Capital Flows and Asset Markets

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(Due to client demand, we will be launching a Yen version of the fund on January 1 - please get in touch if of interest)

For a brief period in November, competition and potentially lower prices threatened to break out in the tech world, as finally some sort of competition to Nvidia’s GPU emerged in the form of the Googles’ TPU. But the gain to Google, was seen to out weight any loss to Nvidia, and the Nasdaq ended higher for the month. The weakness in Nvidia seemed to set off a brief rotation out of cyclicals and into defensives.

Away from tech, Japanese 30 year bond yields touched a new high, just shy of 3.4%.

Gold traded higher, and continues to threaten to breakout against the S&P 500, despite the continued resilience of tech.

Bitcoin was weak despite the strength of tech, and the strength of gold.

Like I said - a strange month. For Brumby Capital, it was another up month.

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Just a very short note.

Michael Green has written a very good note on how the poverty line has failed in the US. You can read it here.

There is no way to sugar coat this - Michael works far harder than me. He has systematically broken down all costs, and then adjusted them over time to show that the official poverty line is too low in the US, especially compared to the pinnacle of US worker focuses policy in the 1960s.

One issue that everyone raises, is that it is hard to adjust for improvement in quality over time. The computers we used in the 1980s, where black and white, and loaded from tape, with no internet connectivity. How can you compare?

But one bit of work I did a while ago was comparing the US minimum wage to the price of a Big Mac. In the 1960s and 1970s, you had a minimum wage that was equal to 3 Big Macs. If you thinking about someone working a low skill job, three Big Macs an hour meant you had another money for food and everything else from a hard days works. Last time I updated it in 2022, we were closer to 1.

These days, many fast food workers require food stamps to make ends meet. Arkansas is not an outlier here - you can read the report yourself.

Of course, minimum wages in many cities have risen well above US minimum wage, which remains at USD 7.25 and hour. But what the change in Big Mac to the minimum wage, and Michael Green’s note both say, are really the same thing. After the Great Depression, and two World Wars, policy makers decided that wage led growth was the key. As long as real wages rose, then the economy would be okay. But from the 1980s, we reverted to free market policies, and real wages began to fall. When I look at the world today, policy makers are groping towards real wage growth focused policies - reducing immigration, raising tariffs, large fiscal deficits - but find themselves unable to grasp the nettle of allowing prices for goods to fall relative to wages, as they would hurt asset owners. How profitable would McDonalds be today is the minimum wage could buy three Big Macs again? What would interest rates be if US minimum wage had risen in line with the increase seen from 1939 to 1980? Over that period it rose from USD 0.35 an hour to USD 3.25 - or a 1000% increase over 40 years. If we had kept that rate of increase, wages would be USD325 a hour today. That seems excessive, but then again the minimum wage has only risen by 100%. A Big Mac cost about 1.25 USD in 1980 - and sets you back USD 5 today, a 400% increase.

One great (?!?) thing about wage inflation, it does help balance government budgets. The post World War II focus on rising wages really helped the UK pay off its debts.

Logically, wage inflation seems the answers to almost every economic/political problem facing voters now - high property prices, income inequality, excessive government debt (maybe even low fertility rates?). But for some reason, both populists and left wing governments are yet to achieve it. But I think it is on its way… well that is what gold is telling me.

The other option is depression - that is falling asset prices. I think that is politically unacceptable. When everybody know the answer, eventually someone will come along and implement these policies. Just a matter of time.

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Just for a change, I am doing a video update - enjoy.

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Long time readers will know that I have become more closely focuses on politics - as that is where I think markets are constantly getting surprised. For me, politics is relentless shifting to the left. In the UK, Nigel Farage’s Reform party is outpolling Margaret Thatcher’s Conservatives (and outpolling the Labour party as well)

I see their core pledges in the most recent manifesto as pro labour - but then again all politicians make promises to help everyone.

But I was scrolling Instagram the other day, and was shocked to see these posts from the Australian Financial Review (AFR), which is the Australian version of the Financial Times or the Wall Street Journal. Its commentary could have been lifted directly from the New Socialist.

I was so surprised, I wondered if it was a scam, but as far as I can tell its legitimate, and also by far the most viewed post I can see from them. The comments are as you would expect were expressing agreement and surprise this was published.

