Paradigm Lost

24 Sep

Headlines touting driverless cars, the death of the combustible engine and other various forms of industry killing technology, reveal the difficulty in discerning what is simply an overly zealous capital market and a real paradigm shift. While the distinction may not appear overly important at first glance, we would argue that the distinction between investments in innovative concepts and ideas born of “free”access to capital often are divorced from long-term permanent shifts in structural paradigms. We can again look to the oil market as a current example of the blurred lines between the structural/secular and the cyclical.

While the concept of peak oil is not new to the investment nomenclature, the excitement surrounding alternative vehicles has given birth to the concept of peak demand. The current line of reasoning shows oil demand slowing drastically going forward as alternative vehicles make aggressive inroads into the combustible engine vehicle markets. This kind of simplistic forecasting fails however to take into account a whole host of real-life practical considerations.  It is no great surprise that Governments, at both the local and National level, have latched unto this Muskmania with Governments in Europe calling for the end of combustible engine sales by the mid-century. What we did not hear from any of this rhetoric was a well thought out, well designed plan to deal with any of the aforementioned real-life practical issues.  But, that is what you get in periods of capital mis-allocation, the cost of capital is not the only thing that is being suppressed; reality is as well.




21 Aug

We look on with somewhat bewilderment at the rise in the valuation of Tesla relative to the valuations of traditional auto manufacturers. For a company that produced 76,000 vehicles last year, it has a market cap of $330 bln.  If those at the Federal Reserve are scratching their heads at the lack of pricing power, they should look no further than the drivers behind this relative valuation. Mark Fields, ex CEO of Ford, is probably wondering as well having been pushed out in favor of a more radical Tesla-like strategy. We take no issue with Tesla as a company, vehicle or technological pioneer but rather the leeway and latitude that is given the company in the capital markets, as evidenced by a $1.8Bln bond issue for a company that doesn’t promise to be cash positive any time soon.  The problem with the Musking of the global economy is that traditional companies are making real competitive decisions based on unrealistic or skewed metrics. How does Ford compete with a company with thirty times its market cap, losing money on every car produced.  As we have continually highlighted, the mis-allocation of capital, driven by zero and negative real rates of interest, has real world ramifications for real world pricing power.

Sturm und Drang

23 Jun

For some unexplained reason, I started thinking about Sturm und Drang over the weekend. The  rough English translation of this  German phrase means storm and stress, and has evolved to characterize those situations of a highly volatile nature. The term itself however was  initially used to define a movement  emanating during 17th century Germany in response to the neo-classical periods such as the French enlightenment. If the period leading up to the 1760 was about rational thought and aesthetics, the period from roughly 1760 to 1780 was all about raw emotion. It has been said that while history rarely repeats itself, it does rhyme, one can’t help but wonder if we are entering a new period of  global Sturm und Drang. The emergence of populist strength in a majority of G7 and non-G7 countries is one indication that the promise of hope and change  for the majority of the citizenry has been mostly an illusion. However, for all the storm and stress extant in the real world, the capital markets could not be more unSturm und unDrang.  The financial press seems fixated  on popular measures of volatility such as the VIX and the apparent disconnect between potential market moving events and the flatlining of said measures. We believe however that, as usual, the focus has been on the 1000 foot view of the trees much to the exclusion of the 30,000 foot view of the forest.  The movements by global central banks to solve a whole host of economic problems, typically outside their purview, has led to a massive, deeply ingrained and entrenched global mis-allocation of capital.  The result has been the suspension of “economic reality” as evidenced by: negative real rates of interest, deeply unprofitable industries with unlimited access to capital markets, Governments at both  the Sovereign and State levels operating with no fiscal restraint, etc..  However, while economic reality may have taken a holiday, the basic laws of math and gravity still exist. 


