We made the decision to travel to Singapore in advance of China’s 20th Party Congress in order to get the perspectives of our Asian community at this critical juncture. 

As is customary at our dinners, each attendee was requested to bring a chart to discuss with the group. Please find a summary of the charts and discussion below. 

Chart 1: Long Watanabe If Japan joins the global wave of monetary tightening, prepare for a rates shock and another selloff in global duration. Buy yen. 

Chart 2: Short Animal Spirits “What’s remarkable about China is that the problems are all self-inflicted. It’s mind-boggling.”

Chart 3: Short Freedom Predicting the end of the zero-covid policy in China has been a fool’s game.

Chart 4: Long Survivors China’s housing market is on the path to become be a dull, low-growth sector, rather than a high-octane driver of economic expansion and speculative bubbles.

Chart 5: Short Bears “Everyone is waiting for a contraction in earnings for the next phase of the bear market. I don’t think it’s coming.”

Chart 6: Long Immigrants America’s prime-age population stopped growing more than a decade ago, and it seems improbable that it will recover naturally due to declining birth rates.

Chart 7: Long Canaries The supply of below-investment-grade debt is near record highs in China and India.

Chart 8: Short Wildcatters “This is the biggest issue the energy industry is facing.”

Chart 9: Short Antifragile “How do you hedge?” 

Chart 10: Long Ashramas If our professional decline is not only inevitable but also occurs sooner than most of us anticipate, shouldn’t we prepare for it?

Long Watanabe


Source: Bloomberg

“How long can the Bank of Japan (BoJ) remain an outlier in the global wave of monetary tightening to tame inflation?” asks the speaker. His model predicts Japan’s core-core inflation rate (ex-fresh food, energy, mobile phones, and hotels) will increase to 3 percent by the end of the year from 1.5 percent today. 

Japan has been attempting to create a sustained period of higher inflation for years in an effort to escape a slow-growth, deflationary trap. One of the most frustrating dynamics for policymakers has been the meagre wage gains.  

Since 1990, wages in the US and UK have risen 40 percent. In Japan, they have increased by 4 percent. Why is that so? Because small businesses, many which of are struggling, employ 70 percent of Japanese workers as opposed to the giant multinational firms. 

However, annual wage inflation is currently running at 1.5 percent, the highest since 2008. About 4,900 unions in Japan secured a 2.1 percent increase in average monthly pay in this year’s wage negotiations. The health ministry raised the average minimum wage for its employees by a record 3.3 percent. 

Change is afoot. And it may get more difficult for the BoJ to keep policy unchanged. Due to the yen’s 25 percent slide this year and rising import costs, Japan’s trade deficit in August was around $20 billion, which was a record high. 

If Japan scraps the yield-curve control policy or even widens the band at which it allows long-term interests to move around its zero percent target, the speaker believes we could get a rates shock and another selloff in global duration. “What happens in Japan doesn’t stay in Japan,” he remarks.

Therefore, he is cautious owning bonds despite the surge in global yields. But he does see an opportunity in buying yen. In the case of a change in monetary policy, Japanese savers, a major source of financial capital worldwide, would liquidate their holdings of US and European bonds and return money home; the yen would soar. 

“Japan will shortly reopen its borders to tourists after more than two and a half years, which could also boost the currency,” one of the attendees suggests. In 2019, the travel and tourism sector contributed $359 billion to Japan’s coffers, or 7 percent of GDP.

The consensus was that no change in policy is anticipated until at least April, when BoJ chairman Haruhiko Kuroda, who insists Japan’s inflation is a short-lived phenomenon, steps away. 

Short Animal Spirits


Source: Macrobond

In response to the 2016 growth slowdown, Beijing increased infrastructure spending, bailed out the local governments, depreciated the renminbi, and imposed capital controls. China’s banks extended a record $1 trillion in loans during the first quarter, which was greater than the response during the 2008 crisis. It worked. 

Beijing’s 2022 stimulus measures add up to $1.3 trillion. However, the tools deployed to stimulate the economy aren’t proving to be up to the task. Low interest rates and easy access to credit have failed to boost growth because firms and households aren’t willing to borrow. Unlike 2016, bank lending to both developers and households is collapsing. 

The message is clear says the speaker: “China has lost its animal spirits.” Looking at his chart, the differential between social financing and M2 growth has turned negative, an indication that the “policy reaction function is not working properly”; deposits are rising but not leading to more spending. 

