Capital Flows and Asset Markets

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For the first time in many years, currency is making a big difference to my portfolio. I have always had a heavy currency focus, and even in my current portfolio I have a big currency position - but I have never had any reason to to talk about it - until today.

Ronnie O’Sullivan may or may not be the greatest snooker player of all time - but he is probably the most naturally gifted. Snooker is a very slow game - and achieving a perfect score is vanishingly rare. Ronnie has the distinction of the fastest ever perfect score. If you wanted to carry on the Ronnie analogy, like Ronnie, I burst on to the scene, did great things, then suffered a form slump, retired from the game, and then returned once my technique was corrected. I like that.

In a game lacking superstars - Ronnie is the only true superstar. But despite that, he has claimed snooker is a bad sport, and would try and stop his kids from taking it up. I would probably concur with macro investing. I find the whole macro world very reactive. Now that bond yields are rising, there are whole sea of commentators writing long and dense theories on what it means, and how it might be “part of a plan”. Like Ronne - I am a fan of quick and direct (no comment!). Bond yields are going higher because politicians need to get wages higher. Trump is imposing tariffs, because he needs to get wages higher. Why do politicians want wages to be higher? Because the voters are telling them that they “want wages to be higher”. Why make things more complicated?

One problem I really have with the macro community is that they focus on consequences, rather than the driver. A good example is this comment forwarded to me by a subscriber.

That clown was not me - as I don’t go on exchange floors. But Marko is focused on consequences rather than drivers. The driver is that the US government is working hard to get wages to rise. For context, from 1939 to 1980, the US Federal Minimum wage rose 1000%.

1980 to 2025, we have seen slightly more than a 100% increase. Guess which era was focused on raising wages, and which era was focused on raising profits and asset values. (Sorry - no prizes for this pop quiz).

My base case assumption is that the US government wants wages to double over 10 years - which translates to around 7% a year. I also assume they want to keep house prices in check, and the dollar strongish (7% pay increase with 10% inflation would defeat the purpose) - so a real rate of 3% or so would be necessary. This gives you 10%. In a world of free movement of capital and no tariffs - our friend Marko here would be correct - the US would be toast. But in a world, where the US has onshored all auto, steel and iPhone(?!?) manufacturing, through the use of tariffs, would there be no jobs? I doubt it. Rather the government would be desperately looking at ways to keep cheap imports out (just like now - for example).

10% does not look that wild to me. It was where we got to in 70s.

Brazil, which has always maintained tariffs to protect domestic workers, already has overnight rates at 14%.

Mexico, which the US still has a trade agreement with of sorts, is already at the 10% rate, even if recent cuts have pulled it lower.

If calling current US policy Latin American-like, leading to Latin American interest rates is too much of a step for you, then we can look at US ally, Japan. Japan is very closely tied to US financial system. Japan is suffering from rising yields, as its workers also need pay increases.

For me the macro world is in denial. In essence, they are saying rates cannot go up, because it would destroy asset prices. This is true - but in many ways is the actual point of rising rates - to get asset prices to fall in nominal terms - to make them more affordable. It’s that simple. Deal with it.

Perhaps the most laughable thing about the macro world is being surprised about bond yields selling off. It was inevitable at some point, but with an obsession with back testing and algorithms, the macro world would not accept it until it happened. On this, I feel a bit like Ronnie O’Sullivan when talking about younger snooker players:

“Yeah, they need to get their act together because I am going blind, I have a dodgy arm and bad knees. And they still can’t beat me!”

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It has been a tumultuous couple of weeks. I will make some general observations to start, and then some market observations behind the paywall at the end.

* American First politics in practice, particular in regards to Ukraine, but with the application of tariffs as well, has probably ended the various independence movements in developed countries. From where I sit, no sane Quebecker, Welsh, Scottish, Flemish or Catalonian person can think being a small nation in this new world makes sense.

