All posts by NY Times Bestselling author Lawrence McDonald

Larry McDonald; founder of THE BEAR TRAPS REPORT investment letter, is a political policy risk consultant to hedge funds, family offices, asset managers and high net worth investors. As former Managing Director, Head US Macro Strategy at Societe Generale, he's a frequent guest contributor on Bloomberg TV, CNBC, Fox Business, and the BBC. Larry is a NY Times bestselling author, his book "Colossal Failure of Common Sense" is now translated into 12 languages. He ran a $500 million proprietary trading book at Lehman Brothers, made over $75 million betting against the subprime mortgage crisis and was consistently one of the most profitable traders in the firm. His "Bear Traps" letter is one of the most highly regarded on Wall St. He's participated in 3 major financial crisis documentaries: Sony Pictures, Academy Award winning documentary the "Inside Job," BBC‘s "The Love of Money" and CBC‘s "House of Cards." He's delivered over 72 keynote speeches in 17 different countries, at Banks, Investment Firms, Conferences, Law Firms, Insurance Companies and Universities.

Garbage Floating to the Top

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Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – top 20 all-time at the CFA Institute.

If the Fed’s gravy train had been this aggressive in 2008, Bernie Madoff would still be sipping mint juleps in the Hamptons. Lehman NEVER would’ve failed. Central bank largess is protecting Enron’s out there – as accommodation is withdrawn – garbage will float to the top. The toxicity is off the charts this cycle – Dozens of Madoffs and Enrons – it is sickening.

All you need to know is one important fact – there is $30T more debt on earth today sub 2% in yield – than there was in the last two hiking cycles. The below 2% part is important because it speaks to colossal convexity in today´s bond market.  Everyone knows – with interest rates UP, bond prices go DOWN.  The problem is – with trillions more debt on earth BELOW 2% – just ONE little 25bps rate hike carries the destructive forces of 4 hikes 15 years ago!!! The bond market is telling us this, screaming at us. The U.S. 30 year bond yield is 1.87% – while the 20-year is yielding 1.91%. Eurodollar futures have recently started to price in rate cuts in 2024-2026, NOT hikes.  The last two rate-hiking syles were FOUR years-long – NOT this time.

Rate Hiking Cycles
The bond market is telling us, the Fed´s ability to pull back accommodation over an extended period of time is HIGHLY limited. Nearly 71% of the U.S. Federal budget is interest spending and entitlement spending vs. 30% thirty years ago.  Close to 14% of Americans are on Food Stamps today vs. near 3% in 2000.  There are bills to pay, the Fed´s hands are tied.

The Secret

The dirtiest secret in economics is that it provides no coherent, provable, and universally accepted theory of recession. The reality is, economists, don’t actually know what causes recessions. The reality is, there may be no single cause. It’s even hard to wrap your brain around how you are supposed to approach the data. For example, if you look at rate hikes and when recessions occur, it’s not clear that rate hikes cause recessions. Certainly, about 75% of the time quick rate hike sequences were followed by recessions. But then, 25% of the time they weren’t.

Well, a cause is something that works 100% of the time. Certain predictable chemical reactions work 100%. Entire industries and thus economies are built on these industries and their 100% certain causalities. They wouldn’t exist if the criterion for a cause = 75%. As traders, we are delighted if we find something that works 75% of the time and so too readily falls into the trap of confounding probability with causality.

So, we can accept that rate hikes are probably followed by recessions. We think the explanation, perhaps, is that a withdrawal of lending by banks causes recessions. And they stop making loans when they feel, sometimes rationally, sometimes irrationally, that if they make loans they will lose money. Sometimes this feeling happens when interest rates rise. Sometimes it doesn’t. 75% of the time in a rising interest rate environment, banks get the feeling making loans isn’t a grand idea.

Well, why does that happen? There are lots of reasons unique to each cycle, unfortunately, which is why there is no grand unified theory of recession. But clearly, if interest rate hikes go too far, somehow the lending proposition becomes less viable. Again, how do we know when the hikes are too far? We don’t, until after the fact. However, we can say that if a bank’s model is to create money by borrowing short term and lending long term, a negative sloping yield curve will kill loan creation. And what causes a yield curve to invert?

The belief that the demand for money will steadily decline i.e. the belief that there will be a recession. So it’s circular, far from rational. Or it could simply be that a yield curve inverts because traders think inflation will be lower later, causing the curve to invert, thereby causing banks to restrain lending, thereby, in turn, causing a recession. In which case traders’ opinions about distant inflation trigger recessions, which seems a tad bizarre but the world is a crazy place so perhaps it’s true. But yield curves aren’t perfect predictors either. And they change. We do know that if growth is greater than the cost of capital that is less likely to cause a recession than if growth is less than the cost of capital. That does seem logical. So if rates rise less quickly than growth, it seems reasonable that there will be no recession. But growth rates can be a moving target, so a rate hike that is appropriate now may be inappropriate two months later. So we don’t know. But we have the odds: 75% of the time rate hike sequences lead to recessions.