Where politics has gone wrong, is that they have focused on raising nominal wages, but not real wages, or at least not yet. Raising real wages would require asset owners and companies to accept below inflation increases. This has happened in some parts of the markets, but not yet, and particularly in housing. Sydney house prices remain extremely elevated.

Higher taxation and higher interest rates should help with this. Australian 10 year bonds have much more to rise in my view.

Also like in the UK, in Australia an anti-immigration party, One Nation, is also surging in the polls. Many of its policies are similar to Reform UK. The question all voters are asking, how can we have record asset prices, but no money to fund the NHS, or better wages? The answer is that politically parties are afraid to take on corporations and asset owners, as they fear they will move away, or cut investment or a number of other things. But what voters want, voters get. I still expect much higher bond yields.

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In the original pro-labour thesis, the idea was that markets would be okay, but that higher yields on bonds would act as a dampener on financial assets. The reality was that we saw equities do very well. I wondered if my original thesis was wrong, and then suddenly markets are trading like I expected again. Strange days indeed. Probably the biggest tell has been the movement of gold v S&P 500. It came back to the 200MDA, and then bounced again.

I had worried we had seen a top in yields, but Japanese yields have surged again.

But at the individual stock level the weakness has been more apparent.

When I first set up Brumby, I had an idea that once it was set up, I would like to tokenise it. I mentioned it in a few meetings in NY, and was surprised by the positive response. In essence, the feedback is that clients want it, and it was already happening with a few money market funds. The big driver is that it would allow investors in a hedge fund to easily sell their position to another investor, rather than both investors having to deal with the fund administrator. This makes total sense to me.

For me, I feel like the current system for fund regulation is overly cumbersome. I understand it is in place to protect investors and to stop money laundering. The crypto sphere offers no protection for investors, and totally enables money laundering - so I understand regulators hesitation with embracing the crypto world. But when the President of the USA has his own crypto currency, it does feel like the winds of deregulation are blowing through the system.

What I am going to do here is lay out what I think would be my ideal for tokenising Brumby.

What I envision:

* To keep the current Brumby Capital with independent administrator who handles subscriptions and redemptions. This would be for investors in the traditional financial system. There would be a monthly NAV, which is the price where investors can deal at.

* I launch a Russell Clark coin, or Brumby Capital coin, where I control the entire supply.

* I make a market for Brumby Capital Coin around the NAV of Brumby Capital - but with a spread. That is if you trade Brumby Capital Coin, rather than Brumby Capital, you will need to pay a spread to get in and get out. So Brumby Capital coin will give you constant liquidity, but at a cost.

* Profits from crossing the spread of Brumby Capital Coin, get paid to Brumby Capital. That is investors in traditional hedge fund gain from other investors chopping or changing. I like this aspect of the model. Liquidity at a cost - and long term holders gaining. This will not be possible if I have to keep the token and fund separate for legal reasons. In this case profits from market making would go to me.

* A key aspect is that there would be no explicit guarantee that Brumby Capital Coin would trade around the NAV of Brumby Capital - just my intention. In other words, you would need to trust me. While this sounds problematic, I see it as moat. There are very few hedge fund managers that anyone would trust with type of product, but I think I am one of those people. The idea would be that when regulations change, I could then easily formalise the link between Brumby Capital Coin and Brumby Capital - but until that moment, you would need to trust me.

Pros

* Brumby Capital Coin would be a token, so would allow investors in other crypto assets to invest without having to enter the traditional finance world.

* For smaller investors, it would allow them to participate in Brumby Capital.

* I think the future is for all funds to be tokenised, so this would be getting ahead of the crowd.

Cons

* This structure requires the token to remain relatively small to Brumby Capital the fund. As there is no legal way invest cash from the token into securities, I would only offer Brumby Capital Coin as a convenience to small investors.

* If there was a very large inflow to Brumby Capital Coin, I would not be able to maintain a price that is representative of Brumby Capital NAV anymore. If investors go wild, there would be no way to stop a Brumby Capital coin from becoming a pump and dump. I have mixed feelings about this - I feel like anyone dumb enough to buy a Brumby Capital coin after it has spiked 100% for no good reason deserves to lose money - but I know it is not a good look.

* Even though my intentions are good, regulators may well decide that just setting up the structure is an intention to defraud (I have seen this logic from regulators before).

