'Buy the Umbrella' - Issue #39
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.
If you missed last week’s issue, you can find it here.
Quotes
"Set your life on fire. Seek those who fan your flames."
— Jalāl al-Dīn Muḥammad Rūmī
"In economics, interest rates act as gravity behaves in the physical world."
— Warren Buffett
Tweet
Eddie Fishman's twitter thread goes into some of the objectives of the recently announced G7 price cap on Russian oil sales, how it will be enforced through sanctions, why China and India will probably comply and the likely challenge.
The objective is fairly simple: the G7 would like pressure Russia's oil revenues, the lifeblood of Russia's economy.
There will actually be *three* price caps: one for crude oil, one for high-value refined products, and one for low-value refined products. The refined product caps will debut on February 5, 2023. Implementation day for crude oil will be December 5 of this year, when the EU maritime insurance ban is set to begin and US GL-8C expires.
How it will be enforced and why China and India will probably comply:
This threat of sanctions is the "stick." But the success of this policy will hinge even more on the "carrot"—the opportunities for China, India, and others to buy Russian oil at even larger discounts than they do today.
The challenge:
The Kremlin has already threatened not to sell oil to anyone that complies with the price cap.
Any supply cuts by Russia could push up global oil prices, which could undermine the price caps. Also, what stops an entity buying the oil at the cap and then selling it at the market price once it is no longer classified as "Russian oil"?
Charts
Headwinds for operating margins and corporate tax rates
In BTU issue #3 we highlighted that towards the end of 2021, S&P 500 companies' operating margins were at the highest level since 1990. We asked whether one could prudently continue to bet on operating margins expanding.
In similar vein, today we ask whether it is likely that corporate tax rates will continue to fall from here? The chart below shows that tax rates have almost consistently declined since their highs during the 1950s.
If we can agree that the odds are tilted towards operating margins declining and taxes rising, then it seems sensible to assume that this would act as a further headwind for corporate profits and in turn equity markets, not to mention the ongoing increases in the discount rate (due to rising interest rates).
Venture capital dollar volumes decline in the second quarter
Much of the media's attention continues to be on public markets however, private markets have also been hit since the end of 2021.
For example, venture capital volumes have declined by 27% as of June according to Crunchbase. Declining inflows will likely continue to drive a reset in valuations and, in the worst case scenario, starve some start-ups of capital as investors look to cut their losses.
The 'Warren Buffett' Indicator
In a brilliant piece for Fortune Magazine in 2001, Warren Buffett spoke about the various equity market backdrops over the preceding century, the resulting market performance and the psychology of investors. Buffett also made an insightful comment on interest rates, which is highly relevant for investors today:
"At all times, in all markets, in all parts of the world, the tiniest change in rates changes the value of every financial asset. You see that clearly with the fluctuating prices of bonds. But the rule applies as well to farmland, oil reserves, stocks, and every other financial asset. And the effects can be huge on values. If interest rates are, say, 13%, the present value of a dollar that you're going to receive in the future from an investment is not nearly as high as the present value of a dollar if rates are 4%."
Buffett also spoke of periods of extreme market irrationality:
"The tour we've taken through the last century proves that market irrationality of an extreme kind periodically erupts--and compellingly suggests that investors wanting to do well had better learn how to deal with the next outbreak. What's needed is an antidote, and in my opinion that's quantification. If you quantify, you won't necessarily rise to brilliance, but neither will you sink into craziness."
Subsequently, he introduced a simple chart which he believed to "probably [be] the best single measure of where valuations stand at any given moment". This chart, now referred to as the 'Buffett Indicator', is shown below.
“For me, the message of that chart is this: If the percentage relationship falls to the 70% or 80% area, buying stocks is likely to work very well for you. If the ratio approaches 200%--as it did in 1999 and a part of 2000--you are playing with fire.”
Average photovoltaic grade polysilicon spot prices continue to rally
Solar costs, which had been declining for at least a decade, have seen spot prices for average PV grade polysilicon rally 510% since the middle of 2020. As a result, solar power equipment makers have continued to lift prices.
Polysilicon, a material that is currently largely sourced from China, is facing supply shortages. Last week, the Chinese Ministry of Industry and Information Technology, the State Administration for Market Regulation, and the National Energy Administration asked regional authorities to take action to halt price increases in the industry.
The Xinjiang region in western China supplies nearly 50% of the world’s supply of polysilicon and is currently in the spotlight due to credible allegations of forced labor.
Articles
South Korea plans to scale down its reliance on traditional renewable energy sources and boost nuclear generation
A new draft of the nations' long-term power supply plan targets 21.5% generation capacity from renewable energy sources by the end of the decade. This is down from 30.2% under the previous version. Most of the gap would be met by nuclear while coal and gas are little changed from the prior proposal.
The proposal will go through government discussions, parliament and public hearing before it’s finalized, according to the energy ministry.
Tencent turns from buyer to seller in investment pivot
Tencent, the Chinese internet firm, is pivoting from years of aggressive stake building to a focus on divestments as it comes under pressure from investors and Beijing’s recent antipathy towards Big Tech.
The company has outlined a soft target of divesting about $14.5 billion of its $88 billion listed equity portfolio this year, depending on market conditions and internal profit targets.
Things that make you go hmm...
California asks electric vehicle owners to limit their charging
Heading into one of the busiest holiday travel weekends in the United States, and just a week after approving an ironic plan to ban the sale of new gasoline cars, California asked electric vehicle owners to limit when they plug in to charge their vehicles.
This notice was issued due to a heat wave hitting the state, pushing up the demand for energy to power air-conditioners. Unfortunately, this is not the first time extreme heat has affected drivers of electric vehicles. Last month, a heat wave in China also caused problems for EV drivers as the government prioritized "more critical daily electricity needs".
Until next time...
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Have a wonderful week.