We would only add that when rate hikes are accompanied by an increase in bank reserves then recessions happen for sure. This is why we are so impressed by China’s recent lowering of reserve requirements for its banks. To us, that is a buy signal. Certainly in the US when bank reserve requirements are lowered, equity bull markets follow.

Value vs. Growth – Late Stage
Value vs. Growth the Epic Final Days of this Battle – TSLA is Through key support – 20% off sale – Tesla TSLA is going through the recent lows pre-market – observation of the week – the 25-30x sales LARGE caps (NVDA – TSLA) – are playing CATCH UP with the COUNTLESS 40-100x sales garbage that is now trading 10-20x (ARKK names). So we have a washout in the Nasdaq with 300+ companies moving from 40-100x sales to 10-20x sales and NVDA still sits unched at 30x sales?? – Large-cap stretched names are playing catch up this week.

Value vs. Growth – Early Stage
Close to 20% off their highs – hot software names are in pain. The Nasdaq Composite Index is up roughly 15% year-to-date. However, when removing the 5 largest equities, the index is down close to -20% on the year! This shows how large the tail-risk to US equity markets is if the largest names are to see a significant pullback. This is one of the most top-heavy markets in history.  As we stressed in January on Real Vision and CNBC – the net present value of FUTURE cash flows is worth A LOT MORE with certain deflation and worth ALOT LESS with certain sustainable inflation. 

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The Week that Changed the World – 13 Years, Just Wow

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“‘China’s Lehman Brothers moment’: Evergrande crisis rattles economy” – The Guardian

“The crisis engulfing Evergrande, China’s second-biggest property company, is the greatest test yet of President Xi Jinping’s effort to reform the debt-ridden behemoths of the Chinese economy. As angry protesters occupied the headquarters of the troubled property developer in recent weeks, some analysts have described the Evergrande crisis as “China’s Lehman Brothers moment”. Only this time it’s a credit-fuelled housebuilder that suddenly can’t pay its $300bn debts, rather than a blue-chip (Lehman) investment bank that many assumed was too big to fail but was instead thrown to the wolves 13 years ago.” They took Lehman´s head underwater and they watched for the bubbles – but why?

Credit Leads Equities – Our 21 Lehman Systemic Risk Indicators

My name is Larry McDonald, that’s our UK book cover above. In the years before the failure of Lehman Brothers, I ran a successful distressed credit business at what was the 4th largest investment bank in the U.S. – becoming one of the most consistently profitable traders in the fixed income division. In late 2008, early 2009 – with Patrick Robinson, we penned “A Colossal Failure of Common Sense” – the Lehman Brothers inside story. At least once a month, I tell my wife while wearing a hopeful smile —“if we sell a million books — we´ll break even on our Lehman stock.” On September 15, 2008 – it all came crashing down in the largest bankruptcy in U.S. history. Known as, “the week that changed the world,” a very painful experience indeed. I was down on the mat looking up at the referee as he delivered the count. It was one of those fateful moments most of us face. Staring into the abyss, drenched in blood-curdling uncertainty, there are times in life when we must get up. Even when it looks like all is lost in a valley of no hope.  Ultimately, the lucky ones learn there are valuable lessons in re-invention. The last 13 years have been a breath of fresh air. Our New York Times bestseller has been published in 12 different languages, the “page-turner” is in the CFA Institute’s top 20 all-time (finance books), and was featured in the Academy Award-winning movie with actor Matt Damon, “Inside Job.” It’s an absolute must-read filled with countless lessons, especially for someone under 35 years of age. Over the last decade, I have been told more than a thousand times – it´s one of the most readable books in finance, ever written. Anyone can enjoy it.

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Life´s Lessons

One of the important lessons in our book comes down to – how to use leading credit risk indicators? In the 2007-2010 period, the global credit risk epicenter was obviously inside the US.  In the 2011-2013 period, Europe´s banks were the focus during the Grexit panic. In recent years, Asia has become far more interesting, a new epicenter has been formed.

Credit Risk, the US Epicenter 2007-2010

As far back as the spring of 2007, U.S. banks began to underperform financial institutions in Asia. By now, everyone knows most of the subprime mortgage credit risk was inside the USA with domestic banks more exposed than other banks around the world. Notice above, Goldman Sachs (green above) 5 year CDS (the cost of default protection on the bank), began to meaningfully divergence from Standard Chartered. Standard Chartered PLC is an international banking group operating principally in Asia, Africa, and the Middle East. The company has far more credit risk exposure to China – Asia than U.S. banks. It is clear above, more than 12 months prior to Lehman´s failure, banks in the USA were dramatically underperforming from a credit risk perspective. In other words, in 2007 – the cost of purchasing credit default protection on Goldman Sachs was far more expensive than the bank´s Asian peers. Indeed, elephants leave footprints – when large hedge funds see credit risk – they start placing bets months if NOT years before a credit event. The credit market sniffed out Lehman´s demise months BEFORE equity investors got the joke.

