Stagflation

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Stagflation
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On Wednesday during Q&A following Jay Powell’s speech to the Economic Club of Chicago, he warned that the near-term impact of tariffs is likely to be rising unemployment and rising inflation. The Fed’s twin mandate is one of maximum employment consistent with price stability. Powell said, “I believe that for the remainder of this year, we may deviate from these goals, or at least not make any progress, and then we will restore progress as much as we can.” 

Slower growth with higher inflation is stagflation, a word Powell managed to avoid but nonetheless described. The Fed can’t address both simultaneously and will generally prioritize whichever variable is farther from their long-term goal.   

The White House has made no secret of its desire for lower rates. Trump has mused openly about firing Jay Powell, but in any event his term as chair runs out in May of next year. The pool of replacements who can satisfy both the president and bond market vigilantes is a small one. Trump’s a real estate guy, and in that business inflation and low rates are a great combination.  

Given the choice, the White House would prefer low rates with debt issuance heavily weighted towards short maturities. Interest expense will exceed $1TN next year, 3.2% of GDP. The budget outlook and interest rate policy are becoming inextricably entwined. Political leaders will increasingly be able to blame the Fed for our budget deficit through pursuing needlessly tight monetary policy.  

The obvious casualty of pursuing the lowest possible short-term rates will be inflation. But we have a lot of debt and its trajectory is no secret. Financing it at negative real rates has been the time-honored solution of profligate governments for centuries. 

In 2013 I made the case that the US was going down this road in Bonds Are Not Forever: The Crisis Facing Fixed Income Investors.  

We still are.  

Part of that process involves debt monetization via the Fed expanding its balance sheet. Their holdings almost reached $9TN three years ago as part of the pandemic response, but since then have declined by over $2TN. Nonetheless at $6.7TN the Fed holds $5-6TN more than needed for the smooth operation of monetary policy.  

Oddly, long term yields have risen during the tariff turmoil. Theories why include liquidation of a huge basis trade by a Japanese hedge fund and concerns about unstable US policy, but there’s no consensus. A reduced trade balance will mean less foreign demand for our debt, since exporting countries will have fewer dollars to invest. This need not matter if we reduce our budget deficit commensurately, but absent that Americans will need to buy more bonds which will require higher yields.  

China’s holdings are declining and will probably continue to. I doubt they’ll sell aggressively because it would be highly disruptive. But if yields move too high the Fed will conclude it must restart quantitative easing. And if it ever looks as if China is dumping bonds, Trump is just the guy to note that when you owe someone $784BN (China’s holdings as of February) it’s really the lender’s problem.  

Another move from the real estate playbook. 

None of this is intended to criticize. Aggressive debt management might be our best strategy when we’ve issued so much. You take the world as you find it. But surely, nobody can seriously believe in 2% inflation.  

The University of Michigan consumer survey shows long term inflation expectations of 4.1%, similar to the levels reached during the pandemic. A quarter of respondents think it will exceed 10%. We have a president and budget outlook both acutely sensitive to interest rates.  

Pipeline tariffs – not to be confused with import taxes – are mostly regulated to prevent unscrupulous pipeline owners from exploiting their position. Wells Fargo estimates that around half the EBITDA of the industry benefits from annual price hikes linked to the PPI. Following the 2022 inflation spike, increases of 13% were not uncommon in 2023.  

This supported 5% distribution growth in 2022, a level which has continued up until today. It’s why the American Energy Independence Index (AEITR) was +21% while the S&P500 was –18% that year.  

 Import taxes are having a modest impact on new construction projects. Kinder Morgan recently estimated it at around 1% of major project costs on their earnings call. But the dominant inflation impact is on companies’ ability to raise prices.  

This is why we believe midstream infrastructure offers one of the most attractive ways to own inflation-protected assets. I’ve been invested in the sector for over two decades, partly because of my long term debt-fueled inflation outlook described in Bonds Are Not Forever. We’re probably facing an imminent bout of inflation. This is a sector that showed its resilience in such a scenario just three years ago. 

