Clash of Empires: Currencies and Power in a Multipolar World

I recently read the book Clash of Empires: Currencies and Power in a Multipolar World written by Charles Gave & Louis-Vincent Gave. It is a great read. No fluff. Quite short with many charts backing up the concepts & on point analysis.

Here are a few of the key themes & notes I took from the book, combined with some of the related themes I have sort of read online.

Their book is at least directionally bullish China (along with nearby emerging markets that will likely benefit from a halo effect if their China thesis holds true), extremely bearish Europe & perhaps at best neutral to the US in the short term with more of a bearish take in the longer run on the US (due largely to the relative rise of China).

Perhaps the directionally opposite take would be Kyle Bass as expressed in multiple interviews on Real Vision.


European Debts & Investments

Europe is largely uninvestable in its current incarnation – particularly bonds & banks. Some of their exporters might be ok, provided they export globally & their production isn’t in a category that is increasingly being competed with by Chinese producers.

The common currency has prevented interest rates & exchange rate changes from being able to adjust to bring the economic system toward equilibrium. While Germany appears financially healthy relative to other European economies, the common currency has meant Germany has had to play shell games to subsidize increasing levels of debt at the periphery.

Non-Euro denominated European equities have recently started to outperform Euro denominated assets.

Illusory Safety

The strength of the German economy has pulled down rates for other countries across the European region, which has made debt servicing costs lower than they were before integration.

Integration has been financial, but there has been no political integration. Any major recession risks collapsing the European Union.

Should the German Deutschmark return, other countries will choose not to pay their debts or to pay debts in a currency of their choosing. With that in mind, Germany might have made more malinvestments than China has.

Should there be a break up of the Euro it would not only be deflationary, but many of those debts German firms are sitting on could be worth approximately zero – the equivalent of taking some of their past production and dumping it directly into the ocean for no gains.

The waves of immigration will only stoke national differences & ultimately can not offset the aging demographics impacting the area which further slow economic growth.

European Innovation

Ricardian innovation – standardized integration & building of infrastructure – has ended as a source of growth across Europe with the Greek debt crisis, Brexit, Russia annexing the Crimea, & Turkey being a proverbial thorn in the side. Africa & the Middle East remain unstable. If the European empire can’t expand geographically then the low hanging fruit has already been picked.

Their Schumpeterian innovation is also more than a bit suspect given increasing regulations over the online economy which are hurting domestic European startups & acting as a subsidy toward the largest multinational players like Google & Facebook. EU venture capital deals have fallen off a cliff after GDPR & that is before the impacts of Article 11 & Article 13 kick in.

Negative interest rates further act as a kick in the face of innovation by keeping zombie firms alive & promoting financial speculation over fixed capital investment.

United States

Debt & Demographics

The United States is also facing an aging demographic profile. Elevated debt levels further constrain growth & high deficits crowd out other investments.

Recent promotions of modern monetary theory are a symptom of wanting to keep high defense spending with a broad-based welfare state without the associated required level of taxation.

Foreign central banks have stopped building reserves over the last 7 years & are no longer funding United States deficits. Foreign firms which took on Dollar denominated debts may be paying back debts. The global monetary base fell over 7% in 2018, which is part of why almost all asset classes performed poorly.

When global reserves fail to grow typically riskier assets underperform lower risk assets, while foreign assets also underperform US assets. When central banks reserves rise again US assets may underperform foreign assets. If central bank reserves grow rapidly the Dollar should fall significantly, with US commodity producers and other exporters being the beneficiaries of the shift.

Growth vs Value in an Age of Central Bank Manipulation of Markets

Pension obligations make some high cashflow businesses have no ongoing value if they are not able to either find new growth markets or aggressively pay down debts while interest rates are still relatively low. Heavy stock buybacks amplify earnings per share while the economy is healthy, but will also amplify losses per share when the economy turns.

Debt saturation makes the economy less dynamic and makes debt-larded companies less able to cope with dynamic changing markets as debt is the opposite of optionality. Some private equity plays like Toys R’ Us are a good example of how private equity driven debt can drive an otherwise solvent firm into insolvency.

Debt saturation makes the entire economy less dynamic. And if investors make more by speculating in existing assets (financial engineering) then there is less funding available for genuine innovation.

Quantitive Easing, ZIRP & even NIRP have lowered the discount rate on investments where returns are highest in the far out future. This in turn has shifted investor preference away from income toward growth by reducing the risk premium placed on growth. It also shifts the economic pie away from wage earners toward asset owners who see the value of their financial assets increase due to central bank intervention putting a bid under the market.

They describe 3 examples of innovative approaches & suggest the third is the path which remains available after elevated regulatory attention to the impacts of tech companies.

  • Apple: make a killer device driving a key platform (though what if there is no next device?)
  • Facebook: use richly priced stock to acquire their would be disruptors like Instagram & WhatsApp (though would any other major acquisitions be allowed at this point?)
  • Amazon: let a thousand flowers bloom with aggressive internal investments in many experiments

The U.S. stock market hosting many intellectual property rich growth businesses that have appreciated dramatically since the Great Recession have pulled in a lot of foreign capital.

High cashflow but slow growth businesses have been to a large degree deemed as having low residual value while businesses engaged in creative destruction of adjacent markets re seen as having high residual values.

If & when markets are allowed to normalize, the high value ascribed to money-losing growth businesses may come back to Earth while value stocks may outperform. They argue the sell off in Q4 of 2018 was the end of this valuation dichotomy. The flood of IPOs in 2019 may further prove them correct as investors now have a glut of supply of new growth stories to invest in at perhaps multiple hundred of billions of Dollars in valuation between entities soon headed to market including: Zoom, Pinterest, Uber, Airbnb, Slack, Postmates, PagerDuty, Cloudflare, Bumble, Crowdstrike, Palantir, Peloton, WeWork & many others which add to the selection of FANG, BAT, and many others that have listed over the past year or so including Spotify, Snap, Twilio, Zendesk, Match & other existing tech plays.

