Stress Tested

This January has been the worst start of the year ever for the stock market, and specifically the market reaction to Fed Chair Jerome Powell’s Wednesday press conference is the worst in modern time with markets reversing to the tune of 3.5% (generally Powell’s press conferences get the worst market reaction… Ben Bernanke’s were the best). At the same time, the biggest invasion force mustered on the outer edges of Europe since the second world war stands ready for the battle cry.

If you are reading this on a Sunday morning, as prescribed, I’ll understand if you go back to bed and hide, it’s a depressing state of the world.

In this respect my intention is not to forecast where the stock market is going to go, nor on what day Russian troops will pour over the Ukrainian border (amongst other considerations it would apparently be considered bad form to eclipse the Winter Games in China, which takes us to late February – keep it close, but the 22nd is the day!), but to rather make the point that these two not unrelated events are stress tests, that reveal much about the world that is evolving before us.

Indeed, there are some common patterns. The first is policy mistakes.

The recent conversion of the Federal Reserve to a tightening stance comes after a decade of easy money that has conditioned investors and households that ample liquidity will continue unabated. Its no surprise then that asset prices and increasingly, consumer prices are extremely elevated. The Fed has many warnings that inflation was rising, and as recently as November officials were describing high inflation prints as ‘transitory’ (the latest inflation deflator released Friday, is at the highest since 1983). The Fed is now chasing its own mistake.

In prior years when the Fed had credibility (and its most senior officials were not dealing in the markets they oversee) a very hawkish tone by the Fed could be construed as the use of words to curb market exuberance rather than rate increases outright (more economically damaging). It is unlikely the case this time.

In and around the Ukraine, much is made of the tactical genius of Vladimir Putin. Without any special insight into how he operates (books like ‘Putin’s People’ and the ‘The Dragons and the Snakes’ help) the intention of his constant needling of the borders of Europe (from the border with Norway to angry Irish fisherman) is to gauge the reaction and readiness of NATO/European countries.

In this instance, even if we do not have a war, his actions are producing some interesting side effects – the readiness of Sweden and Finland to join NATO, the activism of small Baltic states, the dominance of American diplomatic power across Europe and the improving credibility of Tony Blinken, and the turning of even the most mild-mannering German politicians.

In that context, a full war on Ukraine might backfire badly on Putin, wealthy Russians and its economy.  

The second, related element is the way in which the two events – the prospect of higher interest rates in the US and the threat of war in the Ukraine are exposing system vulnerabilities. Here are a few – energy distribution networks, Ireland’s lack of military hardware, the gearing built up in financial markets in the drive to ‘democratise investing’, groupthink in monetary policy, and German foreign policy, to name a few.

In finance, two vulnerabilities that may come into sight later this year are rising credit spreads and weaker housing markets. The euro-zone crisis and the policy reaction to COVID tell us that system vulnerabilities get stress tested until people adapt.

Thirdly, the geopolitical and market stress tests tell us much about the new world order that is forming ahead of us.

To start with geopolitics, in his annual and very long news address in mid-December, Vladimir Putin declared the certain end of a unipolar world, and the advent of a multipolar one. He will no doubt be delighted to learn that this letter agrees with these broad strokes but dismayed that we think Russia is too weak economically, financially, politically and in terms of its soft power, to carve out a Russian zone in this multipolar world.

A defining element of this multipolar world is the greying of the demarcation between soft and hard power and more pointedly, the idea of total war (attributed to a Russian general). This has been on full display in recent weeks, notably the use of press, PR and propaganda by Britain and the US, the prospect of financial and economic sanctions, the threat of massive cyber attacks and the use of energy supply chains as a pressure hold. In the future, places that are on the faultlines of the multipolar world (i.e. Taiwan, Hong Kong, increasingly Africa) will be subject to ‘total war’ style tactics.

An additional point, which always struck me hard whenever I visited Moscow or St Petersberg, is that at the friction points of the tectonic plates of this multipolar world, different countries have very different perspectives on the same situation – markedly so in the way Russia views the situation in Ukraine and beyond, and the way say that British military leaders do.

Finally, to markets, which also have Russia in mind (look at the gap between the Russian stock market and the oil price for instance). At the start of the year we wrote that liquidity would be the dominant factor in markets, and the tightening in financial conditions betrays this with US markets behaving in a way that we have only seen in severe economic crises (2001, 2009 and 2020). This is a concern because it signals underlying risks and threats ahead, and the possibility of further policy mistakes.

