The Perfect Storm
“Don't bet on the end of the world, it only happens once and the odds are against you"
-Art Cashin (Director of Floor Operations, UBS Financial Services)
The Portfolio Performance
The portfolio is down -14.68% YTD
The Perfect Storm
If you read the book or saw the movie you know that the outcome of A Perfect Storm isn't good.
The market already had too much information to digest and now we can throw in a full invasion of a sovereign country by Russia. The monitoring of day-to-day sell-offs of the past few months needs to be exchanged for a forward looking view for the next three months, six months and year end. As long-term investors we need to remain confident in our three to five year outlook; but right now some careful damage control is a rational thing to do.
What's Happening?
Markets are trying to digest far more uncertainty than they can handle and investors are more likely to believe negative news over positive news. To comprehend how negative the market is; as of this morning, more companies are at 52-week lows than in 2008. Powell was making statements that calm markets, while the other Fed Presidents contradict him. Supply chains were getting better until suddenly Canada's trucker protest flares up. Inflation metrics showed a decline, but energy prices and wage inflation overtook everything else. As energy prices were rising a severe cold snap streaked across the United States, draining household budgets as the spend on heating oil, electricity and natural gas increase. Now we can throw in Russia's invasion of Ukraine as a wash out event that moves many more investors to cash. Over 10 million new businesses started between 2020 - 2021 ahead of a tightening in capital markets and rising employment numbers that have shocked economists. These new businesses are a source of our booming economy but they face a lot of uncertainty as they try to borrow money and hire employees that aren't available. When this much uncertainty exists in the market, the response is always the same, sell broadly, reprice everything and sit on cash. If you've been raising cash and have been looking for opportunities to buy your favorite companies cheaper, sit tight, I don't think we're there yet. Come June you might feel like a genius.
"...when driving in a blizzard, sometimes the best decision is pull over and wait it out."
Is This The Worst That Can Happen?
No.
I believe that the market is far more concerned about the Fed and rising interest rates than a war between Russia and Ukraine. I believe that the markets are even more concerned about the U.S cutting Russia off from SWIFT than anything else on the table right now. SWIFT is the Society for Worldwide Interbank Financial Telecommunications. SWIFT is a vast messaging network used by banks and other financial institutions to quickly, accurately, and securely send and receive information, such as money transfer instructions. Without SWIFT many countries would be unable to buy and sell energy, settle stock transactions or conduct daily banking operations. Blocking Russia from SWIFT is the nuclear bomb of our age.
When the Fed meets on March 15th and 16th we'll find out if they will raise rates 0.25%. I personally think that 0.50% is off the table. The Fed may say that the Russia-Ukraine war is a factor in not raising rates too fast, the real worry would be an inversion of the yield curve. Raising rates 0.50% would instantly invert the yield curve and the interpretation by the market would be severe. Yeah, I would be first in line to call for a recession and that wouldn't look good for Powell or Democrats in the upcoming Mid-term elections. Keep in mind that rates are going up because the economy is running too hot.
Let's not forget China and their aggression towards Taiwan, and the increasingly friendly interactions between Putin and Xi Jinping. China has long held that Taiwan is a part of China. Taiwan is the largest manufacturer of semiconductors in the world, and they make the most sophisticated chips known as 3 nanometer chips. Taiwan's foundry's account for 60% of the global chip manufacturing market. China has been building its military presence around Taiwan, expanding airbases on the Taiwan straight, carrying out military flyovers, anchoring a couple hundred ships near by and cruising aircraft carriers through the straight. For the past two years China has been communicating it's desire to build its own semiconductor industry to rival the rest of the world, but the only way to do that in the short-term is to take over and nationalize Taiwan's semiconductor industry. Reading what military strategist have to say, it's unlikely that China would attempt a ground invasion of Taiwan and China may not be in a position to carry out that assault.
Completing TSMCs Arizona foundry has never been more important to the global economy. As President Biden weighs various sanctions on Russia one is to cut off access to semiconductors. Russia's reaction would likely be to turn to China for semiconductors which 'may' cause a further escalation in the China-Taiwan tensions. Since China uses every chip it can make and buys most of its chips from abroad, any further demand could step up China's pace to take full control of Taiwan's semiconductor industry. Obviously this scenario could only happen with a full scale invasion of Taiwan, or a cyber-attack on Taiwans companies and infrastructure, so let's place this bit of speculation way out on the fringe of possibilities.
