporate earnings look better when compared with low numbers a year earlier, the decline in the annual C.P.I. rate will look even better in comparison with the steep readings of the past year. That’s just math.

The Fed does need to raise rates considerably over a few years and reduce its swollen balance sheet, he said, but that can be good news because it means extraordinary measures are no longer needed and it’s time to “normalize.”

In short, it might be helpful to reframe the C.P.I. news.

Newspapers could quite accurately have run this much duller headline: Inflation Remained Stable, Well Below Its October Peak.

These charts seemed worth writing up.  Key is 10 year bond yield minus the 2 year bond yield.  Have a look.  That is some crash (especially that last leg down). Getting back to 2019 lows.

Explainer.  This is a measure of the “yield curve.”  It is roughly a proxy for future economic growth.  If 10 year money is paying a lot more than 2 year money, the market is expecting strong economic growth.  When this number “inverts” (10 year pays out less than the 2 year) that is an almost foolproof recession indicator.  If the number is going down, expectations are going down…

Does this spell “runaway inflation” to you? Or does it say “the Fed is almost done and we’ve all learned the natural rate of interest is scary low because we have a soggy low-growth economy.”  We already learned this lesson back in 2018 last time the Fed tried to hike rates.  They raised a few times until the 10 year rate went DOWN – the market telling us that any more raises would choke off growth.

Is the economy that different from 2018 2019?  If anything, it is weaker.  Fewer participating workers and higher inventories are both drags vs 2019.

Maybe the market is wrong? Reasonable argument to make, but I’d argue that chattering classes “consensus” is Inflation is out of control!!!!  There is a lot of talking head commentary to that effect.  So the market is mostly refusing to confirm what “everyone” is saying.  In cases like that, the market is usually seeing further ahead than the chatterboxes.

The bigger worry is that lower demand, driven by higher prices and not-equally-higher-wages, stalls us. Which would be consistent with that flattening yield curve. And basic market economics. Which a lot of people also seem to have lost faith in lately. Apparently people will just keep paying ever-higher prices forever drawing down on some previously unseen source of funds. OK, they can borrow against newly re-valued houses, but…

Chart 1 – 10 year minus 2 year

https://fred.stlouisfed.org/series/T10Y2Y

Also A Bonus Look at Real (Inflation Adjusted) Yields.  Inflation Expectations Aren’t Driving Rates…

https://fred.stlouisfed.org/graph/?graph_id=983261

The Ukraine situation is very odd.  The US and other allies have shared a tremendous amount of specific intelligence.  Leading up to setting a potential invasion date of Wednesday, February 16th (while the Olympics are still going on).

If this was a bar fight, we’ve just announced to the crowd that Big Noise Bob is going to hit Small Shy Sam in the face right about now.  Without asking Bob’s opinion on the matter.

So where does that leave Putin?

1. He doesn’t throw the punch.  He looks like a schmuck.  He’s climbed down.
2. He throws the punch.  He looks like a jerk.  And he’s in a bar fight.  Sam is smaller, but he’s not a wimp.  He invades during the Olympics, which really annoys his frenemy China.
3. If Putin waits and invades later, he looks like an indecisive jerk.  We all know he is ready to invade this week.  So he’s either kowtowing to China or wishy washy.

I like the whole strategy.  There was no chance we were going to send troops into Ukraine.  So we made a virtue out of that reality.  We’ve done everything short of putting “invade here (at your own risk)” signs up on the Russia/Ukraine border.

We don’t know what Putin wants to do.  If he wants to throw that punch, we aren’t going to step into that bar fight.  But the world is going to know exactly who threw the first punch.

So if Putin’s goal was to throw his weight around and extract concessions, he’s already lost.  He’s won nothing and won’t.  That leaves invade at your own risk).

1. Putin knows the risks of occupying Ukraine.  He also knows the Pentagon is dreaming of bleeding his army dry if he does it.
2. After all this publicity, any regime installed by Putin would be illegitimate.  Likely to collapse after his troops go home.
3. The bits of Eastern Ukraine he already occupies (Donbas) are its rust belt.  Less an asset than a liability.  Trying to carve out and annex more bits looks neat on a map, but…
4. The US has also made some pretty loud noises that Putin’s precious Nord Stream 2 gas pipeline to Germany is at risk.  It runs under the Baltic and is thus highly vulnerable.  Without Nord Stream 2, Putin is stuck with his existing gas pipeline running through… Ukraine.

I have no idea what Putin wants.  Assuming no-one else does either, this was a good way to play it.

