September 9, 2022
By Steve Blumenthal
“I fish to scratch the surface of those mysteries, for nearness to the beautiful, and to reassure myself the world remains.”
– Carl Safina
The islands of Haida Gwaii, formerly known as the Queen Charlotte Islands, sit in the northern Pacific, off the coast of Canada—just south of Alaska. They were first discovered and recorded by Spain’s Juan Perez in July of 1774. In the 1800s, the only people to visit were fur traders, followed by missionaries and non-Haida settlers, who came in the early 1900s.
Rain falls about two-thirds of the time, and we suited up for inclement weather and headed out early each day. On day four, the sky cleared, and we were able to see the majesty of this beautiful part of the world. You’ll find a few photos in the personal section below. My haul: two king salmon, one coho (or silver salmon), one giant halibut, and one cod.
As fishing stories tend to go, the big one really did get away. Mauldin was reeling in a king salmon. As the fish neared the boat, our guide grabbed the net. Out of nowhere, a sea lion struck the fish and won the battle to bring it in. Apparently, salmon swim much too fast for a sea lion to catch them, but on a fishing line, they are slowed. Mauldin did that sea lion a solid.
We arrived at the tail end of the annual salmon spawning run from the Pacific Ocean to the Northwest’s rivers and streams. Salmon face a life-and-death struggle against obstacles both natural and manmade on their way out of the ocean. Orcas feed almost exclusively on salmon, their favorite being the king variety. But enough fish must survive for the ecosystem upstream to stay healthy. Most Pacific salmon die after they spawn, and as their bodies break down, they transport vital marine nutrients into the rivers and streams—environments beyond the ocean. Source: Pew
The Haida Gwaii govern the island, and there are strict limits on the amount of fish one can take. After all, we’re sharing them with eagles, sea lions (as Mauldin learned all too well), and whales. With that in mind, we released most of what we caught, especially the larger fish and we felt at peace. “For nearness to the beautiful…” Indeed.
You can imagine the downtime we had, spent sitting and talking on the boat. In preparation for the Mauldin-Blumenthal “Great Reset” update call, I had a lot of questions for John. Grab your coffee and find your favorite chair. Today, you’ll find the high-level notes, which I put together in advance of the call this past week. Mauldin was excellent. You’ll find a link to listen below or search On My Radar on Spotify. I hope you enjoy the discussion. (Reminder, not a recommendation to buy or sell any security. Our views may change at any time. The information is for discussion purposes only).
The Great Reset September 2022 Update
A Global Macro Risk Board: Blumenthal prep notes in bullet-point format:
The Great Reset. The point in time when we “rationalize” the debt In the US and in most of the developed World.
Timing? 2028-ish. Expect increased volatility.
US – China: The declining power/rising power conflict is between Western democratic ideology and top-down autocratic rule. Here’s a brief history:
- Since the early 1980s, inflation and interest rates in the U.S. have been on a long decline toward 0%.
- Inflation went from the high teens in the early 1980s to near 0%, with the Fed struggling to get it to 2%.
- Interest rates declined from 15% to near 0%. Stocks and bonds benefited.
- China became a global business partner and became a low-cost manufacturer to the world.
- The Cold War ended in the late 1990s, shortly after President Regan encouraged Russian President Mikhail Gorbachev to “tear down that wall.” There was mostly peace between the world powers.
- For much of the last 40 years, we’ve had declining interest rates and low inflation. Debt levels were low, and now they are high.
- We’ve had broad access to natural resources.
- Technology proved to be a massive deflationary force.
- The East produced low-cost goods, and the West consumed them.
China: Today, China is in deep trouble.
- The residential market has cratered. Consumers are angry, as they’ve lost money. Citizens are angry. There have been many, many lockdowns.
- Cement cities are being torn down. Banks are in trouble. Safe CD-like investments offered through the banks backed by real estate in ghost cities are now known to be unsafe and nearly worthless. The banking industry is in a massive contraction/it is broken.
- The impact is a reduction in consumer spending… China is in recession, and it is no longer the economic engine of the world.
- The Chinese leadership has slammed on the breaks… China is in deep trouble.
- Global peace is facing a risk not seen in decades.
- According to the book China’s Vision of Victory by Jonathan Ward, China’s agenda has now become clear to the free world.