LNG Deals Aren’t Swayed By Tariffs

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LNG Deals Aren’t Swayed By Tariffs
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Last week President Trump said the EU should close its trade surplus with the US by buying $350BN of US energy. The Administration’s spontaneous policy switches on tariffs have been unpleasant for investors. But at least for those exposed to the energy sector, there’s a gratifying consistency in that oil and gas are invariably part of the solution.

It won’t be easy for the EU to satisfy this demand. Their total imports of oil, gas and coal last year were $420BN, and this is the place where decarbonization at any price drives energy policy. The EU’s green desire to cut hydrocarbon consumption conflicts with increased LNG imports and is unlikely to draw much sympathy from the White House.

Moreover, EU policy is often disjointed. Imports of Russian LNG reached a new record last year. They have a non-binding goal of eliminating Russian supplies by 2027 although some German politicians would like the opposite.

Meanwhile, German Chancellor Friedrich Merz said he would be willing to transfer German Taurus long-range missiles to the Ukrainian Defense Forces. Perhaps imports of Russian LNG generate the electricity that is used to manufacture the missiles?

Coherence is an accusation rarely hurled at EU policy.

Meanwhile, the buildout of US LNG export infrastructure continues to attract capital.

Energy Transfer announced an agreement under which MidOcean Energy will finance 30% of the development of its Lake Charles LNG export terminal.

NextDecade (NEXT) agreed a 1.2 Million Tonnes per Annum (MTPA) 20 year deal with Saudi Aramco, to be supplied from Train 4, part of Stage 2 of their Rio Grande LNG terminal in Brownsville, TX. On Monday TotalEnergies exercised an option to take 1.5 MTPA over 20 years. With these two deals in hand, NEXT expects to move ahead to a final investment decision on Train 4 and begin construction.

NEXT is a highly volatile stock that is risky by the standards of midstream energy with its reliable cashflows.

From a recent, pre-tariff intra-day high of $9.71 on March 25th NEXT slumped and briefly touched $5.16 on April 7 as markets absorbed the enormity of Liberation Day. A 47% two week decline is only tolerable for those holders willing to overlook the market’s occasional bipolar disorder – which is to say, unlevered long-term holders.

As regular readers know, we count ourselves in that group and believe the upside is commensurate with the risk.

I was in London and Belgium for the past two weeks. I had the opportunity to attend a presentation from a venture capital firm seeking financing for Ukraine’s growing armaments industry, most importantly drones.

I have no military background, but it’s inescapable that UAVs, UGVs and UMVs (respectively, Unmanned Aerial, Ground and Marine Vehicles) have changed the battlefield. The flagship of Russia’s Black Sea fleet was sunk by a UMV last year.

I learned that Ukraine produced 2.5 million drones last year compared with Germany’s 1,000.

The US has underwritten Germany’s defense for decades, enabling their ruinously expensive energiewende (energy transition). The need to boost defense spending and counter the Trump tariffs will force some overdue realism on Germany’s political leaders.

Wherever I travel I’m always looking for contrasts in how different regions use energy. Our hotel room in Belgium had a slot for your room key, without which the lights wouldn’t work. It stops guests going out and leaving the TV on. Dark corridors light up as you enter, triggered by motion sensors that ensure they’re only lit when needed.

This is because on average Belgians pay twice what the US does for electricity. The shale revolution has kept prices down here, and renewables have pushed them up in the EU, especially in Belgium.

London’s congestion charge on vehicles entering the city center has reduced traffic and emissions. It’s also ensured that most of the cars you see in the west end are either black taxis or expensive toys (Ferraris, Bentleys, Porsches etc), the latter often driven by Arabs presumably spending some of their oil wealth.

To be in Europe means being ready to defend US policies. My friends raised the issue of tariffs – gently, because our long friendships will outlive many more presidencies. But this is mostly how foreigners are experiencing the new Administration.