FUN FACT:  I just finished a book on the Mongol Horde that reined quite successfully (and mostly peacefully) over Russia/Ukraine for hundreds of years.  They fought a lot of wars, but ALWAYS tried to manufacture some pretext or insult that allowed them to claim self defense.  It was a culturally critical part of their decision process.  You can see this echo through Putin’s behavior and a general Russian sense of victim-hood.  You can also see how awkward the US strategy makes things.  It is going to be very hard to manufacture a genuine-seeming provocation in sunlight this bright.

Back to blogging. Mostly on macro. Trying to keep it shorter and less tidy and therefore hopefully more likely to publish.

“The cure for high prices is… high prices.”

A lot of people are expecting high inflation to persist. Forgetting this bit of market wisdom “The cure for high prices is… high prices.” So lets have a look.

Where are we? When you get a conflict between absolute conviction among amateurs and/or commentators with a financial interest in the game and deep uncertainty and nuance from the people actually playing the game, uncertainty usually wins.

1. A whole bunch of popular press commentators will, with total confidence, tell you exactly what the Fed has been doing and its impacts.
2. Meanwhile, the Fed itself has been EXTREMELY clear they are not all confident about what impact monetary policy (especially Quantitative Easing) has had. Or if it has had any impact at all. The world of “real economists” is equally uncertain and honest about it.

So what do we really know? The stimulus was powerful.

1. We do know Fiscal stimulus (giving people $$) was extremely powerful and effective over the last 2 years. It had major impact. Whether criticizing or praising the stimulus, most people agree on that.
2. We also know that fiscal stimulus is fading. We can see it in the data.

So where do we go from here? [sound of air hissing out of a tire…]

1. Consumers with less money facing higher prices will do…. what? BUY LESS STUFF. The cure for higher prices is… higher prices.
2. This other bit of wisdom seems particularly apt after 2 years of people shifting spending to buying goods vs services. “I have seen gluts that did not lead to shortages but I have never seen a shortage that did not lead to a glut.”
3. Also remember that higher oil and gas prices are usually set aside as a more like a tax than an “inflation” price input. Meaning that higher prices work like a tax increase (deflationary). More spending at the pump reduces spending elsewhere. You could make the same argument about higher rents. If you spend more on shelter, you spend less elsewhere.

So is there a realistic case for persistently high inflation?

4. The ONLY path for inflation to take hold is a so-called wage-price spiral. That takes few cycles around the track to get going. Wage increases now only count if they are followed by wage increase in 2023 and 2024 AT LEAST. A one time gain for workers in 2022 is just that. a one-time gain.
5. If workers don’t keep clawing out wage gains, they end up reducing spending (or going into debt). That debt capacity is pretty good after all that stimulus. But this is basically just a return to the 2008-2019 economic dynamic. This wasn’t inflationary.
6. So if you are predicting inflation, you are predicting workers will be able to demand raises for the next few years.
7. You are predicting a meaningful shift in the balance of bargaining power between labor and capital.
8. You are (really) predicting a shift in inequality. The poor get richer. Profits suffer as wages increase. The rich get poorer.
9. Is that really a high-probability scenario? I don’t think so.

With respect to inflation and markets. Companies with pricing power ride it OK. Companies without pricing power get squeezed.

Also note that basically no-one has a really good handle on the connection between inflation and money printing or really anything at all (stripping out the Zimbabwe or Weimar Germany examples which are clearly not relevant here). Honest people are willing to admit that. See this Fed paper, which can be summed up as “we have no idea what causes inflation and most of the tidy explanations don’t hold up vs real data.”

Click to access 2021062pap.pdf

I’ve re-written and delayed this piece for a while. Why? Partly I got busy. Mostly because “lessons learned“ exercises depend on being right about where you went wrong. I’m not trying to make excuses. I’m trying to avoid making the same mistakes again.

What I Got Right – Pandemic Trajectory, Shut-Downs, and an Impotent Fed

A year ago, a lot of people were expecting a temporary shut-down in the face of some pretty obvious evidence to the contrary. Jessica Lessin CEO of The Information wrote this today….

In a note to staff, I said the closure was in effect for several weeks or until further notice. Ha! What we didn’t know.

At least I didn’t make that mistake. By about March-May, I’d come to this forecast.

• The pandemic would be prolonged, involve long shut-downs, and not over for all of 2020.
• Mass unemployment for a very long time.
• Chaotic regional responses.  Lack of sustained discipline: People wouldn’t take the virus seriously until it hit close to home. They would get lazy fast.
• The Affluent would do OK.  The Non-Aflluent wouldn’t: People who could work from home would sail along reasonably well. Others would take a huge hit.
• The Fed couldn’t (and didn’t) have much impact: Popular narrative would like us to believe the Fed saved us. But it is pretty clear the Fed’s response had minimal impact beyond stabilizing markets in March-May (mostly via “animal spirits” psychology, not real dollar impact). We know most of that Fed money just round-tripped into the Fed system without ever hitting the real economy or the financial markets. The Fed did keep markets functioning. But the pandemic’s impacts in the real economy were largely beyond its reach. If you disagree, see “Upside Down Markets” link below. I won’t re-hash that here.

