Friday Highlight Reel - Edition #12

A sampling of interesting observations from the Haymaker's network of market experts and favorite resources.

May 12, 2023

(Directly quoted content appears in block-quote format, unless otherwise indicated)

#1: Druckenmiller on What Should Really Worry Us (via Bloomberg)

All this focus on the debt ceiling instead of the future fiscal issue is like sitting on the beach at Santa Monica worrying about whether a 30-foot wave will damage the pier when you know there’s a 200-foot tsunami just 10 miles out.

Team Haymaker Take: For those of you who don’t know, Stan Druckenmiller earned his place in the hedge fund hall of fame by shorting the British pound in the early 1990s, prior to a precipitous plunge. At the time, he was the lead portfolio manager for George Soros’ Quantum Fund and added over a billion to the latter’s net worth. (Yes, I know, many of you are not fans of his political activism; nor am I.) Stan also made himself a billionaire many times over through the course of his career.

Now managing only his family’s money, he remains an extremely astute observer of major economic and financial trends. In the above quote, he’s colorfully describing what I believe to be one of the biggest risks to the financial markets of this year. It’s what I’ve referred to as the Four Fs: a Federal Fiscal Funding Fiasco, with apologies for reiterating this thesis. But I think its criticality warrants copious amounts of emphasis.

Like Stan, I believe the debt ceiling theatrics are a distraction from the much greater threat of an onslaught of Treasury-bond issuance, potentially overwhelming the market’s ability to absorb this supply. Actually, the debt-ceiling drama is elevating this risk, as it is postponing current financing. This creates even more of a glut problem for the second half of the year.

My back-of-the-envelope calculations are $1 trillion of more deficit spending, $370 billion to replenish the Treasury’s depleted checking account (TGA), $500 billion of further Fed selling, and the potential for $1 trillion of deferred Treasury financing. That’s around $3 trillion of either added supply or reduced demand. Other risks to the latter are banks being forced to sell their longer-term bonds and continued foreign central bank divestments of USTs. In other words, it’s a disaster in the making.

As usual, spending is out of control. Per Luke Gromen, trailing three-month U.S. government outlays have been surging at a 25% annualized rate. This is a spending blitz unparalleled outside of the worst of the pandemic and the depths of the 2008/2009 Global Financial Crisis. And that’s only the on-budget numbers. The actual red ink is much higher including off-budget entitlements. Stan estimates those have a present value of $200 trillion.

On a related note, Federal interest costs are doing a moonshot and have shockingly surpassed total defense spending.

Of course, for many years there have been concerns that markets would choke on Treasury supply and, nevertheless, America has been able to access financing. Yet, it’s also fair to note that the Fed has provided about eight trillion of that from its Magical Money Machine. As I’ve often written, that’s been a prime contributing factor behind the inflation we are presently facing. But now, the Fed is a seller, not a buyer.

Accordingly, in the likely event that there is a compromise achieved to yet again extend the debt ceiling, I’d be very skeptical of any resulting relief rally. Don’t get faked out; the truly spectacular pyrotechnics are likely to flare up after the 4th of July.

#2: Krugman on Our Economic Outlook (via Markets Insider)

Signs of a labor-market cooldown without a rise in unemployment is good news for the US economy, suggesting a mild slowdown in growth still remains a possibility, according to Nobel Prize-winning economist Paul Krugman.
Average monthly job creation in the world's largest economy slowed to 222,000 during the February-April period, from 338,000 for the previous six months, official data show. Still, the unemployment rate came in at a 53-year low of 3.4%.
"The good news is that so far it seems as if we've been getting significant labor market cooling without a rise in unemployment," Krugman tweeted on Wednesday. "Soft landing hopes are still very much alive," he wrote, referring to a scenario that involves a non-disruptive slowing of economic growth.

Team Haymaker Take: No doubt, the phenomenon labeled as a "soft landing" for the U.S. economy has been opined about ad nauseam for the last year. Typically, when the Fed tightens the screws on the economy via aggressive rate hikes, this brings money supply, velocity, and economic activity to a screeching halt — often followed by a recession of varying degrees and length. A soft landing, on the other hand, would require a slight pullback in economic growth that doesn't lead to a full-blown recession. While the specter of pulling off this acrobatic maneuver has been debated incessantly among economic talking heads, when Paul Krugman talks, we tend to listen… and lean the other way.