For my part, I do not think that the Fed will raise rates as much as the Fed itself and many investment banks think (4-5 times this year according to some forecasts). The key issue is what level prices need to fall to such that markets become less vulnerable to tighter liquidity, and in that context we might see a second dip before the end of March. At very least, the first week of February may be less stressful than January, for markets and geopolitics.  

Have a great week ahead,


Fooled, Again

Fooled Again

In July 2018 Boris Johnson resigned as British foreign secretary, declaring that Theresa May’s Brexit plan (which he later more or less adopted) would only permit Britain the status of a ‘colony’.

The day after Johnson resigned as foreign secretary the death of Lord Carrington (at the age of ninety-nine) was announced. Carrington had been British foreign secretary from 1979 to 1982. He was generally recognized as an exemplar of integrity in public life, and without repeating myself, I had previously written (in the Levelling) a comparison of Johnson and Carrington, the point being to underline the shallowness and mendacity of Johnson.

At the time (2018) I wrote that ‘Johnson was seen as a natural leader of the Tory Party, but the way he has conducted himself since then has led many party colleagues to the view that, even by the standards of politicians, he is too self-serving, and he has lost support within his party.

That sentence could be used today. Johnson’s consistent traits have been to betray those around him and demonstrate unsuitability for office.  Moralizing aside, and while I was right about his character, the joke was on me (and many others).  

Since 2018, Johnson became prime minister, somehow executed Brexit and set about destroying all the things that are most admired in and outside Britain (the BBC, NHS, the rule of law, sovereignty of Parliament and democracy itself). Politics as a spectacle trumps politics as a serious pursuit.

I and many others (I count the unfortunate and very bitter Dominic Cummings here) were fooled into thinking that (poor) form could not triumph over substance for so long. It did, and we should ask why?

The lesson is not to high handedly denounce politicians of weak character, but to wonder what causes people to look beyond these characteristics and support leaders like Johnson. In his case the answers are on one hand easy – his charisma, ability to glad handle people past the truth and to rile his enemies, all of which proved useful during the Brexit process.  

When a crisis arrived that demanded sincerity, patience and attention to detail – he has been found wanting, and it beggars belief to think how he might behave in war (not least given the proximity of his party to Russian finance). Ironically, opprobrium towards Johnson has been triggered not by the enfeebling of the UK economy, or the human misery and death toll brought on by the coronavirus, but by a drinks party(ies). The FT have called it ‘government by stag do’.  

As I write, those who previously held positions as Johnson’s most fervent supporters are denouncing him, consistent with the ‘blood sport’ that is Brexit driven British politics. He is now spoken of as one of the worst prime ministers. Interestingly there is a range of rankings of modern prime ministers (by academic institutions (i.e. Leeds), the public (i.e. BBC/Newsnight), academics as well as newspapers/journalists).

In general, Lloyd George, Atlee, Thatcher, and Churchill, followed by Baldwin and Asquith do well, while the underperformers are led by Anthony Eden, followed by the likes of Balfour, Douglas-Home and Cameron. The role of prime minister has an allure and drama that has been captured in many works of literature from Anthony Trollope’s ‘The Prime Minister’ to more contemporary versions like Chris Mullin’s ‘A Very British Coup’ and of course Michael Dobb’s ‘House of Cards’.

In Johnson’s case, the risk of a coup is not yet high – senior colleagues are standing off in the hope that the Grey report delivers a killer blow, some backbenchers fear that a new prime minister might take the Tories back towards the centre and a hardy few still believe in Boris’ ability to avoid sanction.

My judgement is that Johnson may struggle on till the spring, but his credibility is now so badly damaged, and his enemies emboldened that he would find it difficult to implement meaningful policy initiatives. His behaviour so far in his career suggests that he is not a ‘resigner’ like Carrington but will need to be removed in a heave.   

Whoever becomes prime minister will have two principal challenges – repairing the economy, not just in terms of its cyclical health but structurally in terms of productivity and investment. The second challenge is reaffirming the rule of law and reversing policies that undercut Britain’s democracy.

