ANDREAS STENO LARSEN: Hi, everyone, and welcome to the Real Vision Daily Briefing. It's Tuesday, August 9th today and I'm Andreas Steno Larsen, the senior editor at Real Vision. I'm extremely pleased to be joined by a friend of mine, Marko Papic, partner and chief strategist at Clocktower Group. Marko, it's great to see you.
MARKO PAPIC: Great to be on again. Thank you so much, Andreas.
ANDREAS STENO LARSEN: Marko, I think the last time the two of us had public chat on market developments, I think it was four or five weeks ago, you told me to go short oil to buy the Euro versus the dollar and to load up on equities. Spot on basically. So, I'll allow you just a brief victory lap here initially. Why have you been so right over the past month here?
MARKO PAPIC: Well, because we got lucky, obviously. We always have to praise Lady Luck. But also, we saw the slowdown in growth, and also slowdown in commodities. So, basically, my team and I, we've been long bonds, short commodities since May. And then oil diverged from the rest of the complex, from the rest of the commodity complex throughout June and we tripled down on the short oil call at the top of the month, on June 20th.
Largely because of geopolitical reasons, but demand was part of the picture as well. What I would say right now, Andreas, what's interesting is that the demand side has proven correct. That view was right, like the slowdown in economic growth in China, Europe, US has articulated itself in the oil price. But I would then stand firm on my geopolitical view and say, hey, you know what, there's more downside if the risk premia dissipates.
ANDREAS STENO LARSEN: And let's touch a bit upon that, because if we look at the geopolitical risk picture right now, I think it's fair to say that some of the arguments that you used, say four to six weeks ago, surrounding the Russian and Ukrainian conflict, they haven't come through yet. So, what's your take on the near-term outlook for the supply picture related to geopolitics when it comes to natural gas and oil?
MARKO PAPIC: Well, I think one thing is natural gas, there's now starting to be enough math done by people rather than hyperventilation. And what I mean by that is that the math is very simple. Russians screwed up. They should have cut off gas in February if they were serious, if they had the guts. But it looks to me like they really care about that $50 billion to get from Europe every year.
And so, they equivocated, they hesitated, so they didn't cut off enough natural gas. That's important because Europe is going to reach their goal of storage, it's like game over. Europe is going to be fine through the winter. Sorry to ruin everyone's favorite thing to dwell on, which is that Europeans are somehow going to price themselves or not. And that's really important, because one, it means that some of the increases in prices in natural gas in Europe are probably overdone.
The second thing is it also tells us a little bit about what Russia really stands for. Russia is not trying to recreate the Soviet Union. They are just trying to deal with the domestic politics. And they really care more about making enough money than conquering all of Ukraine. They didn't have the guts to cut off gas in time, they allowed Europeans to escape the winter. And that's a really big mistake that Russians have made.
The second thing is they have had no success in Donbass. We have a map I can show you here of Donbass difference between May 26 and July 27, the conquered territory by Russians is nothing. They've conquered a little bit in Luhansk. They can claim they now control all of it, but Donetsk remains quite contested. And that just tells you that they cannot in two months of summer combat finish the job in the part of Ukraine that is surrounded by Russia, where Russia faces no logistical or supply problems.
And it's actually inhabited by Russian ethnics, not Russian speaking Ukrainians, but Russian ethnics. If you can't win there, seriously, where can you win? And so, I think we're on track for this geopolitical risk premium to dissipate, because I just don't believe Russians have the guts to pursue the war or even natural gas brinkmanship with Europe for too long.
ANDREAS STENO LARSEN: We'll get back to the geopolitical debate a bit later in the show, but Marko, everybody's waiting for the big CPI report tomorrow from the US. I see that consensus expects 8.7% for headline inflation versus 9.1% a month ago, and for core inflation, the consensus is now 6.1% versus 5.9% a month ago and I see that the UPS for example, calling for a big positive surprise to call. Ahead of this huge inflation report, what's your thinking about inflation?
MARKO PAPIC: First of all, I think inflation is really important. That's why I focus on it. I know, wow, thanks, Marko, for coming on Real Vision and telling us this. But this is why we focus so much on oil prices. And this is what I said when you and I hung out together a month ago. So, if you look at the first chart that I brought here together, it's very simple. It's just what happened in the 1970s during stagflation. And this is obviously manipulated charts.
I did work on the sell side for 10 years, I know how to manipulate a chart, but the point is, if CPI peaks, good things happen to equity markets. And I find it funny because on Twitter, you have these like inflationists who are like, oh, if we go from 9.1% to 8.5%, you guys are all going to scream deflation, like, no, no, I get it. We're in an inflationary regime. We're never going back under 3% in a non-recessionary quarter for the rest of this decade. I'm in that camp.
I'm in the camp that long term inflation expectations are too low. But it does matter when CPI peaks as you can see here. So, the equity rally is not stupid. It could be wrong, don't get me wrong, inflation may not peak. But it's not stupid if inflation did peak. So, that's the first issue.
