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.


China and Russia have halted all sales of materials for fertilizer production to the U.S and other countries. China is a key supplier of critical components in fertilizers, including urea, sulphate and phosphate, accounting for about 30% of global trade. Brazil, a key supplier of corn to global markets has seen an astronomical rise in fertilizer costs, doubling in just 12 months. Brazil is the world’s top exporter of soybeans, sugar and coffee and No. 2 supplier of corn. Brazil needs to buy around 80% of its fertilizer requirements which could lead to extreme price hikes for these commodities, and a significant reduction in planting. Either way, there is a very real possibility of lower crop yields due to a lack of fertilizer and reduced planting.


The good news is that North American fertilizer costs seemed to have peaked in November. I don't want to speculate on this trend continuing as diesel costs, natural gas and other input costs have escalated.



Sanctions?

What do I know about the effect of political sanctions on Russia? Like you, just what I read in the news, but maybe I interpret what I read differently. In 2014 Russia invaded and annexed the Crimean peninsula, and the world essentially let it happen. At the same time Russia began changing their entire economic strategy. Russia's debt to GDP is only 18%. Russia's reliance on bonds is significantly lower than in 2014. Russia has built an economic strategy that relies on a combination of Euros, gold and cryptocurrency making any sanctions in dollars of little consequence. Russia is essentially a big gas station that relies on the high price of oil and natural gas to fuel their economy. What Russia lacks and desperately wants is land, land all of valuable resources. Blockading their ability to generate revenues from oil could have a significant impact, but I don't think Putin cares. Just reading the daily news, Americans seem far more concerned about the pain of inflation than Russian citizens. Putin may be calculating that American's won't be willing to endure the pain of higher prices as long as Russians will. I think it's very possible that Putin is on an ideological mission to rebuild the Soviet Union and make that his legacy.


If sanctions don't work, then an all out cyber-war will be the alternative.


Biden could release some of the inflation pressure by pausing the Federal Excise tax on gasoline and diesel. Oil production in the U.S could be increased. The U.S could resolve issues with Iran and direct all of Irans oil to the U.S. Even an increase of 1 million barrels per day would make a huge difference. Exxon and Chevron have already announced increases in Permian Basin production.


The Biden administration has issued more permits for oil and gas drilling on public land per month than the Trump administration did in its first three years, according to a new analysis of federal data. The catch is, most of Biden's approvals were for leases that met immediately with court actions to block those lease approvals. Coincidence or political maneuvering? While the courts are denying the leases Biden just hours ago stopped new lease approvals citing climate change as the primary reason. Biden seems to have navigated arguments from both sides of the isle.


Where am I investing?

I'm watching daily for opportunities in what the portfolio owns and in new investments. My focus is on cash flows, profitability and strength of a companies balance sheet. The fast growing startups will need to sit on the back burner for a while until the market settled down and returns to a risk off bull market. I might make small buys in the ARKK ETF.


The most important thing I'm looking for is the ability for a company to raise prices and generate growth in revenues during a rising rate environment disrupted by supply chains that are in havoc. I like cybersecurity companies, even with their high valuations. Here's a list of what I like today.


  • Mosaic (MOS) for their dominance in fertilizer.

  • Deer (DE) as a beneficiary of higher commodity prices.

  • Amazon (AMZN), Walmart (WMT), Costco (COST) and Target (TGT) for low prices and ability to navigate supply chain disruptions.

  • iShares TLT (TLT) is an investment that benefits from rising rates and bond buying.

  • SPDR Gold Shares (GLD) is an investment that invests in physical gold.

  • XLU an ETF that invests in utilities that is benefiting from rising energy prices.

  • McKesson (MCK) in the healthcare space as a sector neutral position.

  • Chevron, Devon, Marathon Oil, and EOG resources and the OIH our ETF of oil services companies. These companies have already rallied a lot but there may be some protection in these names for a few months as oil continues to hover near $100 per barrel.

  • Nvidia, AMD, Marvell, Qualcomm, Lam Research, Applied Materials, and ASML as the only maker of equipment that can produce the most sophisticated chips. The best semiconductor companies will be able to raise prices in this environment.

  • Northrup Grumman (NOC), Lockheed Martin (LMT) and Raytheon (RTX) as the best defense contractors to invest in as portfolio defense in an increasingly scary world.

  • Invesco Commodity Index (DBC) is an easier way to invest in a large market basket of commodities that will all see rising prices.

The current market conditions should not change our long-term strategy. The worst decision is to jump in and out of different strategies. While volatility will likely remain in the market for as far as we can see into the future, the current environment will be a short-lived event. By that I'm thinking a few months to a year. The volatility has more to do with the mechanics of the stock market than macro economic events; one is a symptom of the other. Roughly 80% of the daily volume in the market is the result of automated trading by algorithms. This high level of automated trading has the effect of causing very fast rallies and declines. I don't think this makes the U.S stock market unstable or unsafe, but certainly the rapid changes from day-to-day cause tremendous stress that make any projection looking forward foggy at best.



Keep Me Honest 2022

  1. Russia will conquer Ukraine and integrate it into Russia by mid-year 2022.


Standing Note to My Subscribers

I’m going to leave this note in place until I take action to telegraph what I’m planning to do. I’m no longer looking at selling the (GLD) gold position but I am still wanting to sell the iShares Clean Energy Fund (ICLN). We have enough cash in the portfolio that I don’t need to sell the ICLN positions yet. The ICLN provides global exposure to clean energy, whereas the CNRG primarily provides U.S.-based exposure to clean energy.



"Markets don't go to zero, Portfolio's do.

Buy quality, be patient...and look twice for motorcycles."

- Clay Baker

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