Dollar Reserve Currency Status

It is unlikely the Dollar would lose reserve currency status anytime soon. The title of the book does however hint at how the world could become multipolar. The rise of any legitimate competitor to the Dollar would ultimately be a negative for demand for the Dollar, even as the Dollar retains reserve currency status.

The ability to price trade in other currencies enables countries to ensure they have adequate reserves to buy vital commodities like oil without needing as much Dollars on hand to pay for those commodities.

Weaponizing the Dollar by fining foreign firms could hasten the decline of the Dollar’s reserve currency status, or at least encourage other foreign parties to denominate deals in other currencies.

Implications of the Chinese Trade War

President Trump is trying to reduce the trade deficit with China by adding uncertainty to global supply chains in order to try to drive production onshore.

If the United States works out a trade deal with China it could shift winners & losers across investment classes, with emerging markets outperforming U.S. equities & value stocks performing better than growth stocks within the United States.

If the trade war is improved through purchase commitments that would help rustbelt states by boosting commodity purchases. If the trade war is settled through a revaluation higher in the Yuan global asset prices should increase.


Trade Balance

China stopped recycling trade surpluses into U.S. treasuries after the Federal Reserve commenced their second round of Quantitative Easing & instead promoted their Belt and Road program while opening up the Chinese bond market to foreign investors.

In light of the 1989 Tiananmen Square massacre, China has a similar fear of stoking inflation that Germans with a memory of WWII have. They also recall how the Plaza Accord caused the Japanese economy to pop, so should China strike a deal with the United States to revalue the Yuan they would ensure any currency appreciation happened far more slowly.

Building a Reserve Currency

China is trying to build a parallel to the Dollar by promoting the pricing of gold, oil & other key commodities in Renminbi. To offset the US naval strength China is trying to build a land-based alternative integrated trading zone using their Belt and Road program.

Historically Germany has promoted outsized returns to rentiers & bondholders while the United States has promoted outsized returns to entrepreneurs & equity holders.

Like Germany, China views their currency value & bond markets as far more important than their equity markets. China closing their equity markets during the 2015 summer sell off eroded foreigner trust in the ability to invest inside China. To this day many Chinese companies (including Baidu, Alibaba & Tencent) still list their stock in New York vs Shanghai. Many new Chinese tech companies also prefer listing in Hong Kong (like Xiaomi) or New York (like Pinduoduo) over Shanghai.

As China views their currency & bond markets as critical, they are likely to try to keep adding stability to those markets to push down rates, which in turn will pull down rates in other emerging Asian markets, making some of their relatively high yielding bonds a compelling bet when compared to low-yielding fixed-income investments in developed western markets.

Other Key Countries

Inept politicians inside the United States have also drawn Russia closer to China, as ire that might be more appropriately focused on China was placed on Russia because the U.S. does not have highly integrated supply chains running through Russia.

If Germany should choose to have close relationships with Russia the US would likely promote military guarantees to Eastern European countries which would be discouraged by a strengthened Russia.

As Germany leads the EU, if China can improve ties with Germany & can get Saudi Arabia to start pricing oil in Yuan then the US Dollar would face major headwinds.

Implications for Regional Stocks & Bonds

As Chinese growth has slowed & their economy has underperformed they have in successive waves liberalized markets: labor, real estate, & commodities. As they liberalized markets people who speculated on the newly liberalized category performed well.

Their next market to liberalize would be capital.

If China is able to succeed in their efforts they will need to keep opening up access to their financial markets while improving the stability of the Yuan. Should success in creating a parallel reserve currency to the U.S. Dollar look imminent they will likely see falling bond yields & other economies in the Asian theater will also see declining bond yields anchored off the lower yields in China in a way that parallels the impact Germany has had across Europe. That in turn would make current longer dated bonds in these areas a compelling investment, along with many of the region’s equities

The Modern Day Container Ship at the Speed of Light

China is still heavily reliant on the United States & Taiwan for semiconductors. China has invested aggressively, engaged in aggressive IP theft, used antitrust to block mergers while forcing foreign firms to invest in China to try to close the gap.

Semiconductor firms may face margin pressures as they eventually lose access to the Chinese market & then end up increasingly competing against heavily subsidized semiconductors manufactured in China.

In future semiconductors, fiber optic cables & other internet infrastructure will become far more important than container ships are today. Portions of the book were also described in a blog post on the Evergreen Gavekal site named This Century’s Suez Crisis

“what was Xi thinking in laying out an imperial vision which, by any measure, could be seen as a direct challenge to the world’s existing empire, the US? Did he really imagine that he could paint a picture of a world in which “all roads lead to Beijing”, and that there would be no backlash? …

it can easily be argued that the last 60 years were above all the era of the container-ship (with container-ships getting ever bigger). But will the coming decades still be the age of the container-ship? Possibly not, for the simple reason that things that have value increasingly no longer travel by ship, but instead by fiberoptic cables! …

you could almost argue that ZTE and Huawei have been the “East India Company” of the current imperial cycle. Unsurprisingly, it is these very companies, charged with laying out the “new roads” along which “tomorrow’s value” will flow, that find themselves at the center of the US backlash. … if the symbol of British domination was the steamship, and the symbol of American strength was the Boeing 747, it seems increasingly clear that the question of the future will be whether tomorrow’s telecom switches and routers are produced by Huawei or Cisco. …

US attempts to take down Huawei and ZTE can be seen as the existing empire’s attempt to prevent the ascent of a new imperial power. With this in mind, I could go a step further and suggest that perhaps the Huawei crisis is this century’s version of Suez crisis. No wonder markets have been falling ever since the arrest of the Huawei CFO. In time, the Suez Crisis was brought to a halt by US threats to destroy the value of sterling. Could we now witness the same for the US dollar?”