Republican presidents rarely play well in western Europe, because our political middle ground is to the right of theirs. Uncontrolled illegal immigration, fiscal profligacy that fueled the 2022 inflation spike and a centrist that, once elected, veered left set the stage for November’s result.

Few outside the US appreciate this, as my gentle reminders explained. But I also allowed that the tariffs have revealed no presidential advisors willing or able to explain basic trade economics in the Oval Office.

I like Trump’s energy policies. But tariffs as implemented are capricious and may lead us into a recession.

In the vein of aligning with government policy, investing in hydrocarbon infrastructure and especially LNG export terminals is, in our opinion, one of the best ways to achieve acceptable returns through the current uncertainty.

Help With Timing Regional Conflicts

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Help With Timing Regional Conflicts
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Dimitri Alperovitch co-founded CrowdStrike, the cybersecurity firm whose faulty software update on the Windows operating system last year led to worldwide IT failures. Alperovitch was no longer with the company, having left four years earlier to launch a nonprofit called the Silverado Policy Accelerator.

In April 2024 he published World on the Brink: How America Can Beat China in the Race for the Twenty-First Century, a thoughtful book on how the US should approach China.

World on the Brink opens with a hypothetical 2028 scenario in which China attacks Taiwan. This resonated with me more than anything else. The rest of the book chronicles the history of the west’s engagement with China, from Nixon’s visit in 1972 through the strategic ambiguity with which subsequent US presidents have spoken publicly about Taiwan.

Jimmy Carter said, “The Government of the United States of America acknowledges the Chinese position that there is one China and Taiwan is part of China.” Note that we didn’t agree with their position, simply acknowledged it. Joe Biden, when asked in 2022 if the US would defend Taiwan in one of his more lucid exchanges with a reporter, said, “Yes, if in fact there was an unprecedented attack.”

The book goes on to present thoughtful recommendations for US policymakers.

America’s long, ambiguous support for Taiwan has always struck me as not clearly in our national interest. We have a history of favoring democracies over dictatorships, but Taiwan has always complicated relations with China.

It’s like our decades-long military presence in Europe to protect them from Russia. This has passed its expiry date. US defense spending has enabled Europe’s generous government funded healthcare and a ruinously exorbitant pursuit of decarbonization, neither of which would have been possible without American troops stationed in Germany. That’s now changing.

It’s easy to see that this administration’s worldview will assess Taiwan as not worth fighting over.

In 2027 Chinese Premier Xi Jinping will probably be re-elected as leader of the Chinese Communist Party (CCP). At the age of 75, he’ll be in his third decade in power and the oldest leader since Deng Xiaoping. It’ll likely be his last term in office. While US presidents have issued carefully vague statements on defending Taiwan, Xi routinely asserts that reunification of the island with mainland China is inevitable. For the CCP, it’s only a matter of when.

To westerners, Taiwan looks like an island off the east coast of China. But tilt the map on its side as World on the Brink does and it blocks the gap between the Philippine and Japanese archipelagos. A hostile power could limit the access of China’s blue water navy to the deep waters of the Pacific.

Alperovitch argues that late 2028, with the US presidential election leading to a domestic focus and perhaps even a contentious transition, might be Xi’s best and last opportunity.

It’s a compelling scenario. One can imagine the “If not now, when?” argument as Xi considers whether to seal his legacy with a final crowning achievement.

Most of us have no influence over US geopolitical strategy, but as investors we need to think about the potential for a major conflict like this one. Alperovitch explains why it might be closer than we think.

US foreign policy has suddenly become transactional rather than strategic. Article V of the North Atlantic Treaty which governs NATO says “…will assist the Party or Parties so attacked by taking … such action as it deems necessary.”  The treaty itself leaves room for maneuver, and who doubts that any US military action will be preceded by a negotiation.

It’s not clear that Russian tanks invading Poland would be met with US boots on the ground. Taiwan has no more assurance. They look a lot like Ukraine – vulnerable to the regional superpower without their security being in the US national interest.