There are real constraints on the type of infrastructure projects that can get funded. That’s limiting the scope to pump up economic activity. One of the attendees suggests China is also experiencing a “household balance sheet recession” which could take years to play out, similar to what occurred in Japan. 

“What’s remarkable about China today is that the problems are all self-inflicted,” adds a participant. “It’s mind-boggling.” She’s short the renminbi while bullish on rates. Additionally, she asserts that China’s pursuit of zero covid is a method of implementing capital controls. The currency would be even weaker without it.

Authorities have made it significantly harder to access foreign currency and to move money across the border in recent years. The consensus was that the renminbi will continue to weaken, but the PBOC will slow the pace of depreciation to prevent spooking markets.

Given that China is the top trading nation for over 130 countries, there is a risk that a weakening renminbi may set off a vicious cycle.  

Short Freedom


Source: Haver Analytics

As if domestic problems weren’t already enough of a burden, China faces yet another major challenge as external demand wanes. 

The US trade deficit fell to a seasonally adjusted $70.6 billion in July, from $80.9 billion in June, and a record $106.9 billion in March. “Consumption rotation from goods to services will pose a drag on China’s exports,” says the speaker. 

In addition to the August export data falling short of market expectations for the first time in a year, the container throughput indicated further export slowdown into possibly contractionary territory. Exports could contract 1 percent from growth next year, according to the speaker. 

Exports have been the primary engine of the Chinese economy since the pandemic. The speaker posits a question: “Could slowing export momentum compel Beijing to scrap its zero-covid policy in an effort to boost domestic demand?” 

There are thirty-three Chinese cities that are currently in complete or partial lockdowns, causing significant disruption to nationwide and local mobility. Authorities have recently shortened quarantine requirements for inbound travelers and domestic close contacts and Chengdu, a megacity with 21 million residents, managed to control its covid outbreak with just two weeks of lockdown.

“Policymakers are going to have to make a difficult choice to avoid a downward spiral,” says the speaker. But nobody expects that the zero-covid policy will change before March. “Over the past two-plus years, predicting the end of the zero-covid policy in China has been a fool’s game,” a participant adds. 

“We most certainly won’t witness a big announcement from Beijing that they have suddenly decided it’s time to adopt a ‘living with covid’ strategy, similar to what Singapore said in March.”

Long Survivors


Source: Bloomberg

China introduced its “three red lines” policy in 2020 in an effort to rein in excesses in the property sector. Few were aware of how serious Beijing was and that it would cause problems in the real estate market.

In December 2021, when China Evergrande and Kaisa Group defaulted on their borrowings, investors expected the government to step in and support the sector. Many investors ploughed into Chinese property bonds attracted by yields in excess of 10 percent. 

However, Beijing did nothing as it was focused on reducing debt and speculation. Home prices have fallen for 12 straight months. 

Of the 242 dollar-denominated bonds issued by Chinese property firms, 204 are trading well in distressed territory below 50 cents on the dollar. Some have lost more than 90 percent of their value. Total wealth destruction in the sector amounts to $120 billion.

There was a time when China’s high yield property bonds made up 40 percent of the Asian high yield index. A downdraft in the value of outstanding bonds and defaults have caused the proportion to now reduce to 13 percent.

In July, homebuyers at hundreds of unfinished developments across the country vowed to halt mortgage payments until their homes were completed. According to a rescue plan unveiled in August, the central bank would give policy banks up to RMB 200 billion, who would then lend it to local governments, who would then make the funds available to distressed housing projects. 

Local governments, banks, and asset management companies (AMCs) are becoming more active in guaranteeing the smooth completion of unfinished housing projects within their respective administrative regions. Beijing has directed a state-owned credit enhancement company to guarantee bond issuances by a select group of high-quality developers. This may help alleviate new home buyers’ concerns. 

The speaker sees an opportunity in buying property bonds of developers most likely to receive funding. He likes Country Garden, which he dubs a “survivor.” The lack of enthusiasm for the idea around the table was a sign that many had dabbled in China’s property bonds and had been spurned attempting to catch a falling knife. 

“China’s housing market is on the path to become be a dull, low-growth sector,” the speaker argues, “rather than a high-octane driver of economic expansion and speculative bubbles.”