A third challenge, and only for a very brave prime minister is how to sway the Tories away from their Brexiteer, right wing faction. Rishi Sunak, should he become prime minister may find that this cabal has little love for him, and might be the first Tory prime minister in decades to confront the faction that has done so much damage to Britain. In a recent note I wondered if it would be healthier for British politics if the Tory party would split, with the centre ridding itself of the right. It sounds obvious but in reality, will prove very difficult to execute but until it does happen, the Tories will prefer to be led by clowns.

Have a great week ahead,


The Olden Times

It may be that as I get older, I become nostalgic for what my children call ‘the olden times’ (when I was a twenty something). In that spirit a friend, with much the same age and background came to visit recently, and we spent some time discussing ‘university and the research methods’ of the 1990’s economics field.

At the time, in order to undertake quantitative research project, I had to write a 15 metre long computer program, which like a good dish I would leave overnight whilst the program would (from my local faculty computer) dial into a computer at the London School of Economics, borrow some data and analyse it, returning raw regression results to me the next morning (statistical packages like Stata and EViews would follow later).

If there was a problem with either the data or the program, I had to wait till the next evening to rerun the program. That computers in different countries could talk to each other, was relatively novel. Today, such an operation might take a fraction of the time.

Back then, if one wanted to consult a piece of research, often the fastest way of doing so was through inter library loan – a system where a written request was made by one library to another in a different university, and where a photocopied version of the research paper was sent by post. Little wonder then that when Netscape arrived, people tended to conceive of it as a ‘world library’.

That all this happened in the mid to late 1990’s will date me, and I hope show younger generations that research and discovery existed before social media and were generally more interesting as a result. Travel and communication were different also. I can recall relying on pigeon post to organise nights out or arranging holidays with promises to ‘see you on the Charles Bridge (Prague) at 7pm in three week’s time’.

Before I sound too sentimental or old fashioned, I want to stress two points. The first, which I also underlined last week is that humanity is at a crucial point where it is being challenged by technology – our ability to contemplate is challenged by over-stimulation, and our sociability is challenged by the virtual.

The second point is that what really had me thinking about the ‘olden times’ is the bond market. The mid 1990’s was really the last period of sustained high interest rates (having risen sharply in 1994 the Fed Funds rate stayed above 5% till the recession in 2001).

Further, in finance and economics textbooks of the time, as well as banking valuation models, one was always told to use a reference long bond yield of 3.5%.

In today’s increasingly nervy market climate, where inflation in both Europe and the US is spiking to multi-decade highs, the possibility of a fed funds rate of 1% by next year seems profoundly off-putting. One can only imagine the reaction if we went back to 5%, á la the ‘olden times’.

Without going through the boring exercise of trying to forecast inflation (my view is that service price and wage inflation will stay sticky for the next year, though commodity inflation – oil, semiconductors, lumber etc – is peaking), I want to note that the most interesting element of these multi-decade turning points is the psychological one.

People like me whose view of financial theory and practice was formed in the period up the global financial crisis, have difficulty understanding the co-existence of 7% headline inflation, zero interest rates (and 1.7% long bond yields) and record high stock market valuations. Against the benchmark of decades of financial history, it makes little sense, except that central banks decree that it does.

On the other hand, younger people, who may have come into markets since 2007 will find all of this to be normal – rates will stay low, returns will be high and liquidity can only but be plentiful. This is perhaps where the greatest risk lies in markets, that a significant generation of investors are unused to the kinds of forces that have riled economies in the past (rising inflation and subsequently, interest rates).

The other difficulty, which I find relegated in the broader debate over inflation and supply chains (a good overview from the CFR here) is productivity. Once the economic fog of the coronavirus crisis lifts, governments will have to zero in on productivity as the driver of growth. My stories from the ‘olden times’ are good illustrations as to how far computing power and the data industry have come, and the extent to which they have contributed to large productivity gains.

However, what is remarkable about the past fifteen years is that in certain large economies, Italy, Britain and even the US for instance, productivity has collapsed. It is not clear why this is the case – low investment, inefficient or lopsided digitization or long (and thus inefficient) business cycles are some of the factors I can think of. Neither is it clear to what extent the many new technologies (see last week’s note), and approaches to work (zero-hours, work from home) we are witnessing will boost productivity, or turn out less productive humans.

This will be the biggest economic policy challenge of the next decade.