In the Middle East, Iran continues to develop its nuclear weapons capability. Deeply buried and dispersed, eliminating their growing missile launch capability represents a complex military challenge beyond Israel’s capability. Their only chance to take out this developing threat requires US support. Will they ever have a better opportunity than during the next four years, with a US administration that is unabashedly pro-Israel?

If not within the next three and half years, then when?

World on the Brink made me think differently about the odds of conflict over Taiwan. I now assess it as more likely than not. My partner Henry pointed out the Israel/Iran analysis and believes a US-aided attack on nuclear launch sites is virtually certain during the Trump presidency.

We don’t make a living from geopolitical prognostications. We’re not changing our investment posture. It does seem that global defense spending is on an upward path as the world adapts to America’s strategic shift.

We think domestic energy infrastructure is among the best investments you could choose at any time. Over the next four years, even more so.

We have two have funds that seek to profit from this environment:

Energy Mutual Fund Energy ETF

 

The Bull Case For Bitcoin

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Last year luxury car sales in Singapore collapsed. Sales of new Bentley, Ferrari, Jaguar and Rolls Royce models were down by as much as three quarters compared with 2023. This wasn’t caused by an economic slowdown. Singapore’s government clamped down on money laundering.

Most buyers of such cars are Chinese nationals. Car dealers are required to verify sources of financing for new buyers, following a money laundering scandal linked to the Chinese mainland. Vehicles obtained with illicit funds have been seized.

“Pig butchering” refers to a lonely victim who is befriended online and eventually persuaded to transfer money into an investment account – often crypto – at which point the online friendship or romance evaporates, along with the money. The rather graphic term dates back to 2016 or earlier in China.

The Chinese government eventually reacted aggressively, since its own citizens were usually the victims of schemes run by Chinese gangs. Today, a suspicious text message in China is often accompanied by a warning from the government to be careful. Police routinely visit recipients of phishing emails to verify that they haven’t been duped. Public information messages warn people to be vigilant.

Such is the intrusion of China’s security services into everyone’s life that they’re able to protect the vulnerable.

As a result, China has become a harder place for such scams. So, in recent years the industry has gone global. With English being so ubiquitous and America so rich you, dear reader, are the new target.

Scam Inc is an illuminating eight-episode podcast published by The Economist. Journalist Sue-Lin Wong describes a business sector that includes small towns dedicated to scam factories in lawless Myanmar. English-speaking Asians are held there after being kidnapped when applying for a job.

The series opens with the extraordinary story of the CEO of a small community bank in Kansas being duped into transferring $47 million to Bella, a woman he believed to be in Perth, Australia.

Heartland Tri-State Bank CEO Shane Hanes was eventually convicted of embezzlement and sentenced to 24 years. During the investigation and before he was charged, Hanes was so convinced he was involved in a legitimate business deal that he traveled to Australia to look for Bella, who was by now no longer responding to his calls or text messages.

The scamming industry is estimated by some to be worth several hundred billion dollars annually, which puts it in the same league as the illegal drug trade. Many scams go unreported because the victim is too embarrassed or believes pursuit to be futile.

This brings us to Bitcoin and the rest of the crypto industry, since without it a great deal of criminal activity could not exist.

I last criticized Bitcoin in July 2022 (see Bad Investment Ideas Still Flourish (Part 1)) when it was trading at around $24K. I have many friends who have remained that way because they ignored my advice on Bitcoin. They have sensibly concluded that any insights I might have are limited to energy infrastructure.

The list of profitable investments I have missed is a long one, and Bitcoin would not be at the top. Fortunately, I am not afflicted with FOMO (Fear Of Missing Out). Returns from energy have been more than satisfactory and I stick to what I understand.

Nonetheless, it must be said that none of the original supporting arguments for Bitcoin remain. It is not a store of value: it’s too volatile. It is not a medium of exchange: transactions costs are too high. It is not a haven during inflation: in 2022 it fell while US inflation reached 9%.