* In all likelihood, all real changes caused by Brexit, are likely to be reversed, in practice, if not name.

* The beginning of the end of the US as a reserve currency

* The beginning of the end of the preferential treatment given to US corporates in terms of tax and market access, even if negotiations to reduce tariffs are successful.

* Bond markets are correctly (in my view) signally reflation, while equities seem to think deflation

* Probably the only lasting change from this Trump administration will be the remilitarisation of Europe and Japan, and the corresponding weakening of the US as the leading military power.

* The FT reported the head of the British Military was in Beijing - this was not announced by the UK government, but reported by Chinese media. This is the first time this has happened in 10 years. Is the UK looking to do a deal with China? Or acting as a go between? Perhaps the US is not the only nation capable of pulling geo-political surprises.

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I did a market update with Maggie Lake yesterday.

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President Trump has said he wants two things - lower energy prices and lower interest rates. I suspect that he assumed causing the stock market to crash with his “Liberation Day” tariffs would help get both. Together with a surprise increase in OPEC production, he definitely got lower oil prices. WTI is down USD20 a barrel from January highs.

With market down nearly 20% from all time highs in February, you would expect long bond (30 year treasuries - which is what mortgage rates are based on) to have lower yields. The opposite occurred - long bonds went to 5%

When they hit 5% lo and behold, President Trump felt obliged to back away from the precipice of global trade war. Despite the hit to oil prices, gold prices continue to trade well, just about back to new all time highs.

For financial historians, spiking gold to oil normally seen in times of recession, and current levels suggest either gold is overvalued or oil is undervalued.

Other recession indicators, like GBP/CHF exchange rate are also moving ominously.

There is a way to square all of this - but my American subscribers are not going to like it. The rest of the world is treating the US like an emerging market. That is bond and equities are now increasing correlated. Given the phenomenal financing needs of the US, this makes sense. Of course at some point, valuations become attractive enough to bring money back to the US. For me, it is when S&P dividend yield rise above 30 year JGB yields. The problem here is that JGB yields are also selling off.

Trump needs to back away from tariffs to allow foreigners to earn dollars to buy treasuries, or needs to balance the budget by raising taxes, and cutting benefits. As he expressly promised to not do either of these things - I suspect we continue to see the US treated as an emerging market. And that means all US assets look suspect - just like a classic emerging market crisis.

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Just a quick post. I have been bearish on Treasuries for a while. Why? I see investor mindset has completed changed on fixed income from 10 years ago. Back then, no one thought buying a 30 year Treasury at 4% was a sensible trade, but when yields moved to 1% during Covid, everyone became convinced of their ability to rally when thing are bad. But for me bonds reflect politics - and politics is no longer deflationary.

I like shorting TLT, for reasons I will leave behind a paywall, but I was intrigued to note that TLT and the S&P 500 are telling very different stories. Equities are saying recession. TLT is saying…. well nothing. It has barely moved.

As I have often stated, I might get worried about a short TLT trade if JGBs reverted to a deflationary/falling yield trend. But my reading is that Trump and his “beautiful” tariffs is going to force every government to spend and stimulate - that is be inflationary. The JGB market also does not tell you deflation is imminent. In fact, the huge rally in the last two days has almost totally reversed.

The good news is that this means I don’t think we are going to see a huge increase in unemployment, or deflation. The bad news is if you run a business and cost pressures have been hitting your bottom line - things are about to get much worse. And that is real meaning of the movement in equities and bonds - cost inflation is coming big time. Get ready for lower profits and corporate cashflow.

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Wondering whether it is time to change strategy might seem like a very odd thing to say. If I had to estimate year to date performance as of close Friday, it would be up as much as MSCI world is down, but with a net pretty close to neutral. Pretty good. So what is the problem?

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Some surprisingly big moves in the core theme of the portfolio. What do they mean?