Short Bears


Source: Bloomberg

“Everyone is waiting for a contraction in earnings for the next phase of the bear market,” the speaker submits. “I don’t think it’s coming.” With all eyes on the real growth slowdown (blue line), the whole nominal picture (orange line) is being overlooked which remains supportive of earnings growth. 

When inflation historically averaged about 2 percent, a recession would result in negative real growth, low or non-existent nominal growth and a concomitant decline in earnings, leading to lower stock prices. “Any downturn that happens now may be different,” says the speaker.  

Earnings revisions have been downshifting since last summer and turned negative this year, tracking the pattern seen in previous recessions. However, there are indications that earnings revisions are bottoming out alongside the ISM Manufacturing index, which suggests that large earnings declines may be avoided. 

Analysts have been more pessimistic in their revisions to earnings estimates for S&P 500 companies for the third quarter compared to recent quarters, while firms have been more upbeat. Consensus estimates have decreased by an above-average rate of 6.6 percent since their peak in June. Estimates are also falling for 2023, with S&P 500 EPS down 4 percent to $242 from $252 at the June-peak. 

The discussion turns to the possibility of record margins being threatened by rising wages, higher interest rates, and lingering supply chain problems. 

“Costs are rising, but strong revenue growth (because of a higher nominal growth environment) should be an offset,” argues the speaker. The S&P 500 net profit margin (excluding energy and financials) peaked at 12.1 percent last year; it is now 11.3 percent. He doesn’t anticipate a recession and expects margins to remain healthy.

“If we focus on just the four recession periods associated with inflation shocks (1953, 1973, 1980, 1981),” challenges a participant, “we see average earnings decline of 17.7 percent.” The S&P 500 would break the June lows if this scenario came to materialize. 

The speaker was alone in his bullish view.

Long Immigrants


Source: Bloomberg

The pandemic caused a major disruption in America’s labor force, leading to what has come to be known as The Great Resignation. In 2021, more than 47 million workers quit their jobs. However, a deeper examination of what has happened is best characterized as ‘The Great Reshuffle because hiring rates have outpaced quit rates since November 2020. So, many workers are quitting their jobs, but a lot of them are being employed again elsewhere.

When comparing changes in the labor force across different industries, some have a labor shortage, while others have a surplus of workers. 

The transportation, health care and social assistance, and the accommodation and food sectors have had the highest numbers of job openings. Except for the food sector, which struggles to retain workers, the rest have maintained relatively low quit rates.

Meanwhile, durable goods manufacturing, wholesale and retail trade, and education and health services have a labor shortage. Even if every unemployed person with experience in the durable goods manufacturing industry were employed, the industry would only fill 65 percent of the vacant jobs.

Conversely, in the transportation, construction, and mining industries, there is a labor surplus. The manufacturing industry faced a major setback after losing roughly 1.4 million jobs at the onset of the pandemic. Since then, the industry has struggled to hire entry level and skilled workers alike.

The number of people in the labor force rose by 786,000 last month, which is encouraging. But there are still 11.1 million available jobs in the US economy, nearly double the total pool of available workers, which stands at 5.6 million. People over 55 in particular have not gone looking for jobs in large numbers.

“I don’t see how wage inflation slows down given this dynamic,” says the speaker. “The Fed will have to keep raising rates aggressively, which could eventually tip the economy into recession.” But therein lies another problem.

While the Fed is targeting a higher unemployment rate to bring down inflation, she notes that labor demand decreased by around 2.5 million in prior recessions. Given current excess labor demand is 5.5 million, the labor market will remain tight even if we head into a recession next year.  

America’s prime-age population stopped growing more than a decade ago, and it seems improbable that it will recover naturally due to declining birth rates. “If the US needs more workers,” the speaker says, “immigration is the only solution.” Immigrants newly arriving in the US are at about 80 percent of the pre-pandemic quarterly average.

The discussion turns to the surprising US inflation print, showing core prices went up 0.6 percent in August. Shelter inflation was up 0.7 percent from July, a new high for this cycle. Over the last three months all items except energy rose at a 7.4 percent annual rate, faster than during the spring. 

“While the inflation run up usually takes a year, the drop can take between 1 to 3 years,” a participant submits. Considering that the median rental price dropped last month for the first time since November 2021, another participant suspects that shelter inflation may be reaching its pinnacle. 

Everyone worries that the month-on-month decline in inflation will be nauseating even though core inflation peaked in March and the headline rate peaked in June. 

