THIS IS NOT INVESTMENT ADVICE. INVESTING IS RISKY AND OFTEN PAINFUL. DO YOUR OWN RESEARCH.

Last week at this time, investors and the world were wondering if an attack on Iran would spiral into a broader war. Since then, oil prices plunged nearly 20% (shown below), and the focus shifted to TALO. The White House criticized Canada for having the audacity to do to the US what China did—retaliate where it hurts. China restricted rare earth exports, while Canada imposed digital taxes. Same idea.

Given that Iran is now in the rearview mirror, where does that leave us? A few thoughts on markets below.

Before I jump in, however, two podcasts. First, I spoke last week with Democratic Congressman Jim Himes, who accurately predicted the policy with Iran and also shared his thoughts with what is going on in DC more broadly. Among other interesting points: Congress won’t constrain spending until a crisis emerges. This suggests ever-larger deficits until long-end bond yields spike. Other countries are balancing their budgets; the US, not so much.

Second, a past guest, Dr. Alexander Vanyukov, was labeled a “foreign agent” by Russia last week. You can hear our 2021 conversation here. Alexander is a friend and a remarkable person—the type a government should treasure. You can hear why in this podcast. During COVID, his hospital was on the front lines, and among other innovative solutions, he called for volunteers in a notoriously cynical society and recruited soccer hooligans to care for grandmothers. I’m not making this up. That Russia is punishing someone like him shows how far the government has veered off course, alienating talent, as it has for generations. Russia is dangerous, and the US will likely abandon Ukraine to Russia’s grip as fall approaches and US funding dries up. While it won’t happen this fall, if Russia isn’t contained, other countries will end up in Ukraine’s situation. We all know the story; Alexander’s conversation puts a human face on it.

Regarding the markets, three big themes stand out: AI, slowing growth, and tariffs.

* This week, AI went haywire; the NASDAQ surged nearly 4% and is now up 4.5% for the year. But this had little to do with AI. Instead, it was driven by a) the realization that Iran was foreign policy Kabuki and b) expectations the Fed is about to cut interest rates. But why “b”? Not because the Fed said so. The Fed chief stated the opposite in two days of testimony, emphasizing they are in no hurry to cut rates. Yet, the market anticipates rate cuts and priced in another 25 basis points of cuts just as tariffs are set to kick in and drive up prices. As a result, rate expectations shifted significantly, the yield curve steepened, and stocks soared. We now have a sense of what will happen when rates are cut, though I suspect that won’t happen for a while. The line below shows the change in discounting.

* Growth is slowing, slowly and at various paces in different countries. If you look at where unemployment is above average and yet bond markets are discounting relative strength, some of the smaller countries on the periphery stand out, like New Zealand and Sweden. That said, our perception is that growth is gradually slowing everywhere. Most governments are reducing spending, private sector borrowing is lackluster, and unemployment is rising, so incomes are falling. In short, where is the fuel for a boom, outside of AI?

* Tariffs are coming. We just don’t know how much or when, and everyone is confused. If I were the Fed, I’d stick to my guns and hold off on rate changes until inflation and employment data clarify the situation. If I were in the White House, I’d delay the tariffs because signing these deals is clearly tough. If I were Canada or China, I’d do exactly what they are doing. How many times has the US Commerce Secretary said a flurry of deals was just around the corner? The net effect of the uncertainty is loose monetary policy globally (as growth slows), and the net effect of technology is deflation, so the rally in assets (stocks and bonds) might just be getting started. However, the focus could shift to Asia, which a) has strong technology, b) has lagged the equity rally, and c) is increasingly focused on shareholder returns.

This document is strictly confidential and is intended for authorized recipients of “A Letter from Paul” (the “Letter”) only. It includes personal opinions that are current as of the date of this Letter and does not represent the official positions of Kate Capital LLC (“Kate Capital”). This letter is presented for discussion purposes only and is not intended as investment advice, an offer, or solicitation with respect to the purchase or sale of any security. Any unauthorized copying, disclosure, or distribution of the material in this presentation is strictly forbidden without the express written consent of Paul Podolsky or Kate Capital LLC.

If an investment idea is discussed in the Letter, there is no guarantee that the investment objective will be achieved. Past performance is not indicative of future results, which may vary. Actual results may differ materially from those expressed or implied. Unless otherwise noted, the valuation of the specific investment opportunity contained within this presentation is based upon information and data available as of the date these materials were prepared.

An investment with Kate Capital is speculative and involves significant risks, including the potential loss of all or a substantial portion of invested capital, the potential use of leverage, and the lack of liquidity of an investment. Recipients should not assume that securities or any companies identified in this presentation, or otherwise related to the information in this presentation, are, have been or will be, investments held by accounts managed by Kate Capital or that investments in any such securities have been or will be profitable. Please refer to the Private Placement Memorandum, and Kate Capital’s Form ADV, available at www.advisorinfo.sec.gov, for important information about an investment with Kate Capital.