The second issue is that if you look at the next set of charts, oil prices obviously matter. As I said, my view on oil prices ended up being right but I had two reasons for why I was bearish long. One was demand, the other was geopolitics.
Demand is articulated in the price now. So, oil prices fell. But I don't think geopolitical risk has dissipated. And you can see these two charts on the left-hand side, oil prices and Chinese non-oil imports. Very tight coincident relationship. Now there's a divergence in both. I think there's another 20% decline in oil prices that could happen if the geopolitical view is correct.
If we go to the next slide, you can see the geopolitical view what I was telling you just a little bit earlier, Andreas, on the right-hand side, can you even see the difference between those two maps on the right-hand side? One is from May, one is from July. Hey, good going, Russia, you're really kicking some butt. No, you're not. You don't know what you're doing. You literally cannot fight a war.
By the way, there's an [?] here. Do people think that Finland and Sweden are joining NATO out of fear? No, no, no, they're joining out of lack of fear. What kept Finland and Sweden out of NATO was fear of Russia. Now, nobody in Europe is afraid of Russia anymore, because they can't conquer freaking Donetsk. That's what you're seeing, like they're losing face. They're losing the most important part of their arsenal, which isn't fighter jets, it's not tanks, it's credibility, that they're actually capable of fighting a war and they've lost it.
And so, I think Russia given their performance has to essentially proclaim victory, raised a Mission Accomplished banner, and when that happens, all prices should come down. Now, a couple of other charts I just want to throw out there, you've seen this, Andreas, you know this better than me, but next slide, New York Fed global supply chain pressure index is collapsing, ISM manufacturing supplier deliveries are collapsing.
So, this all is basically telling you that there's an easing pressure of supply chains. Next set of charts shows you very strong inventory rebuilds on the left-hand side, total business inventory is through the roof, retail trade, inventory to sales ratio are recovering too. And this is important because basically, after the pandemic ended, all the retailers, all the producers rush to recreate supply.
But now, the supply, and at the same time, we have a slowdown, you're going to start seeing price cuts, as Walmart already announced, which is I think very important for inflation. And then finally, next set of slides, fiscal policy is restrictive. Forget about this stimulus bill they passed, it's not going to make much of a difference. Fiscal policy has been restricted due to rate of change, something you argued earlier this year as well. Right-hand side, you can see M2 just collapsed.
All of these charts and then the next set of chart, Zillow Rent Index has tapers coming down, shelter hasn't yet responded to that, but I think eventually it will and then finally, used vehicle price indexes stopped some of its crazy gyrations. All this comes down to the last point, which is very simple. If we're right about oil prices, and you can see on the left-hand side all the other commodities year to date and then oil is a like an outlier, although it has come down.
If oil prices joined the rest of the commodity complex in terms of performance and are year to date negative, I think, oil price decline will help risk assets such as equities. What I have on the right-hand side is a chart rolling through your correlation between oil prices and S&P 500 monthly return. You can see that during the disinflationary era of risk parity, oil prices were correlated positively with equities.
Every time oil prices went up, it was like an upside to growth surprise, like, oh, cool. Nobody cared what the Fed would do because of oil prices. They weren't targeting headline inflation. But now, on June 15th, Jay Powell says specifically I am targeting headline-- I think this correlation is the opposite. And the more oil prices decline, the better it will be for equities, because investors will be able to say, okay, we'll probably have peak hawkishness And the Fed can still raise rates, but they don't have to do at 75 basis points, they can do 50, 25. And in my view, at elevated CPI prints, that is your Fed put.
ANDREAS STENO LARSEN: Yeah, I tend to agree, Marko. I'm a simple man. And I think the macro picture is pretty simple right now, if you get the oil price right, you get macro right. So, what makes you so convinced that the geopolitical risk premium will dissipate over the next couple of quarters?
MARKO PAPIC: Ukraine is over in my view. Now, obviously, people will quote that and say, Marko, you were wrong, the Ukraine war is still going on. You got to think about geopolitics the way you do about markets. So, we're not here to talk about Ukrainian war, that's not what I do for a living. I'm not a geopolitical analyst for the sake of geopolitics. I'm a geopolitical strategist for the sake of being an investment strategist.
And what that means is that if the second derivative of geopolitical risk premia declines because the war is in a stasis, the Ukrainian war can last for the next 100 years and you shouldn't care. And by the way, there is a war, a serious war that killed a lot of people, including a lot of Americans. It has been going on for the last 69 years. It's called the Korean War.
And guess what, nobody really cares about the Korean War. That war never ended. There was never a peace agreement. There's still a line of contact. People still get killed across the line and all that.
So, my point is that the war, the more this war gets bogged down in Donbass, and provided that obviously, the view is right, it doesn't spread out of Donbass. I think that in six months, the geopolitical risk premium will dissipate on oil prices, one because there won't be a risk of further sanctions. And by the way, like the West could sanction Russia in a much more serious way, the fact that they didn't tells you their intentions. There's no secondary sanctions.