CNH China Currency Volatility
During the 2015-2016 China currency devaluation crisis, CNH volatility was a solid leading indicator while China was hemorrhaging foreign currency reserves. In recent weeks, all has been calm, but in recent days a lot has changed. If an asset manager wants to buy some cheap protection against a credit event in China, one can place a bet against the CNH – Yuan. As capital flows into these kinds of wagers, the cost of currency hedging surges. Hence, CNH vol is on the rise. If there is truly a credit crisis in China, the currency should be a lot lower and the cost of CNH vol should be MUCH higher.

Lessons of 2015-2016

Now, let us think of Asia in the summer of 2015.  The Fed was attempting “liftoff” – their first rate hike since 2004. Finally, in December of 2015, the Fed hiked rates 25bps for the first time in eleven years. In the process, as the central bank prepared the world for the now-infamous rate hike. In just six months the dollar ripped from 80 (July 2014) to 100 (March 2015). Emerging markets were in flames, the Fed had triggered a global dollar crisis. More than $1T left China (the country´s fx reserves were on the run). The world was in a real currency devaluation panic, with Asia wearing the epicenter title this time around.

Credit Risk, the Asia Epicenter 2015-2021

During 2015, the China currency devaluation crisis picked up steam in September and came to risk climax in Q3. But months before, the cost of default protection on Asia´s Standard Chartered began to sharply diverge (blue above) from Goldman Sachs in the U.S. Once again, credit risk was screaming “there is a problem” in May 2015, by September the S&P 500 lost 16%. In 2007, Goldman’s credit risk was so telling. Then, eight years later – banks in Asia would wear the credit risk epicenter title. Fast forward to 2021, Evergrande headlines are all the media rage, especially with the Lehman, the lucky 13th anniversary this week. But, what are credit markets telling us this time? As you can see above – far right. Credit risk is calm on Asia banks with exposure to China, no difference to speak of. Central bank liquidity is so abundant, there is NO way Lehman would have failed today. Free markets no more. Adam Smith has one (invisible) hand tied behind his back. We have unintended consequences as far as the eye can see with Uncle Sam’s fingerprints on every street corner.

The Trillion Dollar a Day Gravy Train

The flood of cash in U.S. interest-rate markets pushed the amount of money that investors are parking at a major central bank facility to yet another all-time high – every day a new high indeed. In recent weeks, EVERY DAY more than Eighty participants have been lining up for nearly $1.2 trillion at the Federal Reserve’s overnight reverse repurchase agreement facility. Large counterparties like money-market funds can place cash with the central bank. This easy money gravy train is hiding the next Lehman Brothers, all embraced in deception. In terms of bond yields, let’s look around the planet. In the U.S., close to 90% of the junk bond market is trading below CPI inflation of 5.3% (highest since the early 90s). Over the last 50 years, the highest this number ever reached was 7%. China’s high yield credit market is just 8-10% away from its March 2020 lows in bond prices – highs in yields. All of which begs the question – How can the U.S.-centric JNK Junk Bond ETF yield 4.4% while China´s junk bonds are offering 10-12% cash flows?! Always with an important lens – our friend, Jens Nordvig reminds us – “foreign involvement is small in China. It is true that the high-yield bond market has a sizable USD component (mostly foreign). But relative to the US, where subprime exposure was sold around the world, it is a much more local (controllable) system.” It has been clear for months, there is Evergrande credit contagion – it’s just inside China at the moment.

An Unsustainable Reach for Yield Comes with a Price – It is NOT FREE

Each year that goes by while central banks force investors to reach for yield – any paltry plus return on capital will do these days – complacency builds over time to an extreme – dangerous level.  Mark my words – there were dozens of Bernie Madoffs, Al Dunlaps, and Jeff Skillings sipping mint juleps in the Hamptons and the beaches of the south of France this summer. Central bankers are these guys’ best friends, that is the reality no one wants to admit. As long as central banks do NOT allow the cleansing process of the business cycle to function over longer and longer periods of time – credit risk will continue to build under the surface. Each month, week, and year we allow this charade to move forth – the corners capital flows into are deeper and deeper soaked with moral hazard toxicity. Today´s players on the field make “Dick Fuld” – former Lehman CEO –  look like a choir boy walking out of Sunday mass. The coming event will dwarf what was – “A Colossal Failure of Common Sense.”