Any companies identified herein in which Kate Capital is invested do not represent all of the investments made or recommended for any account managed by Kate Capital. Certain information presented herein has been supplied by third parties, including management or agents of the underlying portfolio company. While Kate Capital believes such information to be accurate, it has relied upon such third parties to provide accurate information and has not independently verified such information.

The graphs, charts, and other visual aids are provided for informational purposes only. None of these graphs, charts, or visual aids can of themselves be used to make investment decisions. No representation is made that these will assist any person in making investment decisions and no graph, chart or other visual aid can capture all factors and variables required in making such decisions.

THIS IS NOT INVESTMENT ADVICE. INVESTING IS RISKY AND OFTEN PAINFUL. DO YOUR OWN RESEARCH.

This week, we learned a few things.

First, we learned the big round of central bank easing is probably over. For assets in general (stocks and bonds) to go up, the total amount of printing (easing) needs to increase. While the Fed wasn’t easing, most other central banks were. This week, the Bank of Canada and the European Central Bank said they don’t see the need to ease further (though the ECB cut rates). There is no pressure on the Bank of Japan to ease. Moreover, a report today on US unemployment was fine, which means there is no urgency for the Fed to cut rates.

We went from central bank easing (COVID), to tightening (2022), to easing (2024–now), to today’s no expected easing. There had been a broad belief that erratic White House policy would deal a blow to the US and global economy, forcing the Fed to ease. So far, policy seems to have dealt a significant blow to all of our attention spans but not the economy. This is miraculous, but the data suggests it is true. There is a lot of second-tier data showing slowing hiring, but not enough to move the Fed, which means we must now wait for another month. Perhaps the deportations are shrinking the available pool of labor and keeping unemployment down?

Second, we learned a fiscal bill is almost certain to be passed soon in the US, with the deficit clocking in at somewhere between 6% and 7%. The only entity that can borrow at scale at these interest rates is the US government. To increase private sector borrowing, interest rates must come down. To get interest rates down, government borrowing must decrease, and that doesn’t look like it will happen. This bill is going to be passed despite many thoughtful people saying the same thing Musk is, which is that the deficit is too big. The conversation I share here with Pennsylvania Senator David McCormick (and my former boss) sheds light not only on his new book, Who Believed in You? (co-written with his wife, Dina), but also on what the budget debate looks like from the perspective of a US Senator. As he makes clear, President Trump believes he has a clear mandate to cut taxes, so cut taxes he will. This package, combined with the healthy jobs data, suggests that interest rates could move higher. At some point, this hurts the stock market because why take a flier on AI stocks when a 30-year bond pays you 5.5%? And as we figure this out, listen to Dave and Dina’s advice and both seek out great mentors and try to provide the same for others.

Third, we learned that trade uncertainty is going to last a long time. Remember that US trade partners were supposed to submit their offers on Wednesday? Nothing doing. Many other deadlines have come and gone. The US has less leverage than it appears. The global trading system is complex and has evolved over decades. So, the US can get justifiably upset about fentanyl, but then China finds a lever to hurt the US (rare earths), and the conflict goes slow. Xi made ample time to meet with Belarus’s Lukashenko last week and scarce time to talk to Trump. Why rush? China, like Russia, believes it is winning. This trade uncertainty is one more reason why the Fed will do nothing unless unemployment rises sharply. The tariffs are high, well over 10%, so at some point, this should whack spending, as should higher interest rates.

Fourth, we learned that billions of dollars in conventional military spending are not effective against drones. If Ukraine can take out Russia’s bombers with drones, then the same can happen to any other major power. This means in a dangerous world, where conflict in Asia can erupt at any moment, the fundamental techniques of modern warfare are in flux and it is less clear who has the upper hand.

Where does this leave me?

The AI boom is real and ongoing.

The Fed (and other central banks) are on hold until unemployment goes up, which means bond yields will probably go to the upper end of their range.

Institutional investors are wary of a pro-risk stance (long stocks, short bonds) because of what happened in April (stocks down 20%) and the ongoing haze of tariffs. This probably makes it more likely for stocks to crawl higher.

The value of assets that have little to do with the above, like stable cash flow stocks or idiosyncratic bonds, is high, as are assets that can hedge geopolitical conflict.

NOTE TO READERS: I’m at a conference next week, so unlikely I’ll have time to post.

This document is strictly confidential and is intended for authorized recipients of “A Letter from Paul” (the “Letter”) only. It includes personal opinions that are current as of the date of this Letter and does not represent the official positions of Kate Capital LLC (“Kate Capital”). This letter is presented for discussion purposes only and is not intended as investment advice, an offer, or solicitation with respect to the purchase or sale of any security. Any unauthorized copying, disclosure, or distribution of the material in this presentation is strictly forbidden without the express written consent of Paul Podolsky or Kate Capital LLC.

If an investment idea is discussed in the Letter, there is no guarantee that the investment objective will be achieved. Past performance is not indicative of future results, which may vary. Actual results may differ materially from those expressed or implied. Unless otherwise noted, the valuation of the specific investment opportunity contained within this presentation is based upon information and data available as of the date these materials were prepared.

