Market beatings will continue until the war ends. I discuss why I think markets can no longer avoid the war or the inflation it is causing.

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All right.

2

Welcome back to another

Daily Discernments.

3

we got to the point we got

to the point where it's too

4

much to not talk about today.

5

the title of this one is Beatings Will

Continue, and that is because I think when

6

it comes to markets, beatings are, will

continue until the war ends at this point.

7

You know, we've been able to

largely ignore the war from

8

the, a market standpoint.

9

O-obviously, like oil and, has had

big ups and downs along the way.

10

but equities, eh, they didn't really have

to care until really, really recently.

11

You know, like bonds had to, had to like

respond somewhat to energy prices, but it

12

wasn't, it just wasn't that big a deal.

13

I think we've got to a point, and it

kinda really started with the first

14

day Secretary Bessent jumped into

start messing with the bond market

15

whenever he got to about whatever

it was, four point seven, I think

16

it was, on the thirty years, kinda

when, when he jumped in and got…

17

Or maybe I'm thinking of the ten year.

18

But a little activist, let's say, in

trying to get, yields down and had

19

to subsequently follow that up and

follow that up to try to kind of put

20

the, the toothpaste back in the tube.

21

Now he may wanna take it back out.

22

since, since Druck's op-ed came out,

he You know, ha-hasn't been nearly as

23

forceful, if anything, kind of backed off.

24

But, you know, now that you got the

ten-year getting pretty close to

25

not just, you know, the prior highs

from twenty twenty-three, taking

26

that out, but, I mean, you're close

to being back to, like, '０２ levels.

27

You're, like, two bad days,

maybe even one really bad day

28

from being at, like, '０２ levels.

29

so this is, this is getting

problematic quickly.

30

and a lot of it's obviously on the

back of what's going on with the

31

war and what's going on with energy.

32

And I think we've kinda run out of runway.

33

If, if people that listen to the Daily

Dots as well, if you go back, I don't

34

know, two, three months, whatever,

I kept saying, like, "Look, there,

35

there are very real reasons that oil

isn't, like, spiraling out of control."

36

chiefly among them, hey, China,

like, stopped buying massively, like

37

huge amounts of, of oil they stopped

buying, which basically papered over,

38

like, three-fourths of the problem.

39

And then you throw in, you know, what

you're sneaking out of the Strait, what

40

you're, what you're bypassing, and it's

like, okay, well, that makes sense.

41

Like, you went from what looked

like a, you know, ten million barrel

42

a day problem to, two or three

million barrel a day problem, which

43

is a much, much smaller problem.

44

But I kept saying, like, there's

three things holding this together.

45

You know, we-- you have SBRs,

you have bypasses and s-- and,

46

and what you're getting out of

the Strait, and you have China.

47

The point I kept making back then

when everyone was, you know, making

48

fun of people that were bullish

oil because they thought, you know,

49

like, well, if politicians want

it to be low, it'll be low, and

50

there's nothing you can do about it.

51

Well, they still want it to be low

when it's a hundred bucks, right?

52

Like, sorry, but markets still work.

53

Oil supply still matters, as I, you

know, kept saying on Twitter, like-

54

The, the, the problem now is, well, you

still have an SPR lever you can pull.

55

Like, that's not over, and

I think they will pull it.

56

They, they said, whatever, like a month

ago, like, "Nope, we're not doing that.

57

We're not gonna do any more."

58

They will.

59

They're gonna, they're gonna run

the thing down till nothing's left

60

if, if the war keeps going 'cause,

you know, it's politically expedient

61

short term, and as we've probably all

learned by now, whatever's politically

62

expedient short term, who cares

about the long-term consequences?

63

Let's, let's pull that lever.

64

So they will.

65

So like that, you still

have some SPR runway.

66

There's months left of that in the US.

67

But the closer you get to the end

of it, the more the market has to

68

stare down the, a post-SPR world.

