Chaos Unleashed

Two weeks ago Russia began its invasion of the Ukraine in earnest. What had begun in 2014 following the ouster of a corrupt pro-Russian government was followed by the annexation of the Crimea and then the fermenting of a civil war in the Donbas region of eastern Ukraine, finally cumulating in his goal of retaking the entire country and bringing it back under Russian purview, most likely in the form of a puppet government.

No one has been more successful at undoing Russian strategic goals than the Russian government. Putin had once hoped to establish a new Warsaw style pact, he hoped to undermine NATO, he’d longed to set up an Eastern European economic zone to compete with the EU. To imagine that any of these goals could today be defined as likely is to dabble in fantasy. His ultimate goal, at least defined by his own comments, was to restore Russia to its previous status as a respected superpower like it was under the Soviet Union. Today it seems as though his army, impressive and large though it is, has already met its match in conventional warfare in the early days of its Ukrainian adventure.

While the military side of his invasion doesn’t seem to be going according to plan, something that must have really taken him by surprise was the resolve he faced globally. Though NATO has said it won’t get involved, weapons are flowing into the country. Nations, like Finland and Sweden whom Russia has treated as extensions of its old empire, are making loud noises that they too would like to join NATO. Germany, long a NATO laggard has promised to increase its military spending above the target 2% of GDP for NATO members. The notoriously neutral Switzerland has said it will freeze Russian assets, and throughout the world condemnation has been swift, especially on the financial front.

In the space of a few days Russia didn’t just find itself diplomatically isolated, but financially as well. The international banking system has been effectively closed to Russia and its central bank, putting a stop on many of its rainy day funds it will need to sustain its campaign. I won’t endeavor to explain the full range of how the global bank sanctions work, as the process is complicated and other better versed people can explain it more succinctly, but the truth is that the Russian state is deeply isolated and in financial chaos.

Markets have responded to this chaos with a fair amount of volatility, with some big swings both up and down since the invasion began. This is understandable, but what comes next will be more unpredictable. Russia does not have many face-saving ways to undo its situation, a fact that has not gone unnoticed by many. Stuck in heavy fighting in Ukraine, a collapsing economy, a restless population at home and a kleptocratic network of military officials and billionaire oligarchs who hide their assets in Western nations, Putin may find himself backed into a corner with few options open to him, some of which were likely previously unthinkable.

Sun Tzu, famed military strategist and author whose book sits unread on the shelves of tedious hedge fund managers.

I’m reminded of a saying from Sun Tzu, the famed military strategist of ancient China, whose book on strategy is often “required reading” for a certain type of hedge fund manager. “When you surround your enemies, leave an opening; do not push too hard on the enemies who are desperate.” Even if Putin is ultimately successful in Ukraine it’s hard to see what kind of victory can be cobbled together on the world stage. Russia will need a way out, an opportunity to exit and with walls closing in our own “Western” victory of aiming to contain Putin may create more chaos than we are expecting or can anticipate.  

I don’t want to be alarmist, but the nature of war is to be unpredictable, and cautious investors should take note that we are still in the early days of what could prove to be a long, protracted, and ultimately surprising conflict that has many unknowable outcomes, some of which may leave the world order changed, for better and worse. Putin has unleashed something, and what that is can not be fully guessed.

Looking Back on 2021

Its traditional that the end of a year should stimulate some reflection on the past and the future, and so in the spirit of tradition I thought I’d take some time to look over some of the stranger and more surprising aspects of 2021.

China

While 2021 brought the pandemic *closer* to an end through the distribution of vaccines, markets underwent some fairly dramatic reversals over the course of the year. For instance China looked to be the principal economy in January. Following its own strict enforcement of Covid restrictions and solid economic performance, China seemed to be an earlier winner by the beginning of 2021, and set to enjoy robust growth through the year.

By March the tide was shifting however. China’s leader, Xi Jinping, proved to be every bit committed to his past comments about protecting and strengthening the CCP over free market concerns. Several billionaires, notably Jack Ma the founder of Alibaba, disappeared for long periods before reemerging only to publicly announce that they would be stepping down from their roles.

However, even while China was shaking down its billionaires and upsetting foreign nations, a new economic threat appeared in the form of a housing bubble looking ready to burst. Evergrande, one of the country’s largest property developers announced that it could not finance its debt anymore and looked likely to default. This news was unwelcome for markets, but for China hawks it fit their long standing belief that China’s strength has been built on a mountain of unsustainable debt, with property one of the most vulnerable sectors of the economy.

The finer points of China’s housing market are too nuanced to get into here, but it’s enough to know that the property bubble in China is large, built on sizeable debt and could take some time to deflate (if it does) and no one is sure what the fallout might be. Combined with China’s ongoing policy of “Covid Zero” – an attempt to eradicate the virus as opposed to learning to live with and manage it, we head into 2022 with China now a major outlier in the Asian region.

Inflation

Inflation was probably the other most discussed and worrying trend of 2021. Initially inflation sceptics seemed to win the argument, as central banks rebuffed worries over rising prices and described inflation as transitory. That argument seemed to wane as we entered late Q3 and prices were indeed a great deal higher and didn’t seem to be that “transitory” anymore. Inflation hawks took a victory lap while news sites began to fill up with worrying stories about rising prices on household goods.

The inflation story remains probably the worst understood. Inflation in Canada, as in other Western nations has been going on for sometime, and its effects have been under reported due to the unique nature of the CPI. But some of the concern has also been overwrought. Much of the immediate inflation is tied to supply chains, the result of “Just-in-time” infrastructure that has left little fat for manufacturers in exchange for lower production costs. Bottlenecks in the system will not last forever and as those supply chains normalize that pressure will recede.

The other big pressure for inflation is in energy costs, but that too is likely to recede. Oil production isn’t constrained and prices, while higher than they were at the beginning of the pandemic are lower than they were in 2019. In short, many of the worries with inflation will not be indefinite, while the issues most worrying about inflation, specifically what it costs to go to the grocery store, were important but underreported issues before the pandemic. Whether they prove newsworthy into the future is yet to be seen.

