Ataraxia Financial Newsletter - January 2023
Bull or Bear, Who Will Dance in 2023? And the Big Picture - Governments in Debt Spirals and the Possible Way Out for Prudent Low Time Preference Investors.
"The budget should be balanced, the treasury should be refilled, public debt should be reduced, the arrogance of officialdom should be tempered and controlled, and the assistance to foreign lands curtailed lest Rome become bankrupt."
— Cicero (63BC)
Tuesday, January 31st, San Salvador.
The first month of 2023 has seen a magnificent start in the markets with the bull overtaking the lead of the dance from the bear who had been the dominating dancer in 2022, which witnessed one of the worst performances for a typical 60/40 portfolio (60% stocks and 40% bonds) in recent history:
The 60/40 portfolio has been a solid and highly recommended asset allocation for several decades. The basic idea behind it is that investors can take advantage of the profitable developments in the stock market, while dampen the downwards movements by also holding a significant amount of less volatile bonds that are perceived as a cushion and safety provider.
Indeed, historically these asset classes have rarely both had negative returns in the same year and for the last two decades they even had a consistently negative correlation when averaged over a couple of years.
However, 2022 has marked a big shift in this dynamic, with both asset classes declining substantially. The following chart provides an idea of how significant this result has been in a historical context:
The question is, whether this was just an unpleasant bump on the beautiful road to Nirvana — or, could it be that we are in for more damage?
The purpose of this newsletter is to try the best to figure out all of the materials that are used to build the road and all of the dots that need to be connected in order to understand its path. Thus, we try our best to see where the road is leading, where the bumps are and how fellow drivers might circumvent them — and maybe even reach Nirvana someday.
Newsletter Update
First let's do some short house keeping about this newsletter.
The Ataraxia Financial Newsletter actually has just celebrated its first year anniversary!!! 🎉🥳
So far, I personally had a lot of fun and enjoyed writing it. And I also learned a couple of things. 🙂
Here are some basics of what I have learned and got as a feedback:
It takes way more time to dive deep into all of the topics I deem interesting and wanna write about and share with the readers.
I have gotten a lot of feedback that it is really interesting to read but just way too long for a newsletter. In addition, I got differing feedback on what parts of the newsletter are interesting and what parts maybe have gone too deep in particular issues for some readers - especially those readers who are maybe not so familiar with financial terms and concepts.
I also found it challenging to get several larger topics and include them in a comprehensive way into one newsletter.
Thus, I have decided to do some changes.
From now on the newsletter will come out at the end of the month after the markets close. It will only contain the major market developments from a big picture perspective and maybe some interesting ramblings and experiences that I can share here and there.
However, I will keep it shorter by strictly adhering to the email length limit suggested by Substack.
In addition, I will keep researching and diving into some particular topics of my interest (not only about finance, but I am also working on some other stuff around sport, lifestyle and health). I will publish them separately and not as part of this newsletter. But I will provide the links here, for anyone who is interested.
Moreover, I will try my best to explain what’s going on and my way of thought in a way that even people who haven’t studied or worked in related fields can grasp and take away something! 🧠
So, that’s all. Hope you will keep enjoying it and always feel free to provide me with feedback!
The January newsletter will cover the following topics:
Market Analysis
Summary for the December Key Indicators
Summary for the January Key Indicators
The Big Picture
What Is the Role of Money
The Potential Bright Side
Market Analysis
December saw a resurgence of the Treasury yields which caused stock markets to decline again and closing the year about 20% down. As mentioned above, 2022 marks one of the worst years for a traditional portfolio consisting of 60% stocks and 40% in bonds.
A positive side-note was that natural gas prices kept declining across the globe and therefore getting back to more normal levels, which is very important for consumers and producers (especially in Europe were prices had gotten to astronomical levels).
The big story for January was that the Inflation numbers kept falling and it is now the general view that there will be a slowdown in rate hikes. This outlook is bullish for stocks, especially the growth and stocks with a higher perceived risk. These equities saw huge rallies with the Nasdaq rising 10.7%.