69

you know, Japan, Europe, this--

they'll, they still have SPR.

70

Obviously, China has a massive one.

71

So like once ours is over, it's not over

for the world, but that is still gonna

72

be, you know, hundreds of thousands

of barrels a day that's just…

73

It's not there as a buffer anymore.

74

China went from shocking, you

know, demand drop in how much they

75

were importing to less shocking.

76

Like, they, they have

beefed up those imports.

77

Their refinery margins have picked up.

78

As I've mentioned, you know, the,

the Shanghai futures are now more

79

expensive than Brent futures.

80

You're seeing all these signs

that they're coming back.

81

Now, would they like to sit

out at a hundred and twenty

82

or whatever if we get there?

83

Like, yeah, they would love to,

but when you already sat out the

84

last six months, it is, it's really

hard to just sit out forever.

85

Like, the, the math doesn't math

on China being able to, you know,

86

cut imports by whatever, eight

million barrels a day forever.

87

Like, they can't do that forever.

88

They're, they're an import-dependent

economy when it comes to oil.

89

and to be f- to be clear, like the world

needs them to import a bunch, refine

90

a bunch, export the refined products.

91

We so- we have like two hundred and

twenty dollar a barrel diesel right now,

92

which to be, to be fair, you know, w-

the thing I kept calling for, you know,

93

if you go back to like March, April,

May, was like we need the price to get

94

up so that we can bring demand down.

95

To be super clear, six dollar

diesel, th-that's, that's a level

96

where you start messing with demand.

97

Now, is the average 18-wheeler

gonna stop moving goods?

98

Of course not.

99

But You know, if you have, if you

have a small car that you don't

100

really like driving and you have a

diesel truck that you do like driving,

101

you're gonna park the diesel truck.

102

Like, you're gonna start bending,

you know, like that curve on demand.

103

Like some peop- anyone

that can will ration.

104

Let's say, you know, you're, you work

for some contractor that goes out to

105

job sites, you know, all day, every day.

106

Maybe you normally take two trucks

out to those just in case you need

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that second truck for the tools.

108

Eh, now you might start taking one and

call in the second truck if you need it.

109

Like, there's gonna be

little things like that.

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We have, I would argue

six dollar diesel…

111

Okay, now we're, we're reaching demand

destruction levels, and obviously

112

not just in the US, but globally.

113

So that will be a thing.

114

People that can, you know, switch

sources, they're gonna switch.

115

Like, if you can move

over to an EV, you will.

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If you can, you know…

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What- anything you can

do, you're gonna do it.

118

If you can move from a diesel generator

to a battery generator or a, you know,

119

let's say you're out in the field

in Canada, you can, if you can move

120

over to a, you know, nat gas driven

generator instead of a diesel one,

121

what, like, yeah, you're doing that.

122

Like, all these little sources

are going to, to come up.

123

I would say LNG trucks, which

took off like crazy in China, but

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obviously LNG's no, no cheaper thanks

to the same problem in the Strait.

125

so energy prices are doing

what they're doing b- mo-mostly

126

because of the war, obviously.

127

It's hard to see that getting a

lot better right now because…

128

And, and, you know, for weeks, I think

the markets have sleep, just kinda

129

slept on this, which is what I expected.

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I, you know, I wrote a piece

basically outlining The strait

131

is gonna be 20 to 80% open.

132

It's not gonna be 100% open.

133

Everyone's just gonna like,

be like, "Well, who cares?

134

It's 100% open, close enough."

135

And it wouldn't be.

136

It would be somewhere between 20 and 80.

137

They got it up to like 60 pretty

solidly, which is impressive,

138

honestly, when you-- whenever you

include bypassing, to be clear.

139

Now it's less though because that, that

was costing Iran time, and they didn't

140

like that, so Iran got more aggressive.

141

And then obviously, whenever they brought

in the Houthis and started throttling

142

the Red Sea flows, that was a big deal.