An investment with Kate Capital is speculative and involves significant risks, including the potential loss of all or a substantial portion of invested capital, the potential use of leverage, and the lack of liquidity of an investment. Recipients should not assume that securities or any companies identified in this presentation, or otherwise related to the information in this presentation, are, have been or will be, investments held by accounts managed by Kate Capital or that investments in any such securities have been or will be profitable. Please refer to the Private Placement Memorandum, and Kate Capital’s Form ADV, available at www.advisorinfo.sec.gov, for important information about an investment with Kate Capital.

Any companies identified herein in which Kate Capital is invested do not represent all of the investments made or recommended for any account managed by Kate Capital. Certain information presented herein has been supplied by third parties, including management or agents of the underlying portfolio company. While Kate Capital believes such information to be accurate, it has relied upon such third parties to provide accurate information and has not independently verified such information.

The graphs, charts, and other visual aids are provided for informational purposes only. None of these graphs, charts, or visual aids can of themselves be used to make investment decisions. No representation is made that these will assist any person in making investment decisions and no graph, chart or other visual aid can capture all factors and variables required in making such decisions.

THIS IS NOT INVESTMENT ADVICE. INVESTING IS RISKY AND OFTEN PAINFUL. DO YOUR OWN RESEARCH.

A confluence of events caught my attention this week. Here’s what I noted:

* The Chief Justice of the Supreme Court verbally intervened to defend the judiciary.

* The Federal Reserve said they won’t raise rates if tariffs boost inflation, but they will cut them if tariffs hurt growth.

* The April 2 deadline to impose sweeping, across-the-board tariffs (the administration is calling it “Liberation Day”) turns out to be a day where they might announce high tariffs—subject to discussion and lawsuits, which could take months—rather than implement them.

* Technical, flow-based measures on the stock market became more two-sided and possibly, temporarily, supportive.

I suspect a bear market has been set in motion, but there will be ebbs and flows. The ingredients for the bear market are high valuations, tariffs, and long positioning. I say “suspect” because, so far, we lack hard data on a sharp decline in actual economic activity, which will be required for the bear market to manifest. We only have soft data that reflects high uncertainty. The key question is—will many people lose their jobs? So far, fears of this have skyrocketed, but actual evidence of mass firings is scant. If tariffs are aggressively implemented, firings will come.

Recent bear markets unfold in five stages—down, up, down, up, and down—and it is only in the final down phase that most investors finally retch into a can, declare defeat, and swear off stocks. Timing such ebbs and flows is devilishly complex, and even the best practitioners can capture only parts of them, which is why bear markets are so destructive to wealth. Either they hurt your compounding (some popular stocks like Meta fell as much as 70% only a few years ago), or shorting them causes massive oscillations in wealth and mood.

As a result, once a bear market arrives, I look for catalysts that could catch people unawares—either making things worse or leading to a squeeze higher. This week has a number of them, hence this note. I’ll discuss each in turn as well as, further down, introduce my podcast guest.

The administration launched a policy blitzkrieg, large parts of which have been judged illegal. These challenges will now make their way through the courts. Musk and the administration have attacked judges who challenged their decisions. As a result, Chief Justice Roberts stated:

“For more than two centuries, it has been established that impeachment is not an appropriate response to disagreement concerning a judicial decision. The normal appellate review process exists for that purpose.”

He is making it clear that the Supreme Court is not, unlike the Senate, a pliant observer. They want to uphold the balance of power.

Second, the Fed met this week and did nothing in terms of policy but did provide guidance. Powell dismissed inflationary pressure in the data as irrelevant. In essence, he said that if the Fed sees any weakness in growth, they will cut rates, regardless of inflation. Stocks and bonds rallied, but now bonds are priced such that if any data turn out not to be weak, bonds will run into a problem, which will then hurt stocks.

Third, the administration went quiet on tariffs—until this morning when Trump tweeted about Liberation Day. In recent months, any time key administration members opened their mouths about tariffs, stocks promptly fell, which is what happened again today. What exactly happens on April 2? We don’t know. It may be a day when they claim to apply tariffs but, in reality, only name their levels.

I try to visualize the incentives of different leaders. While Putin operates with geopolitical and territorial ambitions involving overt aggression, Trump’s approach is centered at least as much on maintaining prominence in the national conversation. These are different objectives. In Trump's case, the trade policy narrative—like the use of tariffs—can function as a serialized story, drawing ongoing attention much like a long-running TV drama. So, an April 2 announcement may simply transition into the next chapter or it may be something more dire. To help frame my understanding, I interviewed Jennifer Dresden, a strategist at Protect Democracy.org and an expert in authoritarianism. I found the conversation helpful and hope you do as well.

Lastly, stock market flows: There is a cottage industry of people who analyze equity flows at major banks. The net of this “wisdom” now is that a lot of fast money (like commodity trading advisors) is short stocks, meaning that if pension funds or others come in to buy stocks at the end of the quarter, they could trigger a short squeeze and drive stocks (temporarily) sharply higher.

