52 seconds capital

Month: September 2023

Trivia time folks!

Food? Strike 1.

Energy? Strike 2.

Shelter? Bingo!

Why?

Think about it, once you have locked down your tenancy contract with your landlord, does your rent really change month-on-month the way other categories, say Food or Energy, within the Consumer Price Index do?

Your rent changes but with a one-year lag, only when it comes up for renewal.

And that one-year lag in rent changes could create a significant impact in the Core CPI including Shelter (excluding Food and Energy) prints in the next few US CPI readings.

Impact is Weight * Change.

1. On Weight (and this is the simple one) ‘Shelter’ has a 34.8% weight within the US CPI, making it the largest expenditure category. A large part of ‘Shelter’ comprise of two key sub-categories: Rent (7.5%) and Owner’s Equivalent Rent (OER) (25.6%).

2. On Change (and this is the kind of simple that can be tougher than the complex, nevertheless we press ahead!):

a. While both ‘Rent of Primary Residence’ and ‘OER’ grew by 7.8% and 7.3% respectively YoY (Aug ’22 – Aug ’23), the back half of the year could see some deceleration in the rent asks from last year playing out.

b. For lower or flat-lining rents to play out its important that housing prices contract mildly or hold. There is a positive correlation between housing prices and rents; higher house prices translate into higher rents. And lower prices into lower rents. House prices do not need to crash for this to happen. A dial-back in the expectations of a price rise in housing is enough to cool-off rents. Think about Japan: one of the reasons why the country, which has a one-fifth weight towards Housing in its CPI, has gone through an extended spell of deflation despite negative interest rates has been the busted house prices (and from there on the muted rent growth).

c. Shelter has now increased for 40 consecutive months (measured from May 2020 until August 2023). Is that about to change?

A slowing pace of increase in Shelter Inflation over the next few months and the first negative Shelter Inflation print by Mid-2024 appears more likely from hereon, especially when viewed against the twin backdrop of the 30-year fixed rate on mortgages topping 7.5% and the fact that 90% of households (with a mortgage) pay less than the current rates.

It will be Interesting to see how this category within the US CPI trends over the next couple of quarters.

By

Avinash Menon, CFA

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52 Seconds Capital Limited

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The Mexican Presidential Elections of 2024 will be historic: the country is all set to elect its first female president.

Earlier this month, Morena, the country’s ruling party formally nominated Mexico City’s Mayor Claudia Sheinbaum Pardo as its candidate to take on Xóchitl Gálvez, an independent senator who caucuses with the conservative National Action Party in the Senate.

In the lead up to these nominations, the candidates have sparred lightly on various issues: while Sheinbaum has focused on the ‘continuity’ of incumbent president Lopez Obrador’s policies, Senator Galvez has heavily criticised the current regime’s weak security strategy, in particular its failure to crack down on the drug cartels.

Nothing unusual there.

What is unusual is how both candidates have, in all these months, steadfastly refused to acknowledge the elephant that’s standing right between the two candidates: Petroleos Mexicanos (PEMEX), which holds the unsavoury title of being the world’s most indebted oil company currently, has liabilities of $110 billion.

In a sign that that the gloves are finally coming off, Senator Galvez has announced her intent to undertake sweeping reforms at PEMEX opening it up to private investment and bringing in a renewables tilt to its business.

Privatization of energy assets has always been a touchy subject in most countries and especially in Central and Latin America where leftist policies still hold sway: Argentina established the YPF as a state-owned oil enterprise in 1922; Mexico nationalized PEMEX in 1938; Brazil nationalized the oil industry in 1953 (creating Petrobras in the process); and Venezuela did it in 1976.

Some of these policies were disastrous for the nations involved (Venezuela got torched in the process) but Brazil did something remarkably different: in 1997, President Cardoso broke the monopoly and forced Petrobras to compete with foreign firms. And later in 2002, President Lula created a system of public-private partnerships.

It’s the Lula-public-private-model for Petrobras that Senator Galvez appears to have in mind for PEMEX.

The oil giant has regularly received cash injections and tax deferrals from the Obrador government and that’s kept it afloat, but these moves are akin to kicking the can further down the road. The current government’s concessions to PEMEX are estimated to be 1% of GDP. This is expected to rise to 1.5% of GDP under the next government.

With its total debt now standing at 8% of Mexico’s GDP, PEMEX wouldn’t be the first state-owned company to make an ungainly transition from being a crown-jewel to an eyesore.

In the absence of any sweeping reforms, the embattled oil-giant has made itself at home.

In a familiar setting.

On a slippery slope.

