wknd notes: Indistinguishable from the Real Thing

“I don’t think we’re well prepared at all. And I don’t think the public is aware of what’s coming,” said the Chairman of the House Intelligence Committee. He was discussing the rapid advance of synthesis technology. This new artificial intelligence capability allows competent programmers to create audio and video of anyone, saying absolutely anything. The creations are called “deepfakes” and however outrageous they may be, they’re virtually indistinguishable from the real thing. No sooner had we adjusted to a world where our reality seemed fake, then things that are fake became our reality. “We’re outgunned,” said a UC Berkeley digital-forensics expert, “The number of people now working on video-synthesis outnumber those working on detecting deepfakes by 100-1.” Twitter suspended 4,779 accounts it believed are associated with Iran’s theocratic leaders. It republished every tweet sent by these accounts to help researchers analyze and spot behavioral patterns. Already two-thirds of Americans say altered images and videos have become a major problem for understanding the basic facts of current events. Misinformation researchers warn of growing “reality apathy” whereby it takes so much effort to distinguish between what’s real and fake that we simply give up and rely on our base instincts, tribal biases, impulses. Immersed in our leader’s deceits, we come to believe in nothing. Two oil tankers burst into flames, billowing smoke. On cue, a suspicious Iranian Revolutionary Guard boat appeared on grainy video. Viral images flooded earth’s nine billion screens. Each side told a different story. No one quite knew who to trust. Conspiracy theories filled the void, as we each clung to what we most want to believe. And as truth slowly slipped away, we turned to market prices as our proxy for reality; oil prices fell, stocks rallied, volatility declined. But of course, it is precisely because market prices still retain some reflection of reality that our policy makers and politicians work so desperately to manipulate them. 

Week-in-Review (expressed in YoY terms): Mon: China exports +3.8 to +1.1% (imports plunge -8.5%), Chinese May mthly rare earth exports -15%, Chinese foreign reserves +$6bln to $3.01trln, Japan Q1 GDP revised +0.1 to +2.2%, Indonesia CPI +3.3% (1yr high), Trump cancels plan to impose Mexican tariffs, Mexico pledges to ratify USMCA trade agreement next week, US job openings retreat from near record highs, DOJ agrees to turn over Mueller report evidence to House, S&P +0.5%; Tue: Russia to deliver S-400 missile system to Turkey in July (US demands Turkey cancel purchase), Junker “Brexit deal will not be renegotiated,” EIA cuts 2019 global oil demand, US PPI -0.4 to +1.8% (core -0.1 to +2.3%), Trump “US has very low inflation - beautiful thing!”, PPI +0.4 to +2.2% (core PPI +0.1 to +2.3%), S&P flat; Wed: Chinese CPI +0.2 to +2.7% (pork prices +18.2%, food prices +7.7%), China core CPI -0.1 to +1.6%, China PPI -0.3 to +0.6%, Foxconn announces it has capacity to move all iPhone assembly from China if required, Hong Kong protests over extradition legislation turn violent, Japan machinery orders +3.2 to +2.5% (6mth high), South Korea unemployment rate -0.1 to 4.0%, oil falls -3.7% on stockpile build, global ETFs see first net mthly outflow in 5yrs ($140bln YTD inflows shrink -19% from first 5mths of 2018), US CEO confidence falls for 5th month, CPI -0.2 to +1.8% (core CPI +2.0%), S&P -0.2%; Thur: Hong Kong protests continue, Aussie unemployment unch at 5.2%, two oil tankers attacked in Gulf of Oman (US blames Iran), S&P +0.4%; Fri: Chinese industrial output 17yr low, India CPI -0.5 to +2.45%, Russia cuts 25bps to 7.5% (1st cut in a year), non-Opec supply increases exceed Opec output cuts, Moody’s cuts Turkey rating deeper into junk, German 10yr bund yields record low -0.27%, US capacity utilization +0.2 to 78.1, S&P -0.2%; Sat/Sun: Hong Kong indefinitely suspends extradition bill following mass protests, India hikes tariffs on US imports in retaliation.