Have a great week ahead,


Mind Games

In the past year the share price of Apple has outperformed Bitcoin, and Tesla’s share price which has hitherto been umbilically linked to bitcoin, has been far more jumpy (over the last two years it has had 29 one day moves of more than 10% as compared to a mere 17 for bitcoin). 

These insights beg lots of questions, about market functioning, investor appetite and simply, whether bitcoin is now old and dull. There is a debate that instead of being a risky asset across the spectrum of broad asset classes (bonds, equities etc), bitcoin is simply a safe asset within a highly volatile crypto world, though the fact that bitcoin has fallen 15% since I started writing this note nods to the former.

More importantly, it might be that bitcoin is out of fashion and is being replaced in the mindsets of investors by other speedy innovations. Recall the memorable line from a Davos speech by Canadian Premier Justin Trudeau where he said ‘The pace of change has never been this fast, yet it will never be this slow again’.

The spirit of this phrase is caught by the many year ahead forecasts from futurologists, economists and thinkers. Having made my own forecasts before Christmas I have the benefit of sitting back and reading others, one excellent example being Azeem Azar’s weekly ‘Exponential’ email, and a growing number of other notes that try to summarise what is bubbling up.  

What is noticeable is that there is a strong sense of the ‘Roaring 20’s’ in threads of structural trends that analysts see taking place in the aftermath of a pandemic. Chief amongst them is a focus on nuclear power as a substitute to fossil fuels, not to mention the entire greentech complex.

If the forecasts and thought pieces I have mentioned are a good representation of where capital will flow, then a new, exciting infrastructure is being built – in computing, logistics and finance to name a few sectors that happen to be united by data intensity. I might say that having witnessed the bubble, the only value of an asset bubble is that it leaves behind it an important infrastructure (telecoms in this case).

My three key takeaways from parsing many reports, is that whilst on one hand exciting, the central message of the new emerging technologies is that they will lead to a historic and potentially overwhelming challenge to humanity, and in particular to our minds and sociability, with potentially very impactful health related benefits.

Without exaggerating, I feel that 2022 is a threshold year when innovative technologies make our bodies healthier but invade our mental spaces.

To first take a collection of the most popular trends, they cluster around web 3.0, NFT’s, metaverse, social media and crypto currencies. In a brutal way that means that we will all spend more time out of the light, hunched over phones and doubting whether the people and things we have encountered in the metaverse are real at all, and whether it was worth investing USD 10,000 in a metaverse apartment.  

This trend is historic because for the first time, and with only the force of religion (and maybe politics) as a rival, humans will spend time and enjoy experiences in an unreal world, and for some this will come to dominate their existence. Two very obvious side-effects will be sociability and mental health.

In previous bulletins I have remarked that mental health needs to become a core pillar of how health services are reimaged, and it may be that the metaverse is the trigger (ironically it is used to help soldiers overcome post traumatic stress disorder).

Also on the positive side, the enormous advances in medicine and health tech – much of it spurred by the coronavirus crisis, will have a positive effect on humans – pending at least two factors, that the bounty of these advances can be as widely spread as possible, and that the ways in which they are delivered is rethought in the sense that healthcare systems need to change.

One inspiration here, and my second point, is that the rising attention that technologies like blockchain have cast on decentralized autonomous organisations – effectively organisations run by a coded relationships between disparate parties, as opposed to a centralized or even hierarchical bureaucracy (i.e. healthcare systems). While it is a stretch to imagine that today’s healthcare systems and other institutional arrangements can be quickly replaced by decentralized forms, there is much that blockchain can do to cut that bureaucracies (closer relationships between doctors, patients, billing and other parties like pharmacists).

A third related, threshold change in technological influence that is getting a lot of attention and capital, quantum computing (70% of startup level investment in tech hardware goes to quantum computing projects). Governments, notably China and the European Union are also spending heavily on it. In brief quantum computing is revolutionary in that it uses different arrangements of ‘bits’ to produce more powerful processing. Though there are not yet many applications of quantum computing it has the capacity to dramatically change aspects of healthcare, finance and industrial sectors like chemicals.

Having already witnessed historic, positive changes that resulted from the pandemic – the general patience and obeisance of the world’s population, the acceptance of working from home and the power of vaccines, we are now crossing a threshold in terms of how technology will change our bodies, as well as our minds and the ways we relate to the world.

Have a great week ahead,


Death to Democracy?