Eventually, I suspect protracted drama will crush the economy, but it may take a while. We have yet to see hard data demonstrating this. Until we do, US stocks might go violently sideways or even up. If evidence emerges that this policy is hurting growth, watch out—markets will move so fast you won’t be able to keep up. Bear markets are tough. I’m told that teams of traders have already been fired due to the AI rout.

This document is strictly confidential and is intended for authorized recipients of “A Letter from Paul” (the “Letter”) only. It includes personal opinions that are current as of the date of this Letter and does not represent the official positions of Kate Capital LLC (“Kate Capital”). This letter is presented for discussion purposes only and is not intended as investment advice, an offer, or solicitation with respect to the purchase or sale of any security. Any unauthorized copying, disclosure, or distribution of the material in this presentation is strictly forbidden without the express written consent of Paul Podolsky or Kate Capital LLC.

If an investment idea is discussed in the Letter, there is no guarantee that the investment objective will be achieved. Past performance is not indicative of future results, which may vary. Actual results may differ materially from those expressed or implied. Unless otherwise noted, the valuation of the specific investment opportunity contained within this presentation is based upon information and data available as of the date these materials were prepared.

An investment with Kate Capital is speculative and involves significant risks, including the potential loss of all or a substantial portion of invested capital, the potential use of leverage, and the lack of liquidity of an investment. Recipients should not assume that securities or any companies identified in this presentation, or otherwise related to the information in this presentation, are, have been or will be, investments held by accounts managed by Kate Capital or that investments in any such securities have been or will be profitable. Please refer to the Private Placement Memorandum, and Kate Capital’s Form ADV, available at www.advisorinfo.sec.gov, for important information about an investment with Kate Capital.

Any companies identified herein in which Kate Capital is invested do not represent all of the investments made or recommended for any account managed by Kate Capital. Certain information presented herein has been supplied by third parties, including management or agents of the underlying portfolio company. While Kate Capital believes such information to be accurate, it has relied upon such third parties to provide accurate information and has not independently verified such information.

The graphs, charts, and other visual aids are provided for informational purposes only. None of these graphs, charts, or visual aids can of themselves be used to make investment decisions. No representation is made that these will assist any person in making investment decisions and no graph, chart or other visual aid can capture all factors and variables required in making such decisions.

THIS IS NOT INVESTMENT ADVICE. INVESTING IS RISKY AND OFTEN PAINFUL. DO YOUR OWN RESEARCH.

Today, I want to share a podcast, a China update, and discuss the D.C. fiscal/monetary standoff.

Podcast

Bill Bishop writes the Sinocism Substack. I find reading Bill’s missives helpful in keeping me on top of what is going on in China and wanted to hear his story, which I think you will find interesting as well. This relates to the second topic, what will happen in China?

China

China is the second biggest economy in the world and because the volatility of its growth is higher than the volatility of US growth, is more important than the US in determining the swings in growth. There are a number of assets that are cheap … if China rebounds. But these assets, like commodities and the stocks of companies whose earnings are significantly influenced by China, are traps if China doesn’t solve its challenges. It’s also true deflationary pressures globally will intensify if China continues to struggle. That’s important for monetary policy everywhere.

To put numbers around the problem, China is a $19T economy with roughly $8T of bad debt, mostly tied to real estate developers and local governments. Defining what exactly “bad” is isn’t straightforward; a debtor who is having trouble repaying their debts qualifies. Once the debt is bad, the economy can freeze. The debt is a contract that then needs to be re-negotiated or defaulted on. This is the same thing that happened in the US in 2008. A chunk of income goes to servicing the debt, hurting demand. Corporate profits in China are declining, down 7.5% in November from a year ago, which reflects this freeze. This is self-reinforcing and it only breaks when the government (which is the only entity that can still meaingfully borrow) borrows, prints and both weakens its currency and buys back the bad debt. It’s less ideology than physics. From what I can tell, China is not doing this. While there are a lot of policy actions, nothing seems to be tackling the debt issue in its entirety.

A system like China is different than Western systems. Power is concentrated versus dispersed. For instance, even with Republicans in control of the US White House, Congress, and Supreme Court, Trump has been buffeted. Gaetz didn’t get through, and neither did abandoning the debt limit. In China or Russia, one person controls everything. Sometimes this person is more liberal—like Deng Xiaoping or Gorbachev, and these places evolve. Sometimes this person is more conservative—like Stalin and Mao or Putin and Xi, and these places stagnate or go backward. When Xi was told his policies would produce deflation (which makes the debt squeeze worse), his answer supposedly was, “what’s wrong with that?”

That evidence suggests an authoritarian leader is doing a bad job often has little bearing on policy. Putin is killing a significant chunk of his own population (not to mention Ukrainians), and he shows no signs of letting up. Ditto Stalin and Mao, who oversaw the most costly man-made starvation in the history of governance. While I see lots of cheap assets tied to China’s growth, I can’t bring myself to buy them. It looks like bad risk/reward.

