The Global Scan

Plus, an asset allocation update

My desire to reconcile my family’s communist background with my own capitalist ambitions had brought me to Russia, but, naively, I never imagined that this pursuit would result in a human tragedy.

Bill Browder, Red Notice, 2015

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THIS IS NOT INVESTMENT ADVICE. INVESTING IS RISKY AND OFTEN PAINFUL. DO YOUR OWN RESEARCH.

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September will be the last month I’ll post unaudited results, meaning pulling from my brokerage statements and adding them up in Excel. In October, the asset allocation becomes Kate Capital. I will share the asset allocation, with a lag, for subscribers. There are strict US regulations around what I can say publicly about Kate Capital. So I will merely note Kate is a) an investment management company and b) that this essay is NOT an offer or solicitation. Instead, I am sharing what I perceive for you to take or leave. There is no reason for you to believe the below is either accurate or predictive.

My take on conditions is:

1. The USA. In the part of the world where most of the assets are, the US, present trends continue. That is, slowing growth, slowing inflation, OK earnings at companies that have different forms of monopolies and moats. This will last until the Fed cuts enough to stimulate the next upcycle. I suspect the private sector will be quite responsive to Fed cuts because their balance sheets are unusually healthy. Debt costs have been so high the private sector has not taken on much debt. Much attention will be focused on the election. The key market impacts of the election are a) tax policy and b) Ukraine/Taiwan policy. This becomes much more extreme if either party wins control of both the White House and Congress. My hunch is Harris wins and taxes go up and defense spending goes up.

2. Tightening in Asia. There is China and there is Japan. Both are tightening, though one is doing so intentionally (Japan) and probably with justification, while the other (China) is tightening through a combination of anti-entrepreneurial politics and insufficient easing.

3. China. If you listen to the earnings calls of huge global companies like Apple or Siemens, it is clear that domestic demand in China is weak. It’s so weak that I doubt the official government statistics claiming that their growth is near 5%. You can also see this in commodity prices, which are falling (which is why gas prices are low). Chinese policymakers’ response is not to aggressively deal with the problem (which would require money printing and weakening their currency) but to try to export their way out of excess capacity. This is flooding the rest of the world with cheap goods, which is why goods prices are in outright deflation and also why businesses you likely don’t pay attention to, like sea-borne car carriers, are making a ton of money. They are shipping Chinese electric cars to all the places in the world (not Europe or the US) that need cheap transportation and don’t have high tariffs because these countries don’t have domestic production.

4. Japan. Japan had the same problems China now has for roughly thirty years (about how long I think these problems will last in China). The Japanese cured them by printing a lot of money, driving the yen lower, boosting corporate profits and thereby gradually getting out of their protracted real estate bust. Now the Japanese have tentatively begun to tighten. That’s part of what caused the financial markets turbulence last month. My question (and I’m sure the BOJ’s question) is how much the weakness in China and slowing US will impact inflation in Japan. I suspect if the yen remains weak and real interest rates negative (where they are now) not that much. This argues for a still stronger yen and/or higher interest rates. But nothing is certain.

5. Russia. Beyond China, emerging markets are tainted, none more so than Russia. As you know, I started my career in Russia and follow events there closely. The utter criminality of modern Russia is, if you pause to consider it, terrifying. This is a nuclear-armed state that is using raw violence to cause global chaos, be it killing tens of thousands of Ukrainians, global hacking, hostage taking, or foreign assassinations. I personally know people who have either been murdered or attacked by the FSB (modern KGB). Several US regimes have failed to contain Russia, so there has been a grave strategic miscalculation. When I first went to Russia in 1990, the world was full of hope that the end of this epic clash was at hand. But we’ve found out that Russia wasn’t awful because of the form of government, it was awful because of a political culture, a thread that goes from the Czars to the Soviets to Putinism. Russia has repeatedly invaded its neighbors and been merciless to its own, which is why the talented Russians flee. This brain drain is a feature of many emerging markets—China front and center—and creates a self-reinforcing negative cycle where the more open-minded, ambitious and moral flee. I’ve spent a lot of time in both Russia and China but right now I’m too scared to set foot in either place. The photo I posted on the header is from the St. Petersburg home of Vladimir Nabokov, one of so many who fled.

6. Cycles. A final thought on the above—-to build out the portfolio, I am considering the short-term interest rate cycle, but also the cycle in each of the industries I am tracking plus the geopolitical cycle. Even as we get a down cycle in the US economy, we are getting up cycles in tech capital spending, defense spending, and under-investment (thus more cash flow thrown off) in other sectors, like energy. Plus the tightening in China and Japan offers opportunities. Below is the asset allocation and performance, unaudited, year-to-date.