Friday, 3 November 2023 — Melbourne, Australia

By Greg Canavan Editor, Fat Tail Daily

[1 min read]

Dear Reader,

US markets continued to rally overnight. The S&P500 jumped nearly 2%. The small-cap Russell 2000 surged 2.7%.

The popular narrative is that this is all down to the Fed. They’re done raising rates. Higher for longer hasn’t hurt the economy so far, so why should it? Buy stocks!

What you’re not hearing is that this time last week stocks were technically ‘oversold’. This simply means they went down too far, too fast. When that happens, there is a high chance of a rebound. Which is what you’re seeing this week.

The Fed’s ‘no hike’ decision is just a convenient excuse.

But as you’ll see below, in this week’s episode of What’s Not Priced In, I show you this is likely just a short-term bounce within a bearish downward trend.

I also look at a number of sentiment indicators. This is the ‘psychological state of the market. They point to some psychological stress, but we’re not nearly at the stage that marks a more lasting low.

That’s not to say there aren’t plenty of good stocks on sale here. There are. But just beware the latest ‘hot take’. That the market is in the clear because the Fed’s hiking cycle is over.

Read on for more from What’s Not Priced In host, Kiryll Prakapenka…

By Kiryll Prakapenka Editor, Fat Tail Daily

[4 min read]

Dear Reader,

Is the Federal Reserve done hiking?

Is the Reserve Bank done?

Maybe.

My What’s Not Priced In colleague Greg Canavan thinks the RBA will be fools to raise next week.

But he also thinks investors shouldn’t care.

Leave the rate guessing to macro nerds and day traders.

Value investors have more productive things to do.

Like finding oversold opportunities.

As we discuss in the episode, markets are not at a capitulation low yet. Don’t be surprised by further falls.

But opportunities still lurk.

Greg, for one, is buying some ‘smashed up’ sectors.

Red October

October wasn’t good.

The ASX 200 fell 3.6% that month, entering a technical correction. The S&P 500 entered one, too.

Both indexes rebounded this week. But the mood is still downtrodden.

Since early February, the ASX 200 is down ~8.5%. The index is down 9.5% since August 2021.

October wasn’t great, but neither have the last few years.

It’s a similar thing overseas.

The Nasdaq is down over 10% since an AI-led peak in July. The broad Russell 2000 is down over 15%.

Why?

As Greg covered last week, markets fear a rapid slowdown ahead.

So don’t let this week’s bounce deceive you.

October’s best and worst performers on the ASX

October’s best performer was gold.

Conflict in the Middle East played its part. But is there something else?

The question for gold bugs is this.

Is gold’s move purely a sign of geopolitical hedging? Or is gold sniffing weakness in the US economy and a fall in real bond yields?

We discuss at length in the episode.

Now, the worst performers were a mixed bag.

A couple of prominent lithium miners stood out, though. IGO and Liontown Resources.

Liontown suffered from Gina Rineheart nixing Albemarle’s takeover overtures.

But it was IGO who highlighted the sector’s broader issues.

Lithium prices are falling and demand is faltering.

In its latest quarterly, IGO spoke of the need to ‘manage surplus volumes’.

Chief executive Matt Dusci then admitted one of its mines will sell less spodumene in the next quarter than it will produce.

Not to mention the most shorted stock on the ASX right now is young producer Pilbara Minerals. Lithium peers Core Lithium and Sayona Mining round out the top 10.

IGO’s Dusci thinks lithium’s fundamentals ‘remain strong over the medium to long term’.

Short-selling interest suggests otherwise.

We’ll see.

Psychoanalysing the Fed

US Fed officials unanimously voted to leave rates unchanged overnight. The funds rate remained between 5.25% and 5.5%.

The Federal Reserve hasn’t raised rates now for two consecutive meetings. The longest intermission since March 2022.

It left the option of another hike open. But the market was quick to read between the lines. What does this really mean?

Citadel Securities’ Michael de Pass offered this take:

‘They want to maintain a hawkish façade while believing deep down that they’ve probably done enough.’

Despite himself, Greg agrees.