The US Monetary Fiscal Battle

When I look at the set-up going into Trump’s reign, it is also complicated. Stock valuation is high, the market is long, the budget deficit is 6% and the Fed is discounted to cut just one more time. The best aspect of the setup is that bond yields have risen 100 basis points and are now close to the top of their range.

Underneath the surface, a battle is underway. The White House agenda is tariffs and tax cuts. If Trump brings on these policies on day #1, I suspect we get a bond sell-off that is big enough to whack the stock market, possibly hard. The Fed will be reluctant to cut interest rates given that these policies are in part inflationary. They said as much earlier this month.

If Trump surprises, however, he will come out with efforts to reduce the budget deficit and cut taxes only for the middle class, not rich people. He could also talk about tariffs but not implement them. Those policy choices, plus slowing growth and inflation, would give the Fed room to cut interest rates, which can fuel another up leg in the stock market. Said differently, to get what Trump wants—a boom—he needs to give up on something else he wants—tariffs and tax cuts. I’m skeptical he will make this pivot unless the financial markets fall apart.

Trump is both powerful and unpredictable. He ran on policies not that different than Richard Nixon—law and order, strong growth, and reducing foreign entanglements (then Vietnam) with dignity. But what will Trump 2.0 mean in practice? Is he anti-immigration (Maga) or pro-immigration for hi-tech workers (Elon)? Is he for big tax cuts or reigning in wasteful spending?

It’s worth remembering that Nixon was responsible for one of the biggest financial shifts in the last 100 years—the end of the Bretton Woods system of fixed exchange rates. This did not come up in his campaign, of course. Could we be in for a change that dramatic? Maybe. A dollar devaluation would certainly spur growth and the dollar is at its highest level in real terms in decades. My plan is to wait for hard facts and adjust accordingly, perhaps substantially.

Happy New Year, and thanks for reading. I am taking a few days off in the beginning of the year, so will get back to you later in January.

This document is strictly confidential and is intended for authorized recipients of “A Letter from Paul” (the “Letter”) only. It includes personal opinions that are current as of the date of this Letter and does not represent the official positions of Kate Capital LLC (“Kate Capital”). This letter is presented for discussion purposes only and is not intended as investment advice, an offer, or solicitation with respect to the purchase or sale of any security. Any unauthorized copying, disclosure, or distribution of the material in this presentation is strictly forbidden without the express written consent of Paul Podolsky or Kate Capital LLC.

If an investment idea is discussed in the Letter, there is no guarantee that the investment objective will be achieved. Past performance is not indicative of future results, which may vary. Actual results may differ materially from those expressed or implied. Unless otherwise noted, the valuation of the specific investment opportunity contained within this presentation is based upon information and data available as of the date these materials were prepared.

An investment with Kate Capital is speculative and involves significant risks, including the potential loss of all or a substantial portion of invested capital, the potential use of leverage, and the lack of liquidity of an investment. Recipients should not assume that securities or any companies identified in this presentation, or otherwise related to the information in this presentation, are, have been or will be, investments held by accounts managed by Kate Capital or that investments in any such securities have been or will be profitable. Please refer to the Private Placement Memorandum, and Kate Capital’s Form ADV, available at www.advisorinfo.sec.gov, for important information about an investment with Kate Capital.

Any companies identified herein in which Kate Capital is invested do not represent all of the investments made or recommended for any account managed by Kate Capital. Certain information presented herein has been supplied by third parties, including management or agents of the underlying portfolio company. While Kate Capital believes such information to be accurate, it has relied upon such third parties to provide accurate information and has not independently verified such information.

The graphs, charts, and other visual aids are provided for informational purposes only. None of these graphs, charts, or visual aids can of themselves be used to make investment decisions. No representation is made that these will assist any person in making investment decisions and no graph, chart or other visual aid can capture all factors and variables required in making such decisions.

THIS IS NOT INVESTMENT ADVICE. INVESTING IS RISKY AND OFTEN PAINFUL. DO YOUR OWN RESEARCH.

There are about 45,000 Russian casualties a month now in Ukraine. That equates to a rate of 540,000 soldiers per year or about 1% of Russia’s male, fighting-age population, thus the call to North Korea to supply troops. About 15% of Russia’s population died in World War 2, so today’s losses are modest in comparison but by modern standards an incomprehensible cost for territorial gain.

Almost all of those who die come from Russia’s hinterlands. An American equivalent would be if the Pentagon emptied US jails, drafted from the poorest zip codes, sent them to attack Canada, and then gave generous cash packages to the next of kin. Some provincial Russians have even welcomed the war because the poorest, most alcoholic locals have been disposed of and replaced with a cash subsidy.

The question is if President-elect Trump will view Putin’s negotiating position as strong. I don’t know the answer. I do know Trump’s answer has vast implications for geopolitics. China is weighing Taiwan, Iran is weighing its tactic of spreading death and chaos in the Middle East. This also matters for US government finances, bond yields, and equity valuations.