Walgreens Off A Comfortable 13% on Earnings

Walgreens (WBA) announced results where they slightly missed top line revenues & missed earnings.

Net income fell to $1.16 billion, or $1.24 a share, from $1.35 billion, or $1.36 a share, in the same period a year ago. Excluding nonrecurring items, the company said adjusted EPS declined 5.4% to $1.64, below the $1.72 that FactSet analysts were expecting.

In addition, to complete a near perfect quarter, they also lowered forward guidance to suggest they would likely be flat for earnings year over year, down from an estimated increase of 7 – 12%.

They might have another down day or two, but this feels a lot like AT&T trading at around $26 a share last year.

A couple catalysts:

Increased Buyback & Increased Buyback Impact

  • On the conference call they suggested they were increasing share buybacks by over 25%: “we project full year share repurchases of $3.8 billion compared to $3 billion guidance at the beginning of the year. This contributes 4.5% to EPS growth.”
  • as WBA’s stock price fell 19% so far this year that means they could buy 23% more shares per dollar spent on share repurchases
  • combine the lower share price with the higher buyback & that would be buying roughly 68.642 million shares instead of 44.092 million shares – an increase of 24.550 million shares – or an increase of 55.679%

On a related note, they also mentioned they saw no need to do any sort of bet-the-company acquisition at any price sort of transformative buying spree, which certainly makes sense given the market’s reaction to recent CVS acquisitions.

I wasn’t sure if the recent results and the deteriorating backdrop of the retail pharmacy industry would change your views on M&A going forward?

No. Our view is still the same. We are not close to any deal provided the price is right. We don’t see any reason to use our cash overpaying for something just because there is a deterioration of the market. If anything, we have to be more careful now when we buy something because if we don’t believe that the market will turn around, we have to action more carefully. Honestly, we still believe in this market. We still believe that this market is a market for the future, a big market with continuous growth, but to buy something, we must be sure that the money that we employ will come back sooner or later.

– Stefano Pessina, Walgreens Boots Alliance Executive Vice Chairman & Chief Executive Officer

Continued Political Gridlock

Political gridlock appears here to stay. Here are a couple “Presidential” tweets from today.

Healthcare has been underperforming on the risk of any sort of price transparency.

“Commercial health-care markets are rife with complex systems of hidden charges and secret discounts. Policy makers, employers and patients are often unable to see clearly which hospital systems and doctor practices are driving high costs. The administration’s vision—which would possibly include fines for noncompliance—is to arm patients with information needed to make health-care decisions much like shopping for other consumer services. Rates potentially could be posted on public websites, where consumers would check the negotiated price of a service before they pick a provider. That, in turn, could lead to lower copays or deductibles. … Some hospital groups and insurers said mandating disclosure of negotiated rates could violate antitrust or contract law and that negotiated rates are proprietary.”

On Twitter yesterday President Trump suggested healthcare reform would happen *after* the 2020 elections.

Everybody agrees that ObamaCare doesn’t work. Premiums & deductibles are far too high – Really bad HealthCare! Even the Dems want to replace it, but with Medicare for all, which would cause 180 million Americans to lose their beloved private health insurance. The Republicans are developing a really great HealthCare Plan with far lower premiums (cost) & deductibles than ObamaCare. In other words it will be far less expensive & much more usable than ObamaCare. Vote will be taken right after the Election when Republicans hold the Senate & win back the House. It will be truly great HealthCare that will work for America. Also, Republicans will always support Pre-Existing Conditions. The Republican Party will be known as the Party of Great HealtCare. Meantime, the USA is doing better than ever & is respected again!

President Donald Trump

Of course his position is ridiculous grandstanding, as he had both branches of Congress for 2 years & other than repealing the Obamacare mandate mostly left healthcare alone. In fact, even the risk of Obamacare being overturned on any level caused the New York Times to publish an article a few years back about how that could adversely impact the McJobs healthcare paperwork jobs engine.

As demands on the system have grown efficiency has went into reverse

“health care has seen an 80% regression in productivity per unit of expense. The only reason this sort of outrageous regression has ever happened in the history of the economic world is fraud, extortion, racketeering and monopolization.”

Karl Denninger

Collectively we are willing to blame anybody but the correct party.

The administration seems less concerned about the effect of foreign drug pricing systems on patients than with their presumed effect on U.S. prices. The president attributes high drug prices to “foreign freeloading.” Americans pay more for drugs, he suggests, because the Greeks pay less.

But if the president is looking for a government to blame for distorted U.S. drug prices, he need look no further than our own. The federal government requires manufacturers to pay rebates, grant discounts, and comply with various price-distorting directives across a range of programs.

Purdue Pharmaceuticals can quietly push assets into different divisions or file for bankruptcy while the Sackler family threatens the press. Even fentanyl from China remains largely unaddressed in spite of the ongoing trade war.

“In China, the law is what Xi Xinping and the Communist Party say it is. If they want to shut down fentanyl producers the ‘law’ is no obstacle – as it would be in the United States. The fact the PRC doesn’t ban fentanyl ‘of any chemical composition’ – much less go after producers the way it goes after Uighurs, Christians, and Falun Gong – once again suggests the CCP is glad America is awash in fentanyl. … Beijing can stop pushing drugs into America. It just needs a reason to do so. It’s past time to give it one.”

Literal chemical warfare and largely, crickets

“The Chinese cops can do whatever they want. There is no Constitution. No 4th Amendment. No 2nd Amendment. No 5th Amendment. The only restraint comes from official CCP desires. What the CCP desires is to flood the United States with fentanyl. Heh, it’s only 70,000 people a year that die here as a result — more deaths than the entire Vietnam war. The Chinese Government is officially responsible, in no small part, for every one of those deaths. This is, simply put, chemical warfare.”