The Fed’s power partly lies in managing expectations.

It wants people to think rates may still rise to curb any counterproductive exuberance whipped up by people expecting cuts.

Will Australia follow the Fed?

Going by market odds, the Reserve Bank is unlikely to follow its counterpart.

Money markets are assigning a 57% chance of a RBA hike next week. 33 out of 35 economists surveyed by the Australian Financial Review agree.

But Greg thinks another hike is absurd.

So why would the RBA even consider it?

A hotter than expected CPI print is one. Rising home values (and therefore household wealth) another.

Aussie home values are weeks away from a record high.

National house values rose 0.9% in October, according to the latest data from CoreLogic. Since a low in January, house values are up 7.6% nationally.

National home values only need to rise another 0.5% to set a record. CoreLogic eggheads think this is feasible by mid-November.

Will this play a role in the RBA’s upcoming rate decision?

Our new RBA governor, Michelle Bullock, addressed the Commonwealth Bank Global Markets Conference last week.

Later, she fielded questions on house prices.

Some snippets of her answers:

‘Housing prices are on the rise again and we know from history that rising housing prices tend to result in high consumption, so there’s that as well which is impacting things. So it is a balancing act and they’re the sorts of things we’ll be looking at, the inflation numbers obviously and our new set of forecasts.’

‘Household balance sheets on average, in aggregate, are pretty solid. They’ve still got lots of savings and they’re still saving. The savings rate in Australia is still positive. So, they’ve got lots of buffers, lots of saving. We are seeing housing prices rising again, so wealth is rising again, so household balance sheets in that respect are solid.’ 

The IMF butted in, too.

Michele Bullock and her predecessors have a tough job. The whole country has an opinion on where rates should be. And now it’s international institutions, too.

The International Monetary Fund urged the Reserve Bank to lift the cash rate in its latest annual report on the Aussie economy.

The IMF said:

‘Although inflation is gradually declining, it remains significantly above the RBA’s target and output remains above potential. Staff therefore recommend further monetary policy tightening to ensure that inflation comes back to the target range by 2025 and minimise the risk of de-anchoring inflation expectations.’

The IMF then recommended more coordination between Australia’s fiscal and monetary policy, something Philip Lowe mentioned in his last speech as governor.

If the Commonwealth Government doesn’t take a measured approach to fiscal policy, the RBA may have to raise rates ‘even higher’:

‘In that context, continued coordination between monetary and fiscal policy is key to securing more equitable burden sharing. The Commonwealth Government and state and territory governments should implement public investment projects at a more measured and coordinated pace, given supply constraints, to alleviate inflationary pressures and support the RBA’s disinflation efforts. Otherwise, interest rates would have to be even higher, putting the burden of adjustment disproportionately on mortgage holders.’

You must watch Greg’s reaction when I mentioned the IMF’s reasoning to him!

Case against RBA hike

But what’s the case against?

Greg thinks the RBA has done enough. Further hikes are unnecessary, inflicting pain for pain’s sake.

For one, living costs continue to outpace inflation for many households.

On Wednesday, the ABS released data on living costs. Living costs for employee households rose 2% in the September quarter, up from the 1.5% rise in the June quarter.

The growth was almost double the rate of the CPI, which rose 1.2% in the September quarter.

Mortgage repayments are hurting households. These repayments also explain the difference with CPI, which excludes mortgage interest charges.

Mortgage interest charges rose 9.3% in the September quarter after rising 9.8% in the June quarter.

That’s despite the RBA not increasing the cash rate since July.

What do we like to repeat on the show?

Monetary policy acts with a lag.

The flurry of punches the RBA threw at the start of the year to knock inflation out are starting to land.

Why throw more?

Enjoy the episode! 

Regards,

Kiryll Prakapenka,
Editor, Fat Tail Daily

By Nick Hubble Editor, Fat Tail Daily

[5 min read]

Dear Reader,

Welcome to my first edition of your brand-new Fat Tail Daily newsletter.