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Amazon and The Power of Labor – Secular Change


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The winds of secular change are howling, but is anyone listening? We see a colossal impact on asset prices in the months ahead. The clues do litter the field with one of the most telling coming from our planet´s largest online retailer.  Case in point – Amazon’s productivity continues to improve across its roughly 1.4 million employees. As a result, the company can pay them more and still gush cash. Looking at real impact – for its next 125,000 workers, minimum pay has been set at $18 an hour. This means that any business competing with Amazon for workers will have to pay up. We call this wage inflation. So while productivity enhancements by Amazon are disinflationary considered in and of themselves, they are inflationary in their knock-on effects on wage-price pressures on other businesses. And there is an even broader psychological impact. When workers see a minimum pay at $18 away, they will be more vocal about wanting a higher wage for the job they already have. This is how labor strikes get lit. The power of labor is getting a big boost from Amazon. Strikes by Amazon workers in Italy, Germany, and India are bubbling into an international struggle against the world’s fourth-most valuable company – now they are paying attention. International efforts against Amazon have been building for some time. The UNI Global Union helped mobilize thousands of Amazon workers in four European countries to strike in recent years. Momentum is on the rise.

Average hourly earnings climbed by 0.6% from July to August, more than the 0.3% that economists in a Bloomberg survey had forecast. Over the past year, they were up 4.3%, exceeding the expected 3.9%. Pay has been climbing strongly in recent months as job openings have exceeded the number of people actively looking for work. Why is this important? We count $100T of global wealth shoe-horned into deflation assets (growth stocks, negative-yielding bonds, bonds below 2% in yield). This is a COLOSSAL bet on transitory inflation.

Hot AHE – Secular Change in the Power of Labor

For decades, the foundation of “transitory inflation” has been found in the power of labor. The less powerful the labor force the more transitory inflation has become. Since the 1980s, the power of labor has been in secular decline. The kick-off came when the Reagan administration fired the 11,345 striking air traffic controllers, and banned them from federal service for life. In recent years, these tables have turned powered by the Covid-pandemic and a back-to-back fire hose of $3T deficits coming out of Washington (2020 and 2021, $6T deficit spending in total). In recent years, Amazon was criticized for paying workers $12-$14 an hour, now they are up at $18-$19. Everyone knows there are 5.5 million fewer workers in the U.S. labor force (per BLS data) today vs. 2019. At the same time – U.S. JOLTS data, jobs openings are 50% greater than 2019 levels. That is at least two standard deviations above the ten-year mean number of available jobs. So, next time someone tries to sell you on “transitory inflation” – look at the data, labor has more power today in terms of influence on wages than they have had in 20 years. 

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Ida Impact, Crack Spreads and Refiners

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Hurricane Ida made landfall Sunday evening and hit New Orleans and Baton Rouge on Monday morning. The National Hurricane center currently identifies Ida as a “dangerous Category 4 hurricane” with wind speeds up to 150 mph. To compare, hurricane Katrina in 2005 had a maximum wind speed of 175 mph and hurricane Laura (2020) had a maximum wind speed of 150 mph. The storm could damage as many as 1ml homes (think insurers), with a possible reconstruction cost that exceeds $200bl. For the oil and gas industry already battered from Covid-19 disruptions, the impact could be significant in the short term.

As of right now, 1.65ml bpd of crude production is shut in due to the hurricane, equal to 91% of Gulf crude production, 85% of natural gas production is shut in as well. On top of that, 1.9ml bpd of refining capacity, or about 10% of total US refining capacity is shut down or brought to a reduced rate. Refiners that have shut down or reduced production include Marathon’s Garyville (578K bpd), Exxon’s 520K bpd Baton Rouge refinery (50% shut), Phillips 66 Alliance (255K bpd) and Shell’s Norco (230K bpd) facility.

Where is the Trade?

From 2011-2020, cheap natural gas was a colossal headwind for Nuclear power plays like NorthShore Global Uranium Mining ETF (URNM), with prices up 20% since mid-August and 100% since December – natural gas has become a substantial tailwind for the nuclear power sector.

Refining and Chemicals

The total operating refining capacity in the Gulf Coast (a.k.a. PADD III) is currently about 9.6ml bpd. This means that as much as 20% of PADD III refining capacity is shut down. The Gulf coast oil refining industry is also responsible for about 20% of global ethylene production.

In a worst-case scenario, refining capacity could be offline for multiple weeks. This could put further upward pressure on prices of petrochemicals such as polypropylene and PVC (used for bottles, pipelines etc). Dow (Chemical) DOW equity surged to $65.42 Friday from as low as $58.50 in July. Prices for these chemicals are already near all-time highs as a result of the February freeze that caused supply disruptions in the industry. For gasoline, having refiners offline for multiple weeks could also lead to a surge in gasoline prices, as supply is impaired. We see an additional inflation impact here.

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Gasoline Supply Picture Heading into Ida

When hurricane Laura hit Louisiana around this time last year, oil and refined product demand was still depressed because of lockdowns and other corona-related demand constraints. U.S. Gasoline demand was then around 8.6ml bpd, which was 12% below normal levels. Today, gasoline demand is back to pre-corona quantities, which is 9.5ml barrels p/d. To add insult to injury, gasoline inventories are currently well below their 5-year average (chart above). This means that any supply disruption that lasts several days or weeks could have a significant impact on gasoline prices. When hurricane Harvey hit the Texas refining industry around Corpus Christi in August 2017, the nationwide refining utilization rate dropped from 96% to 78%. The disruption lasted about one month before refining capacity was fully back online. Gasoline prices spiked 30% in the days after the natural disaster that hit Texas.

