'Buy the Umbrella' - Issue #34
Hi there!
Here is your latest dose of ‘Buy the Umbrella’, a short list of interesting things I’ve been reading and thinking about during the week.
Quotes
"People base their actions not on reality but on their view of the world, and the two are not identical. [...] Myths about the past have a bearing on the future."
— George Soros
"Power tends to produce overconfidence and the idea that you can make your own rules, and these consequences of having power often cause people to behave in ways that cost them their power and their position."
— Jeffrey Pfeffer
Charts
The humbling process of inflation
Some believe that investment decisions can be made based on inflation forecasts. However, trying to predict the future rate of inflation is like trying to forecast the weather. While it may seem simple, it is all-but impossible to do, especially if you are trying to forecast it several months or years out.
Over the last 12 months, inflation has become one of those inescapable topics. It is important to note that neither the bond markets nor economists have a great track record at forecasting inflation. Even the Federal Reserve, which has over 400 Ph.D economists, got it wrong, believing (or perhaps wishing) strong inflation was "transitory" (i.e. short-lived).
What makes inflation (like the weather) so difficult to try to predict is the sheer number and complexity of the variables involved, not to mention their volatile interdependencies. My favourite way of illustrating the difficulty of predicting inflation's path is by looking back at history.
The graph below shows inflation during the infamous inflationary period of the 1970s and early 1980s. Who could have predicted the following behaviour of inflation?
You will see that by summer of 1972, it seemed like inflation was well under control and reverting to the 1960s range. Instead, it U-turned and took off, this time surpassing its prior high. Four years later, it looked like inflation was again coming back down. Of course, it fooled everyone and took off once more and hit another new high.
What is the relevance of this given how different the world is today? Simply put, while economic conditions may differ, inflation's dynamics have not changed. Inflation is still highly unpredictable and as with most macroeconomic forecasts, a very humbling futile process for those who continuously try to predict it.
Pakistan's bond yields rally as pressures mount
In BTU issue #30, we covered Pakistan's woes. Pressure on the country has further increased with the government's 2027 USD bond trading at a yield north of 19%.
On 13th July, the IMF announced that they have reached a staff-level agreement (SLA) with the Pakistani government. If approved by the IMF's Executive Board, its Extended Fund Facility (EFF) will release ~$1.2 billion in funding, bringing the total disbursements under the program to ~$4.2 billion. The IMF is considering to extend the EFF until end of June 2023 while raising the total available funding to $7 billion, given Pakistan's higher financing needs and eroded reserve buffers.
The IMF's announcement shares further detail on the policy priorities of the program that they believe will help stabilize the economy. Strikingly, inflation in Pakistan exceeded 21% in June, hitting those on the lowest incomes particularly hard.
Venture capital extends losses, wipes out covid-19 gains
The Refinitiv VC index, which tracks US-based start-ups, is now down 57% and wiping out gains since the onset of covid-19.
VC funds are currently in the process of preparing their second quarter financial statements, raising interesting questions about how they will value their portfolios and what sort of markdowns they will be willing to show their investors.
Articles
TSMC sees resilient semiconductor chip sales, yet cuts capital investment plans
The world's largest chipmaker reported record profits, calming near term fears over headwinds for the industry. Notably, the company raised its 2022 revenue forecast however trimmed its capital investment plans by as much as 9% from its initial guidance.
China's property market trouble continues
Chinese authorities held emergency meetings with banks this week after growing alarmed that an increasing number of homebuyers across the country are refusing to pay mortgages on stalled projects. Homebuyers have stopped mortgage payments on at least 100 projects in more than 50 cities as of Wednesday 13th July.
Germany begins rationing hot water, dims its street lights and closes swimming pools
The energy crunch in Germany has begun to spread from the industrial parts of the economy to offices, leisure centres and homes. Europe’s biggest economy has plunged into its worst energy crisis since the oil price shock of 1973.
On Monday 11th July, Russia shut down its main pipeline to Germany, Nord Stream 1, for 10 days due to "scheduled maintenance". Some fear it will never reopen.
Europe is racing to reduce its heavy reliance on Russian energy supplies. The region received 45% of its natural gas imports from Russia last year, and it is currently rushing to refill storage facilities ahead of winter.
Tesla loses its top AI executive who led the 'Autopilot' vision team
After a four-month leave of absence, Andrej Karpathy announced that he is leaving the company. This follows news that Tesla was laying off 229 data annotation employees.
Until next time...
Thank you for reading this week’s issue. If you found it interesting, consider sharing it with someone who would enjoy it.
Do you have any questions or thoughts? Please feel free to reach out.
Have a wonderful week.
Why ‘Buy the Umbrella’?
Individuals, many of whom also run businesses and governments, tend to not think of the downside when the present is stable, and the future is looking positive (usually when we feel most in control).
Just because it is currently sunny, does not mean it will never rain. If we are not prepared, once it does begin to rain, we will end up running around looking for an umbrella in the middle of a storm, when they tend to be in short supply. We therefore need to ‘buy the umbrella’ before it rains.
Simultaneously, we cannot allow our awareness of risk to make us fearful, pessimistic, or paranoid, as this too works against us over the long-term.
Having the right mindset in advance is critical. The challenge is getting the right balance between being optimistic about the future and being able to not only withstand future crises, but in fact grow stronger due to the opportunities they tend to present.
It is not enough just to be conservative. One needs to be willing to put cash to work when others feel least comfortable doing it. To do that with confidence, we need to have a foundational understanding of history, business, markets and human psychology.
Our mission at BTU is to learn as much about the world as possible, and in doing so, to try to find investment opportunities with favourable risk/reward characteristics. These should, over the long term, help build sustainable wealth.