*Update – at the time of writing this we were still waiting on more inflation news, and as of this morning the official inflation rate for the US over the past year was 7%. Much of this is still being chalked up to supply chains squeezed by consumer demand. An unanswered question which will have a big impact on the permanence of inflation is whether this spills into wages.

This political advertisement from the Conservatives ruffled many feathers in late November

Housing and Stocks – Two things that only go up!

If loose monetary policy didn’t make your groceries more expensive, does that mean that central bankers were right not to worry about inflation distorting the market? The answer is a categorical “No”. As we have all heard (endlessly and tediously) housing prices have skyrocketed across the country, particularly in big cities like Toronto and Vancouver, but also in other countries. The source of this rapid escalation in prices has undoubtedly been the historically low interest rates which has allowed people to borrow more and bid up prices.

In conjunction with housing, we’ve also seen a massive spike in stock prices, with even notable dips lasting only a few days to a couple of weeks. The explosion of new investors, low-cost trading apps, meme-stocks, crypto-currencies, and now NFTs has shown that when trapped at home for extended periods of time with the occasional stimulus cheque, many people once fearful of the market have become quasi “professional” day traders.

Market have been mercurial this past year. Broadly they’ve seemed to do very well, but indexes did not reveal the wide disparities in returns. Last year five stocks were responsible for half the gains in the S&P 500 since April, and for the total year’s return (24%), Apple, Microsoft, Alphabet Inc, Tesla and Nvidia Corp were responsible for about 1/3 of that total return. This means that returns have been far more varied for investors outside a tightly packed group of stocks, and also suggests markets remain far more fragile than they initially appear, while the index itself is far more concentrated due to the relative size of its largest companies.

Suspicious Investment Practices In addition to a stock market that seems bulletproof, houses so expensive entire generations worry they’ve been permanently priced out of the market, the rapid and explosive growth of more dubious financial vehicles has been a real cause for concern and will likely prompt governments to begin intervening in these still unregulated markets.

Crypto currencies remain the standout in this space. Even as Bitcoin and Etherium continue to edge their way towards being mainstream, new crypto currencies trading at fractions of the price, have gotten attention. Some have turned out to be jokes of jokes that inadvertently blew up. Others have been straight-up scams. But all have found a dedicated group of investors willing to risk substantial sums of money in the hope of striking it rich.

NFTs, or non-fungible tokens have also crept up in this space, making use of the blockchain, but instead of something interchangeable (like a bitcoin for a bitcoin, i.e. fungible) these tokens are unique and have captured tens of thousands, sometimes hundreds of thousands of dollars for unique bits of digital art. Like cryptocurrencies, much of the value is the assumed future value and high demand for a scarce resource. However, history would show that this typically ends poorly, whether its housing, baseball cards or beanie babies.  

Lastly, there has been a number of new investment vehicles, the most unusual of which is “fractional ownership”. The online broker Wealth Simple was the first to offer this in Canada and it has been targeted to younger investors. The opportunity is that if your preferred stock is too expensive, you can own fractions of it. So if you wanted to invest in Amazon or Tesla, two stocks that are trading at (roughly) $3330 and $1156 respectively at the time of writing, those stocks might be out of reach if you’re just getting started.

This is a marketing idea, not a smart idea. The danger of having all your assets tied up in one investment is uncontroversial and well understood. The premise behind mutual funds and exchange traded funds was to give people a well-diversified investment solution without the necessity of large financial position. The introduction of fractional ownership ties back to the market fragility I mentioned above, with younger investors needlessly concentrating their risk in favour of trying to capture historic returns.

The End

For most investors this year was largely a positive one, though markets went through many phases. But while the pandemic has remained the central news story, the low market volatility and decent returns has kept much of us either distracted or comfortable with the state of things. And yet I can’t help but wonder whether the risks are all the greater as a result. Many of these events, the large returns in an ever tightening group of stocks, the growth of investors chasing gains, the sudden appearance of new asset bubbles and the continued strain on the housing market and household goods add up to a worrying mix as we look ahead.

Or maybe not. Market pessimists, housing bears, and bitcoin doubters have garnered a lot of attention but have a bad track record (I should know!) Many of the most pressing issues feel as though they should come to a head soon, but history also teaches us that real problems; big problems that take years to sort out and lead to substantial changes are often much longer in the making than the patience of their critics. The test for investors is whether they can stand by their convictions and miss out on potential windfalls, or will they become converts right as the market gives way?

Next week, we’ll examine some of the potential trends of 2022.   

The Interviews – 2021

Last year we put on a number of interviews with various experts and journalists. Some were very well received and I’m sharing them again here in case you missed any of them.

Alexander Hay is a global consultant on resiliency, and the author of three books. His work is aimed at helping governments and companies design and implement resiliency plans in the face of natural disasters like flooding. His commentary was insightful and particularly relevant in the face of the massive flooding that occurred in British Columbia last month, wiping out highways and isolating the interior.

Edward Luce is the senior US Commentator for the Financial Times, author of several books on the economic and social challenges facing the United States, with his most recent being the Retreat of Western Liberalism. Edward joined me in July to discuss the United States post Trump, the strength global markets, the rise of populism and the failures of the pandemic response from governments.

Sam Cooper is a journalist with Global News and has made a career out of following political corruption, organized crime and financial crime. His book, Wilful Blindness, chronicled the Chinese government and organized crime’s influence on Canada and the blind eye taken by our political leaders. He joined me in August to discuss his book and how corruption has shaped the opioid epidemic and real estate.

Matt Gurney is a prominent Toronto journalist and columnist featured on television, radio and in print. His insightful commentary through the pandemic has highlighted where our infrastructure has failed, and Matt joined me in late August to talk about what lessons we should, but probably won’t, learn from the pandemic.

In total we did eight interviews last year (several are not permitted for unrestricted release) but I hope you’ll take a moment to check out the above videos if you missed any. There will be a few more video interviews this year and if you have any suggestions for either topics or people we are open to hearing about them.

Please enjoy, and Happy 2022!

The Game Stop Chronicles

Last week may go down as one of the weirdest weeks in investing history.

By now you have been made aware of the company Game Stop (GME:N). You’ve undoubtably been forced to look up what a short position and a “short squeeze” are and have collided head first into the meme fuelled online community of Wall Street Bets, the subreddit that lives for dangerous investments and may go down in history for the first market based populist uprising.