Today, refining utilization is at 92%, meaning that any unplanned outages will cut supply even further. Ironically, during these types of disasters, the stocks of refining and petrochemical companies tend to benefit, as the pricing power more than offsets any loss of sales due to local capacity taken offline. For the petrochemical industry, companies like DOW and LYB are the dominant players and could benefit if the chemical industry capacity around New Orleans is taken offline for several weeks.

Valero VLO Seasonals, Outperformance in Q3, Q4
Refiners such as VLO, PSX and MPC benefit if gasoline prices rise more than oil prices. While oil platforms in the Gulf have been shut down ahead of Hurricane Ida, the offshore infrastructure is much more resilient and quicker to come back online than refiners. As a result, oil prices tend to rally less than gasoline prices in the aftermath of these hurricanes.

Refiners, Crack Spreads – VLO Seasonals Performance
Crack spreads, which are the difference between gasoline and crude oil prices, tend to expand. Rising crack spread means higher profit margins for refiners. In 2017 crack spreads jumped from $18 to 27 following the devastation of Harvey on the refining industry, and in 2005 crack spreads doubled from $14 to $28 after Katrina.

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China vs. USA – The Big Tech Great Divergence, What is Underneath the Surface?

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Breaking July 9:

Biden Administration to Give Technology Mergers Greater Scrutiny

Many of the large platforms’ business models have depended on the accumulation of extraordinary amounts of sensitive personal information and related data.

In the Order, the President:

Encourages the FTC to establish rules on surveillance and the accumulation of data.

Big Tech platforms unfairly competing with small businesses: The large platforms’ power gives them unfair opportunities to get a leg up on the small businesses that rely on them to reach customers. For example, companies that run dominant online retail marketplaces can see how small businesses’ products sell and then use the data to launch their own competing products. Because they run the platform, they can also display their own copycat products more prominently than the small businesses’ products. BN

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An Important Message from Jason Hsu and Larry McDonald

30% off sale – “Didi Extends Drop to Fresh Lows as China Weighs Rule Changes – Ride-hailing company has lost $17 billion in value this week – China plans changes to block firms from listing overseas” – Bloomberg

The future of Chinese Tech and ADRs: What can we learn from DiDi and Ant?

Much has happened this week in the Chinese tech and ADR space. Below are our thoughts in response to some of the questions I’ve been receiving from investors and others.

“The US IPO conveyor belt needs to slow down. US banks MUST do more due diligence. With 30 more China-based IPOs in the pipeline, look for the SEC to put the breaks on any day now.”

Larry McDonald, Founder of the Bear Traps Report

China Internet KWEB vs. Nasdaq 100 NDX
Equity markets have been pricing in pain for weeks in China big tech.

Is DiDi Ant Financial redux?

On July 6th, DiDi plunged 20% following the news of (1) a formal investigation by the Chinese Cyber Security Administration and (2) a temporary removal of its app from all app stores in China. Many western investors viewed this the same as Ant Financial’s scuttled IPO last year. Their analysis started and ended with, “What did DiDi say to piss off Beijing?!”

This is far from the correct interpretation; Didi is not Ant Financial Redux. Let us explain why these two are not even close.

“The SEC should rescind the DIDI offering and protect US investors from China’s shenanigans. It’s time to protect US investors from Xi Jingping. Yet another example as to why China’s companies should BE FORCED TO ADHERE to the same standards as US companies.”

Kyle Bass, CIO Hayman Capital Management

An obvious indicator of the difference between these two is that the Chinese regulator halted the Ant Financial IPO in its tracks. By contrast, it politely waited until one week after the DiDi IPO before announcing a formal investigation. If the Chinese regulator believed DiDi’s deficiencies could not be resolved to its satisfaction or would jeopardize DiDi’s operations in mainland China, it would have asked DiDi to pull its U.S. IPO – and DiDi would have complied. The fact that it allowed DiDi’s IPO to proceed is significant.

Some have suggested Beijing has exercised enforcement unevenly against DiDi and Ant Financial, unfairly targeting Jack Ma for harsher treatment. Again, this is not the correct interpretation. For starters, Ant and DiDi are both incredibly plugged-in and aided by the most connected powerbrokers in China. Rounds of informal but deliberate conversations will have occurred and agreements reached in both cases before anything formal is announced in the press. The key difference is that for Ant Financial, the regulatory deficiency was too great to be remedied under the existing model. To the extent there is reasonable dissatisfaction with Beijing’s handling of Ant Financial, it is that the regulator waited too long to act.

Didi’s IPO was allowed to proceed precisely because, unlike Ant Financial, Beijing believed the company’s deficiencies can be remedied. The concerns regarding data privacy are easily addressable and the punishment—temporary removal of the DiDi hailing app from app stores—insignificant in the long-term. DiDi’s hailing app is, after all, already on every smartphone in China through WeChat.