In addition, Bitcoin saw a major jump for no clear apparent reason. It might be due to the fact that Genesis has finally filed for bankruptcy and therefore some of the uncertainty is now clarified. Also the general increase in risk appetite could be an explanation.
Another good development is the persistent decline in natural gas prices. Partially due to a comparatively mild winter, but also due to various saving initiatives (whether that is a positive thing or not is debatable) and the surprisingly fast opening of Germany’s first out of three planned LNG terminals. In any event, the prices in Europe are back to a more manageable price at a level last seen in September 2021:
Anyway, the next Fed rate announcement is coming up tomorrow. The general expectation is a rise of 25 basis points which would result in a 4.5%-4.75% target rate. Some are also expecting a 50bps hike.
As readers know, I actually did not expect that the Fed would be able to hike the rates to such high areas. I expected that given the high debt level, these rates would cause massively more havoc throughout the economy, which would cause him to pivot. I am still pretty sure that these high levels are not sustainable for a long time as bonds mature and have to be rolled over at higher rates.
However, Jerome Powell has proven me wrong and now I actually think that he really takes it serious to rein in inflation and thereby making his name in the history books as the one who saved the Feds credibility and bring inflation back down just as Paul Volcker did in the 80s.
Therefore I think that he doesn’t like the way the market prematurely rallies and behaves as if the inflation fight is already over.
Thus, with the risk — and high likelihood — of being wrong again, I bet Powell will keep his path and raise the rate by 50 basis points.
…and if he really wants to set a clear exclamation mark, he could even make a 75 bps hike. That would really tame the market sentiment. 🤪
By the time most people are reading it, the number is gonna be out and you will know how wrong I was again. 😅
Let’s turn to the more interesting story, shall we?
The Big Picture
Zooming way out and look on what’s happening on planet earth from an Alien perspective must be quite amusing.
These funny creatures with arms and legs have really pulled it off to run their entire economy with a pure paper money system. 🤯
A paper money system where centralized authorities can decide the amount of issuance, while the embedded incentive structure for those entities that make those decisions are clearly tilted into one direction — expand the money supply. 🤑
What an interesting experiment. 🤡
Zooming back on planet earth, most people still have a huge amount of trust in their institutions and that this system — while it might have some flaws — is working.
Money is a topic that people always talk about and everybody is somehow interested in, but interestingly most people don”t make the effort to really go deep and study what money really is good for and what the purpose of it is in context of an economy.
So we have two fundamental problems:
A misplaced trust in short-term oriented self-perpetuating institutions
A lack of knowledge about money and its role in a society
It follows that almost nobody is really aware of the fact that the global economy is running a monumental global experiment: To run the global economy on a fiat standard.
What Is the Role of Money?
The main ingredients that have allowed our civilization to rise, prosper and flourish are:
Respect for person and property rights.
The ability to exchange goods and services.
Specialization of labor.
These traits in the above sequence have allowed us to crawl out of the cave and with the psychological motive to improve our situation at any given time, human action has resulted in airplanes, skyscrapers and global communication via the internet.
The crucial fuel allowing all of this to happen is the use of money.
Money solves the lack of double coincidence of wants, or the barter's problem. In other words, it will be difficult for someone selling eggs and someone selling houses to make a transaction at any particular time. The existence of Money solves that problem.
In academia, money is usually defined as something possessing the following three attributes:
Store of value
Medium of exchange
Unit of account
With the existence of money, our hypothetical egg seller can now price his eggs in a generally understood price (unit of account), he can use the received money to exchange it for other good and services he needs and desires (medium of exchange) and he can safe his money over a long period to buy a house at some point in the future (store of value).
Throughout history, there have been various commodities that have been used as money, most predominantly gold.
With the introduction of banks, central entities have started to create paper currencies for a more efficient and convenient way of transaction. However, for centuries these paper currencies were backed by a commodity — usually gold.
This introduced the possibility of fractional reserve banking (issuing more paper than the underlying amount that is backing it). There are of course numerous cases where this has led to failures and bankruptcies.
Coming back to our main assertion here is that since 1971, when Richard Nixon officially cut the link to gold and thereby ended the gold standard, we are on a pure fiat currency standard.