It’s been 13 years since I wrote my first article for the Daily Reckoning Australia. You can imagine the world has changed a little bit since then…

And sometimes my colleagues working tirelessly behind the scenes at Fat Tail Investment Research convince me to change with it.

But they didn’t need to convince me that this latest change is the right move for our brand.

It’s all about helping you discover what we really do all day. The Daily Reckoning was and Fat Tail Daily is designed to be just an introduction to our work.

Many of the people at Fat Tail Investment Research were mentored by someone called Dan Denning — a rare American fan of both cricket and AFL. He set up our publishing company in an old hat factory in Melbourne around about 2004, when I first arrived in Australia myself.

His most important lesson to us was that the newsletter business is a relationship business. We live and die by our customer’s perception of what we do.

Fat Tail Daily is the first step in how we live up to that tenet, so it’s an important one. It’s our chance to introduce how we think, and build trust with you over time.

But the real value proposition of reading our work comes from Fat Tail Investment Research’s otherpublications. These can actually give specific and actionable advice to you. They reveal the results of our in-depth research to a select group of people instead of just the general public.

We’ve discovered that the jump from a distinct brand in The Daily Reckoning Australia to Fat Tail was perceived as a leap into the unknown for many of our loyal and longtime readers.

We hope changing the name to Fat Tail Daily bridges this gap by making it clear that our other publications are coming from the same people with the same purpose and the same commitment to our relationship with you. It’s just an opportunity to upgrade.

That’s also why you’ll be hearing from a bigger cast of characters from now on. Some of whom I’ve known since I first walked into the office in 2010. Despite the variety of opinions, and the independence of our editorial, we are a team.

Unfortunately, we’re not the only ones with change on our minds. But no change can compare to what governments have planned for us in the name of protecting you from carbon dioxide…

Housing is on the block

Under Net Zero rules, governments must design and abide by plans to reach Net Zero over the coming decades. This means all other policies are subjected to that constraint.

Heck, even defence is caught up in the furore, with battery powered tanks on the drawing boards of newly environmentally friendly defence companies…

The point is that anything we do must fit into governments’ Net Zero plans. The fact that they’re very sketchy plans is part of the problem. But I suspect we’re already experiencing the consequences…

Right now, there’s a severe housing shortage in many of the countries whose news I follow each day. In each place, the pundits blame different reasons for this shortage.

It might be the banks, the government not freeing up land, taxes on landlords, and no end of other factors available for scapegoating.

It’s always intriguing to watch experts within a country blame local factors for a problem they share internationally. Sometimes the political agenda behind the false furore is obvious. The journalists just mention the particular factor that aligns with the side they’ve taken in local politics.

But when it comes to the housing shortage, I suspect the cause may be a common one — Net Zero.

You see, housing is extraordinarily carbon emissions intensive. The Australian Financial Review recently reported how:

‘Data from engineering consultancy Arup last year showed buildings typically emit 600 kg to 1000 kg of CO2 per square metre over a notional 60-year life span, with roughly half of that from embodied carbon and half from operational carbon.

‘Globally, 50 million square metres-worth of real estate is being designed that will reach completion in 2030, Arup says. Whatever carbon those buildings are built with now will be baked in for a long time.’

Australia’s construction industry accounts for 18% of our emissions and then buildings themselves for another 18% according to the government. Property Council Chief Executive Zorbas reckons, ’Buildings account for more than 50% of Australia’s electricity use and 23% of all emissions.’

In the UK, which I detailed in my book on Net Zero, buildings’ direct greenhouse gas emissions accounted for 17% of total national emissions. Depending on how you do the maths, the full figure including indirect emissions comes in at 45%.

The point being that building more housing goes directly against commitments made on Net Zero. And those are the law, whereas shelter is only a human necessity.

And if you think Net Zero policies don’t have a whopping impact on property development, consider this from the UK’s Telegraph newspaper:

‘New housing starts have surged to nearly a 50-year high as developers scramble to beat a Net Zero deadline.

‘Builders began construction on 73,600 new homes between April and June this year, a 34pc jump compared to the same period last year and the highest quarterly total on record since at least 1978, government data shows.

