Media Worth Consuming – March 2022

Jonathan Rochford

Narrow Road Capital

My top five articles across the month are:

  1. Reliance Industries has outfoxed Amazon by taking employees and store leases from a nearly bankrupt Indian retailer.
  2. Supply chain problems are throwing up bargains for discount stores.
  3. Aircraft lessors are resigned to losing almost all of the roughly 500 planes they have leased to Russian airlines, with a loss of $10 billion expected.
  4. Lenders to office towers are taking huge losses in major US cities.
  5. Recessions are helpful for economies as they restore discipline and reduce speculation.

Chart of the month – Do rate rises cause recessions?

The last year has seen the Consumer Price Index (CPI) in the US surge higher, but it has only been in the last three months that the Federal Reserve has indicated it will lift the overnight rate meaningfully. As the warnings of higher rates have increased, the old debate about whether increased interest rates cause recessions has enlivened. As the graph below from tradingeconomics.com shows, the US CPI is at its highest level for 40 years with the pace of the increase particularly worrisome.

Keynesian economists tend to focus more on the short term impacts and thus generally believe that central banks raising interest rates too far causes recessions. Austrian economists tend to take a longer term view and see the excesses that preceded the interest rate increases as the cause of recessions. Whilst this can initially seem pedantic and technical, the conclusion reached has a significant impact on how central banks and governments respond to cycles; which can either exacerbate or flatten them.

The last 25 years has seen the Keynesian way of thinking dominate government and central bank policymaking. Central bank (electronic) money printing, ultra-low interest rates and substantial government deficits have all been used in increasing measure to try to eliminate recessions. At first, there was a limited impact on inflation which encouraged governments and central banks to stimulate further and allowed proponents of modern monetary theory (MMT) to claim there are no material constraints on governments printing and spending. It’s funny how MMT proponents have been far less vocal in the last year as US inflation has soared.

Those who undertake a cursory review of developed economies over the last 200 years will see that recessions are a regular part of economic life. Many introductory economics textbooks will talk of a 5-10 year business cycle with most of this being a gradual expansion phase followed by a short contraction phase. Participants in financial markets recognise this cycle as well, with the youngest workers often embracing the new developments (think cryptocurrencies and NFTs today, sub-prime loans in 2004-2007, technology stocks in 1998-2000) whilst old heads stay away and for a while look like fools missing out on the party. Recessions are the most effective way of clearing out the trash, reminding investors to focus on activities that make long term profits.

By seeking to eliminate or at least significantly reduce the severity of the recessions, governments and central banks have merely deferred the pain. Several cycles worth of malinvestment and government wastefulness have now accumulated, which together create the risk of a far more severe contraction. Excessive stimulus has given us low productivity and high inflation, with stagflation having the potential to linger for a decade or more (think Japan and Greece) if the existing approach remains.

The alternative approach is to take the medicine Paul Volcker style and allow the economy to be cleansed of excesses and exuberance. Central banks should allow quantitative easing to roll off without replacement and raise overnight interest rates to levels that allow citizens to earn a positive return after tax and inflation. (This implies that both inflation and tax levels need to reduce.) Significantly reduced government spending, taxation reform and productivity reform are the proven methods to generate long term growth.

Here’s the long list of the most interesting and under the radar articles I came across this month.

Finance

Excluding dividends, European stocks have gone backwards since the 2000 peak, which might explain why European shares look cheap compared to American stocks. Funds focussed on BRIC countries have taken large losses this year and have seen huge outflows. China has seen enormous economic growth in the last 30 years but its stock market has performed poorly. A Morgan Stanley derivatives trader has lost his job after losing tens of millions of dollars on derivatives linked to share dividends. A hedge fund specialising in block trades made a 76% return in its first year. Softbank’s gearing ratio is increasing as the value of its investments drops.

Hamilton Lane found that private equity and private credit have substantially outperformed their public equivalents in the last 20 years, but with more money flowing to the sectors can it last? The framework one manager uses to identify find long term, high growth companies. The advice an investment legend gave his daughter in 1994 on how to manage her money. Why more construction industry insolvencies are on the way for Australia.

An index of Russian stocks trading in London fell 98% in two weeks. Short sellers have made massive mark to market gains on Russian stocks but closing out the trades is problematic. Goldman Sachs and JP Morgan have been buying up Russian bonds at distressed prices. Credit Suisse asked investors to destroy documents relating to a securitisation of jet and yacht leases, with some of the underlying borrowers Russian oligarchs. India is happy to buy Russian oil at 30% discount to the Brent crude benchmark.

The collapse in Russian asset prices is a reminder of what can happen when you invest in dodgy countries. Investors were lulled into investing in Russia after 23 years of relative stability. Russia thought it had prepared for sanctions, but the financial sanctions undid much of the preparation. A Russian debt default now should be far more contained than the 1998 default but it will have to deal with the pari passu issue.