It is not safe – Tether was recently hacked for $1.5BN, reportedly by the North Korean government. But it’s also not safe from our government. In 2021 the ransom paid following a cyber-attack on the Colonial pipeline was partly recovered by the US Justice Department.

In fact, there is no point to Bitcoin except that it goes up more than down. That’s the only surviving investment case. Tether, anchored as it is to the US$, doesn’t even offer that.

Nonetheless, Bitcoin’s ascent has been sufficient to draw institutions such as Emory University to invest and the Rockefeller Foundation to consider an allocation. Rockefeller’s CIO Chun Lai, CFA said, “We don’t want to be left behind when their potential materializes dramatically.”

CFA course materials omit a chapter on FOMO, but Mr Lai thinks outside the box.

The scale of the industry uncovered by the Scam Inc podcast suggests that a substantial part of crypto activity supports scams and drugs. Victims often have to buy Bitcoin.

Chainalysis estimates that illicit crypto addresses received $40.9BN last year. This is up from 2023 but still only 0.14% of total transaction volume. However, their original 2023 estimate was $24.2BN which they now recalculate at $46.1BN. They eventually expect the 2024 figure to exceed this.

My guess is that it’s much higher, but well hidden. Bitcoin’s most valuable feature is that it’s hard to trace ownership. It was probably supporting Singapore’s luxury car market, until awkward questions were asked about source of funds.

Scams, illegal drugs and other illicit activity will probably keep increasing, along with Bitcoin. That is the investment case. Just not with my money.

We have two have funds that seek to profit from this environment:

Energy Mutual Fund Energy ETF

 

 

Tariffs And Mismanaging The Economy

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A new administration took office determined to change the economy’s direction with overhauled policies. The leader and key advisers huddled, drawing up their plans in relative secrecy. Once ready, they were unveiled with great fanfare, heralding a new dawn in economic stewardship.

Markets, caught by surprise without having had the opportunity to assess them via leaks, reacted with horror as the looming hit to GDP, unanticipated by the new administration or investors, was immediately reflected in prices.

This was how the new UK government under then-Prime Minister Liz Truss began in September 2022. In her case the UK gilt market was shocked by the scale of proposed borrowing. Yields rose. Sterling fell. The government’s unrealistic plans were widely criticized, including by many in her own Conservative party.

A tabloid famously wondered whether her time in office would outlast a lettuce and helpfully posted a photo of Truss next to one, continuously broadcast via a webcam. The lettuce visibly decayed, but her time as PM was shorter still at 49 days.

The UK parliamentary system can change its PM with a speed and brutality unmatched in the US. The British Conservative party has historically shown its leaders less loyalty than the US Republican party, and our political system doesn’t offer the same flexibility. If not, Thursday’s tariff-induced $3TN loss of equity market value would be the beginning of the end.

The exit ramp could be Congress withdrawing the emergency powers which President Trump has invoked that give him the ability to impose tariffs. We have no insight into how far markets must decline to induce such. The US Senate passed a resolution, but a veto-proof two thirds majority in both chambers will be required.

There’s a scale of equity market losses that will be sufficient, but we’re not there yet. Given the unpredictability with which tariffs have been used, the president’s current autonomy over their implementation will remain in Damoclesian fashion to limit any animal spirits to the upside.

To quote my friend and former head of bond trading, in the meantime, “Down’s a long way.”

The economy, financial markets and even the president will all be better served if Congress reasserts its authority in this area. Republicans may care to recall that after Liz Truss the UK Conservatives never regained their reputation for competent economic stewardship and suffered a thumping electoral defeat to the Labour Party last year.

While investors endure more tariff trauma with its associated equity market volatility, it’s worth remembering that demand for US natural gas has historically been virtually impervious to fluctuations in GDP growth. We think this will continue, supporting volume throughput across the related infrastructure.