Neither side of the political aisle wants to hand the other a political win on healthcare. Any win would be political red meat & optics matter more than anything.

The Powerful Health Impacts of Eating Red Meats

We are literally seeing the return of medieval diseases.

“Infectious diseases — some that ravaged populations in the Middle Ages — are resurging in California and around the country, and are hitting homeless populations especially hard. Los Angeles recently experienced an outbreak of typhus — a disease spread by infected fleas on rats and other animals — in downtown streets. Officials briefly closed part of City Hall after reporting that rodents had invaded the building.”

Like Trump, Nancy Pelosi is in no rush to fix any of the major issues in healthcare.

Wendell Primus, Pelosi’s longtime health policy aide, wants the White House to agree to a delay in implementation of a sweeping rule to overhaul the drug rebate system, lobbyists and health policy groups said. The proposed rule would prohibit drug manufacturer rebates in Medicare and Medicaid unless they are passed on directly to consumers at the point of purchase.”

Up Day

Markets look broadly up so far. I sold Kroger (KR) near open. I also sold off most my MMYT position. With the stock market going up across the board I didn’t want to chase, so there weren’t many of the stocks I liked that had easy buying opportunities.

I just bought a bit of Enova (ENVA). They are one of the few publicly traded lenders that do check cashing / payday loan type of business. They’ve recently sold off with other financials. The mainstream financials sold off on the flattening of the yield curve which lowers their spreads, but with credit card interest rates at all time highs that yield curve flattening shouldn’t have the same sort of impact on Enova as it would on an auto or house or education lender.

A few illustrative stories

Bed Bath and Beyond is up huge on rumors of activist investor involvement where they may push to oust the entire board. One last hoorah for Wayfair as they are now opening a physical store at a mall. A bold move for them would have been using their extremely rich stock valuation to buy out someone like Bed Bath and Beyond to immediately have a big footprint in the offline world & to have many locations to lower customer delivery costs.

General Chopfest

Weyerhaeuser (WY) slid hard shortly after open, so I increased the position size on it & then after turned up sold it. Petmed Express (PETS) and Funko (FNKO) were both strong today, so I sold out on those as well. A 5-day chart of PETS shows how ridiculous the stock action was.

buy the swoop, sell the eroooo

I flipped a bit of MMYT at a profit, though am still holding a mid-sized position which is down a couple hundred (though far less than I have made on that ticker so far this year or what I made on it last year). MMYT has limited trading volume, so when you couple that with an emerging market growth stock, volatility & spreads can be quite high, so you need it to move a bit to make up for the bid/ask spreads.

I am holding a bit of Newmont (NEM) still along with a tiny position in Kroger (KR) I just established today.

My CVS & Walgreens Boots Alliance (WBA) are still off a bit, both having stunk once more today. If I didn’t already have positions in them I would buy with size at current prices. Walgreens announces earnings next Tuesday. A big part of why WBA sold off was in conjunction with the bad quarter & write down CVS belched out recently. If Walgreens reports anything other than absolutely horrific quarter on Tuesday I think they’ll likely gain at least a couple percent & could see them gaining as much as 5%.

I can sit around & watch the market, but I don’t see any of the great opportunities I saw earlier today, so I am off for a nap. 🙂

Up, Down, Up

It appears as though Winnie the Pooh has figured out the market.

On ultra dovish Fed the market jumped slightly & then sold off, then was on fire the following day & on day 3 just ahead of a weekend it appears to have changed directions once more.

Yesterday even some low beta value plays were up 2 or 3 percent. Today many of those have given back a percent or more.

I sold my remaining Kroger (KR) near open & they’ve since slid a bit. Yesterday I sold my remaining Weyerhaeuser  (WY).

One of the stocks that didn’t take part in the rally yesterday (& in fact slid a bit) was PetMeds Express (ticker symbol PETS). They trade at about a 10X P/E ratio & are close to the 2018 December panic lows. They have no debt & about a quarter of their market cap is cash on hand & inventory, so their actual PE is closer to about 7.5 or 8. Their dividend yield is above 5% now. They actually slid a bit more today & were within pennies of new lows before jumping a bit.

The thesis for why they would be a doomed value trap with no hope would be that Chewy keeps eating marketshare (more memorable brand name, faster growth, sells a broader array of products, is playing the growth over profits model, etc.) as the debt-levered parent company PetSmart got a reprieve from genuine market prices on debt as the Federal Reserve hinted at the QE lite program they’ll soon engage in.

On the surface, the sharp decline in 2 year yields did not seem to make sense following the FOMC decision. After all. the Fed was dovish but did not show signs of cutting rates, but the 2-year yield went through the fed funds rate. That did not seem to make sense. However, when taking into account the QE-lite policy that will heavily skew toward the short end of the curve, the move makes more sense. Not to mention when taking into account the lack of FOMC conviction on returning to hikes, the decline in the 10-year also makes sense. … This might be one of the more underappreciated FOMC decisions in recent memory. The Fed is unequivocally retreating from any further tightening for the foreseeable future. How powerful will QE-lite prove to be? That is difficult to answer, but it is likely to show itself most forcefully in the dollar and lower short-term yields.

Samuel E. Rines, Avalon Advisors

According to S&P Global Ratings on November 8, 2018, PetSmart had the following debt structure:

  • $955 million asset-based revolving credit facility (ABL revolver) (ABL agreement dated as of March 11, 2015)
  • $4.3 billion first-lien term loan (credit agreement dated as of March 11, 2015)
  • $1.35 billion first-lien secured notes (indenture dated as of May 31, 2017)
  • $2.55 billion unsecured notes (indentures dated as of March 4, 2015, and May 31, 2017)

Last April the PetSmart acquisition of Chewy was described by Bloomberg as The Most Expensive Takeover in Retail Is Drowning in Debt:

PetSmart’s owners thought embracing e-commerce would keep it competitive in the age of Amazon.