28 Apr

In the spirit of Brexit and Frexit, Central Bankers are now intimating that we may approaching the uncharted waters of QExit. The Fed has begun to make overtures to the markets regarding the normalization of its balance sheet, leaving everyone to speculate as to what a shift in the composition of said balance sheet may look like. Having said that, some at the Federal Reserve are also expressing concern that a re-normalization of the balance sheet might leave it vulnerable to an external global shock. Given that our sitting President is a “low interest guy”, any destabilizing move by the Fed would most likely be met with substantial political fallout, or a series of angry tweets at the very least. In short, while the Fed may allow some recomposition of its balance sheet due to  simple portfolio runoff, don’t expect any major shifts forthcoming.

Navigating A Driverless World

20 Apr

The advent of driverless cars has gotten me thinking about the shifts that have occurred in the investment world over the past 9-10 years. The movement towards alternative forms of Central Bank policy perfectly coincided with the movement towards more and more algorithmically driven capital allocation decision making. The “New Normal” not only involved much lower levels of interest rates and market volatility, but also a de-emphasis on  heretofore tried and true historical investment metrics. The global oil market is a perfect example of one sector of the global capital markets where traditional fundamental analysis has been rendered somewhat moot. Prior to the advent of the financial crisis, one might  attempt to project the future price of oil using global supply and demand per barrel numbers combined with some assumptions about rates and relative exchange rates. An analysis of the oil market today however would involve a much different set of underlying metrics. Today, it might not be much of a stretch to say that the price of a barrel of crude is driven primarily by technology and interest rates/relative exchange rates. Therefore, in some sense the price of crude is being less driven by pure fundamentals and increasingly more by what have traditionally been only ancillary factors. Evidence of this can be seen in a number of spread relationships which currently reside at multiple standard deviations away from their historical average.

Pick Your Donald

6 Apr

During the Iraq war, Secretary of Defense Donald Rumsfeld, in response to a question regarding WMDs remarked” because as we know, there are known knowns; these are things we know that we know. There are known unknowns. That is to say, there are things that we know we don’t know. But there are also unknown unknowns. These are things we don’t know we don’t know.  I’m not sure why, but I love this seemingly nonsensical quote. Perhaps because if you really think about it, there is a tremendous amount of truth behind that statement. Unfortunately in this instance however the statement was being utilized to back up some serious “un-truths”.  Fast forward to 2017 and we still have a Donald (Trump) struggling with knowns and unknowns, primarily within the realm of 140 characters or less. There is no introspection with this Donald however and the only unknown in this Trump reality show is what version of the facts will be on display. While political theatre can be entertaining, our primary goal as an asset allocator is to distill an investable thesis from this sideshow.  Perhaps an analysis of that other institution currently struggling with knowns and unknowns,the Fed, can give us some guidance as to what the immediate future may hold.  The Fed’s( and other Central Bankers) version of reality is similarly skewed in that it doesn’t know what it thinks it knows, does’nt actively seek answers to that which it doesn’t know and is wholly unconcerned with unknown unknowns (black swans).   In light of the populist ground swell in the United States, France, and the U.K., Central Banking is firmly ensconced as the only ” adult in the room”. One might argue however that as the political landscape becomes much less benign, pressure will mount for Central Bankers to address issues involving geo-political friction e.g. Trade. The necessity to address  new problems in an increasingly Balkanized world may require the use of new monetary tools. While we may only speculate on what these new tools may involve, rest assured that further attempts at stability will only lead to further instability across all global financial markets.

Don Yuan

12 Mar

President Xie of China will hit the links with President Trump in April and we would love to be a fly on the wall in those conversations. Our president has not hidden his contempt for alleged unfair trade practices and has also discussed a potential “deal” involving a future haircut on Chinese U.S. debt holdings. President Xie should take some comfort in knowing that he is punching below his weight as the Donald recently called the National Security Advisor at 2 am to question whether we should be pursuing a strong or weak dollar policy ( spoiler alert: the NSA chief commented that he was not the person he should be consulting on economic matters). The bottom line is that with all this rhetoric regarding the imposition of trade tariffs and border taxes, the concept of on-shoring has once again come to the fore. It is interesting that these discussions are taking place at the same time that financial markets are experiencing unprecedented levels of complacency as measured by capital market volatility. Perhaps those in the capital markets should take note that the environment that has produced low levels of volatility( for the most part) was partially predicated on seamless flows of global capital.