Weekly Close: S&P 500 +0.5% and VIX -1.02 at +15.28. Nikkei +1.1%, Shanghai +1.9%, Euro Stoxx +0.4%, Bovespa +0.2%, MSCI World +0.5%, and MSCI Emerging +1.5%. USD rose +1.8% vs Australia, +1.2% vs Sterling, +1.1% vs Chile, +1.1% vs Euro, +1.1% vs Canada, +1.1% vs Turkey, +1.0% vs Sweden, +0.5% vs Brazil, +0.5% vs India, +0.4% vs Indonesia, +0.3% vs Yen, and +0.2% vs China. USD fell -6.7% vs Bitcoin, -4.0% vs Ethereum, -2.4% vs Mexico, -1.0% vs South Africa, and -0.6% vs Russia. Gold +0.0%, Silver -1.1%, Oil -2.8%, Copper +0.3%, Iron Ore +6.3%, Corn +6.8%. 5y5y inflation swaps (EU -10bps at 1.13%, US -6bps at 2.01%, JP -1bp at 0.11%, and UK -4bps at 3.66%). 2yr Notes -1bp at 1.84% and 10yr Notes flat at 2.08%.

YTD Equity Index Returns: Greece +35.2% priced in US dollars (+38.2% priced in euros), Russia +24.9% in dollars (+15.6% in rubles), NASDAQ +17.5%, Canada +15.7% (+13.8%), S&P 500 +15.2%, Argentina +15.2% (+33.9%), Switzerland +15.1% (+16.8%), China +14.8% (+15.6%), Saudi Arabia +14.3% (+14.2%), Australia +13.1% (+16.1%), Israel +13% (+8.5%), Russell 2000 +12.9%, New Zealand +12.4% (+16.2%), Germany +12.2% (+14.6%), Thailand +11.4% (+6.9%), Portugal +11.3% (+13.7%), Denmark +11.1% (+13.4%), France +11% (+13.5%), Netherlands +11% (+13.4%), Brazil +10.8% (+11.6%), Italy +10.2% (+12.5%), Euro Stoxx 50 +10.2% (+12.6%), Ireland +9.9% (+12.3%), Colombia +9.8% (+10.5%), India +8.6% (+8.8%), South Africa +8.3% (+11.6%), Norway +8.1% (+7.9%), Philippines +8% (+7%), UK +7.9% (+9.2%), Japan +7.3% (+5.5%), Sweden +6.6% (+12.8%), Mexico +6.3% (+3.6%), Spain +5.4% (+7.7%), Czech Republic +5.2% (+6.6%), HK +5% (+4.9%), Austria +4.9% (+7.1%), Taiwan +4.9% (+8.2%), Belgium +4.5% (+6.8%), Singapore +4.3% (+5%), Finland +4% (+6.2%), Indonesia +2.1% (+0.9%), Poland +1.4% (+2.4%), Hungary +1.2% (+3.7%), UAE +1% (+1%), Chile -1.8% (-0.9%), Korea -3.6% (+2.7%), Malaysia -3.9% (-3.1%), Turkey -10.7% (-0.5%).

One of Eight: “One million protesters took to the streets,” he said from Hong Kong, on one of those private phones. “That means one out of every eight people on this island is defying the government, aware of the stakes, the consequences, and putting themselves and their families at great risk.” Hong Kong is a surveillance state, blanketed in cameras, streaming data through facial recognition programs, saved on servers, in perpetuity. Infinite memory. “They’re fighting legislation that if passed will empower Beijing to have them extradited for their defiance.”

One of Eight II: “The Tycoons have already established their Plan B,” he continued from Hong Kong. “They started moving money years ago. But most of the 8mm residents here are poor. This is their country, their life, they can’t leave.” When the Brits turned HK over, China agreed to leave its system intact through 2047. Beijing has been pulling that timeline forward. Once it changes, the HK we’ve always known is gone for good. “Back in 1967, it seemed unimaginable that Beirut would ever be anything but Paris of the middle east. By 1968 it was rubble.”

One of Eight III: Hong Kong suspended the extradition legislation in response to threats of ever greater protests. One million brave, united citizens forced the gov’t to blink, and destabilizing consequences for the mainland are now in motion. The impact on the trade/tech conflict with the US should not be underestimated. And as news of this triumph slips through Beijing’s sensors, the risks protestors took will inspire an unknown percentage of the 1.4bln Chinese living under surveillance, denied rule of law, longing for liberty. Some will rise. But will it be one of eight?

Free Markets: Not a single person in power wants truly free markets. Central banks were established specifically to tame them. Sweden was first, in 1668. There’s nothing they won’t do to deny the reign of free markets. In 1992 the Riksbank hiked overnight interest rates to 500%. Today the Swedes have set rates at -0.25%. They’re not alone. Japan’s central bank owns over 100% of GDP in Japanese debt. But the ultimate example of market manipulation is the simple fact that $12trln worth of bonds now trade at negative interest rates. 