- The world benefited from low-cost Chinese manufacturing for the last twenty years. Prices came down and stayed down. The Chinese government encouraged and financed low-price manufacturing to gain market share and, in many cases, steal IP.
- But the world has woken up. Companies are leaving China for friendlier shores where they won’t get caught in the geopolitical line of fire. Friend-shoring has arrived.
- Manufacturing is shifting to Vietnam, Singapore, Mexico, friendly countries, and back home…
- This all comes at a higher cost. It impacts company earnings unless they can pass those costs on to consumers.
- Europe is a mess.
- The structure of the Euro was imperfect from the start. It was envisioned as a union of countries, which is different than a union of states.
- It allowed less financially sound southern countries to benefit from Germany’s low interest rates. Debt levels swelled.
- Rogoff and Reinhart studied hundreds of years of history and documented that debt becomes an impediment to growth. The line in the sand is 100% debt-to-GDP.
- 24. Italy is 352% of GDP, Portugal is at 440%, Spain is at 402%, France is at 549%, Ireland is at 888%, and even Germany is well above the important 100% threshold at 313%.
- Mario Draghi presided over the European Central Bank during the Eurozone crisis and became famous throughout the world for saying that he would be prepared to do “whatever it takes” to prevent the Euro from failing.
- He has failed as prime minister of Italy. A new far-right leader is likely to win the September 25 election.
- Europe is a mess, as you’ll see in the following chart. Italy may crack first. But it could be any of the European countries. My focus is on Europe simply because of the politically challenging structure of the European Union.
- Inflation is high in the U.S., and even higher in Europe.
- Merkel closed all of the nuclear energy plants and shook hands with a mafia leader, Vladimir Putin.
- The Nordsteam II is his economic weapon. Germany made itself dependent on Russia and China…
- A strategic miscalculation.
Oil – Middle East – Russia
- Russia has limited excess capacity and is using oil in its economic war with Europe and the U.S.
- Mauldin and I had dinner in Vancouver with a former senior OPEC official. He told us Russia is selling their oil to other countries at a discount but they have limited excess capacity, and with Haliburton’s exit from Russia, talent is lost. And, he added, their technology is far behind. Russia’s production is hurt by the exit.
- The US has excess production capacity with vertical and offshore drilling. However, there is little new drilling due to Biden’s ESG objectives so oil companies are returning cash to shareholders, either through increased dividends or share buybacks. The number of new leases issued under Biden is at an all-time low.
- Trying to partner with Iran for oil is a mistake as long as the country is run by radical leadership. There is no good business with bad people!
- Our new OPEC friend believes that even if we cut a deal with Iran, the supply is not enough to move the needle, and their drilling technology is decades behind.
- That spells higher prices even if Iran comes back on.
- The strategic petroleum reserve in the U.S. is low and will need to be replenished. This buying demand should support higher prices.
- Winter is coming, and governments are advising citizens to cut back on energy use, especially in Europe due to Putin’s chokehold on supply.
- Even California, with its mission to go 100% EV by 2035, is telling its citizens to cut back and refrain from charging their electric vehicles.
- While it’s an inspiring goal, the system is not equipped to deliver wind and solar energy. Nuclear energy, yes, fossil fuels, yes.
- We’ll get to a much better fossil-free world, but we are nowhere near that point, and we need oil, natural gas, and nuclear to get there. Windmills require tons of cement and forged steel, for instance. We need some fossil fuels to make that happen.
- Oil and natural gas shortages mean logistics costs rise, manufacturing input costs rise, and consumer utility costs rise, which means inflation rises.
- Oil is likely going up in price.
United States – Fed – Markets
- I take Powell at his word in regard to his conviction to fight inflation.
- Few in the press are noting the Fed is pulling $95 billion per month out of the system. Think of it as draining liquidity out of the system.
- This is happening at the same time the Fed is raising interest rates. I expect another 75 bps bump in September to 3.25%
- Where does the Fed stop?
- Inflation above 5% has never come down until the Fed funds rate was higher than inflation.
- Inflation is at 8% and likely declining. We have a ways to go.
- QE is different than QT. This QT is different than prior periods of tightening.
- September won’t be the last rate hike. And I believe the Fed will tighten until something breaks.
- Then more sugar (QE). Then a better outlook for equities.
- The first wave of the market sell-off was margin selling. The level of margin debt has declined significantly. Still high, but not insanely high (see chart).
