Thursday, October 20, 2022

Thursday Night Links

  • While it is our belief that the free market is a much more powerful indicator of where the "real bottom" is, the subsequent two catalysts should help provide an even higher floor for oil prices going forward. With the oil market now confirming that the range is somewhere between $80 to $125, what we should expect going forward are the following: Energy stocks will now price in a higher floor. Investors will start to underwrite energy companies using a higher base oil price, which should start seeing a change in the trading multiples. The price band should start to narrow. With worries over global oil demand today due to macro concerns putting a ceiling on oil prices, and low absolute oil inventories putting a floor, the trading band should narrow. At some point down the road, the band will break, and our analysis indicates that it should be to the upside given how constrained supplies will be going forward. [HFI Research]
  • In the last few decades we had long cycles and rare but big recessions. These recessions were always a result of a slow build-up of excesses in certain areas – for instance, TMT in the 1990s, Real Estate and Financials in the 2000s. These excesses in investment and employment were then corrected during the recessions, which necessarily took some time. In the new world of high & volatile inflation, recessions are likely to be more frequent and shorter. Exactly this was the case after WWII – a short recession every three years, for a period of 15 years. Recessions driven by spikes in inflation, solved by falls in inflation. And for a variety of reasons, investment grade (“IG”) spreads hardly moved during such recessions as the downturns were short, nominal growth was decent, and excesses had not been built. Needless to say we make this particular point with some trepidation. Given very high public and private debt levels around the world, the risk of a much worse type of recession certainly exists. But that is not our base case. To this point, we anticipate a future issue of The Road Ahead to discuss what the next severe crisis could look like. The implication, we think, is that credit may be surprisingly defensive through recessions in the next few years. Our judgement, today, is that now is the time to increase exposure to credit, with for instance US IG yielding close to 6% and US HY yielding close to 10%, currently. [Man Institute]
  • Harvard blamed some of its losses on a decision the university made to divest of fossil fuel-based investments. Narvekar said a number of large investors “leaned into the conventional energy sector” in a strategy that added “materially to their total return”. He said Harvard “did not participate in these returns given the university’s commitment to tackling the effects of climate change, supporting sustainable solutions, and achieving our stated net zero goals”. [FT]
  • [You’re saying that central banks are powerless?] They’re impotent. This is a shift of power that cannot be underestimated. Our whole economic system of the past 40 years was built on the assumption that the growth of credit and therefore broad money in the economy was controlled through the level of interest rates – and that central banks controlled interest rates. But now, when governments take control of private credit creation through the banking system by guaranteeing loans, central banks are pushed out of their role. There’s another way of looking at today’s loud, hawkish rhetoric by central banks: Teddy Roosevelt once said that, in terms of foreign policy, one should speak softly and carry a big stick. What does it tell you when central banks speak loudly? Perhaps that they’re not carrying a big stick anymore. [Russell Napier]
  • Third-quarter earnings for four of the biggest US diversified banks came out last Friday: JPMorgan Chase, Wells Fargo, Citigroup and US Bancorp. What did we learn? We knew that certain highly interest rate- and market-sensitive businesses were going to be weak, and they were. So, for example, Wells Fargo’s non-interest income was 25 per cent lower than a year ago, as mortgage origination fees fell. A doubling in mortgage rates will do that. Similarly, at JPMorgan, investment banking fees fell by almost half from a year ago, as the IPO and underwriting businesses dried up. But then there are the core economic signals a bank’s results send off: are people spending? How are deposit balances? Is there demand for commercial and credit card loans? Is anyone defaulting, or paying late? Here the story is very different. The banks reported, in short, that these things are sending no signals of a slowdown whatsoever. Start with what the banks’ leaders said. An analyst asked JPMorgan execs if they were “beginning to see cracks, either be it commercial, real estate, consumer, where it feels like the economic pain from inflation, higher rates is beginning to filter through to your clients?” The CFO answered (italics ours): "The short answer to that question is just no. We just don’t see anything that you could realistically describe as a crack in any of our actual credit performance . . . We’ve done some fairly detailed analysis about different cohorts and early delinquency bucket entry rates and stuff like that. And we do see, in some cases, some tiny increases. But generally, in almost all cases, we think that’s normalisation, and it’s even slower than we expected." That message was echoed by executives at every bank that reported. [FT]