Two chief executives and $3 billion later, they’re discovering it takes a lot more than web smarts to outrun an avalanche of debt.

The nation’s leading pet supplier has to figure out how to pay $8.1 billion in bond and loan maturities even as its sales and margins are shrinking. Half that debt traces back to a 2015 buyout led by private equity firm BC Partners, whose bidding was so aggressive that it actually topped its own offer to seal the deal, leaving veteran rivals agog at the final price.

The self spin off of a 20% stake in will likely mean the entities largely operate as parallels, rather than as a synergistic whole.

PetSmart’s bondholders had been expecting a spinoff of some of the equity in for months as the performance of PetSmart’s brick-and-mortar stores lagged behind while continues its rapid growth.

The company’s same-store sales have been falling for several quarters. By contrast,’s revenue jumped 81% to $760 million in its most recent quarter. Despite surging sales, the e-commerce business is still losing money.

That makes the justification for larding up so much debt on the company sort of moot (at least until the debt can be restructured & they force losses onto bondholders to lower the overall debt load). But seeing declining in-store sales, mounting losses on their online play, ongoing legal disputes with bondholders, etc. … Add that to the huge wave of IPOs that will come to market (Uber, Lyft, Slack, AirBNB, etc.) before could be fully spun out & an that is using ad revenues & cloud hosting profits to compete on prices … I don’t see how could IPO anytime soon.

Virtu was off a couple percent today but quickly recovered. Anytime the market keeps bouncing back and forth that one is frequently a solid play for a quick gain if it slides, as eventually some figure the outsized day to day churn ends up leaving more meat on the bone for an HFT market maker. Virtu sold off more in the July to October timeframe & then started improving as the broader stock market sold off.

It looks like the market had a delayed reaction to the Fed’s move & that Wayfair put I bought the other day just shot the moon.

option holders caught catching the jumping knife

Great company, no idea why they’d sell off especially hard in a sell off. I mean, the fundamentals are utterly fantastic.

Last year, Wayfair’s operating expenses grew 8.5 percentage points faster than sales, causing operating losses to double. Despite this seeming lack of operating leverage, not all of Wayfair’s cash expenditures are accounted for on its profit and loss statement. Deep in the weeds of its 10-K, Wayfair discloses that it capitalises its “site and software development costs”, before amortising the asset over two years. In 2018, this had the effect of reducing operating losses by $63m, all else being equal. … In the face of less predictable and lumpier revenues, the market seems to think Wayfair’s future deserves the loftiest of valuations. Excluding Amazon, Wayfair’s 2.3 price-to-sales is higher than all its rivals, including The Home Depot, RH and Bed, Bath and Beyond, according to S&P Capital IQ. Of this bunch, it also has the second lowest gross margin — just 23.4 per cent — behind pseudo-crypto company Overstock.

Options are so much harder to trade than stocks because their value decays so fast unless the trade works out quickly. Wayfair aggressively promotes their growth narrative while their CEO sells ~ $5 million in stock each week & the shorts have been getting killed for years on it.

assumed, adjusted, etc.

Great comment on the FT on their above linked article about Wayfair

Demand is highly cylical and intimately tied to housing sales.

Supply is often highly geared (e.g. DFS ‘buy’ now and don’t pay for a year) and dependent on credit sales (4 year  or more) with a consequent high risk of default. Unlike cars, second-hand repossessed sofas have minimal value. 

People buy furniture when they move house, and if and when it falls apart. It’s surprising how long you can make a sofa last, and tables can last forever.  … Nearly all the furniture retail companies I have profiled over the years have gone bust, no matter how big. 


If the market keeps sliding Wayfair is one to watch.

Federal Reserve Winds Down Balance Sheet Wind Down

Coming into today lots of people were net long ahead of the Federal Reserve announcement & remembered the pain of the prior two meetings, so there was a sell off early in trading.

Those who put money to work ahead of the Fed’s announcement saw decent gains as the market recovered somewhat on the new scatter plots showing a low likelihood of any hikes this year & perhaps only about1 to at most 2 more hikes until rates are fully normalized over the longer term along while stating policy is currently neutral.

The Fed also announced that the balance sheet wind down would soon be wound down.

  • The Committee intends to slow the reduction of its holdings of Treasury securities by reducing the cap on monthly redemptions from the current level of $30 billion to $15 billion beginning in May 2019. The Committee intends to conclude the reduction of its aggregate securities holdings in the System Open Market Account (SOMA) at the end of September 2019. The Committee intends to continue to allow its holdings of agency debt and agency mortgage-backed securities (MBS) to decline, consistent with the aim of holding primarily Treasury securities in the longer run.
    • Beginning in October 2019, principal payments received from agency debt and agency MBS will be reinvested in Treasury securities subject to a maximum amount of $20 billion per month; any principal payments in excess of that maximum will continue to be reinvested in agency MBS.
    • Principal payments from agency debt and agency MBS below the $20 billion maximum will initially be invested in Treasury securities across a range of maturities to roughly match the maturity composition of Treasury securities outstanding; the Committee will revisit this reinvestment plan in connection with its deliberations regarding the longer-run composition of the SOMA portfolio.
    • It continues to be the Committee’s view that limited sales of agency MBS might be warranted in the longer run to reduce or eliminate residual holdings. The timing and pace of any sales would be communicated to the public well in advance.
  • The average level of reserves after the FOMC has concluded the reduction of its aggregate securities holdings at the end of September will likely still be somewhat above the level of reserves necessary to efficiently and effectively implement monetary policy.
    • In that case, the Committee currently anticipates that it will likely hold the size of the SOMA portfolio roughly constant for a time. During such a period, persistent gradual increases in currency and other non-reserve liabilities would be accompanied by corresponding gradual declines in reserve balances to a level consistent with efficient and effective implementation of monetary policy.

