Ad Hoc Commentary – 2014 outlook: the rise of Russia

Our outlook for 2013 can be found here:

Ad Hoc Commentary – 2013 outlook

Our basic premise for 2013 was the sovereign debt crisis will migrate from Europe to Japan, and then back to Europe. Thus we called 2013 to be Japan year. Yours truly expected FX to stay stable and the crisis to be good for equities, bad for bonds, and good for commodities. We got Japan year correct. We got Europe lull correct. We got equities correct. We got sell bonds correct. However, yours truly didn’t see the strength in USD early in the year, and thus buy commodities was a wrong trade.

Even though yours truly did change in early Jun stating that USD will be strong, but that’s just an excuse for the bad commodity trade:

Ad Hoc Commentary – the USD will be strong for the next 2 years

What does 2014 bring us?
In markets, yours truly expect more of the same, but much higher volatility in 2014:
1. Equities are still in a long term bull market, but a short term correction is probably long overdue. One might want to stay light and buy in early Feb – the debt ceiling showdown for Feb 7 will likely have a favorable outcome for equities. They should just abolish the debt ceiling since they raise it every single time without fail. Equities will be mainly driven by a great rotation from bond to equities in 2014.

2. Bonds are still a sell unless governments increase austerity to pay the debt (e.g. Malaysia), or confiscate pensions to convert bonds into contingent liabilities (e.g. Poland). Of course, there is a much better solution, the repayment of all sovereign debt with investment dollars that can only be used to buy infrastructure debt. However, it seems that the politicians are too busy fire-fighting and nobody has time to sit down in a Bretton Woods-like conference to rethink the system.

3. Commodities will be suppressed because taxes will increase globally, putting pressure on the middle class, and thus reducing demand for commodities. Also, US dollar strength will force commodities lower since they are all denominated in US dollars.

However, the most important event for 2014 will be the rise of Russia:
Russia giving solace to Edward Snowden and telling America to back down on Syria is just the beginning. If one remembers World War II, the Allied almost lost the war because of German U-boats:
“…all were agreed on one point, which was summed up by General Alan Brooke, Chief of the Imperial General Staff. ‘The shortage of shipping,’ he said, ‘was a strangle hold on all offensive operations, and unless we could effectively combat the U-boat menace we might not be able to win the war.’”, page 358, The Prize, Daniel Yergin

Putin likely understands the importance of submarines since his father served as a cook aboard a submarine of the Red Banner Fleet. Stealth Russian submarines will strike fear in the future: Borey-class for surface targets, Yasen-class for underwater targets, and Varshavyanka-class for both surface and underwater targets. The Americans are probably too complacent and are still waiting for their Sputnik moment.

This is why US dollar strength will not last for more than a few short years. The catalyst will likely be the next government shutdown battle that will only happen in two years’ time thanks to Obama’s new deal: http://swampland.time.com/2013/12/26/obama-signs-bipartisan-budget-deal-easing-cuts/

When the time comes, America’s president hopefuls will probably be debating between defaulting internally or externally. And since power comes from a barrel of guns, or rather power comes from a fleet of submarines, the American leadership might be constrained. They will likely cut welfare and increase taxes. But which president hopeful will have the audacity to promote austerity and still expect to win the elections? It will be one of the most difficult elections, but they should resist a Magister Populi, however tempting that might sound.

Good luck in the markets.