My first twig that something was going on came the week before last. I had investments in Blackberry (BB:TSX), a company that I had felt was undervalued and believed had made a successful transition into cyber security, a market sector I believe poised for long term growth. The ride had had not been fun. And then, all of a sudden the stock began going up. At first it seemed to be in response to a series of positive news stories; a settled IP legal case with Facebook, a new deal with Amazon for cloud services, and the sale of some 90 patents to Huawei. And then the stock took off. Within days a stock that had been languishing around $8 – $9 had suddenly doubled and was now looking to triple.

I was elated, until I read about Wall Street Bets (WSB), Game Stop, a hedge fund and how a number of stocks, including Blackberry, were being driven higher in an attempt to hurt a hedge fund. The story was fascinating but also terrifying. On Tuesday morning I exited Blackberry and began trying to understand what was going on.

The internet is a weird place, and far from creating a new universal society, it has instead hastened the growth of more insular and specialized communities. From the outside these groups can feel pretty alien. They have their own language, jokes and hierarchies and the subreddit Wall Street Bets is no different. But once you had pushed past the memes and lingo, it became clear the WSB, which is filled with amateur traders, had caught on to a risky move by a hedge fund called Melvin Capital. Melvin Capital had taken out large short positions on Game Stop, a legacy business that sold physical game cartridges in malls that was obviously struggling. The price of the stock had recently gone up following a new board member and announced plans for further restructuring. The traders at Melvin Capital believed the price of the stock over valued and had opted to short the stock (a method of betting on a future price decline by “borrowing” stock, selling it and buying it back within a set period of time). What the investors over at WSB understood was that the size of the short was too big, and that if they were to buy up all the available stock and hold it they could create a “short squeeze” in which the price of the stock climbs and the available supply of the stock falls, forcing potentially unlimited losses on those holding the shorts.

From here everything becomes extremely weird. It turned out the Wall Street Bets crowd wasn’t interested in making money as much as they were interested in crippling Melvin Capital. The trading platform that facilitated all of this, Robinhood, which prided itself on “democratizing trading” and offered no fees for doing trades, suddenly seemed to fold under the most minor of pressure to the request of another hedge fund to restrict retail trading on Game Stop, allowing only selling and no buying on Thursday. Suddenly members of Congress from across the political spectrum were tweeting and complaining about the restriction of trading regarding Game Stop and threatening to hold hearings into Robinhood’s practices.

On Friday limited purchases of Game Stop reopened, and much to the surprise of many, the commitment to “hold” did hold. While the price of Game Stop stock had fallen Thursday during the period only selling was allowed, the price decline reflected minimal volumes. On Friday morning the stock opened again above $300, and despite considerable volatility closed the week at $325 a share.

You’d be forgiven if you’re having a hard time following all the facets of this story, but from my vantage I’d like to share the 4 major issues this convoluted chain of events has created.

1.Populism and Democracy – Twitter and Reddit have been alive with excitement over screwing with a hedge fund, and its apparent that those engaging in the initial rally for GME are committed to undermining Melvin Capital, but the sharp response from Wall Street institutions that this represented some kind of illegitimate assault on the markets highlights the lack of interest in a “democratized” market. Like a lot of internet buzz about “making things more accessible” or “democratic”, when put into practice established institutions don’t seem to like the rabble actually having all that much power. Whether it’s a crowd sourced populist group of traders playing the other side of an over leveraged short position, or simply an online vote that wishes to name a scientific vessel “Boaty McBoatface”, efforts to open, engage and democratize previously closed off institutions seem to fail when it turns out the masses don’t share the goals or reverence of those institutions.

2. Hedge funds often describe themselves in terms of significant reverence and are self-styled “Titans of Wall Street”, but as a group hedge fund performance frequently falls flat. What hedge funds have been good at is risking other people’s money. The brashness and over confidence displayed by hedge fund traders is precisely how you end up with a short position worth 130% of the available stock of a company and squandering $5 billion in a week. Some may find “shorting” a controversial practice, but in reality it is a common and well understood strategy. But in the hands of hedge funds it can become predatory as efforts are made to sometimes game the system and force stock prices down unnecessarily.

3. The Robinhood trading app, which has become all the rage with DIY investors seemed to have its brand implode in the week, and it perhaps revealed far more about this business than anyone had wanted. Like Google or Facebook, where the service is “free”, people using the Robinhood trading platform were the product. Robinhood, legally but controversially, makes its money by “payment for order flow”, or by directing the orders to different parties for trade execution. This all gets pretty complex, but at its core those using the Robinhood app may have been paying fractionally too much for their trades, but when in the context of billions of trades it adds up to a substantial amount of money. The benefit of buying overflow is that high frequency trading algorithms can potentially front run those trades, which was the subject of the controversial Flash Boys book by Michael Lewis. Perhaps more nefarious was who was Robinhood’s primary purchaser of order flow; Citadel Execution Services, which is owned by Citadel LLC, which just bailed out Melvin Capital.

4.Much of this will end up bypassing the bulk of the population. The story is too weird, to convoluted and too specialized. It involves a cynical and anarchistic online community whose rallying cry is “WE CAN REMAIN RETARDED LONGER THAN THEY CAN STAY SOLVENT”, something that many will find repellent and will keep people from looking closer. What might make people pay attention is the money.

The apocryphal story of the famous investor receiving investment advice from the shoe shine boy right before the great crash has some modern parallels. Prices for stocks, some at all time highs, keep going up despite worrying fundamentals. Companies like Tesla, which have devout adherents, have bid up that stock so that the total company is worth more than all the other major car companies combined! This reeks of the beginnings of a mania, one that can only be made worse by a prolonged lockdown, low interest rates, and the use of social media to hype up a stock. The allure of easy money, embodied by the events surrounding Game Stop will only attract more investors that believe that they too can beat the market.

At the end of last week the number one app in Canada was the Wealthsimple Trade App, a similar low cost trading platform to Robinhood, while the Robinhood App itself remains highly popular south of the border.