143

And the Houthis, unlike, unlike Iran,

like they don't really pull punches.

144

They're not, they're not trying to

like massage this thing and, and,

145

and keep like, keep the ability

to pivot right back to diplomacy.

146

Like, I don't think the Houthis

care about diplomacy at, at the

147

same rate that, that Iran does.

148

So they are just reaching out and touching

Saudi oil infrastructure almost every day.

149

and, and one of the reasons I

wanted to record today is because

150

it looks like they've done some

damage to the East West Pipeline.

151

Now, I don't know if they just maybe

hit one pumping station that can be

152

fixed in two days or something, and

it's not that big a deal or, or more.

153

But there's clearly like some

emergency flaring it looks like going

154

on on the East West Pipeline, like

a lot, and you know, the flow is

155

gonna be down and that, that is…

156

The lion's share of the offset from

the strait is coming from that East

157

West Pipeline, so if that thing

is degraded, that's a big deal.

158

The Houthis keep hitting oil storage tanks

at refining facilities in Saudi Arabia.

159

Saudi Arabia basically copped, copped

160

level on, oil production right now.

161

Like, so you're talking about a

multi-decade low in production from

162

the world's biggest swing producer.

163

Like that is, that's a big deal.

164

And again, like whenever you have

$100 oil, which, you know, just

165

hit 100 today, that's not enough

to-- for demand destruction.

166

Now diesel has hit it.

167

Gasoline starting to get, I would

say, close to being able to do that,

168

but probably have some more, more

to go before you have real demand

169

destruction on a, on a level that

starts to make this all even out.

170

And, and what makes this worse is,

is the Houthis have pressed towards

171

the Bab el-Mandeb Strait, like taking

territory, conquering territory from

172

the, you know, the Yemeni governent-

government on the other side.

173

So they were already able to affect

Bab el-Mandeb flows because, you

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know, they have ballistic missiles.

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Those things go far.

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They literally kind of leave,

you know, Earth and come back.

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So now that they are there, like

controlling islands right next

178

to the strait and having coastal

territory and stuff, like they

179

can really disrupt that stuff.

180

And it may let them target up north

back towards, you know, the, you

181

know, the, the East-West pipeline

itself, where it empties in Yanbu, you

182

know, onto ships and then goes north

through, through the strait there.

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Like that, it, it offers them

probably a little bit more tactical,

184

possibilities to hit that stuff as well.

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So point being, Iran is getting

more, aggressive with the way they're

186

controlling the Strait of Hormuz, and now

I would argue that the Houthis are getting

187

more power to control Red Sea flows.

188

So Persian Gulf and Red Sea flows,

like it's almost like a vice on both.

189

It's getting tightened down.

190

Now, you're still getting,

you're still getting stuff, stuff

191

out of the Strait of Hormuz.

192

Don't, don't, don't get me wrong.

193

but it looks to me like the Iranians are

starting to take ship-to-ship transfers

194

a little more seriously, threatening

ports, threatening stuff that's anchored.

195

not to mention getting more aggressive

towards the US Navy with, not just, you

196

know, some of their kind of lame coastal

missiles and, and drones and stuff, but

197

even potentially hypersonic missiles that

are not easy to shoot down for the Navy.

198

and I think it goes without saying

that if we got a carrier hit or a

199

destroyer hit, that's a really big deal.

200

and it makes it clear, like you

might need to back up, and if

201

you back up, it gets harder to,

you know, keep your blockade on.

202

Not to mention, like the, the

United, you know, American people

203

are already against this conflict.

204

So you start losing, you know,

Having major damage done to naval

205

order of battle, in addition to all

the air order of battle we've lost

206

or had damaged in the conflict,

more, more fatalities, God forbid.

207

Like, it, it just gets that much more

unpopular, especially as the price

208

of the pump keeps rationing higher.

209

so as we kind of lose these offsets,

you know, China can't really stop.