There is no doubt that Beijing intended to make a point with by announcing the formal investigation. Sending a signal to other industry players is often a primary objective when there are public sanctions against the clear industry leader for industry-wide infractions. However, the issue at hand is relatively minor. The regulator was apathetic enough to be willing to agree to a delay in the formal investigation until after the IPO, and that tells you everything you need to know about the difference between DiDi and Ant Financial.

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Is Beijing going after Chinese tech firms listed in the U.S.?

Some of the issues the China regulator is investigating regarding DiDi are industry-wide, which means the government action has broader implications. This was on display when major indexes tracking Chinese tech ADRs took a major nosedive on July 6 – even though most of them had not yet added DiDi!

This is One, Unsustainable – Yet Impressive Divergence
In the USA, close to 92% of corporate profits sit in the hands of the largest 100 companies, up from 57% in the 1990s, per the Wall St. Journal. Monopoly power is on the rise as Washington is on the sidelines, for now.

Clearly, the market is reading something much bigger into DiDi’s cybersecurity investigation. Investors are now concerned about all tech firms that store massive amounts of data and perform analyses on Chinese citizens and businesses. The Chinese government, like the U.S. government, does not want those servers to run on foreign hardware and software, which could make them vulnerable to foreign spyware. Tech firms are squarely in the regulator’s bullseye.

Meanwhile, the government’s claim against many of the same tech giants for anti-competitive business practices also looms large. The Ant Financial action served to signal zero-tolerance for innovations the regulator feels may circumvent financial stability regulations. This has caused tech players to abandon one of their core business strategies—taking a slice of the massive Chinese consumer finance market while avoiding the high compliance cost of distributing financial products. This was a valuable business. So yes, it appears a revaluation might indeed be warranted for all Chinese consumer tech giants. But that is hardly due to Beijing turning anti-tech or even anti-capitalism— it is just Beijing discharging its duty as the steward of China, Inc.

It may appear to some outsiders that China is targeting the firms that have chosen to list in the U.S.. After all, many of the most highly scrutinized firms –like Alibaba, JD.Com, Meitun and now DiDi – are widely held ADRs. But this is far from the truth, and it is a matter of correlation rather than causation. Stated differently, these firms are not being targeted because they are listed in the U.S.

Most of the U.S.-listed consumer-tech firms pursued listing in the U.S. not because they were “defecting” from China in pursuit of a better venue. These Chinese firms listed in the U.S. because they could not receive approval for listing back home. Alibaba, for example, could not gain approval for listing in mainland China or Hong Kong because of its corporate governance deficiencies, where Jack Ma as a small shareholder could always out-vote everyone. DiDi also actively explored listing on the mainland exchanges in addition to HKEX before it decided those paths were nearly impossible due to their various unresolved compliance issues related to China’s labor laws and tax codes (think Uber in the U.S.). The growing concern around DiDi’s ability to generate positive cashflow and reach profitability also made local regulators queasy about approving the company for listing, especially given the recent froth in tech shares. For DiDi, the quickest path to unlock liquidity for its founding core and its PE backers before the global tech euphoria recedes was to dash for the U.S. From filing to listing, DiDi took only 20 days, and priced at the top of the range. Heck, if Lyft can list successfully while stating in its prospectus that it has no business model toward eventual profitability, then surely DiDi can make a fine listed company on the NYSE.

When you consider that many firms listed in the U.S. are tech firms that listed here precisely because there were facing domestic regulatory concerns, it should be no surprise to find that a disproportionate number of the firms facing investigation are those listed in the U.S.

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Understanding Chinese Regulators

Those seeking to understand Ant Financial, DiDi, or other regulatory actions in China should start their analysis by understanding the differences between the U.S. and Chinese regulatory approaches.

Chinese regulators are interventionist. They so this, in part, because their financial markets are dominated by unsophisticated retail investors. Appealing to the wise invisible hand of an efficient market is a luxury that Beijing does not have. Thus Chinese regulators have to set P/E caps for IPO pricing to avoid irrational retail investors bidding prices to astronomical ranges during the subscription period. Thus Chinese regulators chose to take time to vet company financials and business model independently before approving listings. There is real personal career risk for the regulator who approves a firm that turns out to be a fraud or that craters in price due to its inability to execute on the promised business plan.

What Is An Investor To Do?

Foreign investors wishing to invest in Chinese firms must also accept a higher frequency of government intervention at the market, industry, and firm level. They should also understand that this intervention is not driven by senseless bureaucracy or a desire to punish success. The China’s regulator intervenes because it has a foundational (and sensible) lack of trust in its own inefficient capital markets. In China, the invisible hand wears a red glove.