Since the shale revolution released enormous amounts of domestic gas, consumption has grown. The 2008 financial crisis was barely a blip. Even during the 2020 pandemic when crude oil prices briefly went negative because of lockdowns, natural gas volumes fell 1.7% but quickly recovered. Within a couple of years they were 3.7% higher. Over the past decade consumption has grown at a 2.2% compounded annual rate.

The US Energy Information Administration expects production to grow at 2% this year and next.

It’s not hard to see why.

Coal to gas switching has resulted in cheaper, cleaner power over the past fifteen years. Pennsylvania’s Homer City coal burning power plant is being converted into the natural gas Homer City Energy Campus. It’ll produce 4.5 GW, enough to power 2-3 million homes although local data centers will be the main users. That will require around 0.8 Billion Cubic Feet per Day (BCF/D) of natural gas, around 0.7% of US output. When operational in 2027 it’ll be the biggest natural gas power plant in the country.

Demand from data centers and LNG exports will continue to underpin natural gas demand growth.

In one bright spot a few days prior to Liberation Day, Vietnam announced it was cutting its import tax on LNG from 5% to 2%. The White House is assuming that our trade partners will generally not engage in rounds of reciprocal tariff hikes. We need more examples like this.

I was in London last week where I reconnected with several people from high school that I had seen once or not at all in the ensuing 45 years. We had much to catch up on. Satisfyingly, people whose company I enjoyed as a teenager remain that way today. I’ve never regretted emigrating to the US but always enjoy returning to where I grew up.

We have two have funds that seek to profit from this environment:

Energy Mutual Fund Energy ETF

 

Screwed By Tariffs

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Americans did vote for tariffs when we elected Donald Trump. Many perhaps thought they’d be implemented with a clearer strategic purpose. I had hoped we’d use them to open up foreign markets such as the EU, reducing our trade deficit by exporting more not by importing less. And most voters probably weren’t voting for a recession, odds on which Goldman Sachs revised up to 35% for next year.

Among the improbable targets of tariffs on steel and aluminum imports are screws, along with bolts, nuts, coach screws, screw hooks, rivets, cotters, cotter-pins, washers (including spring washers) and similar articles, of iron or steel. These are all members of the Harmonized Tariff Schedule (HTS) code 7318.

When a blunt instrument is applied with force, it will inevitably hit more than the intended target. Last year we imported $7.05BN of HTS code 7318 products and exported $5.63BN, for a trade deficit of $1.43BN.

There’s no particular trend in the series. The net balance in HTS 7318 was worse in 2022 than last year. Exports have been growing at 12% annually, faster than imports at 9%. We bought almost two thirds of our HTS 7318 imports from just three countries: Taiwan, China and Japan. The two biggest buyers of our exports were Canada and Mexico under the USMCA and no doubt including the auto sector’s integrated cross-border assembly processes.

China’s the world’s biggest exporter in this category and the US is the biggest importer. But that’s true for many traded items.

The trade deficit in 7318 doesn’t seem especially problematic. Manufacturing screws isn’t obviously in the national interest. If other countries can make them better and cheaper, go for it. The net deficit in 7318 is only 25% of our exports. There’s a lot of two-way flow in the category, as what economists call comparative advantage drives production to where it’s done relatively better.

Somebody is getting screwed with 7318 tariffs, and the market fears it might be the American worker.

Adding manufacturing jobs is always good, but US manufacturing employment is in fine shape. A decades-long decline ended when the shale revolution began to lower domestic gas prices.

During tariff turmoil, midstream energy has been showing its value as defensive sector, beating the S&P500 by 17% since the election. A Fox News poll found that 69% of Americans believe tariffs will lead to higher prices. White House trade counselor Peter Navarro claimed they’d act as a tax cut, a fringe view that’s simply wrong.

It’s not only that US energy has limited exposure to tariffs. Many pipelines are regulated by FERC which links price increases to PPI. The FOMC’s most recent Summary of Economic Projections showed policymakers had shifted their growth expectation down and inflation up, hence the stagflation headlines that accompanied its release.