Today, I want to talk about the policy choice and financial implications and also share a conversation I had with Lt. Gen (Ret) HR McMaster, Trump’s former National Security Advisor. He offers a perspective I lack and I am grateful he made the time to talk with me and allowed me to share that conversation with you.

US Policy Decision

While Republicans control the White House and Congress, there are splinters within the Party. Some are isolationists, others are internationalists. HR does not share his affiliation but he believes the US can be a force for good. If someone like Musk wants to cut government spending, he needs to slash either social security, medicare, or defense. Slashing defense would narrow the US budget deficit and be a radical restructuring of the global order.

But such a sharp jag is off-brand for traditional Republicans. A report by Senator Wicker (R. Miss) is making the rounds. It is titled “Peace Through Strength” and is clearly meant for Trump’s desk. Below is an excerpt. I put the key sentence in bold.

America’s national defense strategy and military budget are inadequate for the dangerous world in which we find ourselves. An emerging axis of aggressors is working to undermine U.S. interests across the globe. Congress and military leaders agree: The United States has not faced such a dangerous threat environment since the years before World War II.

The epicenter of this test is Ukraine. Regardless of Party, US Presidents have not wanted to deal with Russia for the last quarter century. It’s far away, has almost no economic relationship with the US, and is highly corrupt. But time and again, US Presidents have been forced to focus on Russia in a way that has sometimes sabotaged their domestic agenda. Could this happen to Trump 2.0?

Context

Putin took over on December 31, 1999. Not long after problems began developing and each US President sought their best to ignore them for the same reason—they didn’t want to engage in conflict. However, this has only allowed the situation in Russia to metastasize. This echoes the same process that unfolded in Germany in the 1930s, so Wicker’s comment is apt. While Russian assassinations at home and abroad began early in Putin’s reign, the key events where the US whiffed was when:

* Russia annexed parts of Georgia under President Bush in 2008.

* Russia annexed Crimea in 2014 under President Obama.

* Russia fired on Ukrainian ships in 2018 traveling between Ukrainian ports under President Trump.

* Russia invaded Ukraine in 2022 under President Biden.

In each case, the response was bumbling and timid. Note that Russia and the US both signed the 1994 Budapest Memorandum whereby Ukraine gave up its nukes in return for its borders being secured.

While it sounds extreme, I don’t think it is a stretch to say that this is the 1930s with Putin playing the role of Hitler and the US playing the role of UK’s Neville Chamberlain. Russia has slowly been swallowing more territory, violating international law, and threatening the West with nuclear war if the West intervenes. The assassinations on Western territory continue. Just last week, the UK foiled a Russian plot to murder investigative journalist Christo Grozev. If Putin isn’t stopped in Ukraine, I believe he will move on, possibly to the Baltics.

Fiscal Implications

The US budget deficit is currently at 6%, even as the economy is strong. This is unusual. The only solution to narrow the deficit is by raising taxes and cutting spending. The solution isn’t conceptually complicated but it is politically toxic.

But what will Trump do? From what I can tell reading McMaster’s books, Trump is conflicted. He wants to appear “strong” and also hates foreign entanglements. His ideal environments are neater, like Trump Tower or Mar a Lago or a golf course he owns. If he were to quickly sign a peace deal with Putin, I suspect Trump would look weak. But Ukraine is exactly the type of mess he wants to avoid.

To deter Russia, the US is going to need to spend a lot of money. McMaster said he thought the US defense budget needed to go from 3% of GDP to 5% of GDP. Without tax hikes, that would drive the deficit to 8% of GDP and possibly drive bond yields to 5% or 6%. This then would hit the stock and housing markets.

Since Trump got elected, US bond yields have fallen. It’s interesting and counter-intuitive unless one thinks a significant adjustment in government spending is coming. This is also a bet that the Fed will cut rates later this month, of course.

To be sure, If the Fed were strictly following an inflation mandate, they would not cut. Inflation in the US is around 3%. The target is 2%. The last major inflation print of the year comes out next week and is expected to be 3.3%. Trump confronting Putin is not in anyone’s expectations. But if he goes down that route, it certainly is not priced into markets.

This document is strictly confidential and is intended for authorized recipients of “A Letter from Paul” (the “Letter”) only. It includes personal opinions that are current as of the date of this Letter and does not represent the official positions of Kate Capital LLC (“Kate Capital”). This letter is presented for discussion purposes only and is not intended as investment advice, an offer, or solicitation with respect to the purchase or sale of any security. Any unauthorized copying, disclosure, or distribution of the material in this presentation is strictly forbidden without the express written consent of Paul Podolsky or Kate Capital LLC.

If an investment idea is discussed in the Letter, there is no guarantee that the investment objective will be achieved. Past performance is not indicative of future results, which may vary. Actual results may differ materially from those expressed or implied. Unless otherwise noted, the valuation of the specific investment opportunity contained within this presentation is based upon information and data available as of the date these materials were prepared.