You may be asking, why am I publishing this note? Well I talked to some lawyers who are well versed in the crypto space, and they both recommended publishing. Their logic is that when regulators just see your actions, then they will assume the worst. When you state out loud what your actions are and why, then at least you can say you were not planning on deceiving anyone. That being said, I still feel a bit nervous about the whole thing - and for any regulators reading this, I have not actually done anything to bring this about - for the moment it is just words and ideas. Whether I go forward with this idea (or some variation) will largely rest on the response to this post. I will update you all in due course.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit www.russell-clark.com/subscribe

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The way I work is pretty simple. I look at the where we are today, look at when was similar in the past, and then position my portfolio to make money if past repeats itself. I looked at the current politics of tariffs, and anti immigration, and thought that we would see wage rise significantly. In my mind this would drive inflation unless central banks raised interest rates significantly. This led me to being long gold and short treasuries. This trade has been good.

I tried to find a long term graph to quantify how far this could run. When looking at this graph, it suggested a 1970s style market, which was bad for asset markets.

In other words, I expected gold to massively outperform the S&P 500. That is beginning to happen, but not to the extent I thought.

Looking at this, the strategy makes sense, I just need to be patient and wait for the market to come to me. Which is fine. But one thing has caught me by surprise has been the performance of emerging markets and cyclicals vs defensives. Emerging markets have broken out, after being a nothing done since 2007. (I am sometimes called a permabear - but I started as a Emerging Market fund manager, and went bearish in 2008 - so justified when it comes to emerging markets in many ways I think. My real mistake is not seeing the US market doing this well for so long.)

Not unrelated has been the surge in cyclicals versus defensive stocks. Below is the GS cyclical v defensive (ex commodities) chart.

Spreads on emerging market debt has also come down to extremely low levels.

My view of higher interest rates, which despite central bank cuts, the long end of German and Japanese bond markets still have cycle highs in yields, and rising tariffs did not think this would be a good environment for emerging markets. Of course, this could all just be top of the market stuff - and that would suit me fine, but I started to get an inkling of another way to think about markets other than as pro-labour vs pro-capital shift. So what could explain the big moves in gold versus treasuries AND the continued rise of asset values?

So going back to first principles, I see an inflection in the bond market which has been driven by political change. I still see that as correct.

Now I saw the political change as one that prioritised raising wages, and particularly in real terms. And wages have certainly risen. But maybe rising wages and rising interest rates are symptomatic of something entirely different. In the pro-capital era, which ran from 1980 to 2020 in my view, the idea was that countries competed on price. Investment would flow to wherever was cheapest (Japan in 1970s/80s, Asia in 1990s, China and Eastern Europe in 2000s). If a country became too expensive, then it was likely to suffer a capital withdrawal, slow growth, deflation and weak currency until it became attractive to foreign investors again, and the cycle would turn again. It was a system designed to keep prices of all goods in check, which in turn led to lower and lower interest rates. Rather than calling this pro-capital, perhaps we should call this “price is king” era. Lowest priced operator wins. Underpinning this was governments cutting tariffs, and allowing the free flow of goods, capital and people. These policies would mean that high paying jobs flowed to the countries with the best educated workforce, while low paying jobs flowed to countries with cheapest workforce. Cities with the brightest and smartest people did well, while everyone else had to compete via price. This was globalisation, and it has been rejected at the ballot box in the west.

So the new system that is being conjured into existence is that governments choose where investment and jobs are created. For a sense of irony - the 1980s and 1990s was the movement of communist nations into the world trading system, and price based economies. The 2020s seems to be representing the reversal of that system in the West - or if you like, the Sinification of the US. China has strongman leader, the US has a strongman leader. China directs industrial policy, the US directs industrial policy. China bans foreign technology, the US bans foreign technology. Chinese government complains about foreign portrayal of China, the US government complains about foreign portrayal of the US. You get the idea.

In the “price is king” era, investing could lead to profoundly negative consequences. Currency crisis, debt crisis, over capacity. This had the negative effect of discouraging investment. A much better business was one that with pricing power, and limited investment needs (Coke Cola, See’s Candy, “Old” Microsoft). But in a new era perhaps we are in the “investment is king” era. Now I know a lot of people reading this will be rejecting this out of hand - but hear me out. Back in the first pro-labour era, from 1945 to 1980, the US grew production of everything. Steel production grew through that whole era.