Pipeline investors have little to fear from inflation given that around half the industry’s EBITDA is linked to PPI. In 2022 when inflation reached 9%, midstream returned +21% while the S&P500 was down 18%.

The market is pricing in at least two rate cuts by the end of the year, suggesting investors expect the Fed to regard tariff-linked inflation as temporary. In this scenario, midstream earnings will get a boost from the PPI linkage while maintaining relatively attractive yields.

Energy consumption is very stable (see Midstream Is About Volumes). Power generation is rising because of AI demand after two decades of being flat. Liquids (about half of which is gasoline) have been between 20 and 21 Million Barrels per Day for many years. Natural gas consumption continues to grow strongly. For fifteen years this was driven by the coal to gas switch in US power generation. Now increasing LNG exports and the growth in data centers are the drivers.

There’s little reason to expect any of these trends to change.

Morgan Stanley noted that Oklahoma’s natural gas rig count has risen from 44 to 54 this year in response to higher prices. They expect the beneficiaries to include Energy Transfer, Oneok and Targa Resources as E&P firm Anadarko pushes increased volumes through their infrastructure.

Shipping giant AP Møller-Maersk expects the EU’s proposed maritime emissions trading scheme to encourage the use of gas-powered engines, saying it was, “highly likely that fossil LNG remains the cheapest option.”

LNG stocks have sagged recently on fears that a cease-fire in Ukraine could see increased Russian gas exports to the EU. A senior coalition member in Germany’s new government recently said the sanctions regime was hurting the EU more than Russia. We continue to think the White House would not look kindly on a resumption of gas shipments through Nordstream.

We have two have funds that seek to profit from this environment:

Energy Mutual Fund Energy ETF

 

ARK’s Cathie Wood: Getting Rich While Losing Money

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ARK’s Cathie Wood: Getting Rich While Losing Money
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Which is a more important measure of an investment manager’s skill – the return on the first dollar invested at inception, or the return on the average dollar?

Return since inception is widely used because it covers the longest period. If performance is reasonably consistent, both methods should tell the same story. That this is not the case is surprisingly common.

It was the motivation behind my 2011 book The Hedge Fund Mirage: The Illusion of Big Money and Why It’s Too Good to Be True in which I showed that the average hedge fund investor would have been better off owning treasury bills, even though the industry’s since inception return was good. Although hedge funds generated substantial profits, the 2 and 20 fee structure transferred most of those gains to managers.

The Hedge Fund Mirage received coverage in my favorite magazine, twice (see The Economist Once More Writes About The Hedge Fund Mirage). Since my writing aspires to be as good as theirs while inevitably falling short, I took this as the ultimate endorsement.

Several hedge fund managers told me they fully agreed with the revealed widespread mediocrity, while noting that it didn’t apply to their hedge fund. Hedge fund consultants, who make a living promoting them, were critical (see The Hedge Fund Lobbyists Fight Back). Thus was the gulf in IQ between the two groups confirmed.

The difference between the two measures of performance is explained by the fact that early hedge fund investors did well but weren’t that numerous. As new money flowed in and hedge funds went mainstream, profit opportunities became scarce under the weight of this additional capital. During the 2008 Great Financial Crisis I estimated hedge funds lost $500BN, wiping out all the profits they’d ever made. The promised delivery of absolute returns came up short.

It can be illuminating to apply this analysis elsewhere. Three years ago, I did this for a popular $15BN fund (see ARKK’s Investors Have In Aggregate Lost Money). Equity funds can lose money because of a weak market even if their stock picks are good, so some might say this is an unfair way to look at Cathie Wood’s ARK Innovation ETF (ARKK).

More recently, a team at Morningstar found that Cathie Wood’s firm ARK Invest tops the list of value-destroying fund families at $13.36BN over the past decade. The S&P500 returned 13.1% pa over the same period, a considerable tailwind. It seems Cathie Wood isn’t very good at picking stocks.