  • Mises is underrated.  His 1922 book Socialism is still the best and also historically most important critique of socialism, ever.  His earlier articles about the impossibility of economic calculation under socialism are among the most important economics articles, ever.  Those are already some pretty important contributions, and yet he is often talked of as a crank, perhaps because in part some of his followers were indeed cranks. Liberalism I quite like.  His book Bureaucracy is underdeveloped but still pretty interesting, and his hypotheses about the logic of cascading interventionism, if not entirely correct, still are an important contribution to public choice.  They do explain a lot of the data.  Human Action is big, cranky, and dogmatic, but for some people a useful tonic and alternative to the usual stuff.  I can’t say I have ever really liked it, and in an odd way the whole emphasis on “Man acts” undoes at least one part of marginalism.  The early Theory of Money and Creditwas a pretty good early 20th century book on monetary theory. Hayek somehow ended up as “the reasonable face of classical liberalism,” but in fact Mises was far more politically correct by current standards. Obviously there is a sliver of people who very much overrate Mises.  Here is a guy who hardly anyone rates properly.  I’m still sticking with considerably underrated. [Marginal Revolution]
  • There could be a period when stocks and bonds go down together. For example, instead of stock declines -> people wanting the security of bonds, people might decide that stock declines lead to bailouts which are really stealth currency devaluations, and decide they want no part of the long end of the yield curve. [...] Remember, all of the federal, state, and municipal governments are planning to borrow to cover their operational and pension shortfalls. They think it will be no big deal thanks to low interest rates. If you synthesize the best parts of Falkenstein and Redleaf, you predict that the next crisis is going to come in the investment that is currently perceived as riskless enough for highly leveraged institutions like banks to buy. Right now, government bonds are accorded zero risk in calculating bank capital ratios. The idea that government bonds are riskless when governments are planning to flood the market and when the expenditures are consumed (building no collateral) may prove to be the latest extraordinary popular delusion. [CBS]
  • Leibig's law of the minimum says that plant growth is limited by whatever substance is present in the soil in the least adequate amount. Many times, this is nitrogen, which is why most of the world's civilizations independently discovered intercropping of legumes in order to add nitrogen to soil, as early as 12,000 years ago. Liebeg described agriculture's principle objective as "the production of digestible nitrogen," and as a 19th century chemist noted, "every vital phenomenon is due to some change in a nitrogen compound and indeed in the nitrogen atom of that compound". But nitrogen was very scarce for humanity, because plants cannot use atmospheric nitrogen, and the only technology for increasing soil nitrogen was the symbiotic nitrogen fixing bacteria associated with legumes. The result was that the nitrogen cycle had to be kept very tight, with nitrogen wastes being returned to the soil, and even going so far as to harvest nitrogen-rich seabird guano from islands off the coasts of South America. [CBS]
  • John F. Cavanagh was a man who liked to tinker around. Type his name into a database for patents, and you’ll find dozens of inventions connected to him, everything from a hat rack to a staple remover to a power-driven toothbrush. In the 1940s, his sons once recalled, a Rhode Island priest approached Cavanagh asking for a favor: Could he build a machine that would allow nuns to bake and cut communion wafers at a wider scale? The resulting product was known as the Cavanagh Baker, a piece of equipment purchased by hundreds of convents to great acclaim, so much so that one group of Boston nuns devoted prayer hours to Cavanagh. The timing coincided with a sea change in the Catholic Church. Previously, churchgoers participated in communion monthly; around this time they started partaking weekly. [link]
  • Altria Group, announced that a subsidiary has entered into an agreement with a subsidiary of Philip Morris International Inc. (PMI) under which Altria will receive cash payments from PMI totaling approximately $2.7 billion (pre-tax) in exchange for assigning exclusive U.S. commercialization rights to the IQOS Tobacco Heating System® effective April 30, 2024. [MO]
  • The board of directors of Magellan Midstream Partners, L.P. (NYSE: MMP) has declared a quarterly cash distribution of $1.0475 per unit for the period July 1 through Sept. 30, 2022. The third-quarter 2022 distribution is 1% higher than the $1.0375 paid for both second quarter 2022 and third quarter 2021. The new distribution, which equates to $4.19 per unit on an annualized basis, will be paid Nov. 14 to unitholders of record at the close of business on Nov. 7. [MMP]

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