210

Ke-- I don't think China can

go back to the lows of buying.

211

I think at best, you know,

they're gonna stick at these

212

s- a little bit higher levels.

213

And God forbid, they-- if they go back

to, like, a normal import level or even

214

close, you know, oil, oil is easily one

thirty, one forty, one fifty on that.

215

the-- some people seem to think they

want that to happen, like, but you don't.

216

Like, other than to maybe reduce some

pressure on diesel, assuming they

217

would export enough refined products.

218

But…

219

And then on the, on the, on the other side

of this, which is kinda the same side of,

220

you know, or a different, the other-- a

different side of the same coin, rates.

221

I mean, exploding higher.

222

You now have almost four,

you know, hikes priced.

223

You have, like, three point three, three

point four hikes priced now at this point.

224

the two-year yield is eighty-three,

eighty-four basis points

225

higher than the Fed funds rate.

226

So it's, you know, three and a half, hikes

priced into the next two years there.

227

so now you're, now you're

starting to, like, mess with,

228

you know, cost of capital.

229

And with the AI fellows needing to sell

bonds to keep that dream alive, like, you

230

know, their cost of financing gets worse.

231

All the private credit stuff tied to SOFR,

you start rate, doing rate hikes, well,

232

obviously that means SOFR's going higher.

233

the, the cost of capital

is becoming a problem.

234

And sure, like, Google can pay the

cost of capital, but not everyone can.

235

Like, there are small businesses out

there that have to borrow money tied

236

to SOFR, and all of a sudden it's

gonna be fifty, seventy-five basis

237

points higher, and it, that could be

a big deal for some of these people.

238

Especially as they're getting squeezed

by higher, higher costs for themselves

239

and, you know, regular people have

their real income getting squeezed

240

and going negative because inflation

is outpacing their wage gains.

241

So it's not like they're gonna--

you can just charge customers

242

to make up the difference.

243

Not for everybody.

244

Some people can, but, but a

lot of people won't be able to.

245

So point being, you're gonna start up

here at these levels, you know, five

246

percent ten-year, six dollar diesel.

247

As we move above those, if the war

keeps going, because we've lost our

248

ability to kind of blunt the war

impacts, start messing with the real

249

economy, you know, inflation's been

good enough in the threes or whatever.

250

Like, well, next thing you know,

you're pressing five percent inflation.

251

If the war continues for

another few months, like

252

Point, the big overarching point is

markets have been able to largely ignore

253

this war other than, you know, markets

that everyone's basically have to ignore.

254

Like, the average American could care

less that, you know, the Europeans and

255

Asians are paying a bunch for LNG or that,

you know, some chemicals prices went up

256

or, you know, other than farmers, no one

cares about some of those input costs

257

that farmers have tied to the straight,

you know, like sugar or whatever.

258

Like, no one's noticed that yet 'cause

it hasn't flowed through to retail

259

prices in a, in a meaningful way.

260

We're, we're talking about a bunch

of wholesale prices that have moved,

261

and obviously retail prices have.

262

Like, you know, the, the inflation report

tomorrow is expected that headline to

263

come in at point four month over month.

264

You know, I don't…

265

That's close to five percent

annualized inflation.

266

That's not nothing.

267

but we haven't really seen this stuff

flow through yet and, you know, to

268

see some, some of the people at the

Fed still acting like, "Oh, well,

269

underlying inflation's gotten a lot

better in the last couple months."

270

Like, guys, look, look out the window.

271

It's like I always try to-- I always

like to s- you know, compare this to

272

the map is not the territory thing.

273

You know, the…

274

That, that cliff wasn't on my GPS.

275

I feel like that's where we're

at with the, with the Fed.

276

Like, just look out the

window, six dollar diesel.

277

Like, inflation's going up, and it's going

up a lot, especially with agriculture

278

prices doing what they're doing.