We are living in times of profound change. What I am trying to do with Brumby Capital is capture the opportunity of those changes. I have set up a website - www.brumbycapital.com - that includes a beta version of AI Persona for the fund. You can speak to it, and it answers in an Australian accent. Please give it a go and give me feedback on where we can improve it. At some point I hope to train it on my own voice. The AI Persona has been set up by a company that I am invested in and if you would like to know more please reach out.

For me, there were two profound moves in the market last month. First gold broke out again the S&P 500. It does not do this often - and it can have fake out moves from time to time - but when it does move, it tends to be a powerful signal of change.

The other move was the break higher in JGB yields. From 1999 onwards (the beginning of my investment career), buying JGBs when US equities fell was a money good trade. For the first time I can remember JGBs were not a safe haven during US equity weakness.

Having been in NY last month to meet various investors, I can say that I think the average American is in deep denial over how the world has changed. The reason that the US spends so much more than other countries militarily was that was exactly the system the US wanted until recently. After World War II, Japan and German were explicitly guided away from having any offensive capacity. When the Soviet Union collapsed, the US offered security assurances to Ukraine to get them to give up nuclear weapons. And because of this security blanket, the US received reserve currency status, and a primary voice in how western economies should be structured. Betraying Ukraine has shattered this system. Europe and Japan now know they need to remilitarise, and that following the US line on China is now optional. No major nation will be looking to use Treasuries or even other government bonds as reserve currencies anymore. The movement in gold tells you this. The unending bid for government bonds is gone in my view.

There are now two big political drivers to markets - firstly Europe and Japan need to remilitarise. This will require hiring more military personnel at a time of record low unemployment, and to build out there own secure military supply chain. Both of these things will require money. The good news is that nations like Europe and Japan actually have a great deal of money salted away, either in foreign reserves, or savings. The problem is that almost all of that savings has ended up in the US, one way or another. We can see this using the Net International Investment Position (NIIP) data. They will need to bring that money back. This data is also picking up foreign reserves. But the second big driver is that no nation can really perceive the US treasury as a safe reserve asset anymore.

When I was in New York as made this argument, I was often told the US would remain the reserve currency forever, and that it was still the best option. Maybe this is true - but for me it feels like the genie is out of the bottle. This trip reminded me of of capital raising trip I did to Brazil in 2012. At the time, I was heavily short Brazilian assets, as the Brazilian Real was expensive, and the Chinese construction bubble, and associated steel and iron ore bubble looked ready to burst. I had found US investors that agreed with me, but when I suggested this in Brazil to Brazilians, they could not bring themselves to sell the Brazilian real to buy US dollars. The currency has weakened ever since, and Brazilian assets have been very poor in US dollar terms.

I suspect President Trump, just like Prime Minister Boris Johnson, is pro-cake and pro-eating. In this case I think President Trump wants to have all the manufacturing AND capital flows into the US. For me, its hard to see how that is possible - foreign credit flows into the US are a consequence of the flow of manufacturing jobs overseas. Putting all of this together, and I see capital flows across borders slowing and reversing, and I see the cost of capital rising across the board. I suspect this is going to put downward pressure on all asset markets. Take emerging markets for example. During the dot com bust, and due to the Asian Financial Crisis and the Argentinian and Brazilian devaluation crisis, spreads over US treasuries were 9%. Today, they are barely 3%. How do they perform well when spreads are so tight and US yields are rising? Same is true of corporate debt.

The bigger earthquake for financial markets is dealing with the fact that US Treasury is no longer a credit worthy asset. The market is already beginning to trade this way. Back in the 1970s the US also became uninvestable, with a number of non-free market policies, we started to see a huge gap open up between Swiss and US bond yields. In recent years, this spread has begun to appear again. At its peak the spread was 10%, and I think we are headed back to those levels.

If the GFC was about discovering that mortgage back securities were not safe assets - how does the market deal with discovering that US treasuries are not a safe asset? In simple terms, I see long term US interest rates going to 10%. Current valuations for most assets will struggle in that world.

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