Free Markets II: It’s not just central banks that stand in opposition to free markets. Politicians do too. So do entrenched corporate interests, their greatest fear is change, disruption, creative destruction. Naturally Opec opposes free markets. as does every commodity producing nation on the planet. But despite the weight of these collective forces opposing free markets, prices still manage to move, sometimes freely, often influenced. And even in those dark corners of the world, under threat of death, black market exchange rates fluctuate as money changes hands.

Free Markets III: Two tankers exploded in the Gulf, not a single market closed. Oil rallied 4% on the news, but by week’s end closed -2.5% from the previous Fri. Where would it have closed in the absence of a march toward war with Iran? Is the oil price telling us there will be no war? Or that we’re headed to global recession regardless? An aerospace/defense ETF closed the week -2.2%. Russian stocks +1.6%. Israeli stocks +0.8%. Saudi stocks +0.5%. Bahrain +0.9%. Qatar +1.75%. S&P +0.5%. Gold flat. VIX fell. And the US dollar jumped on Iran’s black market.  

Telling Tales: US bond yields peaked in Nov as markets expected additional upward rate manipulations by the Fed. Markets forced them to reconsider. Yields repriced violently. And now for some odd reason, investors once again seem to care what the Fed Chairman thinks and says. Anyhow, the forces at play are not isolated to the US. Markets are global. Here’s what they’re telling us: In Nov 2018 US 2y yields peaked at 2.96% (they’re now 1.84%), US 10yr yields peaked at 3.24% (they’re now 2.08%). German 2yrs peaked at -0.57% (now -0.70%), 10yrs peaked at 0.45% (now -0.26%). Japan 2yrs -0.13% (now -0.20%), 10yrs 0.13% (now -0.13%). Australia 2yrs 2.08% (now 0.99%), 10yrs 2.76% (now 1.37%). Canada 2yrs 2.35% (now 1.38%), 10yrs 2.54% (now 1.43%). UK 2yrs 0.83% (now 0.59%), 10yrs 1.56% (now 0.84%). Italy 2yrs 1.37% (now 0.39%), 10yrs 3.61% (now 2.34%). And the only market that tells a slightly different tale is China where 2yrs were 2.79% (now 2.79%), and 10yrs were 3.54% (now 3.25%).

Anecdote: “So Jackson was named All-American, First Team All-State, First Team All-FCIAC, and won the State Championship -- any reason I had to hear this 2nd hand?” asked Coleman. He was Jackson’s 8th grade lacrosse coach and has turned out more All-Americans than just about any American. Not a single player will forget their season with him. The smartest ones stay connected forever. When I grew up, I was blind to the value of filling my world with people like Coleman. But decades of trial, error, success and failure, taught me to seek out extraordinary coaches, mentors, guides. Helping my children learn that lesson early is the greatest gift I’ll ever give. “He really dropped the ball Coleman. You obviously should’ve been his first call, I clearly have more work to do with him,” I said. He laughed, he knows my son in ways few others do, in ways I don’t. He spotted Jackson when we moved east, then did what great coaches do, developing the player, the person. Behind the scenes, I encouraged Jackson to involve Coleman in his life, to seek his counsel, to be fully transparent, share his fears, frustrations, triumphs, failures, obstacles. There have already been a few bumps, and as a high-school junior, life’s challenges have only just begun. He’ll need support. No one wins this game alone. “Time to start preparing Jax for what comes next,” said Coleman. “His senior year will be fun, easy, his skills will develop naturally. But he’ll soon leave you and Mara, his brothers and sister.” In thirteen-months Jackson heads to the U.S. Naval Academy, a nine-year commitment. “My Military Academy boys are a special group. And they all return wishing they’d appreciated how precious that last year with their family would be,” said Coleman. “So I need to help Jackson learn to treasure the little time he has left with you all.”

Good luck out there,

Eric Peters

Chief Investment Officer

One River Asset Management

Disclaimer: All characters and events contained herein are entirely fictional. Even those things that appear based on real people and actual events are products of the author’s imagination. Any similarity is merely coincidental. The numbers are unreliable. The statistics too. Consequently, this message does not contain any investment recommendation, advice, or solicitation of any sort for any product, fund or service. The views expressed are strictly those of the author, even if often times they are not actually views held by the author, or directly contradict those views genuinely held by the author. And the views may certainly differ from those of any firm or person that the author may advise, drink with, or otherwise be associated with. Lastly, any inappropriate language, innuendo or dark humor contained herein is not specifically intended to offend the reader. And besides, nothing could possibly be more offensive than the real-life actions of the inept policy makers, corrupt elected leaders and short, paranoid dictators who infest our little planet. Yet we suffer their indignities every day. Oh yeah, past performance is not indicative of future returns.