In case the Fed laid an egg I bought a put option on Wayfair, but quickly sold it after their release for a ~ $40 loss.

Yield on the 10-year looks to be testing 2019 lows. FANG and gold miners are both up a good bit while Virtu is off a couple percent.

As of writing this the Nasdaq is up about 2/3% while the S&P 500 is up a 3/10% & the DJIA is up about 1/20th a %.

Growth is clearly beating value today. Health stocks were off a bit today. And some value investors are exiting stage left in spite of bond yields falling.

Kroger’s lead director, Robert D. Beyer, who has been on the company’s board since 1999, sold 80,000 Kroger shares on Tuesday for a total of $1.96 million, an average price of $24.52 each. … Beyer’s sale—at a price that represents an 11% loss from the end of 2018—is the biggest sale unrelated to the exercise of stock options by a Kroger insider in six years

CNBC Scary Headline of the Day

The stock market reaction to this sort of headline Stocks rapidly give back gains on report China walking back trade concessions was quite bullish.

By the time the digital ink had dried (was it ever wet?) the market once again traded higher.

And stocks which would be impacted heavily by an escalating trade war like the following groups were up

  • retailers: Dollar General, Dollar Tree (selling cheap & low margin goods manufactured in China without the supply chain redundancy of a Walmart)
  • auto manufacturers: Ford, GM (large, complex supply chains)

And then the broader stock indexes were still up on the day other than the Russell 2000.

In the 15 minutes of decline that was enough time to revise the headline on the above article & advertise it sitewide using a red banner & breaking news headline.

Then when the market recovered it was revised once more: Stocks whipsaw on conflicting trade deal reports, Dow now 100 points higher

We are talking a fraction of a percent here.

That is how low volatility is.

A fraction of a percent is enough to drive words like rapidly & whipsaw.

Anyone trading with excessive leverage while being emotionally triggered & responding to the latest “news” headlines is almost guaranteed to lose unless they fade the over-hyped micro stories.

Update: so the market turned down slightly into the close, which is I suppose makes the stuff I exited during the trading day a good call. Right before the close I bought a tiny position in web hosting & email marketing company
Endurance International Group (EIGI). They were off 7% on the day & have given up about 75% of the gains they had since the December low. Their market cap is under a billion & they have a bit over a billion in annual revenues. Given their widespread usage amongst hosting customers they’d be a great buy for anyone who wanted to cross sell stuff to webmasters (a parallel to how Square bought Weebly a while back) & I suspect if they fall much further a P/E group would probably buy them out.

One could certainly argue that, Instagram (new checkout feature), Etsy & other such entertainment or shopping destination marketplaces are displacing independent websites. This is true particularly in light of:

I still think domain names & web hosting have a lot of value in the overall structure of the web. Having your own site gives you optionality to change business models or shift what you focus working on. Further, over-reliance on any platform ultimately leads to abuse by said platform.

It is also worth noting the Chinese (or people in the Trump administration) are very good with their timing of rumor releases. With the Federal Reserve meeting today and tomorrow Bloomberg has this story: U.S. Sees China Trade Pushback as Trump Touts Progress.

Chinese officials have shifted their stance because after agreeing to changes to their intellectual-property policies, they haven’t received assurances from the Trump administration that tariffs imposed on their exports would be lifted, two of the people said on condition of anonymity.

Beijing has also stepped back from its initial promises over data protection of pharmaceuticals, didn’t offer details on plans to improve patent linkages, and refused to give ground on data-service issues, one person familiar with the U.S.’s views said. Beijing is trying to bring in wording that would ensure rules in the trade agreement have to comply with Chinese laws, the person added.

One of two things is happening there:

  • either the Chinese are trying to make the Federal Reserve look politically captured & own by President Trump, or
  • the Trump administration talks up great progress in between Fed meetings (under-state risk while over-stating upside) & repeatedly puts out some version of this story just ahead of Federal Reserve conferences so that the Federal Reserve owns any market declines.

Either view ends up ascribing more political savvy than most would like to give credit to Xi or Trump, but then you don’t get to lead such a strong country by being an absolute idiot.

Portfolio Insurance, Real or Imagined

Volatility in currency markets is largely nonexistent, at least for now:

With central banks standing pat and little else to drive markets, the betting on low volatility itself is helping to drive trading, says Russell LaScala, Deutsche Bank’s global co-head of foreign exchange trading. He calls the situation “self-perpetuating,” adding that “these loop orders control the market absent any events.”

But this can easily be undone. If an economic or political event leads to a market swing, banks can suddenly forgo their hedging activities, looking to profit from any rise in volatility. That would remove a stabilizing force from the market. At the same time, investors who had bet on low volatility would get burned and rush for protection. That in itself would feed further volatility.

The risk is that the current situation proves similar to one that preceded the big selloff in stocks in January 2018 after a long stretch of ultralow volatility. 

What goes up when currency volatility increases? The underlying currency that rises & perhaps a currency hedged equity play in the area where the currency falls, or put options on overly extended high beta stocks. If there is a strong play there with limited holding cost that seems like a nice asymmetric bet at the moment.

The first quarter has been quite strong for both stocks & commodities.

The S&P 500 climbed to a five-month high last week, putting the benchmark equity gauge on track for its strongest first quarter since 1998. Meanwhile, U.S. crude oil rose to its highest level since Nov. 12, pushing its early year rebound to almost 30%. … Still, many remain concerned about this year’s rebound. One reason is that assets that are considered safer, such as Treasurys and gold, have also held steady after early year ralliesmaking it challenging for investors to piece together a clear trend of market momentum. Bond prices and gold often decline when stocks rally, a trend that has historically signaled faith in the economy. … about $60 billion flowed out of global stock funds from the start of the year through March 6, the largest such outflow to begin a year since 2008

The yield curve has remained quite flat in spite of the recovery in risk assets.