So a pretty decent forecast. Yay me!  Then I drove myself into a ditch.

What I Got Wrong – US Elite Response (Politics) and Fiscal Stimulus:

I got a few big things wrong.

• Trading Excess Deaths to Minimize Capital Losses: I never imagined the US (elite-driven) policy response would amount to “lets accept 500,000 deaths to keep the shops open.” Strip away the rhetoric and we (OK “they”) chose to sacrifice lower-class lives to protect/preserve upper class Capital. Red states were the worst, with Georgia’s no-pretence-at-caring re-opening setting the tone. But the Blue states weren’t much better – a lot of performative lockdown theater and magical thinking/obfuscation.
  A year later, we have done a remarkable job of preserving Wealth. Meekly accepting a few hundred thousand excess dead people as a cost of doing business.
  I simply didn’t imagine that “we” (or really “they”) would make that choice.
• Fiscal Stimulus Worked Vastly Better Than I Expected: The Fed’s monetary intervention didn’t do much. Congress’s fiscal intervention did all the heavy lifting and then some. The $600 unemployment benefit (especially) and $1,200 checks had a HUGE impact. I totally under-estimated that.
  A particularly bitter pill given I’ve always professed faith in the impact of giving immediate cash to poor people with a high marginal propensity to spend. But I wildly under-weighted how powerful that impact really would be.
  For more, take a read through the paper below. Those checks found their way through the economy and (eventually) into financial markets. Sparking the stock-market rally that I also totally missed.
  • “Upside-Down Markets: Profits, Inflation and Equity Valuation in Fiscal Policy Regimes” https://osam.com/Commentary/upside-down-markets
• Inequality is Worse Than I Thought or “The Little People Really Are Rounding Error vs the Top 15%-20%“:  I knew income inequality was bad, but I didn’t understand just how bad.  I thought millions of unemployed people would be a serious drag on the economy.  But a huge whack at the bottom 80%-85% just didn’t stack up for much against the top 15%-20% who kept on (or amped up) spending.  I knew the Affluent would do OK.  But I didn’t really appreciate how much they dominate(d) the spending pie.

What I REALLY Got Wrong (Investing) – Too Much Macro Fear for Too Long. Too little Faith in my Secular Growth Theses.

I really screwed up the investment call: I sold out of everything in March. I can actually sort’ve justify that decision. I needed to preserve that capital and the downside scenario was arguably dire enough to warrant it. But I failed to buy back in the Summer as the stimulus rolled through the economy and the markets. That was just dumb pig-headedness. Two errors compounded.

• Over-Weighting My (Negative) Macro Outlook. Staying Wedded to It For Too Long: I can justify the dire macro scenario I was protecting myself against by selling in March-April-May 2020. I knew I was giving up some upside potential to protect against massive downside risk. Faced with that choice again, I’d probably make it the same way.
  But I stuck with that negative macro scenario for way too long. I was working from a “2008-2009” playbook and missing that (gasp!) 2020 was nothing like the Financial Crisis.  OK, I wasn’t alone in making that mistake, but I should have figured out the facts weren’t flowing my way sooner than I did.
• Under-Weighting Secular (Tech) Trends and Their Acceleration In a Time of Stress: I run a concentrated Tech portfolio focused on secular multi-year growth stories. In March I had Cloudflare (NET), Atlassian (TEAM), Docusign (DOCU), Amazon (AMZN), and Infinera (INFN). INFN is “only” up 100%+. The others are up more like 300%-400%. Even worse, I knew it was a good COVID portfolio at the time.  I just put too much weight on the macro risks and too little on the increasingly obvious acceleration of the secular trends driving those stocks. Especially as we rolled into June/July. I preserved my capital, but missed out on huge potential returns.

So where do I go from here? More to come on that. Short version is

• Don’t bet against the Biden stimulus. Giving money to working people drives a lot more growth than giving tax cuts to rich people.  Why Republicans have been so dead-set against establishing that precedent.  We are now repeating the fiscal experiment without the Fed “doing” anything new.  A year from now, it is going to be much harder to ignore the impact of stimulus to the bottom of the income pyramid.
• Conviction Bets or Nothing.  The market is not cheap and potentially over-valued. But Cloud is a secular trend strong enough to drive massive returns regardless of that the market does. Make concentrated bets.  They seem higher risk.  They will be higher volatility.  But they are actually lower-risk.  The potential returns are worth it, volatility be damned.
• Let those bets ride. Keeping fingers crossed we don’t get another 100 year flood in the next few years.