An investment with Kate Capital is speculative and involves significant risks, including the potential loss of all or a substantial portion of invested capital, the potential use of leverage, and the lack of liquidity of an investment. Recipients should not assume that securities or any companies identified in this presentation, or otherwise related to the information in this presentation, are, have been or will be, investments held by accounts managed by Kate Capital or that investments in any such securities have been or will be profitable. Please refer to the Private Placement Memorandum, and Kate Capital’s Form ADV, available at www.advisorinfo.sec.gov, for important information about an investment with Kate Capital.

Any companies identified herein in which Kate Capital is invested do not represent all of the investments made or recommended for any account managed by Kate Capital. Certain information presented herein has been supplied by third parties, including management or agents of the underlying portfolio company. While Kate Capital believes such information to be accurate, it has relied upon such third parties to provide accurate information and has not independently verified such information.

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Happy Friday!

This is a fun interesting conversation. I originally posted it last month but due to how Substack is set up only a portion of you were able to hear it. So I am re-posting now for broader distribution. As we may be on the cusp of another major trade war, this conversation could not be more timely. Hamish is the President of Starbulk Carriers, which operates a fleet of boats that ship grain, iron ore and other key ingredients to global commerce all over the world. It’s an ancient business. If you understand shipping, you understand a lot more about how global trade actually works. Terms like “global supply chain” are abstract. This exchange makes that idea very concrete.

Enjoy!

Inside and outside at the same time. That is the key.

Richard Koo

THIS IS NOT INVESTMENT ADVICE. INVESTING IS RISKY AND OFTEN PAINFUL. DO YOUR OWN RESEARCH.

I read Richard Koo’s books years before I spoke to him, a conversation I share here. Richard is the first person I know to provide a comprehensive diagnosis for something evident across much of the world—weak borrowing. While many people have the capacity to borrow money, most don’t. Explaining this phenomenon is interesting in two respects. First, the propensity of the private sector not to borrow much impacts the price of many things dear to us, like stocks, bonds, and real estate. Second, Koo came up with the idea by looking at the same data as everyone else but arriving at a different, more insightful solution.

Creativity is exactly that—looking at the same thing as others but seeing a different answer. I asked Richard why he thought he was able to spot something everyone else missed. His answer was that he was an outsider and an insider at once. He is Taiwanese but speaks fluent Japanese. He was inside Nomura Bank but inside the think tank, not the trading floor. He was at the US Fed, but his formative experiences were in Asia. That’s a rare combination and while being an outsider doesn’t always feel nice, it does hone the talent of observation.

His framework explained something I first noticed in the 1990s. I was standing on a trading floor in Boston talking to our $/yen trader. On his desk, he had a Japanese newspaper advertising a 30-year mortgage at 1.5% or thereabouts. I knew interest rates in Japan were low but seeing that number was a shock. Why wasn’t everyone levering up to buy a new house? If house prices rose a few percent a year, you could borrow for free, right?

But it isn’t that simple. The tricky thing to understand about economies is how many economic relationships are self-reinforcing. For instance, if people don’t want to borrow, then interest rates are low, and real estate prices are depressed, which leads to people not wanting to borrow, which keeps interest rates low. In slightly different language, both Soros and my old boss Ray wrote about this.

Richard talks about a “balance sheet” recession. It’s an odd but powerful concept. The essence is that a borrower is cash flow positive but balance sheet negative, such that they use their cash to pay down debt, not buy stuff, which then leads to widespread economic weakness, which then leads to worse cash flow. Everyone is thrifty at once, which makes the pie shrink, which forces everyone to be yet more thrifty. John Maynard Keynes coined the term the “paradox of thrift” in 1936 after the Great Depression.

In Japan’s case, the 1990 real estate bubble left the corporate and banking sectors with terrible losses, which they slowly tried to pay off. But their frugality meant the economy was so weak they were caught in a trap. The only solution was that someone needed to spend big to get the economy to operate above potential, generate inflation, and boost nominal incomes such that debt burdens fell. That only began to happen after 20 years, in 2010, when the Bank of Japan printed a lot of money and the yen slowly weakened.

In 2008 in the US, the same thing risked happening. But this time the central bank chief was Bernanke who had studied the Great Depression and knew exactly what to do, which was force money into the system. He printed money and bought bonds and shoved dollars into bank balance sheets such that they were forced to lend it out because the interest rate on their balances dropped to zero. The Japanese mimicked his policy and are now doing much better.

Yet years after the 2008 real estate crisis, US household debt as a percentage of GDP is still falling.

The long tail of financial crises is profound. I believe China is going through the same thing now, which is why I have so little confidence in the measures Beijing has announced. As I’ve said before they are addressing symptoms—falling stocks and bond yields—not the cause, at least so far.

Which brings me to the US and the forward-looking picture. Inflation is a function of supply and demand. On the demand side, I suspect private-sector borrowing will remain weak, limiting overall demand. On the supply side, we are in an era where technology makes itself profitable by finding a way to do something bigger for less cost. In recent decades we have a) turned goods prices into deflation b) now are disrupting real estate due to remote work and c) going-forward are just scratching the surface of what we can do with services. Japan is less an outlier than the template. The pandemic inflation was the outlier.