The wind has been let out of the sails somewhat this week. Game Stop closed under $100 on Tuesday, and early hype that silver was going to be the next big WSB play seem to have fizzled also. Markets seem to have responded to this cooling of temperatures by resuming their positive direction, but the spectre of market mania looms over returns. Where we go next, I don’t know. But I do know that sensible investors should be watching this with concern. Whatever the merits of hunting hedge funds through crowd sourced market initiatives, the larger story remains one of deep concern, involving all the worst aspects of investing.

“Information in this commentary is for informational purposes only and not meant to be personalized investment advice. The content has been prepared by Adrian Walker from sources believed to be accurate. The opinions expressed are of the author and do not necessarily represent those of ACPI”.

After Trump: The Persistent Discontent


Supporters of President Donald Trump rally at the U.S. Capitol on Wednesday, Jan. 6, 2021, in Washington. THE CANADIAN PRESS/AP, Jose Luis Magana

The shocking scenes of Trump supporters storming the capitol building on January 6th, sometimes jovially, other times with what seemed like murderous intent, may have permanently cemented Trump’s fate. He’s been impeached, again, and efforts are being made to prevent him from running for office in the future. He may also be facing multiple criminal charges and possibly even bankruptcy.

Explanations for the insurrection both over and under explain the problem. Yes, Trump is a demagogue and its true his supporters have been radicalized in a number of ways, including conspiratorial thinking and racist ideas about threats to white people and black lives matter. But as the saying goes, “the issue isn’t the issue”.

In a video about anti-vaxxers (people who promote ideas that are untrue about vaccines) the YouTube Channel WiseCrack pointed out that vaccine acceptance was highest during and just after the Second World War, a period of high confidence and trust in the government by the American citizenry. Today that confidence has ebbed to an all-time low, and that collapse in trust isn’t necessarily unwarranted. The rise of a managerial and technocratic elite has placed an unacceptable distance between citizens and their governments, while government failures seem never to lead to any improvements or accountability.

The cost of these mistakes remains high. In Europe it has led to Brexit, months of protests by “Yellow Vests” in France, the erosion of the center-left ruling party in Germany and a resurgent far right party, the decline of liberal democracies in Hungary and Poland, and a number of anti-establishment parties getting control of small countries like Greece and big countries like Italy.

Canada, forever looking reasonable and calm compared to other countries, is having its own struggles. Prior to the pandemic we had rail protests across the country, have shown a consistent inability to get large infrastructure built and continue to see the erosion of our manufacturing sector. Pandemic response itself has been a laughable mess, from overconfident and condescending pronouncements on the ineffectiveness of masks and accusations of racism about concern of the virus, to complete reversals of position. Vaccine acquisition and distribution has also been underwhelming. The federal government didn’t seem to get enough at the right time, and provincial governments have struggled to get the vaccine to those who most need it (This is nothing compared to the US, where health care workers are actually refusing the vaccine).

In this moment, China can make credible claims for being a useful alternative to the US and other Western countries in its growing sphere of influence. A competent dictatorship with substantial economic growth and a rising standard of living must seem appealing to autocrats and some global citizens alike.

There are other concerns too. The gap between Main Street and Wall Street has grown ever wider. During early months of the pandemic the collapse of jobs and business was mirrored by a resurgent stock market that began gaining steam even while the real economy was crashing. This disparity between the world of investing and the world we live in only heightens inequality concerns. Ownership of stock by Americans closely correlates with age, ethnicity, wealth, and education. For many people today, inequality continues to look like a political class consorting with a billionaire class that don’t play by the same rules that govern everyone else. In a pandemic Jeff Bezos gets rich, and you get fired.

This is obviously not universal. Different countries have different problems and the degree to which these issues are felt by individuals depends a great deal on background and government. But even if we assume that the American situation represents an extreme amongst Western nations, it should not blind us to the anger that people rightly felt when they learned of politicians and executives travelling outside of Canada while asking everyone else to cancel their Christmas dinners. Politicians of all stripes seemed to believe that they would be exempt from the restrictions they imposed on others and had a hard time fathoming that constituents would be upset.

Fixing these problems will not be easy. Technocrats, that is governing authority due to technical expertise, imbues our current leaders with a lot of confidence on issues where there may be no correct answers. They leave people blind to what they do not know and encourage authorities to rely on models and projections rather than real life.

Take for instance inflation. Governments and central banks are very concerned with inflation. Too little and the economy will not grow. Too much and the economy will stall while savings lose value. Inflation needs to be “just right” which is currently considered somewhere between 1% – 3%, with a target rate of 2%. According to Statistics Canada, the CPI since 2010 has been around 1.5%, just below the current 2% target. In other words, $100 in 2010 would buy roughly $85 of similar goods today.

But would it?

Inflation has been higher and felt more directly by lower income people. Using data collected by Statistics Canada (you can click the link below to download the spreadsheet with all these numbers and my calculations) for retail food prices between November 2010 to November 2020, we can see that many food staples have become more expensive in the last decade at rates in excess of core inflation. In that time, the price of beef has risen between 4% to 7% per year depending on the cut. Potatoes have risen in price over 10%, onions by 5.5% and carrots by 6.3% a year. Baby food rose by an average of more than 9% a year, and toothpaste by 8%. Almost none of the staple groceries tracked by Statistics Canada had price increases contained to the 1.5% official rate of inflation, instead many rose at rates double that or more.

Like real estate, another asset class that continues to defy gravity without an impact on inflation but a dramatic one on the population, a rising price of food that remains unaddressed only highlights the different reality Canadians seem to be living from our elected officials. Despite a great deal of lip service about the importance and risks facing the middle class, governments have yet to seriously tackle these issues, or make them central in elections. Instead we continue to deal with these problems in a patchwork of modest tax credits and empty rhetoric.

I, and I assume many others, would like to put the Trump era behind us and treat it as an anomaly. But to do so would assume that Trump had landed (as had Brexit and other populist movements) fully formed but alien to us, and that we had been taken by a madness that can finally be broken.

I think we know this is not true.

From the moment that Hillary Clinton called Trump supporters “Deplorables” (or half of them at least) there has not been a clearer delineation between those that control the cultural zeitgeist, and those who have come to resent it. We have a similar divide in Canada too, with Alberta constantly at odds with more “progressive” provinces over environmental issues, and Quebec (doing as it always has) putting its historic/cultural/religious identity ahead of more multi-cultural aspirations of equality. Toronto and Vancouver may sit at the centre of Canada’s cultural output, but these two economic powerhouses do not share much with the rest of the country.

