Last Friday’s Non Farm Payrolls were seen by markets as ‘weak’ and supportive of a ‘no inflation scenario’ leading to a sell off in the US$. However, in our view, this is 180 degrees the wrong way around. The lack of job creation largely reflects workers ‘out of the market’ and puts upward pressure on wages, while the weaker dollar will merely compound the $ based commodity price inflation clearly evident everywhere else as recovering demand meets restricted supply. Meanwhile, as day-traders seemingly swap Tech hype stories for Commodity and Crypto speculation, long term equity investors can hope for some ‘normality’ to return to their markets

Short Term Uncertainties.

It looks increasingly like the stay at home day-traders are walking away from the Equity Markets, which is helping deflate a lot of the bubble stocks that were bought on hype and margin this time a year ago. Retail buying of call options, the main vehicle for such market participation, has fallen sharply and we suspect that the day-traders have followed the professional speculators off to the Commodities and (crypto) currencies markets. (Note the froth re-appearing in Silver for example). One obvious casualty of this fal in participation is likely to be Cathie Wood at Ark Funds, who not only own a lot of this stuff bubble tech but have also seen large redemptions that cause problems in illiquid stocks. Perhaps unsurprisingly they have had their worst start to a month ever in their flagship Ark Innovation fund, dropping over 10%, this despite Tesla, famously their biggest holding, being essentially flat. The situation won’t have been helped by the admission last week that one of the original seed investors in ARK funds was Bill Hwang, whose Archegos Family office implosion is still resonating across various parts of the capital markets.

Cathie Wood has also been a vocal backer of Crypto currencies and bought heavily into Coinbase on its public offering, so its near 20% fall here from the first week hype will have hurt. The day-traders have also been playing around heavily in Crypto Currencies of course, with the ramp up in speculation in Dogecoin last week seemingly linked to the appearance of Elon Musk on Saturday Night Live. DOGE had doubled from 31c to 62c since the beginning of May and Musk was supposed to hype up even more excitement in the ‘coin’. When he didn’t – indeed he referred to it as “a hustle” the Dogecoin hit a classic ‘air-pocket’ and collapsed right back down again, before rallying and settling in the mid 50s. How it settles and how the leveraged day traders unwind their assorted narrative positions remains probably the biggest short term uncertainty for markets at the moment.

Medium Term Risks

Another market ‘shock’ that came last week was the notorious Non Farm Payrolls (NFPs) number, which came in much ‘weaker’ than expected. We have long regarded this datapoint as the ultimate ‘noise trade’, the equivalent of Sports Betting, whereby the economists ‘predict’ the number in the manner of tipsters and the traders/bookies price accordingly for the speculators/punters to put on their bets. The narrative is all based around “what it means for the Fed”, but the reality in fact is that the Fed has not responded to the NFPs for years, if not decades. There is usually huge amounts of sound and fury leading up to the number being released and then…it is all over. Just like a horse race or other sporting event. Last week, the NFPs was supposed to be a ‘good number’ on the basis of the sharp pick up in activity that we already knew about (another point against the NFPs is that the stock markets already discount the economic data being put into the ‘models’). However, the shock was that the number of jobs created was apparently only around a quarter of the 1 million ‘predicted’. Part of the reason of course was the fact that paying people not to work and stay at home means that this is exactly what happens (who knew?) which actually means that the risk is for upward wage pressure. In other words it means that the inflation risk is higher, not lower!

The trader narrative nevertheless was that weak payrolls equals no need for Fed to raise rates (they were never going to do so anyway) so sell the US$. The logic may be backward, but the consequences are important and we note that the US$ is slipping once again on a trade weighted basis. In particular we would point to the exchange rate against the Chinese offshore Yuan, the CNY, which broke recent support and is threatening the lows of 3 years ago (ie the $ is weakening against the Chinese Yuan).

Stronger Yuan means higher $ commodity prices

On the one hand this has implications for trade with China, but more importantly it puts upward pressure on $ based commodity prices as they are now ‘cheaper’ in Yuan terms and, lest we forget, China is the main buyer for most things in this space. As such, the cost of not only all US imports, but also all $ based basic materials is likely to rise. Combine this with upward wage pressure and it looks like this time we really will see inflation rising in the US.

We consider the main medium term risk to portfolios is not to have enough exposure to the cyclical recovery. Moreover, as part of the resumption of existing trends after a pause in April that we discussed last week, a weaker $ will intensify the pressure to diversify away from US$ Assets – or in the case of Asian savings to allocate less to US$ assets.

Longer Term Trends

A lot of the long term concerns being discussed in Markets- Russia, China, Climate Change to pick the three ‘front page’ topics – are actually more like short term uncertainties being viewed through one particular narrative lens. In our discussion last week of left Brain versus right Brain dominance (one world, two realities) we touched upon the fact that different market participants could see two different stories from the same dataset. This is particularly important for the overlap between short-term uncertainty, medium term risk and longer term trends. For example, long term investors using right brain analysis can identify the motivation behind ‘western’ activities to separate Russia from Europe, or to destabilise China’s One Belt One Road efforts (the latest through insurgency in Myanmar) or to undermine Made in China 2025 through weaponising the Taiwan and Hong Kong issues. This does not mean, however, that the left brain narratives about Russian aggression or Chinese expansionism do not affect prices in the short to medium term, rather that, should they result in particularly high risk premia, then there are opportunities to participate in the longer term reality at better prices. In a similar way, left brain narratives about Climate change being pressed into longer term investment themes can have real world effects – even if they are the very opposite of what was intended. Thus, as with the above mentioned mis-allocation of capital away from conventional Oil production to renewables, there is a short/medium positive liquidity effect on renewables, but equally also a medium/long term positive effect on the traditional sector, as well as impacting price levels more generally through the cost of energy. The narrative may talk of flooding and never seeing snow again, but the long term investor is taking such statements as opportunities to buy ocean-front property and ski Chalets.

Finally, another surprise over the weekend was the apparent cyber-attack on some US pipelines as part of a ransom scheme, which had the effect of slowing supply and squeezing prices in a market already being squeezed for all the reasons mentioned earlier. This modern day piracy is only going to get worse, not least as the new Working From Home environment makes hacking so much easier due to a massive expansion of nodes on any system. Digital Security is one of our longer term Thematics in our Thematic Model Portfolio and for good reason. Still at least it’s not like we are building a giant government database containing all our personal information, health data together with a sample of our DNA (through PCR) and all keyed off our NHS number, is it? Oh.