One of the many books that came through the O’Sullivan chimney this Christmas was Blake and Mortimer’s ‘The Last Swordfish/Le Dernier Espadron’. The Blake and Mortimer comic book series is now under new authorship but started in Belgium (close cousin of Tintin) in the late 1940’s and like the earlier John Buchan books for example, they speak to a caricature view of Britain, its upstanding male role models, along with doses of racism.

Similar to books like Greenmantle or the Three Hostages (Buchan), the Blake and Mortimer ones have a recurring theme of good versus evil, the possibilities of technology, and the contest between the free and tyrannical countries.

Reading ‘Le Dernier Espadron’ my first thought then is that in Britain today many of the leading politicians (Gove, Johnson etc) remain ideologically and sociologically planted in what they deem the socio-political roots of early twentieth century Britain, á la Blake and Mortimer, whilst showing none of the competence, bravery and virtue of those characters (and those of Buchan and similar writers).

This is manifesting itself not only in a crisis of identity and relevance, but also one of democracy. Britain, in its own way, is rightly admired as an exemplar of democracy and strong institutions, though the current government has done much to erode this, such are the temptations of populism.

At a time when we are faced with many great risks – climate change, war in Eastern Europe and the COVID pandemic to name a few, my greatest fear is that the core of the democratic world is ebbing.

Another example from this week’s press (undoubtedly ahead of Jan. 6) is the front cover of the Economist (always a poor predictor) that shows the Republican Party in the USA ‘walking away from democracy’. An even more troubling, recent example is the de facto snuffing out of the free press and opposition in Hong Kong. It has been subsumed by China, with barely more than a squeak of protest from democratic countries.

With the world setting off on a new chapter (post-COVID, multipolar) that is marked by dazzling technologies, financially healthy consumers, we remain in a democratic recession, to use the political scientist Larry Diamond’s term.

This idea is backed up by last year’s EIU Democracy Index which shows democracy in poor health (the Index is at its lowest since 2006, and only 8% of the world’s population live in ‘full democracies’). Similarly, Freedom House shows that last year was the worst year since 2005 (when they began measuring the spread of democracy) for democracy in the sense that the number of countries whose democracy weakened versus those where it improved (-45) is the highest on record.

In both cases, the spread of democracy halted in the aftermath of the global financial crisis and then deteriorated from 2015 onwards. This is a key watershed. Under globalization the idea was that democracy would spread out from the democratic countries to the rest of the world, now, in a multipolar, contested world, democracy is simply one of a number of competing models or sets of values (the diplomatic spat between little Lithuania and China is worth watching here).  

It’s gloomy stuff, though as I have flagged in my last note of 2021, democracy in Europe is in decent shape as we approach elections in Italy and France. One reason for this may be the fact that the party system in countries like France, Germany and Italy is supple – within limits (funding and vote thresholds) new parties can be formed and rise to power whilst old ones are quickly distorted.

In the medium to longer term this produces political vessels that push extreme views to the edges of politics and makes the centre a contested political space. Imagine if the Tory Party had been allowed to split in the 1990’s, Brexit would likely never have happened. The same is true in the US.

I am not quite sure what it will take to break one of the four main Anglo-Phone political parties, though ideological divides within them are the most stretched ever. It may be that an aspiring breakaway leader (Tom Tugendhat in the Tories or Liz Cheney in the Republicans) will need the help of large (social) media organisations and wealthy donors, a compromise that is itself the antithesis of democracy.

I find that struggle between the ‘Bush’ and ‘Trump’ Republicans fascinating, not simply in terms of the spectacle but also the entry of new people to the fray (such as David McCormick of Bridgewater as a potential Republican candidate in the Penn. Senate race).

Against this backdrop, where the consensus view is that the American body politic is busy destroying democracy, it is worth spending time thinking about the non-democratic world, where in notable cases ‘managed democracy’ has been replaced by the idea of mediaval ‘strong man for life’ (Russia, China and Turkey). Turkey, like Lebanon, shows that people’s patience for the erosion of democracy has limits, and at a point, is linked to banking systems (there has been massive deposit flight across Turkish banks).

China is fascinating here. Growth is slowing, Hong Kong is a depressing vision of the ‘China Dream’ and as we move through 2022, the big story may be mounting opposition (within the Communist Party) to the policies of Xi Jingping – if we ever get to hear about it.