‘Developers raced to start projects ahead of a June 15 deadline that saw new homes subject to onerous regulations designed to reduce carbon emissions from buildings.’

In other words, Net Zero compliance is going to prove a real constraint to housing supply, cost, availability and standards in the future.

Governments will not be able to build enough housing without breaching their Net Zero commitments. Companies won’t be able to build affordable homes. And so supply will shrink.

But Net Zero will also impact immigration. I mean, how can Australia credibly have the same emissions target as Japan (Net Zero by 2050) when our population trajectory is just a bit different…

Australia expects its population to surge by 10 million by 2050 while Japan is set to lose almost an Australia’s worth of population over the same time frame...

Unless, of course, migration policy changes radically…

When the UK’s FIRES group of universities (Future Industrial Resource Efficiency Strategy) considered what ‘absolute zero’ would amount to, meaning we can only do activities which don’t emit carbon, they came to a startling conclusion that makes the World Economic Forum look like a charity. Airports would have to close, shipping would have to cease, cars could only run fully occupied, and the list went on…

This means that building airports and ports is likely to be in contravention of Net Zero laws. Which might sound ridiculous, but a UK court ruled just that over Heathrow’s third runway.

There are of course other ways to reach Net Zero. It’s called ‘net’ for a reason, after all. We could just offset all our carbon emission…right?

Well, so far, carbon emissions projects seem to be having as much trouble as the energy transition itself. After the Guardian found the world’s top 50 carbon offset programs were either outright dodgy or probably dodgy given the lack of information, Bloomberg reported this:

‘The integrity of one of the largest single sources of credits in the $2 billion carbon market faces serious doubt following the collapse of the partnership behind Kariba, a mega-project in Zimbabwe backed by the world’s top seller of carbon offsets.

‘South Pole, the company that sold most of the credits tied to the forest-protection project, said on Friday that it terminated its contract with Carbon Green Investments, which owns and develops the site. Dozens of corporate giants, including Volkswagen AG, Nestle SA, L’Oreal SA, Gucci and McKinsey, have purchased credits from Kariba representing millions of tons of greenhouse gas emissions.’

It's a remarkably good business proposition, if you think about it. Sell carbon offsets to big companies and then fail to offset the carbon…

No wonder even the climate change activists see Net Zero as a scam. That’s why the FIRES group conducted the absolute zero analysis — what our world would look like without a functional and cost-effective carbon offset industry. Suddenly, we really won’t be able to fly or ship or drive…

My point here is that the pains we’re seeing in our economy and society are by design — by law. If we subject our economy to Net Zero by 2050, along with many targets in between, this is going to force a very long list of other changes onto our lives.

Things won’t be built, products won’t be made, energy won’t be provided and much more…

As more and more of these changes become obvious, the pressure against Net Zero will continue to mount until the dam breaks, perhaps literally in some cases.

Are you ready for that moment?

Regards,

Nick Hubble,
Editor, Fat Tail Daily

By Bill Bonner Editor, Fat Tail Daily

[4 min read]

Dear Reader,

'My generation…we’ve given nothing. We’ve given nothing! And now we want to screw our grandchildren…We’ve got to stop guys, we’re DRUNK....We're digging this deep hole...What are we doing here?’

~ Stanley Druckenmiller

It is All Souls day, at time of writing. What do the shades have to say about us?

Driving through Normandy this morning we passed through the town of Vimoutiers. There is nothing special about the town. Like so many others in Normandy, it was largely destroyed by Allied firepower in The Second World War. Today, it is drab.  Uninteresting.  Nothing to see.

But in the town is a plaque recalling an instance of private generosity. Margaret Mitchell, author of Gone with the Wind, had heard about what had happened during the war. She sent a check to rebuild the town’s hospital. In return, she was made an honorary citizen. She wrote a thank-you:

‘Nothing that has happened to me before has ever pleased and touched me as much as this honor which you and the Municipal Court of Vimoutiers have paid me.’

She intended to visit the town, but was killed in a car crash in 1949. She was dead…but she left things behind that would be remembered and appreciated for generations.

