For the fiscal quarter ended September 30th, the DJIA posted a return of -1.9%. The S&P 500 provided a negligible increase of .002% for the quarter and the NASDAQ reported a negligible loss (less than 4/10th of 1%) over the same period.
In the quarter ended 09/30/2021 the Gnostic Capital portfolio closed with an NAV per share of $603.32 USD per share. In the prior quarter, the portfolio NAV was valued at $570.53 USD per share. This represented an increase of 6.2% for the three months ended 09/30/2021.
For the first nine months of 2021, the DJIA has grown by 10.5%, the S&P 500 has appreciated by 14.7% and the NASDAQ index advanced by 12.1%. In comparison, the Gnostic Global Portfolio has increased by 27.8% USD for the same interval.
US M2 money supply, as reported by the Board of Governors of the Federal Reserve System, had risen by 8.7% (end of December through August 2021). M2 calculations have been slower to publish for all of 2021 as compared to prior years. Assuming that the rate of growth for September remains consistent with prior increases throughout 2021, it would not be unreasonable to estimate total M2 increase, for the fiscal 9 months, of 9.8%.
https://fred.stlouisfed.org/series/M2SL
The prospect of a major private business default in China, wrangling over an American fiscal spending bill and a US debt ceiling negotiation impacted investor sentiment late in the quarter.
For equity investors, the quarter started off strongly and ended on a very sour note. An untoward potential event in China, that being the potential default of certain debts by the nation’s second largest property developer, Evergrande, cast a significant pall on global equity markets. Evergrande has seemingly fallen prey to an inflationary mismatch; the cost of materials and labor required to build its properties has exceeded the contracted prices for its projects. This is not a unique issue with real estate but impacts China quite specifically as most of the home building/buying market is a cash market. As the cost of completing projects had soared all throughout 2021, Evergrande, apparently, ran out of funds to finish the developments contracted for delivery.
In global equity markets, the travails of a company such as Evergrande make for sensational headlines. Various punters love to trot out terms such as “Black Swan Event” which would refer to a series of unpredictable consequences that might occur as a result of an Evergrande default. In my assessment, these pundits are using wholly incorrect terminology to ascribe Evergrande as something unfathomable. Evergrande is a highly predictable potential default; despite the size of the company in question, the mechanisms for dealing with a property developer default are easily managed in the playbook of China and the fallout should largely be maintained within China. Yes, to real estate developers in general, it is unsettling to determine that a commercial developer and homebuilder cannot make a buck in a fast increasing global real estate market; let us NOT go madly off in all directions and attribute a simple mismatch of obligations, based upon an incorrect inflationary bet, as being the harbinger of global doom.
Evergrande isn’t even an interesting case study; textbooks are already replete with businesses that defaulted and ultimately recapitalized after selling too much of their output for less than the cost of the inputs.
Also in September, the US government began its seemingly interminable renegotiations of the federal debt ceiling, as an adjunct to a massive stimulus bill. The debt ceiling is run into at least annually. Subsequently, in procedural votes held by the US legislature, the ceiling is raised. Leading up the the annual redetermination, a great gnashing of teeth and wailing by the media occurs, as does posturing by the various parties comprising the US legislative assemblies; positional and highly fluid lines-in-the-sand inevitably spill over into the equity markets. Worries about US government default have, yet again, emerged in various equity publications, both online and otherwise. The annual increase in the debt ceiling is always anti-climatic.
Crosswinds differ greatly from headwinds.
A crosswind is any wind featuring a perpendicular component to the line or direction of travel. The force of a crosswind can be separated into two vector components: the headwind or tailwind component in the direction of motion and the crosswind component perpendicular to the former. A crosswind can push you sideways and potentially represent a hazard. Alternatively, a crosswind may also be utilized to increase your speed of travel, provided that you can realign your direction to increase the apparent wind on your object.
Is the Evergrande potential recapitalization a headwind? Is the US debt ceiling negotiation a headwind? Is the delay in a multitrillion US dollar spending bill a headwind? No, they are merely crosswinds that endeavor to push you sideways for a time; none of them have the ability, in isolation, to negate the benefits of strong secular tailwinds that propel certain investments inexorably forward. And none of the current crosswinds, despite cries to the contrary, represent potential “Black Swan” events, because a true Black Swan event is a total surprise to all and therefore remains unquantified; everyone knows that the US government will eventually get a spending bill passed, everyone understands fully that the US debt ceiling will be raised due to a democratic majority in the house. So too does everyone understand that Evergrande will be recapitalized, nationalized by the Chinese government, dissolved into a good asset/bad asset restructuring or any of the other permutations of business rejuvenation necessary to maintain the integrity of the Chinese real estate market. The aforementioned crosswinds have already been quantified and the subsequent market pullback represents the recalibration.
All these winds shears mean little to those surfing powerful secular trends. However, for those riding weaker secular waves, a strong crosswind might serve to push an investment sideways for enough time that one becomes disoriented; the temptation grows to reorient oneself, via positional shifts so as to better manage the shear winds. Shifting due to transient winds is work. Further toil then follows to reposition, yet again, whenever the crosswind abates. This is entirely too much exertion, for too little long term return, to suit my preferences.
The true headwind is still mid-ocean.
I have previously noted, at length, the persistent price inflation for investments, over the last several years. Thus far in 2021, M2 has increased by almost 10% and in order to grow one’s investment purchasing power in this year, one would have needed to earn a return of about 10% just to tread water. Thankfully, major indexes have provided a return beyond that.