279

And by the way, diesel is a

giant input in agriculture

280

prices, so it's gonna get worse.

281

clearly inflation is high and rising

and potentially getting a little,

282

you know, nonlinear all of a sudden.

283

Rates, same thing.

284

And, you know, if you're the average

equity, like, eh, you have-- you

285

really haven't needed to care.

286

But if we're gonna press higher

from here without pan- policymakers

287

panicking imminently, beatings

will continue until the war ends.

288

so what the market needs at

this point is policymaker panic.

289

Whenever they panic, you

can un-panic as an investor.

290

So yes, Bessent has stepped

in with the, you know, buyback

291

stuff, but that's really mild.

292

Now, whenever they talked about

using the TGA, different story.

293

Like that, they can get yields down

if they weaponize the TGA at scale.

294

But you probably need that to be worse

than here to justify it or to have,

295

you know, the Fed just go mop up f-

you know, half a trillion dollars

296

doing QE or something like You can't

do it just because the price is unfun.

297

Like now a day like today, ten basis

points on the ten year, you get a few

298

of those and you can make the argument,

look, this is disorderly, this is crazy.

299

We can't have this.

300

We have to step in.

301

you're not there yet though.

302

But point being, you need policymakers

to panic so markets cannot.

303

Or more to the point,

you need the war to end.

304

But with that said, you know, it's

not like we're-- it's not like

305

FinTwit guys or the only people that

can, can draw a line on a chart for

306

yields or, or, or oil or diesel.

307

Like promise you Scott

Bessent has his own crayons.

308

You know, people in the White

House have their own crayons.

309

They drew the same lines you did.

310

They see this stuff breaking out.

311

They know what it means to.

312

Which means, yeah, you, you are

likely getting closer to some sort of

313

policymaker panic, whether that's, you

know, restarting negotiations with Iran

314

and, and chilling out and coming up

with some new creative framework for

315

the Strait that lets them control it.

316

But you make sure you get a bunch out

and, you know, wink, wink, the, the tolls

317

they, they charge are very voluntary.

318

Like no one has to pay them.

319

You know, this is all

above board, wink, wink.

320

Like there, there's stuff you can do

to end this war, get it over with.

321

Anyone paying attention will

know how much Iran won, but

322

they're gonna win either way.

323

So you may as well take the L and, and,

and start trying to move on from it.

324

And hey, like five percent yields

and you know, a hundred and five and

325

counting oil and six dollar diesel.

326

Like that's the kind of stuff

that policymakers have to…

327

It's a constraint.

328

Like they can't ignore the constraints.

329

but I will say like, I think we

also have to be prepared for instead

330

of them going after the roots of

this thing, just, you know, going

331

after the, the, the side effects.

332

that's not what they should do, but

we may get some side effects stuff.

333

And I think from a market practitioner

standpoint, what we have to watch here,

334

what we have to-- the, the way we have

to make our decision is do they treat the

335

symptoms or do they treat the root cause?

336

If they treat the symptoms, you

keep pressing because beatings

337

will continue until the market

improves or, or until the war ends.

338

If they go after root cause, then, then

you, you know, if you're involved in

339

these things, if you're short bonds,

you're super long oil or whatever,

340

you, you back away if they, if they

panic and go after the root cause.

341

If they just, you know, try to go

after the side effects, then I think

342

you can kinda press ahead, you know.

343

So that, that's what I'm gonna

be watching for as we go forward.

344

But I think it's important to note,

like we've reached a point where like

345

stocks don't get to ignore this anymore.

346

You know, the bonds and oil, they

just don't have the same, margin

347

of error and wiggle room they had.

348

So I-- it's now, it's now

time to watch this stuff.

349

It's time to hedge.

350

It's time to be long vol and stuff

until the policymakers freak out.

351

That's, that's the, that's the message.

352

But that's all I got for today.

353

be back next time.

354

I think there's enough important

stuff to, throw out some discernments.

355

Cheers.