About our Associate Jason Hsu

Jason Hsu is the founder and chairman of Rayliant Global Advisors. Throughout his accomplished career, Jason’s commitment to academic rigor and investor advocacy have led him to research, develop, and bring to market investment strategies that create significant value for investors. At Rayliant, Jason is continuing that commitment by educating investors and offering products to transform the investment ecosystem in Asia and beyond. Prior to his current role, Jason was the co-founder and vice chairman of Research Affiliates.

Jason is at the forefront of the smart beta revolution and is one the world’s most recognized thought leaders in that space. Building on his pioneering work on the RAFI™ Fundamental Index™ approach to investing with Rob Arnott in 2005, he has published numerous articles on the topic, notably his articles “A Survey of Alternative Equity Index Strategies,” which won a 2011 Graham and Dodd Scroll Award and the Readers’ Choice Award from CFA Institute; and “The Surprising Alpha from Malkiel’s Monkey and Upside-Down Strategies,” which won the 2013 Bernstein Fabozzi/Jacobs Levy Award for Outstanding Paper in the Journal of Portfolio Management. In 2015, Jason received the Bernstein Fabozzi/Jacobs Levy Outstanding Article Award for “A Study of Low-Volatility Portfolio Construction Methods” published in the Journal of Portfolio Management. He has twice received the William F. Sharpe Award for Best New Index Research (2005 and 2013), which is awarded by Institutional Investor Journals.

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One for the History Books, a New Control Regime in Oil


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One has to give pause when you think that the only news in markets that mattered today is OPEC+ and what is their next move. We live in a world with growing oil demand and shrinking supply – the stakes are sky high. ESG matters, climate change, inflation, Iran, etc, mean nothing today in the global crude market. All people want to know is – what is OPEC+ going to do next? So clearly, IT is an important issue for the market before we tackle anything else. The sticking point in the talks – the UAE (United Arab Emirates) want a higher baseline after large-scale CAPEX investments in recent years’ production capacity and wants to boost production by 700mbd. On the other hand, the Saudis do not want to offend the Russians and other players by adjusting the UAE baseline.


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Gasoline, Summer Driving Season
After the U.S. handed far more control over the price of oil to the Saudis and Russians, consumers are paying the price. The White House wants this problem fixed by the time the 2022 midterm elections come around. Brent now up close to 116% since the eve of the 2020 U.S. Presidential election.

We are told OPEC+ is proud their “control of price” regime is back. A mere year ago, it was hard to grasp that they had any control after a 10-year hiatus as the dictator of pricing. We feel they canceled today’s planned meetíng just to save the pain of having to create more anxiety in the market when they admit OPEC+ could not land on a solution. Frankly, the agreement likely lies behind closed doors with a few parties and not the whole group. That is likely what is happening. But there are a bunch of people out there that say they have ‘inside contacts’ that likely know or think they know. “The deal we see is, no extension past April 2022, gives time for UAE to argue for a higher baseline, both are sides committed. Larry, there is a low probability of a destructive breakdown with a large boost in production, that´s not happening.” Energy Fund CIO in Canada, in our live Bear Traps, chat on the Bloomberg terminal.

The market hanging on the outcome of the weekend along with the meteoric rise of Saudi control of the market over the last year. All should be seen as a sign that they (OPEC+) don’t want to blow this opportunity. The March 2020 testosterone show inflicted a lot of pain on all sides, those scars are still healing. Oil price risk is to the upside. The likely UAE deal is a kick of the can to April 2022. The world is watching them again for signs of control or lack of it. OPEC lost control for 10 years when the Shale drilling spewed new non-OPEC supply into the market in ’09 and they don’t want to lose control like that again.

We are in a period of strong demand and weak supply. The UAE weekend proposal says no extension past April 2022, OPEC + wanted the extension for all of 2022. In recent months, years, the Saudis have worked many other members into contained quotas, baselines. A total breakdown is highly unlikely, “the oil market globally is in a sweet spot, there is too much money on the line for all the players. Demand globally is strong, we are looking at a deficit of 2.3 to 2.5mbd in June, the highest since last year coming out of covid” CIO, Pension Fund in Canada. If OPEC can’t make that perfect scenario work then it is sending a signal of significant weakness to the market. If they go down that disruptive road, volatility to pricing will be back. That is the last thing the Kingdom wants at this juncture. In other words, derivatives players will start controlling the price and we could see dramatic whipsaws in Brent – WTI as we did in the last decade prior to COVID rebalancing the market. While Saudi is in control, you won’t see the shorts show up. They have warned the speculators to stay away or be hurt. They listened for the most part but would show up again if this cartel were to start showing significant cracks. We just don’t think that OPEC+ is that unwise to let all of their great efforts go to waste over this quota issue. Demand surge is real, summer driving. Overall market dynamics best in decades, the risk to oil prices is to the upside. “All the emergency spare capacity is outside the USA now Larry.” Portfolio Manager in the U.S. Midwest. Spare capacity globally is mostly inside core OPEC, the ESG overdose has crushed US shale investments. “There is too much money in the hands of core OPEC, two years ago this was NOT the case with shale cranking” CIO, Macro Fund in NYC.