Long Canaries


Source: Morgan Stanley

Despite speculation that the US is veering toward a recession, the speaker isn’t worried about corporate bankruptcies piling up. 

“Near-term maturities appear broadly manageable after issuers lengthened maturities at historically low rates during the more favorable financing conditions of 2021,” he notes. “Contrary to popular perceptions, the US economy can operate at higher interest rates.” 

Spread on investment-grade corporate debt is 160 basis points. During the Great Recession, investment-grade yields surged to more than 600 basis points above Treasuries. In March 2020, that gap hit nearly 400 basis points. “Credit markets aren’t breaking,” the speaker adds.

While speculative-grade debt is more vulnerable to refinancing risk, it represents a relatively small slice of debt maturing—only $205 billion maturing in the US over the next 18 months and $116 billion in Europe. 

In the first half of 2022, the issuance of leverage loans decreased by a fifth year over year. “That’s the canary in the coal mine,” an attendee argues. The combined amounts of US high yield bonds and leveraged loans trading at distressed levels is $125 billion, up from $33 billion at the end of 2021.

Another attendee shares that about 81 percent of emerging market corporate debt maturing in 2023 is US dollar-denominated, raising exchange rate risk for issuers that are not adequately hedged. The supply of below-investment-grade debt has reached near record highs in China and India. 

Short Wildcatters


Source: Novilabs

The speaker believes many of the global oil fields, including the Marcellus gas or Permian oil in the US shale patch, are in phase 1 or phase 2 decline. His chart, which plots oil and gas production by vintage year, shows that decline rates have accelerated very sharply in the last couple of years. 

“Should we run much harder on the capex treadmill for even small growth in supply as base decline rates accelerate?” asks the speaker. “This is the biggest issue the energy industry is facing.” Governments aren’t making the decision any easier as they impose a windfall tax on the profits of energy companies. 

The speaker points out that the number of rigs drilling for gas has risen to 166 from 106 at the start of the year and a low of just 68 during the pandemic’s first wave in 2020. However, gas production was up just 4 percent in the second quarter of 2022 compared with the same period in 2021, despite prices well above long-term averages.

US shale drillers are struggling to meet strong demand for gas from domestic generators as well as customers in Europe and Asia scrambling for replacement supplies following Russia’s invasion of Ukraine. Working inventories in underground storage have also been below the pre-pandemic five-year average continuously since late January and the deficit has shown no sign of closing.

The speaker anticipates that the price of US natural gas will be much higher next summer than what is reflected in the futures curve right now. He’s less bullish on oil and thinks that the European demand estimates from gas-to-oil switching are overblown.  

Short Antifragile


Source: Bloomberg

The speaker is worried about systemic risk. He believes that a soaring dollar and a 4 percent Fed funds rate are too much for the global economy and financial markets to handle. “Something is bound to break,” he says, looking at the density of near term vols moving higher. “The system is more fragile than we think.” 

One of the attendees notes that the volatility environment has been profoundly abnormal this year. The first half of 2022 has been the weakest for volatility relative to similar S&P 500 price moves since launch of the VIX Index twenty-nine years ago. 

Because of the lack of an implied volatility increase in 2022 relative to what has occurred in similar historical market drawdowns, those using put options to hedge a downside move in the S&P 500 did not get the response they were looking for from their option hedges. 

“So, if you’re bearish, how do you go about hedging?” an attendee asks. A 60/40 stock-bond portfolio is down more than 20 percent this year. There were no great answers. Macro investors at the table welcomed the volatility. They were all having a great year.

Long Ashramas


Source: Various sources 

Several studies reveal that for most people, in most fields, their professional decline starts earlier than almost anyone thinks. The world changes, our skills become less relevant, or our intelligence begins fading. Despite this, the biggest mistake people make is trying to sustain peak accomplishment indefinitely.

“If decline is not only inevitable but also occurs sooner than most of us anticipate, shouldn’t we prepare for it?” asks the speaker. “The wisdom of Hindu philosophy offers a way.”  

According to Hindu tradition, a person passes through four ashramas or stages in life. 

The first is Brahmacharya, the period of youth and young adulthood dedicated to learning. The second is Grihastha, when a person builds a career, accumulates wealth, and starts a family. Many people who get attached to earthly rewards—money, power, sex, prestige—try to make this stage last a lifetime. This is a common trap. 