The Nobel Prize-winning economist thinks the recent trend of slowing labor market growth without a rise in unemployment could mean a soft landing is still a very real possibility. Average monthly jobs creation in the U.S. decelerated to 222,000 from February-April, down from 338,000 during the previous six months. Meanwhile, unemployment registered its lowest reading in 53 years, at 3.4%. Of course, the elephant in the room is inflation, which continues to be unusually "sticky" and the Fed seems committed to its crusade of using rate hikes to rein in prices.

We remain skeptical that the U.S. economy avoids a recession altogether, and the government's ability (or lack thereof) to fund itself is seriously in doubt, per the lead section, which poses a major threat to the financial markets and the overall economy. That being said, there remains abundant liquidity in the system and several notable Haymaker friends agree with Paul Krugman. However, his sanguine view of inflation of two years ago, and his cheerleader role in the housing bubble of 20 years ago, leave Team Haymaker less than impressed. Interestingly, the aforementioned Stan Druckenmiller is highly dubious a soft landing can be achieved. By the way, two years ago he was vehemently warning of a pending inflation eruption.

While it’s presumptuous to disagree with a Nobel prizewinner, Mr. Krugman appears to be overlooking leading indicators of the labor market, blinded by his usual partisan bias. Per the below chart, jobless claims are rising at the highest rate since October, 2021. In fact, 70% of U.S. states are reporting increasing initial claims for unemployment. One of the labor market’s best forward-looking metrics, temporary workers, is declining at a recession-like rate. Sorry, Paul, but I think you’re going to be proven wrong… once again.

To learn more about Evergreen Gavekal, where the Haymaker himself serves as Co-CIO, click below.

Private Wealth Management

#3: Gizmodo on AI-enabled Wealth Transfers

Although economists have different opinions on the impact of AI, there is general agreement among economic studies that AI will increase inequality.
One possible example of this could be a further shift in the advantage from labour to capital, weakening labour institutions along the way. At the same time, it may also reduce tax bases, weakening the government’s capacity for redistribution.
Most empirical studies find that AI technology will not reduce overall employment. However, it is likely to reduce the relative amount of income going to low-skilled labour, which will increase inequality across society.
Moreover, AI-induced productivity growth would cause employment redistribution and trade restructuring, which would tend to further increase inequality both within countries and between them.
As a consequence, controlling the rate at which AI technology is adopted is likely to slow down the pace of societal and economic restructuring. This will provide a longer window for adjustment between relative losers and beneficiaries.

Team Haymaker Take: When OpenAI released its ChatGPT chatbot to the world at the end of 2022, few could've predicted the magnitude and speed of its impact. For the uninitiated, the technology allows you to type in almost any question under the sun and receive an instant and thorough response in seconds. But ChatGPT isn't just a glorified search engine. Users can also input data and ask the AI to perform tasks. For example, you can type in a bit about yourself and ask ChatGPT to generate a perfectly formatted résumé. So, in a matter of seconds, you can have AI perform a task that would take the average person a couple of hours, if not more. High school and college students are having the software write their essays. Working professionals are deploying it to increase their productivity by performing menial and time-consuming tasks like sorting email and data entry. With this type of quantum leap in efficiency and information transferal (and we've just scratched the surface), AI's potential reach across the spectrum of human activity is simply mind-blowing.

The lingering question looms large: where does the human/AI relationship go from here? Some economists warn AI might not just alter the way we do things, but reshape the structure of the economy as we know it. Specifically, the new AI paradigm will likely disproportionately affect lower-skilled laborers, widening inequality across society. There are countless variables to consider and philosophical questions to be had, but one thing is clear: the evolution of AI, and how we continue to incorporate it into our lives, is going to have a major impact on the human race.

#4: Yahoo! News on the Global Market for Russian Oil

Russia’s crude has continued to flow to international markets since its troops invaded Ukraine in February 2022. But Moscow’s oil revenues have shrunk, falling in April to just a third of last year’s level, hit by sanctions and price caps on its exports. Budget proceeds from crude and petroleum products fell 67% to 496.9 billion rubles ($6.4 billion) last month, the Finance Ministry said on Thursday.

Piece Continues

Russia’s Lifelines
The combined volume of crude on vessels heading to China and India plus smaller flows to Turkey and quantities on ships that haven’t yet shown a final destination rose for a fourth week to reach a record 3.55 million barrels a day in the latest four-week period, the highest since Bloomberg began tracking the flows in detail at the start of 2022.
As the ultimate destinations of cargoes loading in late January became apparent, flows to China rose to new post-invasion highs, and remained close to those levels in February and the first weeks of March. Historical patterns suggest that most of the vessels currently identified as “Unknown Asia” destinations and heading for the Suez Canal will end up in India, while those loaded onto very large crude carriers off the north coast of Morocco or, more recently, in the Atlantic Ocean, will head to China.