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Earlier this year, in March, you will recall how over the course of just a few days, three small-to-mid sized US banks failed. The triggers for their failures varied: SVB went down after it realized MTM losses on its long durations USTs; Silvergate and Signature, both holding significant exposures to crypto assets, followed suit. And then later, across the Atlantic, Credit Suisse collapsed.

It’s a well-known fact that regulators typically try to resolve a banking crisis over the weekend.

Consider that: only a 48-hour window to delve through reams of data. Broker a rescue. Attempt to stem a potential contagion. And arrive at a decision before Monday rolls in.

Against such a backdrop, it is safe to assume that speed takes precedence over accuracy. And ‘guesstimates’ trump the most detailed of valuation models. (What else can explain UBS recording a $29 billion negative goodwill on its Credit Suisse acquisition? or JPM’s grand bargain price on its First Republic acquisition?)

That first act in March was also characterized by Jerome Powell laying the blame for the collapse of these banks squarely on the bank management’s failings.

Beyond that, not much really came through from the US regulators, on steps to be taken to avoid a chaos of this nature in the future.

Until late last month, that is.

On August 29th, a clutch of US regulators, including the Department of Treasury, the office of the Comptroller of the Currency, the Federal Reserve System, and the FDIC, released a consultation paper, that proposed for:

“certain large depository institution holding companies, U.S. intermediate holding companies of foreign banking organizations, and certain insured depository institutions, to issue and maintain outstanding a minimum amount of long-term debt.”

The consultation paper goes on to say that:

“The proposed rule would improve the resolvability of these banking organizations in case of failure, may reduce costs to the Deposit Insurance Fund, and mitigate financial stability and contagion risks by reducing the risk of loss to uninsured depositors”

This echoes similar views from FINMA in early August.

The line of thought is clear: banking regulators are nudging the industry in the direction of “Bail-ins” (“Bail-outs” help to keep creditors from taking losses while “Bail-ins” mandate that creditors take losses).

A Bail-in has its fair shares of pros and cons (but that’s a story for another day), but the regulatory direction is clear: shift the costs of a bank’s failure closer to where it originated from ─ its shareholders and creditors (and away from the general public’s coffers!).

It’s also a vote from the US regulators and FINMA for lesser chaos (and less frenetic weekends 😉) during the resolution of the next banking crisis.

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The pandemic hijacked 2020; NFTs, SPACs and IPOs (and the Kim-Kanye breakup) were perhaps the biggest draws of 2021; the War and its problem child ─ Inflation ─ were dominant in 2022; and so far, Generative AI has been the overarching theme of 2023.

2024 will see large sections of the planet’s population witness something that has always had high entertainment value.

2024 is chock-a-block with elections.

The year kicks off with the Taiwanese Presidential Elections. Followed by Presidential Elections in Russia (Putin, has not yet officially declared his intention to run, but if elected, it would be his fifth term); general elections in India, Mexico, and Indonesia; culminating in the US Presidential Elections.

As you scour through the various campaign promises made by both the opposition and the incumbent party leaders, beyond the cheap thrills provided by media sleuths unearthing skeletons from the past (remember how Obama had to wave his birth certificate around?) or fuelling xenophobia (Melania Trump is a spy), what you are really looking for from the leadership candidates are the ideas that are unstoppable. And usually what makes an idea unstoppable, apart from the simplicity of its structure, is the time or the era within which it takes roots.

Vivek Ramaswamy who is making waves in the Republican primaries, appears to be holding a bag full of such ideas: a new American Revolution that draws inspiration from the nation’s founding fathers; driving a wedge between Russia and China; slashing aid to Ukraine; and all this while taking clear aim at the Woke Movement.

Of what he holds in that bag, two ideas in particular, stands out for its boldness (and evokes memories of Sen. Elizabeth Warren’s call in 2020 to ‘Break Up Big Tech’):

1. Vivek Ramaswamy plans to take a large axe to the federal workforce, with plans to lay off 75% of the workers. Yeah, you read that right, that’s 75%! He also believes there is no place for what he refers to as the ‘administrative government’ comprising of the FBI, DOE, and CDC among others in his idea of America.

2. Pegging the USD to Gold, thereby reducing the influence of the US Fed on the economy.

Very often all that an idea needs is a simple structure and great timing. And what can eventually lead to an idea’s demise are a lack of details around execution.

A lot can change between now and election date, but for you and I and all the other market participants, what makes election year interesting are the ideas that could turn out to be unstoppable.

The ones that were best described by Victor Hugo when he said: “Nothing else in the world…not all the armies…is so powerful as an idea whose time has come”.

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Avinash Menon, CFA

Founder and CEO,

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