Those who fail to leave Grihastha skip the spiritual development of Vanaprastha

Around the age of 50, we should deliberately shift our attention away from career aspirations and toward spirituality, service, and wisdom. Entering the third ashrama, Vanaprastha, does not mean that we need to stop working; rather, it proposes that our life goals should adjust.

To fully experience the bliss of Sannyasa, a state of inner peace and equanimity, we must prepare for the last stage of life and be ready for death. Our chances of finding peace increase the more detached we are from our egos. 

“Which ashrama are you in?” asks the speaker. 

“This framework resonates with me,” says the CIO of a sovereign wealth fund. “I don’t want to be in my current role for more than five years. It will be hard to walk away but I want to make way for others to grow and prosper.” 

He is fully aware of the influence his position commands. “Maybe Jawad will still want to talk to me after I retire but most people won’t,” he submits light-heartedly. He’s on a quest to figure out how to devote his time during Vanaprastha so that he’s still engaged and excited. 

Retirement need not be something to dread; rather, it may be an opportunity for progress. “I don’t have any ideas at the moment,” he reflects. “Is there anything I can do, starting now, to better my chances of avoiding life’s typical pitfalls?”

“Try Burning Man,” one of the participants jokily suggests, pointing to Ray Dalio’s picture. Everyone bursts out laughing, including the CIO. 

“I’m not as dependent on monetary rewards as I once was,” shares a participant in his fifties. He takes more pleasure in building new businesses, exploring new asset classes like crypto, and coaching newcomers. He has stopped working like a maniac in favor of a more “meaningful” life. A question he thinks about often is: “How can I be as energetic in thirty years’ time?”

Another participant admitted that his quant skills are in decline. Experience in markets has given him perspective, however, and his intuition is stronger. “What if there’s not a linear passage through the ashramas; rather, we move around based on different aspects of our life?” he suggests. In parenting, for example, he’s still in the learning phase of brahmacharya.

A macro PM in his thirties shares that he wants to make a positive difference. “I’ve been thinking about teaching school kids,” he says. “You sound like you’re already in Vanaprastha,” says an attendee. “Shouldn’t these be your formidable Grihastha years?” 

“I can do both,” he responds, looking clearly determined and wise beyond his years. “My needs are met.” 

“If you peak you retire,” shares another macro PM. “I’ve been searching for my peak my whole life.” He offers the example of Soros, who still appears to be in Grihastha!

“I have learned to forgive myself for bad trades and missed opportunities,” he continues. He’s more adept at handling P&L and minimizing the negative effects of his long hours on his family. A “balanced” life is important to him.

“What matters for me is the horizontal limit not the vertical one,” says another participant. “How do you broaden your horizon? I am aware that I can profit from the markets. What else can I do?”

The pandemic experience taught her to have more patience, to let herself explore different possibilities, and to be at ease being her true self. “I believe that’s the only way you can really figure out what you like or dislike, and what you can or cannot accomplish. And that defines the boundary of the box we are in.”

She took up mountaineering and launched a fashion brand, all the while managing a multibillion-dollar fund.

“I recall a conversation I had a long time ago regarding the purpose of life. The person said, ‘My life will have meaning if, when I leave this world, I know that even one life—a human being, an animal, or a plant—is better off because of my existence.’

“That really struck me,” she adds. “I thought it was really beautiful.” In other words, when it comes to impact, we don’t need to think big. Each of us may give back in our own unique manner. 

Another participant submits: “In India, since there are so many obstacles to overcome during the Brahmacharya period in order to reach Grihastha in pursuit of financial security, it is usually too late to think about purpose and freedom.” He’s focused on providing for his extended family, which is a laudable goal in and of itself.

An attendee recently promoted to deputy CIO shares that he’s finally reached a stage of his career after a few career twists where he finds work to be rewarding and enjoyable. He is held to a lot of expectations from his family and colleagues, and he seems ready to assume that responsibility. His feet are firmly planted in Grihastha, and he’s fully committed to his role. “It’s too soon to stop,” he says. 

“You don’t necessarily have to quit your job,” offers the final participant. “There’s another, more enlightened way of being.   

“In Karma Sannyasa one’s worldly life is balanced with one’s progress in spiritual life, so that both roles are beneficial to and complementary to one another. We can maintain our external identity and even continue to make advances in our career, but inwardly we are cultivating spiritual awareness and striving to detach progressively from earthly rewards. 

“In this way, work itself can become a transcendental pursuit. The world is full of Karma Sannyasans.”