Living in the Black Box

It doesn’t matter whose war it is; it soon becomes everyone’s problem. Brent crude is no longer crashing every time the White House reports progress in peace talks, because after eight weeks of energy shortages, there comes a time when physical supply starts to bite.

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For the UK, the inflation problem that was slowly going away is back. In 2022, we had a 10% one-year expected inflation rate at a similar oil price, whereas today’s inflation forecast is half that level.

Brent Crude Oil and UK Inflation

Source: Bloomberg

There are large differences between then and now. This time differs from the Ukraine war as the oil price has moved by less, and the price of natural gas has moved by little at all. Electricity is directly linked to gas, and so far, electricity prices have not been impacted. Back then, the economy was booming, at least temporarily, as we emerged from lockdowns. This time, the economy is soft, which eases the inflationary pressures.

UK Electricity and North Sea Natural Gas

Source: Bloomberg

The cost of borrowing has also been rising for the government, at a difficult time. We have rising bond yields and rising inflation, which means we are back in the black box, and it is not very comfortable.

Money Map

Source: ByteTree

Traditional low-risk investments, such as bonds and quality, are not working either. As our black box keeps pushing further to the top right, that puts pressure on gold and growth too. There is nothing wrong with the black box in normal times; it can be a lucrative investment environment to operate in. But keep pushing too hard into the top right, and it puts downward pressure on everything else.

Until March, the US market had been lagging the world, with Europe and Japan doing well alongside emerging markets. Now, the US is recovering, while EM is leading.

Global Markets Relative to the World

Source: Bloomberg

The geographical chart is telling us more about semiconductor exposure than anything else. The US has some, and EM has lots. Europe and Japan are light.

What they don’t tell you perhaps, is that the Emerging Markets Index is invested in Taiwan Semiconductor to the tune of 14.7%, Samsung 6.1%, and SK Hynix 4.1%. This is even worse than the concentration of the Magnificent 7. The MSCI emerging markets index comprises 1,222 stocks, yet 80% of the money is in Taiwan, China, Korea, and India.

Only 20% made it to Southeast Asia, Central Asia, the Middle East, Africa, Emerging Europe, or Latin America. Like so many things in modern investing, it isn’t always what it seems.

When one scrambles around to find opportunities to boost diversification, the mainstream market products don’t offer it. To do that, I believe you need to think very differently, and hopefully, I do a good job of that.

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