In other words, Indian companies are not getting sanction for buying Russian oil, but they are if they buy Iranian oil. The US could have been a lot tougher on this issue, and it hasn't been. So, one, I think that there won't be any, the risk of more sanctions will dissipate. Second, I think the risk of Europeans actually implementing that oil embargo dissipates as well.
You've got Italian elections coming up, probably will produce a populist coalition of moderately pro-Russian parties. It's not fair to call them pro-Russia, by the way, let's call them ambivalence towards Russia. And so, you will start seeing many European countries skirt the sanctions or say like, hey, listen, we like that $30 discount on [?]. Sorry, our economy is suffering, so we're going to go and do what Hungary is doing, what Bulgaria is doing, all these exceptions that other countries have gotten on pipe oil, on seaborne oil.
I can see Italy asking for one of those as well six months from now provided that I'm right that the war is bogged down into part of Ukraine, that no European really cares that much about.
ANDREAS STENO LARSEN: By the way, that's a very interesting pattern when it comes to Italian exports. The Italian exports to Turkey, they've skyrocketed, and the Turkish exports to Russia, they have skyrocketed during the same period of time. So, I basically think that the Italians are already exporting to Russia circumventing the sanctions via Turkey. But that's a whole different story. We have a question from the audience that I'd like to throw into the debate here. It's from Jim asking you, Marko, what's the endgame for Russia? Should this standstill in the invasion of Ukraine continue?
MARKO PAPIC: It's difficult to say, but I think nothing positive. It's interesting that that surface level analysis tells us Russia is doing great, current account surplus is growing globally strong. And they conquered more territory here because they need it. First and foremost, they conquered the West Virginia of Europe. And I mean that with no criticism in West Virginia. I just mean it like they conquered the part of Europe that produces coal, like big deal. It's not the 19th century, let's relax here.
Nothing that they've gotten in Ukraine is strategic, including Crimea. By the way, Crimea is not even strategic to Russia. Their main military base in the Black Sea is [?], not Sebastopol. It's not the mid of 19th century and the Russian Black Sea Fleet, by the way, is pathetic. The Greek navy could sink it in 10 minutes. So, Russia's got nothing out of this and the surface level analysis of macro factors like current account surplus really don't reveal the depth of the problems that Russia will face over the next several years.
So, what I would say is that once the patriotic fervor dissipates, once Russian people get over the fact that they're not pariah, which sucks and it's not a nice place to be, it tends to create internal cohesion. People rally around the flag, around the President and say, hey, listen, if the West doesn't like us, screw you. There's a lot of that happening in Russia right now, and it's a very human emotion, but 6, 12 months from now, when they take account of what they got for the cost that they had to pay, I think that that's not a good place to be if you are in the Kremlin right now.
You have to understand that the faster you end this war, the faster you end this conflict, the more chances you have to survive the next five years. The more you double down and triple down on it, the higher the chances of some a domestic revolt.
ANDREAS STENO LARSEN: I wanted to play a soundbite for you from a debate I had with the former executive of Bank of America, David Woo, who's got Taiwanese roots, by the way, in relation to what's going on in Taiwan and the potential correlation to what's going on in Ukraine at the moment. His point is that the US is basically behind most of the turmoil in both places. But he also thinks that August will be a make it or break it month. So, let's listen to David and get back to that discussion.
DAVID WOO: But now with the US on the offensive vis a vis China, you're going to have to think if you're Xi Jinping, you're going to think twice. If you've decided that's it, it's possible impossible to find a middle ground with the US and the US now wants my head, wants to go after Taiwan, then China will have no choice but to cross that bridge, and make Russia great. So, I think from now point of view, and so I think this is where it's going to come in, because I would say probably before the end of August, we will know how the situation in Ukraine is going to play out.
ANDREAS STENO LARSEN: The entire interview with David, who is available on the Real Vision platform for Essential, Plus and Pro subscribers. Marko, in relation to what David just said in the soundbite, first of all, do you concur with the view that August is a make it or break it month for the crisis in Ukraine?
MARKO PAPIC: Yeah, I think so. Again, if you look at those two maps I showed, the Russians have wasted two months. And if they wasted another month, at some point, you have to ask the question, do they even have any initiative left? So, I would agree that August is very important for the conflict in Ukraine, they will show whether my view is right or not, whether this is now stasis, or whether it doesn't renewed initiative by Russia.
ANDREAS STENO LARSEN: Let's assume for a second that Russia will actually be able to gain territory in the eastern parts of Ukraine through this month. Do you think that will allow China to go on the offense versus Taiwan as well?
MARKO PAPIC: No, I don't think so. because first of all, the leap that the Russians would have to make to illustrate success in this operation would have to be great. Think about it, if Russia manages to conquer some territory, and they walk away with Donbass, some parts of Kherson, [?], that's like the, I don't know, probably Paris Saint-Germain winning TF1. And for all of those who are not Europeans, obviously, Andreas and I are like geeking out here, but Paris Saint-Germain is like this great global club that's always going to win the French league, but they're really trying to win Champions League.
So, when China looks over to Russia and Ukraine, like winning Donbass, is something that the least, the least the Russians should have done. The