Yes, immigration and wars can disrupt this deflationary picture and there may be World War 3 with the epicenter in Asia. A paper about that topic is evidently circulating in China now. It is a terrible thought to contemplate but within the range of expectations. Absent those forces, however, deflation almost certainly has the upper hand and Richard Koo’s work helps explain why.  

Other updates:

* My previous podcast was public but the post I shared it in was not, so it didn’t hit Apple and Spotify podcast feeds, a glitch of Substack. I will re-release the podcast so don’t be surprised when it shows up in your inbox.

* Kate Capital LLC goes live next month and for now I want to pause the payments I receive from Subscribers. I can only do so many things at once. I will continue to write, but won’t share my asset allocation and performance publicly.

* I’m watching the price action and two things stand out. First, skepticism about China. Second, the market betting Trump will win. That’s my simplest explanation of why US bonds have been selling off. Trump has said he will cut taxes and boost tariffs. That means bigger budget deficits and more inflation, which is bad for bonds. It’s that simple.

* Copies of my latest book, The Uncomfortable Truth About Money, arrive on my doorstep today and in bookstores next month. I look forward to sharing the book with you.

THIS IS NOT INVESTMENT ADVICE. INVESTING IS RISKY AND OFTEN PAINFUL. DO YOUR OWN RESEARCH.

China’s splendid isolation nurtured a particular Chinese self-perception. Chinese elites grew accustomed to the notion that China was unique—not just ‘a great civilization’ among others, but civilization itself.

On China, Kissinger, 2011

Oops…looks like I didn’t send out the link to the actual podcast. Sorry about that.

Here you go!

We know the internet is simultaneously a recent invention, integrated into every niche of our lives, and difficult to understand fully. I like to anchor theoretical questions—how does the internet actually work?—in specific case studies. Today’s podcast guest, Lev Borodovsky, creator of The Daily Shot, is one of them.

Lev has created a daily email with a pile of macroeconomic charts that thousands of people—myself included—subscribe to. Think of it like a bakery (fresh bread each morning) only the hot rolls are snapshots of macroeconomic conditions. Below is one of today’s charts. (Note the jump in hospital costs, exactly what Mario Schlosser, founder of Oscar, discussed on the previous podcast.)

Lev’s success is a revealing data point. There is an important difference between disruptive inventions and cash flow. Airplanes are a wonderful invention but the cash flow from investing in them isn’t very good. Who makes money on the internet?

We know part of the answer is behemoths like Amazon that use scale to displace Walmart and Costco. Another part of the answer is that consumers enjoy lower prices, what economists call a “consumer surplus.” But there are also individual operators with a niche product and a well-defined audience that otherwise would not exist. That’s Lev.

He created The Daily Shot by accident and his missive hits inboxes at 6 am sharp each day. It is not as widely read as, say, The New York Times, but that doesn’t matter. As long as Lev keeps his expenses contained and quality high, he has figured out how to make a profitable “bakery.” As you will hear, like any exceptional baker, he is obsessed with quality.

I have had others on the show, like Remy Munasifi and J Mintzmyer, who both also found their niches. The recipe is similar—high-quality product, niche audience. I suspect 30 years ago, Lev would have been lodged inside a lumbering media organization or perhaps The Daily Shot wouldn’t even exist. As we gain clarity about how today’s internet works, I try to imagine the future—driverless cars, swarms of drone defenders, robot caretakers. Those are all themes I am researching and looking to position in my portfolio.

Note to readers: I am offering a sale this week. I started these posts as an experiment three years ago. They have now grown into a conversation with thousands of unpaid subscribers and hundreds of paid ones. I am grateful for each subscription. A service that started at $75 now costs $700 a year. If I could offer a sliding scale based on need, I would. But I can’t. So this week, I am lowering the price to $500 a year, or $1.36 a day. Also, I’m at an investment conference this week and won’t be publishing on Friday.

Mario is a fascinating person, a tech guy disrupting the US insurance industry via a company he founded, Oscar Health. For those of us in the US, dealing with health insurance is right up there with visiting the Department of Motor Vehicles or having your toilet overflow in terms of quality experiences. The US system is expensive and of poor quality, a Kia priced like a Mercedes.

“Health care costs have been inflating at twice the CPI for 40 years,” he said.“If your job description is to manage health care costs,” which is what an insurer is supposed to do, “there is no value there.”

As a result, entrepreneurs from Google to Amazon have tried to offer a better option leading them into a thicket of regulations and local providers. Google has taken numerous bites at the apple, all failures. Mario is German, so he understands well why that system is so much more efficient while the Canadian and UK plans are not.

Beyond being an expert on health care, he has experienced the entrepreneurial roller-coaster first hand. What’s it like to IPO and see your stock fall by 90+%? A risk taker needs to be tough to withstand the punches. After all the tussle, he retains a sense of humor and curiosity that I found inspiring.