- The next wave will be earnings-driven, as in a drop in corporate earnings causing valuations to adjust lower.
- The average bear decline market in a recession is in the high 30% range. My best guess, and it’s only a guess, is 3,200 on the S&P 500 Index. Logic is driven by fair valuations based on 58 years of valuation history and technical support. 3,200 is the pre-covid high.
- The yield curve remains inverted. A recession is unavoidable. Frankly, they happen, they are somewhat healthy for the business cycle, and we always get through them.
- The U.S. economy and the markets are not yet out of the woods.
Inflation – Stagflation – Deflation
- The Fed is not going to back down until maybe later this year or in early 2023. Don’t fight the Fed.
- Food prices are also going up. Wheat and corn due to drought and a rise in fertilizer prices due to the Russia-Ukraine war.
- The rise in oil prices means it’s more expensive for farmers to farm, and the higher fuel costs mean it costs more to transport the food to consumers.
- The wage-price spiral is happening. How long? Employees are asking for higher wages to keep pace with inflation. Unions have regained leverage. Wage gains are likely to stick.
- A mini-recession is happening, and inflation can cause it to deepen. It may run longer and deeper than most are expecting.
- “Stagflation” is slow growth with high inflation. Likely the most probable outcome.
- Supply bottlenecks are easing. Higher oil and gas prices reduce consumer appetite for spending…
- A move in inflation back below 5% is probable.
Globalization allowed China to become a serious competitor for the U.S. The U.S. improved China’s wealth, which improved China’s military capabilities, and we now have a rising power challenging an existing power. Under Putin and Russia’s nuclear arsenal, Russia found its way back into the global picture. And Germany became one of the biggest exporters to world.
Much of the growth in the U.S., China, German, and the balance of the developed world came from debt. And there was relative ease amongst the large global partners with the belief that the co-dependence built on trade would keep the world peaceful for many years to come.
Much of the growth was accelerated by debt expansion. We are facing the consequences that occur at the end of long-term debt supercycles. Something history has much to teach us about. Historically, governments and dictators have chosen the seemingly easy path to debase their currencies. We are seeing the same today. The US, for example, has printed 50% of all the dollars ever created in the history of the republic in just the last two years. Much of that got into the system with the direct helicopter of money to the people due government’s response to Covid. Not judging, just saying. This is a meaningful cause of current inflation. It is not just supply chain disruptions and current energy/oil challenges.
My best guess is more is ahead: An inflation cycle that comes and goes in a series of waves and stays with us through most of the 2020s. The Fed is stuck between a rock and a hard place. Inflation has its hold. We are on the path to the Great Reset. Mauldin thinks we resent in 2028, but it is just a guess. My bet is governments choose to print and monetize the debt. A global debt jubilee of sorts. It will take global coordination, and you can imagine the impact on various currencies and capital flows. If the debt in your household is high and rates are rising, you are feeling more tension. Same thing with countries. Bottom line: The end of long-term debt cycles is bumpy. That’s where we are… We’ll get through it.
Not all is bad so let’s keep our heads up. I am bearish on cap-weighted index funds and low-yielding bonds. If that is the lens through which you view investing, the message is bearish. However, there are a number of ways to prosper. It’s a question of positioning wealth. I like well-collateralized floating rate short-term private credit, absolute return focused long-short hedge funds, active management – dividend-paying stocks, put-hedged ETFs, agriculture, certain metals, and disruptive technologies in biotech, AI, and more.
Here is the link to the Mauldin-Blumenthal Podcast discussion on Spotify.
Trade Signals: Nothing Good Happens Below The 200-day Moving Average
September 7, 2022
S&P 500 Index — 4,199
Notable this week:
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Personal Note – Langara Island, Haida Gwaii
If you’ve ever fished for flounder before, you know you drop your line near the bottom of the ocean (or bay) and hope for a bite. Jim and I traveled out several miles and dropped a line more than 300 feet. Jim explained to me that pulling in a halibut is like reeling in a barn door from the bottom of the ocean. It is a long fight and a straight-up pull. Pictured is Jim’s catch.
Rushing to hit the send button. I hope you had a relaxing holiday weekend and that some fun is ahead for you this weekend. I’ll be golfing with clients and friends, thus the rush!
Wishing you and your family the very best! Thanks for reading!
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
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Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman and CIO. Steve authors a free weekly e-letter entitled, “On My Radar.” Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.
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