Team Haymaker Take: You might have noticed that, over the past year, there’s been a lot of public discussion on the idea of a newly bisected geopolitical framework, one that is often generally (meaning quite imperfectly) described as a modern-day East-v-West “alignment”, or re-alignment, depending on your interpretation. To the extent that any such shift is underway, it should be thusly understood: valuable commodities are predictably finding markets where high demand overrides the presumed geopolitical default of siding with the United States and/or NATO in the former’s proxy war. It’s troubling for many who imagined the concept of status quo was eternal, rather than being subject to actual eternal concepts, like that of supply and demand.

The U.S. goal of undercutting Putin’s war-manufacturing capabilities via economic strangulation is a tricky one to realize when the power of international trade, buttressed by immense developing-world energy demand, enters the equation. Of course, per Yahoo!’s reporting, it’s hardly been all upside for Vlad, and the lost revenue can’t be glossed over as anything other than it is — very damaging to Russian prosperity (qualified though that notion may be). In the long run — which is surely the racing format Putin prefers — the new trade paths and commercial relationships Russian energy producers are discovering will see global markets reconfigured. This may lead to the signing of embarrassing trade agreements between morally repulsed NATO affiliates and a Russia that, despite its current setbacks, remains commodity-rich and well positioned to continue exporting wherever the market dictates.

#5: THR on the 2023 State of Content Streaming

Warner Bros. Discovery ended March with 97.6 million global streaming subscribers, compared with around 96.1 million as of the end of 2022 and ahead of estimates, the entertainment conglomerate disclosed Friday in its first-quarter earnings report. Importantly, its streaming unit swung to a $50 million profit, compared with a loss of $654 million in the year-ago period and a $217 million loss in the fourth quarter. Wall Street will take note of that streaming success as a sign of continued progress toward management’s vow to make the business sustainably profitable and of delivering on its promise to not chase subscribers at all costs.

Piece continues…

Various Wall Street analysts have turned bullish on Warner Bros. Discovery this year amid management’s focus on free cash flow, debt reduction and streaming profitability.
The company unveiled in mid-April that it would combine its HBO Max and Discovery+ streaming services into the rebranded Max, set to launch in the U.S. on May 23. Its goal is to make Max the streaming destination for everyone in a household, with the new tagline “The One to Watch.” Max will offer the company’s library product and new intellectual property, but also double down on beloved franchises with the likes of a live-action Harry Potter scripted television series and new installments of The Big Bang Theory and Game of Thrones.

Team Haymaker Take: It’s always tempting to extrapolate seismic and exciting predictions from apparent changes to a major medium or cultural institution. The movie theater, for instance, has been on an imaginary deathbed since the moment Netflix adopted a streaming model. From THR’s reporting, however, one conclusion that does appear sensible is that a consolidation of platforms (and brands within those platforms) is ongoing within the industry. The so-called “Streaming Wars” have seen intellectual property hungrily snatched up, glossily packaged, breathlessly advertised, desperately re-advertised, haphazardly traded around, and in many cases (sigh) “reimagined” as different content providers seek to either carve out an audience niche or dominate a category altogether. But there’s a lot out there, and consumers are probably perplexed, perhaps even flattered, by the surfeit of brands/providers vying for their attention. In short, we’re due for a settling of the dust and a moment or two of stability within the streaming industry. (In contrast to Warner Bros. Discovery, rival Paramount is coping with the streaming wars much less effectively, at least for now.)

Despite the THR-reported concept of Max as “the streaming destination for everyone in a household”, you might instead see more large-scale IP (intellectual property) holders start carefully tailoring the contents of their respective libraries, perhaps working hard to identify their brands with an established set of genres. This would be reminiscent of the old Hollywood “Studio System” in which the major studios (there were so few back then!) were associated with certain narrative styles, rather than trying to be all things to all eyeballs… which is how modern content producers regard their audiences, by the way. We prefer the term “customer” for that purpose.

Haymaker

Friday Highlight Reel - Edition #12

A sampling of interesting observations from the Haymaker's network of market experts and favorite resources.

(Directly quoted content appears in block-quote format, unless otherwise indicated)

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