Our prolonged period of peace, wealth and stability has tricked us into believing that unrest, dissatisfaction, and failure are aberrations. But the history of Canada, the United States, Great Britain, and other European powers has been one of long periods of unrest. William Jennings Bryan, before being disgraced in the Scopes Money trial, had been a tireless campaigner for agrarian populism. In Canada we too had an agrarian populist movement (interestingly enough, similarly conservative and steeped in conspiratorial anti-Semitism, prominent in Alberta and Quebec) that only really started to disappear after the mid-60s and not totally until the late 80s. Political dissatisfaction can have long legs.

Five people died as a result of the assault on the capitol on January 6th, and one was Ashley Babbitt, a Q-Anon, MAGA loving Trump supporter who had breached four lines of security in an attempt to overthrow the government on behalf of Donald Trump. But while her motives and goals were deeply misguided, her past remains a window into a dispiriting world for many Americans. A fourteen year veteran of the United States air force, Babbitt now owned a pool supply business that was struggling, forcing her into a short term loan with a 169% interest rate. Medieval Europe had better rules governing usury than California. Or consider the North Carolina woman who took to social media because she couldn’t afford the $1000 insulin prescription for her son. Insulin, among other drugs in the United States, has been reported on multiple times for its rising price. Despite that, no government or corporation has been able to act in such a way to curb the rising price of a life saving drug that been around for a century.

All this is baked into America, and represents a growing risk for the future. Though the country has a more dynamic market, holds more patents and has some of the largest corporations, the failure to consider the effects of pushing up stock valuations at the expense of everything else will likely only deliver diminishing results in the future, both for investors like you, but also for the global liberal order that provides much of the stability we rely on.

Information in this commentary is for informational purposes only and not meant to be personalized investment advice. The content has been prepared by Adrian Walker from sources believed to be accurate. The opinions expressed are of the author and do not necessarily represent those of Aligned Capital Partners Inc.

Defeating the Coronavirus?

Monday, markets exploded after learning that Pfizer may have a viable and highly effective vaccine for Covid-19. The Dow Jones briefly rose above 1200 points before settling back down to a more respectable 835 points for the day. Similar rallies were seen in Toronto and in overnight trading in Asia and Europe. In all, it’s been a good week for markets even while Covid-19 cases continue to surge.

Courtesy of @jkwan_md

The arrival of a vaccine remains the only thing that can truly right our social and economic ship, and without it the economic reality is poised to get worse. Despite efforts to use non-pharmaceutical interventions (social distancing and masks), the virus is resurgent almost everywhere, with new cases exploding across Europe, Canada and the United States.

So the news of a potential vaccine offers the first real potentially positive change for economies. And while the Pfizer vaccine may be the first, it likely will not be the last. Eli Lilly has also introduced an antibody treatment that has received emergency approval from the FDA. Again, such treatments will not be the last, and hint that the balance in the fight against the pandemic is beginning to shift back towards us and away from the virus.

Some quick thoughts on these developments:

  1. Had this announcement come out before the election Trump likely would have won, despite his uniquely poor handling of the pandemic. 
  2. There are still many unknowns about the vaccine, and so we should temper our excitement. This includes how many doses (two, reportedly), how long it lasts in your system, and how effective it will be for the most vulnerable parts of the population.
  3. How long it will be before we get a vaccine is still up in the air. Nicholas Christakis, author of Apollo’s Arrow: The Profound and Enduring Impact of Coronavirus on the Way We Live, recently spoke on Sam Harris’s Podcast saying that it is no small feet to design, produce and distribute a new vaccine (you can listen to that podcast HERE). It could be several months, perhaps even a year, before we see the full recession of the pandemic.
  4. Markets should respond positively, but not indefinitely. Volatility will surround progress or delays in the vaccine, but so long as progress remains steady the vaccine should offer stability in markets for a wider recovery.

Finally, as a father, I’m excited to see that prospect of a return to normalcy for my kids. We’ve spent months sheltering patiently, denying my kids aspects of their childhood for the wider protection of our family. Like many parents with family members that have compromised immune systems, we’ve chosen the path of virtual learning, a half measure that allows for some academic progress but without the important social aspect of school. But the toll is visible on our children, and I am deeply saddened that my kids (as I am for everyone) should have to see a part of their lives, and their innocence about the wider world, forfeit to the reappearance of our oldest but most enduring foe. It is welcome news in a year so full of difficulty.


Information in this commentary is for informational purposes only and not meant to be personalized investment advice. The content has been prepared by Adrian Walker from sources believed to be accurate. The opinions expressed are of the author and do not necessarily represent those of Aligned Capital Partners Inc.

Some thoughts on the end of Donald J. Trump

President Trump, Evan Vucci AP

This was written on Friday, November 6th. Since then the election has been called for Joe Biden.

It’s Friday, November 6th, and Pennsylvania seems to be looking like it will go to Biden. With four battleground states showing narrow Biden leads, the math seems inescapable. Biden will be the 46th president of the United States.

The narrowness of this victory is unsettling. A record turnout for both Republicans and Democrats, the largest turnout since the 1960s of the electorate, the largest percentage of votes by visible minorities for a Republican candidate since Richard Nixon, only showed that American remains a polarized land. The hoped for “Blue Wave” as Americans repudiated Trump and his enablers did not materialize. The Senate will likely remain in the hands of Republicans. The House of Representatives may flip to Republicans too.

Even now, after all that has unfolded over the last four years, much of what brought Trump to power; anger at a failure of the establishment to protect jobs, uncertainty about the ethnic and cultural future of the United States, the erosion of the middle class, the simultaneous exhaustion of being THE global superpower while being blamed for being one. These issues linger, promised but unaddressed by Trump, ignored by his party and fueling alienation in the general populace.

Other, more persistent aspects of American culture have also been on display. Since Richard Hofstader first wrote his book Anti-Intellectualism in American Life in 1962 (He calls Eisenhower “conventional in mind, (and) relatively inarticulate” – cruel words for one of America’s best remembered Republican presidents) Americans continue to lament, often publicly, just how stupid they find one another. Whether it is over face masks, the environment, or conspiracies about “the deep state”, Americans remain shockingly divided, often down the middle.