Further to that, there is an agreement that all parties are saying they are obligated to work with until Apr ’22. Even UAE says they are not trying to be a thorn or break up the cartel or even the agreement. So we think we can assume this agreement will be honored and we have relative stability until then. That is a lifetime in this market lately. Iran’s new supply risk is out in November in terms of getting oil to mkt, current shale new rigs coming online are not sufficient to impact prices near term. “Watch RIG equity as CAPEX investment start to come in, Q3. Very tight global market through year-end. One producer needs to produce 2.3mbd to get the mkt into a surplus, that is a high bar, not in anyone´s interest.” CIO Energy Fund in Canada.

US shale is not a threat as it is very high-cost production and requires higher prices or contango in the curve to see incremental supply enter the system. Also, the ESG (backfire) narrative still weighs heavy on their ability to grow. In this cycle, companies are being forced to return capital to shareholders. There is far less cowboy-up speculation, drilling. Frankly, this ‘noise’ around OPEC+ stability only shakes the ground under the US producer to remember how quickly prices could collapse again. After the colossal financial hit in Q1 – Q2 2020, shale speculators took their ball and went home.

The Curve is Telling
“It is time to think of the oil curve CL1 (front-month futures contract) is priced at $75.16 vs. CL36 (36 months out futures contract) down at $57.95. As you can see above the spread above is eye-opening looking back from 2005 to 2021. “Larry, the one-year backwardation roll is 11%, just wow” says a Veteran oil trader in our live chat. “Spikes in oil prices have triggered economic slowdowns historically. Remember, oil isn’t a forward-looking product. It is a ‘demand is here now’ product.. The curve shows it, CL36 at 2y highs vs. CL1 at 7y highs speaks volumes. WTI is saying this is a short-term supply and demand imbalance, Otherwise, PBR would be at $50/sh, its closer to $12.” Veteran Energy Sector portfolio manager, in Brazil.

Inventories are dropping and global demand is on the rise via economic re-opening, a massive increase in driving and massive unprecedented infrastructure spending around the world. We have yet to see the impact of global travel amongst countries via airlines which will add almost 3 mil b\d of demand. We don’t see any increase in OPEC+ production being considered as a threat to the current price. In this status quo market, we need more of their supply or we are going to see higher oil prices. The current situation is a very unique opportunity for OPEC to cash in. Non-OPEC – Ex USA production spare capacity around the world in decline. “We see strong demand (India, Europe) with real supply risk, it is not in OPEC´s interest to blow this opportunity.” CIO in London. Oil has a shot at $90 to $100 in, next 6 months.

We do not believe that a price-destructive “non-deal” is in the cards at this time. This is the strongest period OPEC+ has had in the market in decades and they don’t want to give that all up.





Timeless Bitcoin

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In the Mayan empire, the cocoa bean was the unit of exchange.  The “Early Preclassic Maya” years walked through the late 1800s BC, while “Early Classic Maya” danced out to 600 AD. The Mayan kings of the city-states kept strict control over the cocoa bean supply. It was hard to grow. A supply growth under arrest, sound familiar? Cocoa crops failed all the time. And they had to be specially dried and fermented in a certain way to be valid legal tender. In other words, a cocoa bean required a lot of energy and was of limited supply. Like Bitcoin.

XBT Fails at the 200 Day
As the mad mob chases the brass ring, the drawdown brings a reality check. It took Google nearly 24 years to reach a $1T market cap, XBT just twelve years with the last $500B of gains this year. What does that mean? The beast inside the market is telling us there is a lot of capital that owns Bitcoin at MUCH higher prices. There is a substantial amount of weak hands in XBT that thirsts every minute of every day this week, “to get even and get out.”

Offered to the Kings

Keep in mind, there was a big difference. If you were caught growing cocoa beans illegally,  there was a good chance you’d find yourself on top of a pyramid with your living heart cut out of your body by a blood-encrusted priest (it was taboo to wash off victims’ blood) and have your still pumping heart offered up to the sun. The hot chocolate was the drink of kings. It was a special treat for the rest of the population. They literally drank money. Naturally, if a particularly expensive war came to a fruitless draw, the kings would release more of the cocoa beans than usual, i.e. they would debase their currency.  When a century-long drought came, the Mayans released so many cocoa beans they became all but worthless, the middle class was wiped out and that contributed to the Classic Mayan Collapse. Well, at least that is one hypothesis.  In any case, the real point is, the  Mayan kings watched their money supply like hawks. If someone had invented a virtual cocoa bean, he would have found his heartless body tumbling down a long flight of pyramid steps into a rapturous crowd.
And this brings us to Uncle Sam and Form 1040, which, after establishing your name, social security number, and contact information,  asked if you had traded any virtual currency during the past tax year. Then they asked about your deductions and normal income as per usual.  No government wants to see serious competition to its currency that it can’t control.  Sounds to us like the obsidian knives have been sharpened.