Another Era

Back then, Americans were known for acts of kindness and generosity. The US economy boomed. Its lunch-bucket workers and wealthy investors grew richer together. Its dollar was the strongest currency in the world — backed by gold. Its trade with the rest of the world was in balance. So was its federal budget.

One generation comes on the scene. Another departs. What does it leave behind?  In order to have something to leave, you must save. In order to save, you have to make more than you spend. That is, you have to take some of your output and set it aside. It is the part of your harvest you did not eat. It is the money you made, but did not spend. It is the trees you planted, but did not cut down…the houses you faithfully maintained…the public buildings you did not blow up.

But instead of encouraging saving, for the last 30 years, at least, the Fed has lured people to borrow and spend. It rewarded borrowers with the lowest interest rates in 5,000 years. It punished savers, leaving them with a return on their money that was, after inflation, negative.

Our generation, those of us born after The Second World War, was lucky. Jobs were plentiful. Housing and transportation were (relatively) cheap. And, since 1980, our assets — houses and stocks — rose. But we were lucky in other ways too.

Our grandparents had brought forth the power of fossil fuels…greatly improving US output and giving us the richest country on earth. Our parents had just trounced Germany and Japan. Then, Eisenhower cut ‘defense’ spending, balanced the budget, protected the dollar, and warned us not to let the ‘military industrial complex’ get too big for its britches.

The War Corps

All over the world, people looked to America for leadership…as a country that would do the right thing…whose technology, books and movies set new standards…and whose institutions could be imitated. And for good reasons. The Marshall Plan was an American initiative to rebuild Europe, at a cost of $173 billion (in today’s money). American donors rebuilt Versailles and other priceless monuments. Private US citizens contributed to rebuilding churches…and restoring whole towns. Privately-supported charities, missionaries and relief organisations rushed to the Balkans, the Middle East, Africa and the Far East offering whatever help they could. In 1961, John F. Kennedy created a ‘Peace Corps’ which was intended to promote progress and harmony throughout the undeveloped world. In 1966, Jimmy Carter’s mother — at age 68 — signed up for service in India.

But how things change!

The Peace Corps today is a legacy project of an earlier age, with a tiny budget, less than 1/10th of 1% of Pentagon spending. 

America still has no real enemies in the world — except for those it has created itself — Iraq, Afghanistan, Russia, Palestine, China, Iran.

General Eisenhower brought military spending down. But it didn’t stay down. For the last 40 years, defence spending has gone up year after year. The old general was right…military/industrial complex lobbyists put our representatives in their pockets, like nickels and dimes. Now, the US spends more than the next 10 largest counties — combined. Little of this has much to do with defence — which could be accomplished with a lean, mean Eisenhower-style military at approximately one-third the present cost.    

When we were young, we had a nation that was the envy of almost the whole world…with a huge net investment position with the rest of the planet. Today, we are the world’s biggest debtor, with an annual trade deficit of nearly $1 trillion.

And now, even the Industrial Revolution seems to have run its course. We can introduce new machines, but we get only incremental gains. The use of traditional fuels is actually going down in the US.

Mea Culpa

As for the balanced budget, don’t make us laugh. The measure of our forward progress is the difference between what we produce and what we consume…and how it is used. It determines what we leave to our children.  

But today’s US budget deficit — at 7% of GDP — leaves little for the next generation. Little is left to build new factories and create new jobs. As for rebuilding the factories of the Eastern Ukraine or hospitals of Gaza — who’s going to do that? Instead, we borrow more money to provide weapons to the Ukraine and Israel…so they can blow them up.

Back in the US, our existing capital base — our manufacturers, infrastructure, schools and hospitals — wear out. How can they be replaced?

And we, the Baby Boomer generation…we have presided over a degradation of the USA in almost every category. Financial, economic, political, technological, moral…

…what do we have to say for ourselves?  

And what do we do when it becomes impossible to keep living in the style to which we’ve become accustomed? Do we own up…and straighten up?  

Or print more money?

Regards,

Bill Bonner,
For Fat Tail Daily