But with Biden elected (presuming he survives all the legal attacks and mandated recounts) and once the final vote tallies are certified in a few weeks, a corner will have been turned. Trump, in his role as a lame duck president will likely shore up personal protections, lash out at allies that failed to defend him, denounce democratic institutions that have allowed for his failure, and presumably pardoning those in his close circle and looking to shield himself from any future prosecution. Biden will hopefully find some common ground in the Senate and House of Representatives that will allow business to proceed, but it seems safe to assume that the most ambitious parts of the Democrat’s wish list won’t make it into law. Similarly, hopes for a Trump sized stimulus package will now also be dashed by a Republican establishment always uncomfortable with Trump’s lavish spending but fearful of his wrath.

From the perspective of the investment world this seems to be a continuation of the status quo. Biden does not possess Trump’s unique skill at bullying, backed by the threat of his irate voters. Instead the hope will be that he can better negotiate with Republicans. But with the election leaving the GOP in a strong legislative position there will be little appetite for aggressive policy shifts. Instead we should expect tepid fiscal stimulus, continued strength in businesses profiting from the pandemic (like tech stocks) and a wider, more subdued recovery as we face the immediate economic uncertainty.

So often we think big things represent monumental shifts. The election of Trump was one such event, but in the end his legacy will be a great deal smaller, and I suspect better thought of, than we might guess now. His ignorance, narcissism, and sociopathy were critical flaws in a man that showed great skill in reading the American public. His few achievements, including peace between Israel and several Arab states, challenging China and striking some kind of trade deal, and boosting American military spending were not missteps. His useless forays into border walls and needless antagonism of American allies will not be missed. At the outset of his presidency he even had the foresight to surround himself with some accomplished and knowledgeable people. In the end Donald Trump’s biggest enemy was himself. Were Trump a more competent and less incurious man he could have been a formidable political force. Instead, his certainty in his own skill and inability to adapt made him an aspiring autocrat in search of a balcony.

To cultural observers, the election of Trump should be a reminder that small things that go unnoticed or ignored often prove to be bigger issues. The sudden mysterious outbreak of an unknown form of pneumonia in Wuhan at the end of 2019. The subtle shift in economic thinking by political leaders across the West. A demographic trend that sees a generation shrinking, maybe even incapable of marrying. The rapid economic growth of an often-overlooked part of the world. It may even be the surprising growth of visible minority voters for a candidate long believed to be their enemy. These quiet things, hiding in the corners, may be the issues that guide our future rather than the bombast of men like Donald Trump.

In 2015 I wrote that “You don’t have to love people like Rob Ford or Donald Trump, but their ability to change the political terrain, to question traditional assumptions about the electorate and undo the laziness of identity politics is healthy for a democracy, even when you don’t like the messenger.” Looking back on four years, I am only desiring a return to normalcy, but with so many of the issues that brought Trump to the White House still unaddressed I’m afraid that whatever normalcy Joe Biden can bring will be short lived.

Information in this commentary is for informational purposes only and not meant to be personalized investment advice. The content has been prepared by Adrian Walker from sources believed to be accurate. The opinions expressed are of the author and do not necessarily represent those of Aligned Capital Partners Inc.

The Undiscovered Country

Pandemics, plagues and other disasters have previously heralded major changes to economic and social landscapes. Most notably, the Black Death had the effect of badly eroding the existing feudal structure. Literally so many people died that feudal lords had to entice serfs to come and work their land or risk it sitting fallow. The Irish potato famine, which reversed the demographic trends in Ireland and made it an outlier in European population growth, also drastically improved the lives of those that survived the famine. This pandemic will be no different, changing the fortunes of many by the time it is gone.

While I wait for books on our current situation, governments aren’t sitting idly by. Faced with an unprecedented crisis, politicians have cried havoc and let slip the public purse strings, passing huge relief bills and providing large social support to ease the monetary impact of global shutdowns and the sudden halt to economies.

This marks a serious departure from what might be considered “peace time” economic management. In normal times, and for much of the past 40 years, control of the economy has been left in the hands of central banks who have manipulated the overnight lending rates (or key interest rates) to encourage or retard economic growth. Even if you haven’t paid much attention to the work of central banks you are likely familiar with some of the most notable names. Alan Greenspan in the 1990s, Ben Bernanke through the financial crisis, and Mark Carney as the Governor of the Bank of Canada and then Governor of the Bank of England have all helmed a central bank and were a staple of economic news and forecasting.

The job of setting rates was to encourage growth and mange inflation; increasing the cost of borrowing should slow economic growth and curb inflation, while cutting rates should make borrowing cheaper and speed up economic growth. But since 2008, with rates hovering at near zero and now a global pandemic destroying wealth, governments have had to take a more active roll in direct economic management.

Enter Modern Monetary Theory, or MMT, the new(ish) idea that governments can largely spend their way out of problems and that fiscal deficits may be the cure for what ails us. The theory has been nicely (and optimistically) covered in the book “The Deficit Myth” by Stephanie Kelton, who argues that our understanding of money and taxes are wrong and as a result we have misunderstood the best way to deal with wealth inequality and job creation.

Kelton’s book is well written, but natural criticisms of her argument feel conspicuously absent. The crux of her thesis is that so long as you’re a “monetary sovereign”, that is a nation that issues its own currency and issues debt in its own currency, its impossible to go bankrupt. In addition, concerns that printing your own money might lead to inflation are not well grounded and that governments are not running deficits large enough to get to full employment. Some of this makes sense, indeed for many years we’ve seen countless countries like Canada, the United States and Japan all run very large deficits with no serious repercussions. But much of the language in the book feels unusually precise, navigating us around large objections with clever rhetorical sleight of hand. Where anyone with a passing understanding might wonder how it is that countries that have previously succumbed to too much debt and hyperinflation didn’t reap the benefits of MMT, the book is quick warn that you don’t want to have the “wrong” type of deficit and that too much spending can be detrimental, before rushing the reader off to see what can be done with MMT to fix pressing issues.