For consumers, however, inflation recognition comes at the last stop on a lengthy pass-through exercise. Raw material and commodity producers pass their pricing increases onto manufacturers, who in turn pass those higher costs onto consumers; all of this has time-lags built into the system. There are strains already noted in the manufacturing chain. Anecdotes abound of hard line manufacturers holding back fully paid-for orders for 4-6 months because of their own mismatches in raw material costs vs the final sale price of the finished output; in holding back enough underpriced orders, newer and higher-priced orders from the refreshed price lists can smooth out those losses. It is an accounting thing.
Manufacturers currently lay back-order blame upon Covid-19 workforce disruptions and, in equal measure, a lack of computer chips. These explanations seem plausible until one actually does a deep dive into both the volume and diversity of back orders and determines that far too many of the items unshipped don’t have a single computer chip required, or, that the manufacturing process utilized is sufficiently automated it would take almost a complete elimination of the work-force to plausibly result in the delivery slowdowns noted.
An unstated hope, I believe, among many hard line producers, is that numerous back-ordered product will actually be cancelled by disgruntled, impatient, consumers. Said products can then be repriced, reintroduced back into saleable inventory and ultimately sold for a profit. All price lists used at the start of 2021 are probably about 20% lower than new coming prices required for manufacturers to generate a reasonable profit. There is only so much cheapening of a product that one can accomplish, or reduction in the size of a package that one can foist off on the consumer, before the hard decision must be made to permanently increase the list price to its new and true level. And, in a persistent inflationary environment, attempts to smooth out such increases, in the assumption that prices will fall; that backfires at the manufacturer level and can lead to variations on an Evergrande style potential insolvency.
https://www.ismworld.org/supply-management-news-and-reports/news-publications/inside-supply-management-magazine/blog/2020-10/report-on-business-roundup-september-manufacturing-pmi/
Too much money has been introduced into circulation over the past 24 months for it not to have a strong inflationary impact, even using trickle-down economics.
Evergrande is little more than an annoying crosswind in the big picture. Rising interest rates to hold back consumer and producer inflation, entirely due to unprecedented M2 money supply growth; now that’s a true potential headwind and, I am sure, is what now keeps policy makers up at night. The pipe-dream of governments worldwide is that in ignoring inflation, to pretend that it fails to exist, or that if it does exist, that they greatly understate its severity, all in the conviction that inflation dies out all by itself; these are tiresome half-truths towards dealing with sensitive topics that inevitably only get us into more hot water.
The amount of money in circulation has grown by 38.4% in the US over last 23 months and this represents THE ROOT CAUSE OF INVESTMENT PRICE INFLATION, PRODUCER PRICE INFLATION & CONSUMER PRICE INFLATION. You cannot increase money supply by almost 40%, in such a short period of time, without expecting a corresponding price impact upon the cost of goods, services and investments.
https://fred.stlouisfed.org/series/M2SL
Should inflation not somehow degrade itself into a manageable form that won’t damage the hosts, the logical tools to stomp out inflation are to raise taxes and/or withdraw money from the system and/or to raise interest rates to discourage consumption. All of those options represent true headwinds that will impact almost every investment, both secular and cyclical alike. Governments grudgingly concede the point that there is some inflation, that it is indeed higher than they anticipated; they rebut with a Gish Gallop, designed to prop up their narrative that such inflation is merely “transitory”. The notion of transitory inflation is nonsensical considering that money supply growth continues at a sustained, double digit annualized pace, through 2021. Inflation cannot be transitory under the current monetary policy program; so long as abnormal money supply growth remains persistent, abnormally high inflation should also persist.
If you think about it at some length, money supply inflation represents an economic version of a virus, its overriding purpose is to spread, until it infects everyone and everything that does not possess natural immunity, or, alternatively, to mutate over time into something more genial, so that we all accept it as part of our ongoing affairs. The economic antidote to the Covid-19 viral outbreak was an entirely novel increase in money supply, completely dreamed up in a policy lab, so to speak, and then released upon an unwitting public, who are only now gleaning a vague awareness of money supply inflation’s inimical effects. As a crude analogy, does that money supply release not sound like the public perception of the Covid-19 virus release; ie, is the cure as bad as the disease?
Inflation kills more than purchasing power.
Roughly 9 million persons die annually due to starvation and hunger related diseases. If the price of basic foodstuffs increases by a meaningful amount, does that not imply greater numbers of deaths due to starvation are likely as a result?
The UN estimates that roughly 3 million persons die annually from water-borne diseases, primarily due to water contamination. If the price of basic water purification chemicals rise meaningfully as a result of price inflation, will that not logically lead to more deaths due to water-borne illnesses among the poor, based upon a lack of affordability?
There are no comprehensive global statistics on deaths from lack of affordability and access to basic medicines. However, the Global Burden of Disease Study in 2015 indicated that as many as 11.3 million people die annually from communicable diseases, with the overwhelming number located in the poorest nations on the planet. 39.8 million people died of non communicable diseases in 2015; again, the majority were located in the most impoverished nations. When the price of basic pharmaceutical ingredients shoots up due to inflation, increasing the costs of manufacturing and selling generics, will not more of the least fortunate globally perish, as a result of the lack of affordability?
In aggregate, I will go so far as to suggest that a rampant price inflation “virus” has the potential to, rather easily, dispatch more persons annually than Covid-19.
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