Thus, we are trusting in currencies that are purely determined by centralized entities, namely governments and central banks who have the ability to create money at their own disposal.
If anyone has the power to create money, there is a huge incentive to make use of it!
And this is of course what has happened.
The expansion of the money supply distorts the market by lowering interest rates below the natural level. The main chart to look at is the 10 Year Treasury Yield:
Since the 80s it has been constantly trending downward almost to zero in 2020. But since then, the trend has been reversed and the big question is whether this new trend will persist.
The problem of rising rates is that governments have accumulated massive debt burdens, which cannot realistically be paid back. In other words, most governments have already entered into a debt spiral, which they cannot escape.
This in turn has detrimental consequences in some form or another.
It basically boils down to two options:
Honestly default → more short term pain, but better from a long term perspective
Dishonestly inflate the way out → constantly robbing savers and hard working people, rewarding people who take on debt to buy assets (usually the rich).
Governments with the ability to print traditionally embark on the road of the second option.
In consequence, particularly the store of value function of all fiat currencies is under threat and deteriorating quickly.
The Potential Bright Side
The bright side is that there is an alternative for people who want to save their money in something that cannot be inflated away. With the invention of Bitcoin we now have a possible alternative to the fiat system.
And if used prudently and cautiously, it is also almost impossible to be confiscated.
It offers a potential monetary system that cannot be controlled by any entity. Everyone can participate and nobody can be censored.
Wouldn’t that be a way better solution?
Here is Bitcoin’s main value proposition that I outlined in the first Ataraxia Financial Newsletter one year ago:
In my opinion there are three essential features that make up Bitcoin’s fundamental value proposition:
A hard cap (of 21 million Bitcoin).
Pier-to-pier transactions without a middleman, hence enabling uncensorable transfers of value.
The ability to store and secure it just with a string of letters and numbers (private key), making it not only globally accessible, but also enabling to hide and obscure its possession, which makes it basically unconfiscatable.
To capsulize it, Bitcoin is the first asset in history that has a predetermined supply which cannot be diluted, it furthermore can be transferred without requiring permission by anyone, and finally can be “transported” around the world without the knowledge of anyone else. In short: it is the perfect conceivable configuration for a store of value.
By the way, I paid for the coffee that I drank for writing a substantial part of this newsletter this morning in BTC:
El Salvador might be a developing country in many regards, but when it comes to payments, it might give a hint in the future of payments.
Over the lightning network (which is a second layer running on top of the Bitcoin blockchain), the transaction confirmation happens faster than swiping the credit card and it happens basically anonymously and without any 3rd party in between — it definitely feels somewhat magical! 🪄
Hence, in addition to the store of value function, second layer solutions show also how Bitcoin can scale and provide cheap and quick small transactions which has been a point of critic for a long time.
I highlighted the transaction fee that I paid which is basically zero. From a customers perspective this might seem irrelevant since the fee that goes to Visa or Maestro is usually paid by the merchant. However, this fee is in developed countries usually around 3% and in developing countries such as El Salvador considerably higher.
In consequence, it has considerable implications when it is applied more broadly not only by the above mentioned features, but also by lowering overall friction costs.
I am not gonna go into more details here, but the key is that while the price remains volatile and Bitcoin has already died 469 times, under the hood it keeps improving, growing and getting more and more resistant.
…every 10 minutes… Tik Tok, block by block. 🚀
We're gonna explore this topic more in the upcoming newsletter.
Stay tuned…
I hope you enjoyed reading this newspaper. Likes, comments and shares are highly appreciated. I put a lot of work into it and if you think the content is worth your time, please consider to subscribe, so you can receive it on a monthly basis. Its free and without commercials.
Best regards,
Disclaimer: The content of this newsletter is for informational and educational purposes only. It contains my personal views and opinions, which are not to be taken as direct investment advise. All investments have risks and you should do your own due diligence before making any investment decision. If you require individualized advice, to review your unique situation and make a tailored advice for you, then contact a certified financial planner or other dedicated professionals.