Whether this is a good idea or not, MMT has found a champion in Justin Trudeau, a prime minister for whom spending money as a political solution is as constant as the northern star. Reportedly our new finance minister Chrystia Freeland may be a fan too, a departure from the more traditional Bay Street pedigree of Bill Morneau. But even if our most senior politicians do not have any explicit endorsement of MMT, the direction of spending and the behavior of the Bank of Canada suggests the Modern Monetary Theory is central to current government policy.

Since March, the Bank of Canada has purchased the vast bulk of Canadian government issuances, particularly at the long end of the yield curve (debt that matures in over 11 years), and by the end of 2021 the BoC is expected to hold 60% of all outstanding Government of Canada securities. Intentional or otherwise, this is what MMT looks like, with the government effectively issuing debt to itself so it can spend more. And currently Canada is on track to run the largest deficits of any country, developed or otherwise, in the world.

Governments frequently run deficits but have relied on efforts of slowed spending and economic growth to reduce the long-term debt burden. In fact, it has very rarely been the case that governments ever cut spending, more frequently simply reducing future promised spending below predicted rates of inflation. Yet despite the fact that no government I can think have has run a surplus over the last decade, the belief that we haven’t spent enough will likely only be a reassuring message to governments looking for opportunities to improve their standing in the polls.

Under MMT, politicians like Donald Trump actually look very good (this goes unacknowledged by Kelton, but its impossible to miss). Trump’s lavish spending and huge deficits did seem to have the desired impact of reducing unemployment to below 4%, much lower than the previously believed “natural” rate of unemployment of 5%. And as a result of the pandemic, the US deficit moved from an expected $1 Trillion in 2020, to about $3.7 Trillion for the year. It’s currently an open-ended question how much more needs to be spent before the deficit will be large enough to offset the impact of Covid-19, let alone all the other ills that society faces. Given that most economists are calling for even more spending into 2021 and maybe even 2022, its hard to imagine how big a cheque will need to be written.

A central tenet of our society has been that debt makes us weaker, and that unconstrained spending, either by a household or a government will inevitably become a problem if left unchecked. Modern Monetary theory turns this on its head, and while the theory is serious it would likely not have found mainstream consideration were it not for the pandemic. Like feudal lords forced to consider paying serfs to work their lands, politicians are having to make peace with running huge deficits and manage ballooning debts.

But MMT remains untested, its ideas about money, debt and financial sovereignty are theoretical. Our relationship to debt and our ideas about preserving wealth are very old and persistent, while those that have broken the bond of fiscal prudence, be it Greece in 2011, Zimbabwe in the 1990s, the Weimer Republic in post war Germany or Revolutionary France, have always ended in defaults and hyper-inflation.

I remain skeptical of ideas like MMT, but open to new approaches where old ones seem to be failing. Covid-19 will likely be with us until 2022, putting pressure on all levels of government for the immediate future. Politically, Western nations weren’t doing well prior to the pandemic, plagued with populist political insurgencies, a retreating liberal order and lack luster economic growth. Now with a mountain of new problems, MMT offers perhaps a path to saving economies and people’s livelihoods by freeing us from previous assumed constraints, but carries with it awesome risk. Will our political class be able to resist borrowing or printing too much? We may have no choice but to embark on this path, into an undiscovered country.

Information in this commentary is for informational purposes only and not meant to be personalized investment advice. The content has been prepared by Adrian Walker from sources believed to be accurate. The opinions expressed are of the author and do not necessarily represent those of Aligned Capital Partners Inc.

The China Syndrome

Even before the pandemic the Chinese Communist Party had been flexing it’s muscles. In response to the arrest of Huawei executive in Canada, the Chinese government illegally kidnapped and has continued to hold two Canadians on fictional charges of espionage. [MT1] China has gone tit for tat in response to the Donald Trump led trade war, putting tariffs on US agricultural goods. [MT2] In Australia, an effort to buy control of Australia’s mining industries and infrastructure has led to tightening controls on foreign investments. Border clashes in India’s far north have led to a month’s long standoff and increasing buildup between the two nuclear armed nations. The world has watched the Chinese government crackdown on Hong Kong, reversing its promise of 50 years of autonomy and One China, two systems. It reneged on its pledge not to militarize the Spratly Islands in the South China Seas. In the far west of the country, a crackdown on China’s Muslim inhabitants, Uighurs, has led to an internment of over a million people. China is also reportedly using its extensive Belt and Road initiative to gain strategic access to countries to broaden its sea power. [MT3] In countries where they have done substantial lending, particularly in Africa, efforts have been made to get the Renminbi used alongside the US dollar. In July of this year, the new security law passed by the Chinese government made it effectively illegal, globally, to advocate for democratic reform in Hong Kong.

Figure 1: Hong Kong- 9 June 2019: the crowd protest in the rally. More than 150,000 protesters with no main organisation, took to the streets of Hong Kong Sunday to oppose a controversial extradition bill

For a year replete with terrible things, China has given its best efforts to be more than an “also-ran”. But for any superpower (and make no mistake, this is a superpower and we live in a multi-polar world) this seems like a lot of toes to step on. Canada, the US, Australia, South Korea, Europe, and India have all, in one way or another, been challenged by the Chinese. Even the Chinese response to Covid-19, as detailed in Bob Woodward’s new book, Rage, shows that the Chinese authorities covered up the seriousness of the new virus, and that a charitable reading of its actions would be disinterest in how other countries might deal with it. At worst, it’s actions might be described as malevolent, interested in seeing it become a pandemic for their own benefit.

The response from the international community has been mixed however. Far from relying on old alliances to convene panels and establishing a coordinated international response, countries have largely faced these problems in isolation, and it is precisely for that reason that China has been so aggressive over the past 12 months.

Under Obama, whose own foreign engagements were at best mixed, there was at least a sense that the US intended to lead an organized response to China’s growing power status. Between the two leaders as well there seemed to be a clear understanding that their relationship was going to need ongoing management. But the election of Trump changed that math. First, the US bowed out of the Trans Pacific Partnership (both Trump and Clinton vowed to not sign the signature deal that would have aimed to get out in front of China in Pacific trade relations) and Trump has maintained a signature focus on “America First”, a mindset that has backed away from multilateral strategy and look for deals that exclusively benefit the United States.