Steel was a vital resource and needed to be produced at home. We could see a similar logic in nuclear warheads. Competition spurs investment and production, while collaboration spurs price wars. Competition is inflationary, collaboration is deflationary.

Maybe the old cold war needed steel and warheads. The new cold war needs AI, compute and electricity. So in my first “pro-labour” era, you did not need to worry about investing - demand would always be there, and prices would always rise. In the “pro-capital” era, financial assets did well, and pricing could fall, hence excess investment was a big mistake. Tesla was a forerunner of this change - it was very much “built it and they will come” style investing. And if you think about the subsidies that EVs have had thrown at them - this is the success of “investment as king” era.

This “build it and they will come” attitude attracted record short interest. The short sellers were dead wrong. A lot of them are still around, but have quietly moved on to other projects.

I would say right now, in the AI world, there is some angst over the “built it and they will come” strategy. And I understand that. But I also do not see US politically moving back to “price is king” world, because that would imply allowing Chinese tech to dominate. What I think is more interesting is the AI build out now seems to be crowding out other borrowers, and forcing up the price of electricity. This should weigh on markets - and makes the 1970s more likely. But until the threat of China is dissipated, I would not bet on a deflationary bubble bursting. More likely we use up all the excess capital lying around. Betting on higher yields still makes a lot of sense to me.

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Since launching my new fund, Brumby Capital, markets have rallied strongly and yet oddly the short book has not been much of a problem. Why? I don’t short indices, and most of my shorts are in the US. The equal weighted S&P 500 have been pretty flat over the last year. This has been in line with my pro-labour view of markets. Or in other words, the average company in the US has been okay, which it what I would expect with rising labour costs and rising interest rates.

The problem is that no one seems to have told the Magnificent Seven. It continues to surge higher.

There is a lot of bearish chat surrounding AI at the moment, and we even have Michael Burry buying puts on PLTR and NVDA. AI is often portrayed a bubble that is about to burst.

But what exactly does a bubble mean? For me, the stock market follows pricing, and pricing normally follows supply. Previous bubble bursting was driven by decline in prices caused by over investment. For example, broadband and semis in 2000. We can see both the dot com bust and the current boom today from TSMC semi pricing. The late 90s saw bubble and then bursting in 2000s. Pricing has surged again, so if history repeats semiconductor pricing should fall again, and the bubble will burst.

The problem is that back in 2000, there were a lot of near competitors for TSMC. If we look at just TSMC, Intel was a near competitor. Intel was investing USD 7bn in 2000, compared to a 16bn today, and 25bn a few years ago. But we can see that it does not generate the cash for it to invest these days - which is why it has asked for help from the US government.

TSMC was investing USD 3bn USD in 2000, and now is investing USD 40bn. But almost always investing less than the cash it was generating.

In the 1999 dot com bubble - Intel and TSMC were generally correlated. A bubble bursting should take out all operators in an area, as everyone suffers from falling prices.

But that is not the case anymore. TSMC have been distinctly uncorrelated to INTC since 2024.

I think what I am trying to say, is that bubble bursting is the wrong name for what happened in 2000 and 2008. It was free markets at work, where new entrants started to take market share from incumbents, and so the incumbents began a price war. I used to take weakness in a small player as the beginning of a price war. Back in 2000, weakness in TSMC was a great lead on weakness in INTC. But this relationship no longer holds for TSMC and INTC, but for the whole tech area. SNAP has been weak, but META strong. NIO has been weak but TSLA strong.

If I had to put a finger on a difference, it would be that the biggest companies no longer compete on price, but compete on investment. Who can out invest the competitors? Microsoft is an example of this. Capex has increased exponentially. Is this a new feature of a pro-labour world? Companies compete on investment not price?

The Chinese government has encouraged its big tech to compete on price, and its tech sector has underperformed the US massively. But China has also had deflation and lower bond yields.

With US tech the “invest to compete” model is probably driving inflation - particularly in electricity prices.

The outlook to Mag 7 is as much political as it is financial. When do voters tire of inflation and falling real wages? When do politicians act to get lower prices? Perhaps Michael Burry has his timing perfect. I don’t know. But for me, as long as gold is trading well against Mag 7, I can keep to my current positioning.

If this inflects lower, then I will have to think about how to hedge the Mag 7 risk.

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