I’m as hopeful on the Macro outlook as I’ve been in a long time.  Nursing hope we might actually be able to grow/inflate our way out of the current macro mess we are in.  That implies an overheating economy for the next few years.  That would be good for stocks.  More important, it would avoid the shipwreck of a “secular stagnation” deflationary doom spiral etc…

Q:  You’re in an elevator with Donald Trump, Vladmir Putin, and Mitch McConnel.  You have a pistol.  It only has two bullets in it.  What do you do?

A:  Shoot Mitch twice to make sure he’s dead…

(note)  Illustrative only.  I sincerely hope no-one ever shoots Mitch.  Way too much of that talk these days.

“The Democrats” didn’t gain power with Georgia’s Senate election.  Power actually shifted to to a (dwindling but thankfully still extant) group of generally right-wing-leaning centrists.  This is extremely good news for the economy.  The Senators below are likely to actually listen to Jay Powell and Janet Yellen when they tag team the message “we really do need more direct Federal Spending now.”

• Joe Manchin – Nominally a Democrat but a 1990’s era Republican in policy terms.
• Susan Collins – R Maine.
• Mitt Romney R Utah
• Kirsten Synema D (AZ) – Not a progressive by any stretch.
• Lisa Murkowski  R AK

Even more important, power shifted away from Mitch McConnell.  It isn’t that “moderates win” as much as “Mitch no longer can gum up the works.”

The last 6-12 months have seen a growing chorus of the Fed, IMF, and mainstream non-political economists practically begging for Fiscal Stimulus.  Seeking to stave of a deflationary spiral.  That has fallen on deaf ears in a lot of places in Congress.

The “problem” (if you are Mitch McConnell) is that stimulus implies an economic boom in ’21 and ’22 leading to overheating and (much-needed) inflation.  That would be great for America, but bad for Republican’s prospects in the 2022 and 2024 elections.

We know Mitch would have gladly sabotaged America’s economic future to improve his prospects of holding power.  Why?  Because he did it before.  This 2011 Atlantic article has aged very well – describing him as a  “strict obstructionist”  McConnell  was clearly setting up a repeat of the Obama-era “my job is to make him a one term President” playbook. We know he was headed down that path.  It doesn’t matter if Mitch didn’t know or didn’t care that would risk a deflationary spiral.  My bet would be on “doesn’t care.“

McConnell has now lost the power to bury bills he doesn’t like.  Even bills “his” Senators might want to (or feel obliged to) vote for.  Look at how he buried the $2,000 stimulus checks last week (while a chorus of vulnerable Senate Republicans pledged fingers-crossed support knowing they’d never face a clean up/down vote).  That is a great example of Mitch’s negative power.  That power has shifted to Mitt Romney et al.

Schumer still has to keep those centrists happy.  They hold the real deciding power.  He won’t be able to get a Medicare for All bill through.  But Schumer gets to decide what bills come up for vote and that is HUGE.  As an example, a clean bill authorizing that $2,000 check would be a tough thing for most Republican Senators to vote “against.”  Or a clean bill raising the minimum wage to $15.  Also tough to vote “against.”  McConnell’s was brilliant at side-stepping those sort of votes.  Schumer can force those awkward votes.  As long as the content isn’t too radical, they will likely pass.

“Infrastructure” is the obvious win here.  I am still perplexed as to why we never got that promised “Infrastructure” package over the last 4 years.  It seemed like a political no-brainer and a pork-barrel bonanza that should have gone through on Day 1.  My guess is that the Republicans couldn’t come to an internal consensus on how to proceed AND didn’t want to pass any sort of bill that needed (and would have gotten) substantial Democratic support.  That failure measures the (deep) depth of Republican dysfunction.  Regardless, a big Infrastructure spending bill likely will happen now with lots of projects earmarked for Utah, Arizona, Maine, Alaska, and West Virigina.

This isn’t about “who wins” politics.  It is about “we all win or lose” economics.  We know how to handle inflation.  We know that deflation is much harder to control.  Until yesterday, we’d risked steering (or really drifting) into deflation.  With Mitch gleefully pulling us towards the rocks – consolidating his power at the expense of our misery.  Diminishing that deflationary risk is HUGE.

Realized this is my first post since October.  I’ve actually been (gasp) working pretty hard.  It also felt like the world didn’t need more political commentary during the election.  The post-election economics weren’t clear until last week.  I will be posting more regularly in 2021.