In the short term the US is likely to benefit, signing deals by themselves means fewer compromises seen in large multilateral deals. But America’s strength has never been that it can “go it alone”. Though much of its’ historic growth did come from its rapid expansion across the continental US, the US’s rise to prominence at the end of the Second World War was its ability to build an extensive network of allies and client states. Compared to the Soviet Union the US lacked a conventional army to match its Soviet rival, but through the Marshall Plan, NATO, and other strategic alliances there has been no corner of the Earth that the US couldn’t reach and influence. That allowed the US to establish the “global order”, one that was initially in opposition to the Soviet Bloc, but one that also became the sought-after route to global prosperity. 

Figure 2 – The Chinese Navy aims to be the central power in Asian waters, including the South China Seas and Indian Ocean to the Eastern coast of Africa

Following it’s admission into the World Trade Organization, China has also massively benefited from this global order, but like any rising power it seeks to remake the world in ways more advantageous to itself. Xi Jinping, like Donald Trump, has been explicit in his desire to “Make China Great Again”, undoing the “Century of Humiliation” that looms large in the minds of CCP officials. The historic China is that of a great power, a centre for global culture, surrounded by vassal states like Korea and Japan. Xi Jinping and the CCP, wish to see China returned to this role in the 21st century, making Pacific neighbors subject to its influence and providing a growing alternative to US and Western economic development. All this is old hat. The real question is why is it that China seems to have suddenly become so aggressive despite the immense success its had while not being antagonistic.

One explanation might be China’s policy of Active Defense, a position that dates back to the founding of the Communist regime. This is a posture that seeks for maximum aggression in the face of potential conflicts with larger enemies. Forms of active defense appeared when China helped the North Koreans beat back US forces in the Korean War, the Sino-Indian war of 1962 and an attack on Russia over a border dispute in 1969. This form of defense aims to put potential aggressor nations on a back foot and establish clearly that China’s will regarding national interests is resolute.

Figure 3 – An Indian soldier high in the Himalayas

Another possibility is that China is testing the waters. With much of the world struggling to deal with Covid-19, this is as good a time as ever to see how united the traditional great powers have been. So far the response has been disorganized and uncoordinated. India, which has never had a strong desire for international alliances now finds itself fairly isolated, traditionally antagonistic with its neighbours (the longest walled border in the world is between India and Bangladesh) surrounded by nations that increasingly see their economic development through China. In Europe, the resurgence of a nationalist far right and the high cost of economic bailouts following 2008 has left many countries at Europe’s fringe more open to help from outside the EU. Meanwhile, the high cost and duration of the wars against terrorism have left Western powers far less interested in open conflict and their populations more wary of joint military adventures.

Whether the CCP under Xi Jinping lied about the nature of the novel coronavirus (almost certainly), or deliberately allowed it to escape across its borders (hard to conclusively prove), the Chinese government now finds itself exactly where it always wished to be, ascendant against a disorganized and self-serving group of largely Western antagonists. And while America may get some short terms gains from its “America first” foreign policy, the collapse of an organized and united group of nations committed to the global order will only make life more unpredictable and more costly.

***

In 2010 China blocked the export of rare earth minerals to Japan over arrested fishermen, and in 2011 China stopped buying salmon from Norway after awarding the Nobel Peace Prize to a Chinese dissident. In 2012 China punished the Philippines by leaving bananas on the docks until they rotted during a “prolonged investigation” after the Philippines challenged China’s claim on islands in Philippine waters. In February China stopped buying Canadian canola as part of its campaign to have Canada release Meng Wanzhou. In response to an Australian request for an international inquiry into the outbreak of the Covid-19, the Chinese government stopped accepting Australian beef and placed an 80% tariff on Australian barley. All of these events were a result of China responding to international decisions or publicity they didn’t like. In another time these penalties would be of little consequence, but China is the number one trading partner for 130 countries, giving it unprecedented economic leverage on a global scale. That makes the possibility of an effective response to Chinese economic might all but impossible without committed allies.

Figure 4 – Caricature of the British Diplomat, Lord Macartney on his failed mission to Peking. From 1792 by James Gillray

A famous but apocryphal saying from the 1850s was “If I could add an inch of material to every Chinaman’s shirt tail, the mills of Lancashire could be kept busy for a generation.” In the early 21st century those dreams have been realized but they’ve come with a high cost. At it’s current rate of growth (around 6.9%) every four years China adds the equivalent of the economy of Germany to its own. With such economic power why wouldn’t China assume that the world should be remade in its interests? Why should China not have more say in international organizations? Why should it not set the terms of border disputes with neighbours? Why should it not tell human rights organizations to butt out of its business? Why should China not “have its place in the sun?”, as Kaiser Wilhelm once said of a similarly ascending Germany more than a century ago?

China’s rise is real and cannot be undone. It must be managed, and for those of us that believe that the world is better under the current global order, that means that middle economic powers like Canada, Australia, Western Europe, the UK, Japan and South Korea, will need to better manage our own big power, the United States. With China now the largest market for cars, cell phones, online shopping, alcohol and luxury goods we also cannot ignore or live without the Chinese economy. We are bound together, but not yet subservient. As citizens in a free world, and investors in our own future, these are the problems we must begin demanding of our own politicians to solve, or we will all pay for the consequences with a poorer and more turbulent world.

Books used in this essay include:

               Destined for War by Graham Alison

               Active Defense by M. Taylor Flavel

               The China Wave: Rise of the Civilizational State by Zhang Weiwei


Information in this commentary is for informational purposes only and not meant to be personalized investment advice. The content has been prepared by Adrian Walker from sources believed to be accurate. The opinions expressed are of the author and do not necessarily represent those of Aligned Capital Partners Inc.

Manufacturing Foxes

Manufacturing Foxes – Tenuous Connections Across Time

In a display of sheer audacsiousness, Adrian tries to connect a forgotten sport from the 1600s to difficulty in re-shoring businesses today.

Can he do it?

Watch and find out!

Information in this commentary is for informational purposes only and not meant to be personalized investment advice. The content has been prepared by Adrian Walker from sources believed to be accurate. The opinions expressed are of the author and do not necessarily represent those of Aligned Capital Partners Inc.