When investing is like thermodynamics
The past few weeks have been the some of most difficult for investing I can remember. There’s not only no crystal ball; there’s no map, no compass, no light. Last weekend I ran the latest quarterly Synthetic Systems update, but the level of fundamental fog and noise gives me little confidence in any forecast. The drivers of investment performance lie uncharacteristically beyond the world of finance and economics.
We’ve been in a deflationary environment, by which I mean currency, in particular the US dollar, has been outperforming most other assets. This means that an overweight in cash and short term Treasuries has been working. The only other asset that has consistently outperformed is broad commodities, especially energy and agricultural commodities. I anticipated this at the outset in Outlook 2026, but had no inkling so much would happen so fast.
So do you just sell everything and go to cash? That’s a high risk proposition too, because at literally any minute the world could change, and the markets with it. The standard division of the asset markets into “risk on” and “risk off” is too pat to be of any use. For there is no such thing as a risk free asset. Even supposedly risk free cash is vulnerable to loss of value. Yet even that’s an understatement … that’s what it does most of the time. Cash is volatile too … a property merely obscured by our habit of measuring its value in terms of itself or other currencies.
Risk control is therefore not found in any asset, but rather combinations of assets. At the moment I continue to hold stocks, bonds, and commodities funds including gold. But more than the usual amount of cash and more than the usual amount of broad commodities. The fund COMT for the latter for instance has been the one thing that has been moving up when everything else has been moving down, fulfilling the role more traditionally assumed by Treasuries and gold. This has allowed me to continue to hold stocks, bonds, and gold while helping keep volatility under control.
Just as a stock is a security issued by a corporation and a treasury bond is a security issued by a government, cash is a security that is issued by a central bank. When you sell a stock or gold, you’re buying cash, not getting out of the asset markets.
There’s no such thing as being invested in nothing, apart from taking a vow of poverty and joining the brotherhood. It’s like the laws of thermodynamics, which have been whimsically paraphrased as:
1) You can’t win
2) You can’t break even
3) You can’t get out of the game
And so the world did turn … and the markets with it … just since my post at 15:36. Rumours of peace … if only a temporary peace … and suddenly stocks are soaring, gold is vaulting higher, and oil is coming off the boil. Even Treasuries have rallied sharply. Aren’t you glad you didn’t sell everything and go to all cash?
You could be forgiven if you did … countless advisors have been warning of deep declines in stocks. Not that they might not yet turn out to be right.
My guess would be that the worst is indeed over for now. Synthetic Systems is still tracking. But I’m an economics guy, not a geopolitical guru …
A reminder that we are still in a commodity cycle. Oil will not go back below $60 anytime soon. Just looking at the fundamentals, remember that there is an ongoing global release of oil from reserves. These are borrowed barrels that are expected to be repaid, simply shifting supply in time. What’s more, oil production facilities have been taken off line. And it’s much more than oil, there’s gas, fertilizer, helium, inputs into agricultural commodity prices, all in the pipeline.
Broad commodities funds such as COMT should be expected to be down sharply tomorrow, and, for those following our Model Portfolios that include it, it would continue to be held, possibly at a lower weighting. I expect to hold my overweight (~5% versus 2.5% neutral) for the remainder of the first half of 2026.
After that, the potential for another deflationary wave emerges, as the Fed belatedly tries to counter the inflation it created in the wake of the 2020 Covid crash and never quite mustered the backbone to quash after 2022. But we’ll cross that bridge when we get to it.
I feel we are in very uncharted water………….dangerous water at that.
I am happy or rather content to be 50/50 cash/PM’s, i feel that anything else will be far too volatile for the next year.
All i know is INFLATION IS coming!
Mike
No stocks? UK stocks have been doing very well, and still a better bargain than the US.
You can say that again about inflation. We haven’t even finished reaping the last crop and the next one is already being sown.
I am surprised that the economic gyrations of the past 18 months have been so mild. I expected much larger effects from the tariffs, and much larger effects from the Straight of Hormuz. I’m happy about it, but confused. Maybe large effects are still developing and will be arriving soon in our portfolios and home prices and labor markets. But so far the bad outcomes have been modest when I look out my window.
There may be more shoes to drop on the Hormuz front, but tariff-wise, it’s played out basically as I expected. Tariffs represented a tax increase, but were offset by tax cuts elsewhere. Even then, federal spending is always paid for one way or another … if it’s not through direct taxes, it’s through the inflation tax. So even absent other tax cuts, the tax increase from tariffs would be offset by a reduction in the inflation tax. This is why economists were so wrong in their dire predictions of a year ago. As I argued long before “Liberation Day”, Tariffs Are Not Inflationary.
Free trade as an issue incidentally dates to the birth of this web site; Free Trade Begins At Home was our first post. Not that tariffs haven’t had other costs. The sheer herky-jerky, bellicose, and confrontational implementation has hobbled efficient business planning, and less efficient production at the margin just means a hit to living standards. Maybe a little less affordable housing, medical care, aging infrastructure …
War is a horse of a different species. Real capital is expended to destroy real capital. And it too will be paid for one way or another. The menu of options is small. Direct tax increases, of which none are yet on the horizon, borrowing, which implies repayment (let’s be serious, what are the chances of that), and inflation. The process of elimination alone leaves us with inflation. And a much bigger hit to living standards.
So between the two, there’s no contest. Tariffs (assuming a predictable policy environment) mostly just move stuff around. War destroys it.
Want to invest in Airlines?
⚡️BREAKING
Europe predicts that its jet fuel reserves will run out in about three weeks:
– The Strait of Hormuz remains largely closed at this time
– Asia has already started jet fuel rationing
– In the past 24 hours, only one oil tanker has left the Middle East
Mega’s dispatch from England:-the oncoming storm
Morning Gang sorry for the lack of MDFE but every time i tried to write something else happened. I did try yesterday but some female from a 3rd world nation rang me to warn me that “Hacker” had broken into my PC & she works for Microsoft…here to help.
I let the cow waffle on for 10 mins & got to the point were she was directing me to a website to down load software when i pulled the plug. She rang back, blew up & threatened to “Block” my computer.
“Block away my dear BTW is your mother proud of what you doing for money?”
She replied in her native tongue, cant say what she said but it was along the lines of what a drunk/coked up hooker once said to me in a bar….when i told her how much she have to pay me to sleep with her 😉
Anyways
Here in blighty we are still very much in the soft light of a Phoney war. Little has changed. We already had a recession on the way before the Iran war we fallen to zero growth. Like any ponzi scam once that happens the troubles start.
Yes fuel costs are climbing fast, indeed i was delighted to see diesel at almost £1.90 a litre. Its most gratifying because of all those bastards & bitches whom decided they were going to swan around in an SUV the size of the Queen Mary. Indeed i happened on a “You tube” about 1970’s “Land yachts” in the US, same sort of thing.
All of a sudden the era of cheap energy is coming to an end. Wot they don’t understand is they going to have to bid for every barrel. Even the ministry of truth……sorry BBC news is now telling the plebs that the real price is $147 not $96. They even saying that they critically low on Jet fuel.
While this is jolly good news for US exports when the prices start to spike in the US Trump has a choice. Go into the mid terms with rocketing costs or an export ban to cut the price? Facing the real change of both houses going DNC then his ass is out by Xmas am sure he ban exports.
Then the real pain will begin…………….
Cheers Mike
Oil up 8% tonight,,,,,,,,,,,,,,,,,,,so far