As of today’s session, before the close, the UST curve is absolutely ridiculous (again). The 5-year note is now trading almost equal to EFF (effective federal funds) once more, eleven bps less than the 52-week bill. The yield on the 5s is now significantly (4 bps) below the equivalent yield on the 3-month bill. Nominal rates from there down the curve are mere bps off the January 3 lows. This isn’t quite how “dovishness” was supposed to turn out.

The eurodollar futures curve is likewise revisiting the worst case (so far). As these contracts have predicted, LIBOR rates have fallen which doesn’t mean things are getting better. Outer contracts are being bid to prices above those from January 3, which suggests this huge, crucial market is starting to get the sense that “whatever” is going on its effects might alter the long run, too.

I recently read Howard Marks Mastering The Market Cycle & it is rich with quotable quotes. One that comes to mind:

in an interconnected, informed world – everything that produces unusual profitability will attract incremental capital until it becomes overcrowded and fully institutionalized, at which point the prospective risk-adjusted return will move toward the mean (or worse). And, correspondingly, things that perform poorly for a while will eventually become so cheap – due to their relative depreciation and the lack of investor interest – that they’ll be primed to outperform. Cycles like these hold the key to success in investing, not trees that everyone is assuming will grow to the sky.

After the extremist attacks at mosques in Christchurch, New Zealand three days ago, we might be off to the races with another round of terrorist garbage fueling more terrorist garbage as it was just reported by the WSJ Dutch police are searching for a gunman from Turkey who killed three people in Utrecht & wounded several others. Should more attacks happen volatility should rise & markets which were up decently today turned south on the news.

In case that terrorst garbage picks up further steam I just bought a LendingTree April put option with a strike price just below market. They’re up about 10% since the 7th & are up about 70% from their lows last December. High beta companies which fueled growth through increased ad spending & competitive acquisitions may see their share prices fall. Of course any decline like that which would be akin to what Quinstreet did might be another earnings report or two away, but anything that has moved 70% in a few months could easily give a bit back should things turn dicey.

The China trade war stuff keeps getting pushed out, with the latest whispered extension going into June, so it can be a fresh memory of a win for the 2020 election. There’s no incentive for Trump to rush it so long as the Fed is on pause & is perceived to own any market correction.

Meanwhile, green shoots abound as China’s ageing solar panels are going to be a big environmental problem.

Lu Fang, secretary general of the photovoltaics decision in the China Renewable Energy Society, wrote in an article circulating on mainland social media this month that the country’s cumulative capacity of retired panels would reach up to 70 gigawatts (GW) by 2034.

That is three times the scale of the Three Gorges Dam, the world’s largest hydropower project, by power production.

By 2050 these waste panels would add up to 20 million tonnes, or 2,000 times the weight of the Eiffel Tower, according to Lu.

A Bull Market Masks Many Sins

It is easy to attribute strong returns to one’s own skill & greatness, but any day some crazy event like an earthquake or war could massively tank the markets.

When the stock market goes up broadly momentum stocks work, but then when the market is really strong overall sometimes there isn’t even a lot of sector rotation & anything that falls also gets bid back up.

It certainly looks like the bottom is in on CVS & WBA. Today Bernstein initiated coverage on CVS at outperform, causing the stock to jump over 3 percent. And that is after a couple days of strong performance.

I sold out of a bit of Coca-Cola & Google I have been holding for a while, both at tiny losses. I also sold out of Weyerhaeuser on Monday at a decent gain & went in and out of Kroger a couple times over the past few days during the post-earnings swoon for small gains.

The tough part about the stock market isn’t making small gains repeatedly & winning on average, it is the constant sort of sucking in of attention. There is always another story to read, another topic to think about. And then are you actually learning something that gives you an edge, or are you busy engaging in a game of confirmation bias?

I’ve been reading Howard S. Marks’ Mastering the Market Cycle and it is certainly easy to feel like you are able to see the capitulation stage on stocks like CVS last week (though one can of course catch a falling knife a bit early!), but the broader market is an area that feels a bit less certain to me today.

The broader trend is clearly up right now. But there hasn’t been more than a few days of pullback since the December bottom & it feels like risk is accumulating as price goes up. As of writing this, so far today only 5 stocks in the S&P 500 are down a percent today – that’s opposed to 99 that are up that much or more. The only strong recent pullback is Boeing, but even after the pullback they are still up almost 300% since early 2016.

An escalation of the trade war, another sort of impeachment threat, etc. … the market seems to sort of shake off and ignore these types of stories for now, but any day the response to negative stimuli could turn the other direction.

Sometimes when you see growth stocks go up there is a rotation out of bonds & bond proxy stocks like dividend aristocrats, utilities, telecom, REITs & other assets that are frequently negatively correlated with an up day in the broader market like gold, miner stocks & plays like Virtu. But today almost everything is up.

  • Smallcap, midcap, or largecap, * value, core, or growth … up up up, up up up, up up up.
  • Brexit uncertainty in the UK? GBP up, Euro up, UK stock market up, European stock markets up
  • Commodities up
  • MercadoLibre announces a secondary stock offering that dilutes existing shareholders 4.7% … stock up 3% on the news. why not?

About the only tangible^ things that are down today are the Dollar, volatility & VIX.

I guess today I’ll deploy patience. I still think CVS has a bit to run, but I will stay mostly in cash until something slides a bit. Better to have a bit of cushion on an entry point rather than doing like I did where I bought Google about a day before the WSJ announced Google had a security issue with Google+ & then before they recovered from that there was the Federal Reserve induced year end swoon driven by the October comment about being a long way from neutral. After the market slid the Fed changed their tune, but that Google stock was dead money for almost a half year.

In December Google announced a second security issue with Google+ & Google is perhaps about to eat some #MeToo movement in the near future for their executive compensation practices colloquially known as their golden furry handcuffs policy.