Evergrande had $2.1 billion of cash pledged for guarantees seized by lenders. The World Bank sold $150m of “Rhino Bonds” with the payments determined by the rate of growth in the African rhino population. AT&T sold $30 billion of bonds in a day, the fourth largest US investment grade issuance of all time. A record number of US CLO warehouses could be a big problem if CLO spreads don’t reduce. Chinese property prices are falling in most cities, will the government respond with stimulus and bailouts?

A Chinese nickel producer was margin called and forced to sell out of some of its nickel futures position causing the price to triple in a few days. JP Morgan and China Construction Bank then provided emergency financing to meet the associated billions of dollars in margin calls. The London Metals Exchange is accused of cheating and favouring crony clients after reversing trades to benefit the Chinese nickel producer. The Archegos blow-up and the nickel shenanigans have a lot in common. How the nickel price spike almost bankrupted many large traders. Despite record profitability, commodity traders want a bailout.

Politics & Culture

The bankruptcy of the Boy Scouts will be a lawyer’s feast but deliver little for abuse victims. America’s legal system is going woke and the principles of justice are being bent. Most corporates have backed away from woke bigotry but a few persist with racist and sexist actions. A large Australian charitable foundation has suspended grants to a university over a handful of honorary doctorates being awarded to white men. Philadelphia has banned its police from stopping cars with dangerous defects in a misguided attempt to reduce racism.

The Babylon Bee has been suspended by Twitter over a satirical news article. Facebook has been hit with court action for profiting off celebrity scams. 16 months after the Presidential election, the New York Times now admits that the Hunter Biden laptop story is accurate after previously claiming it was Russian disinformation. Bernard Collaery won’t be allowed to see some of the evidence used to prosecute him for assisting a whistleblower.

After cracking down on private companies, the Chinese government is now signalling it will start providing taxpayer support. How the Chinese government took revenge on H&M for speaking up on civil rights. Russian agents are suspected of carrying out 14 murders on British soil. Most Russian billionaires obtained their wealth through political connections rather than innovation. Russia’s invasion looks disorganised in many aspects, but if peace isn’t found Ukrainian cities are likely to end up being flattened. China and Russia are far from natural allies.

Economics & Work

Land taxes incentivise denser building, which creates more affordable housing. Tighter credit rules and higher interest rates have cooled the New Zealand housing market. Expect continued high CPI readings in the US for the next year as spiralling housing costs gradually feed into the index. If Fed members did their own grocery shopping they would have acted against inflation already. A solar and battery project in remote Indonesia is another example of international aid having good intent but bad outcomes.

Free markets and deregulation have raised prosperity and slashed poverty, but some of the biggest beneficiaries are now funding “research” against them. Germany experienced high growth rates after the Second World War from sound money, low taxes and allowing free markets to flourish. Many former Russian states have prospered after leaning away from Russia and towards Europe. Russia’s central bank head wanted to quit but Putin wouldn’t let her leave. Most historians have a poor understanding of what successful economic policies and presidencies look like.

Miscellaneous

Legislation to enact permanent daylight savings sailed through the US Senate as no one could be bothered to object. The arguments that daylight savings creates physical and mental health issues. Historians have concluded that the year 536 AD and the decades around it were the worst ever time to live. An NBA star wasn’t allowed to play in New York because he wasn’t vaccinated, so he sat in the crowd maskless and watched instead. China’s delivery drivers are fighting back against the delivery platforms.

Why propaganda is effective. The world’s biggest aircraft was destroyed in a Russian bombing of a Ukrainian airfield. The International Cat Federation has banned Russian cats from competing outside of Russia. A 16 year old English boy is suspected of being behind a series of high profile hacks of major companies.

For a small fee, Japan’s “rental-san” will turn up when you need a person to be there. Farmers are getting a bump in crop yields from using treated human sewage. Poo transplants are being used to treat depression and other mental health conditions. How the LA Police blew up a neighbourhood when detonating homemade fireworks. 

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This article has been prepared for educational purposes and is in no way meant to be a substitute for professional and tailored financial advice. It contains information derived and sourced from a broad list of third parties and has been prepared on the basis that this third party information is accurate. This article expresses the views of the author at a point in time, and such views may change in the future with no obligation on Narrow Road Capital or the author to publicly update these views. Narrow Road Capital advises on and invests in a wide range of securities, including securities linked to the performance of various companies and financial institutions.

Jonathan Rochford
Portfolio Manager
Narrow Road Capital

Narrow Road Capital is a credit manager with a track record of higher returns and lower fees on Australian credit investments. Clients include institutions, not for profits and family offices.

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