^ and then there is Pinduodu, the Chinese version of a socialized Groupon 2.0 that slid about 15% today after announcing wider than expected losses. They are still valued at about $30 billion – roughly 15x what Groupon is valued at – so I can’t say I see that one as an opportunity, particularly as they are still losing money & are trading at something like 10 times sales in a low-margin industry. Total pass. Yuck. And – as a bonus – they did a secondary offering last month knowing the results of the quarter they just reported.

Retail Fail

Kroger’s quarter bombed on lower sales, lower guidance, and lower profits. A triple lindy trifecta of pure winning.

I traded the dead cat bounce on it for a quick gain. Shares were down about 12.8% when I bought & around 10% when I sold.

“Its shares slid 11.6 percent in morning trade after it also reported a 10 percent fall in fourth-quarter revenue and lower-than-expected earnings for the first time since October 2017. Profits are expected to come under pressure as the retailer plans annual spending of up to $3.2 billion — up from $3 billion last year — to overhaul stores and improve its online business under a program called “Restock Kroger” launched over a year ago.”


The big tech monopolies can basically spend infinite CAPEX and have it get brushed off as justifiably investing in faster growth, while any of the old line slower-growth & lower-margin businesses going through transformation get slaughtered for making similar adjustments to modernize their business to take advantage of the web.

Conceptually, Amazon can consider anything a beta (nixing their pop up shops) & get rewarded for any sort of news / change / noise / speculation, which tells the old line businesses to invest to narrow the competitive gap or at least the narrative gap & then they get killed for it.

Kroger’s digital sales rose 58% during its latest quarter, and the company said it is offering delivery or online pickup at 91% of its stores. … Kroger has pledged to generate $400 million in operating profit by next year, in part by diversifying its sources of revenue. The grocer is pushing into financial services, selling its consumer data to suppliers and selling more ads to target shoppers.

That really shows the power of leading a trend versus following it or trying to play catch up.

Not only do the tech monopolies get the benefit of the doubt, but there are dozens of food delivery startups which lose money on every order, yet they are raising billions.

“Billions of dollars have been spent in a quest to build services that reliably move fresh food from one place to another, yet many in the business wonder if they will ever get the economics right. Most delivery orders remain unprofitable. … Only 1% of 2,874 consumers surveyed by the research firm were willing to pay the full cost of grocery delivery. And 85% of consumers aren’t willing to pay more than $5 for restaurant delivery, according to a recent survey of 2,000 fast-food and fast-casual customers conducted by online ordering platform Tillster. … Venture-capital firms put $5 billion into U.S. food and grocery delivery services last year, more than four times the amount they invested in 2017 … Food sellers pay the services an average fee of 10% to 25% on each order, which means the actual deliveries often lose money. Better placement on the services’ websites or apps costs even more.”

Retailers with a 1% to 3% profit margin aren’t going to win by paying third parties 10% to 25% of each sale.

And as long as humans are needed for deliveries margins will be terrible at third party delivery services. And when automated delivery becomes highly commoditized & widely available, most of the value will bypass any third party delivery services and accrue directly to the retail outlets.

I might consider buying KR again in the future, but the whole market feels like it is sliding down & when the market is sucking an egg you basically have to trade almost perfect on long-only trades to stay flat. Unless you short stocks, you are almost better off ignoring the market until there is an uptrend.

The S&P 500 sliding below the 200-day moving average is not a great thing. Even if that is a nonsense technical signal of limited relevance, the fact that many people follow it makes it real. Many will be selling to de-risk portfolios and keep some dry powder.

CVS is down once again, along with Walgreens Boots Alliance (WBA). At this point both are deep value plays which are priced as though their business models are doomed. If multiple company insiders spent 6 figures on CVS shares at about $58 a share about a week ago, then the current $52 share price doesn’t look particularly expensive.

Big tech companies like Google, Amazon, Spotify & Pandora are challenging increased royalty rates for song writers.

The three-judge board, appointed by the Librarian of Congress to determine copyright payments, voted 2-1 last year in favor of raising the percentage of mechanical royalties owed to a song’s writers from 10.5 percent of revenue to 15.1 percent of revenue by 2022. The decision followed a two-year trial regarding how songwriter royalty splits might adapt to the streaming era. The leading songwriter association is calling the appeal by tech companies “shameful” and has announced plans to file its own appeal.

Central banks are pouring fuel on the fire as normalization seems to be … err … not working so well.

The Bank of Japan appears a decade or two ahead of other central banks in their seemingly never-ending interventions. They’ve killed their bond market (as they are the market) & the central bank owns a huge portion of their domestic ETF markets while bond yields are effectively zilch out to about a decade.

China is a firehose of money, seemingly announcing a new stimulus measure almost every week. Lowered reserve requirement ratios, QE-styled stimulus, tax cuts, etc.

The ECB announced new stimulus measures.

The European Central Bank made a major policy reversal Thursday, unveiling plans for fresh measures to stimulate the eurozone’s faltering economy less than three months after phasing out a €2.6 trillion ($2.9 trillion) bond-buying program, making it the first rich-country central bank to ease policy in response to the global slowdown.
The ECB said it would hold interest rates at their current levels at least through the end of this year—months longer than previously signaled—and announced plans for a fresh batch of cheap long-term loans for banks.

And not only is Trump once again complaining about the Dollar being too strong along with record trade deficits, but the Federal Reserve stated they paused rate hikes due to corporate debt saturation inside the United States.

A $5.7 trillion borrowing binge by U.S. companies could make a slowdown in the world’s biggest economy even more painful and is one more reason the Federal Reserve was wise to put interest rate hikes on hold, Robert Kaplan, president of the Dallas Fed, said.

60 Minutes will soon have a segment with Federal Reserve head Jay Powell this Sunday. It’s probably nothing.