At this point a friend of mine who ran government bond trading at JPMorgan decades ago would helpfully say, “Simon, if you had her money, you’d burn yours.” Which is to say that the failure of her investors to avoid poor manager selection hasn’t impeded Ms Woods’ ability to become rich. Her net worth is estimated at over $250 million.

The fortunes of clients and their money manager have rarely diverged so spectacularly.

Inflows to the ARK Innovation ETF (ARKK) peaked in late 2020 following an annual performance of 152.8%. Since then, ARKK has lost over half its value.

Many of those 2020 investors are deeply underwater and are hanging on, waiting for a recovery. Inducing abject hope in your clients can be a powerful asset-retention strategy.

In other news, there are signs that opposition to reliable energy in New England might be softening. A recent conversation took place between NY governor Kathy Hochul and President Trump over the Constitution pipeline.

Intended to deliver natural gas from Pennsylvania to a hub near Albany for further distribution, Williams Companies finally threw in the towel in 2020 after four years of challenging the New York State Department of Environmental Conservation’s 2016 denial of a key water quality permit.

New York and its neighboring New England states have some of the country’s highest energy prices. This is because renewables are expensive, and they sometimes have to import liquefied natural gas. Democrats are worried that working class voters in poor Boston communities won’t prioritize climate change as highly as the college-educated progressives who drive policy.

Much needs to be agreed upon before the construction project can be resurrected. And WMB will worry that the pipeline won’t be fully utilized for its projected 30-40 year useful life if regional policy turns back against hydrocarbons.

But it was surprising that New York’s governor could have a productive conversation with Trump about any topic. Perhaps some pragmatism is intruding.

It also highlights the enduring appeal of natural gas. While US gasoline demand may have peaked in 2019 before the pandemic, natural gas consumption continues to grow along with exports. It’s why we often remind investors that the Natural Gas Transition is the only energy shift of any consequence in the US.

We have two have funds that seek to profit from this environment:

Energy Mutual Fund Energy ETF

 

 

Energy Wants To Invest In America

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$1.4TN is a huge sum by any standard. It’s more than Spain’s entire stock market capitalization and just behind Switzerland’s. It’s more than Indonesia’s GDP and not far below South Korea’s. This is the sum that the United Arab Emirates (UAE) has committed to invest in America over the next decade. It’s probably the best way to make and stay friends with the White House.

Details are light, although some of that capital has already been committed. There was an announcement that Emirates Global Aluminium (English spelling) would help finance the first new US aluminum smelter in 35 years.

In January Trump asked Saudi Arabia to spend $1TN in the US over four years. Next time they talk he might say that was too low. The muscular, America First tariff-heavy stance the new Administration has adopted isn’t drawing much love from countries that thought they were friends and allies. But it doesn’t seem to be bad for investment flows.

We like a recently announced partnership between the UAE’s sovereign wealth fund and Energy Capital Partners to invest $25BN in energy infrastructure and data centers. We also like that ADNOC, the UAE’s state oil company, invested last May in NextDecade (NEXT). The alignment of interests between the UAE’s money and Trump’s quest to increase US energy exports should be good for LNG export infrastructure.

JPMorgan has examined the order backlog for gas turbines and estimates this will add 6 Billion Cubic Feet per Day (BCF/D) to domestic gas demand by 2030. Currently 35 BCF/D of gas provides 43% of our power, a share that will likely grow with the insatiable demand from data centers.

Meanwhile Morgan Stanley reports that LNG feedgas flows hit a new record of 15.7 BCF/D.

Infrastructure capex has generally been declining for the past few years. Climate extremists have weaponized the legal system, although this was turned back on them recently (see Greenpeace Picks The Wrong Fight).

To a large degree we have the pipeline network we need for liquids. Growing gas demand does require more investment. 2024 saw 17.8 BCF/D of added natgas pipeline capacity, more than double the prior year. Interstate projects were over 10 BCF/D, almost 5X the 2023 total. Pipelines that cross state lines (interstate)are generally more susceptible to court challenges since their permits are issued at the Federal level.

Capacity additions were led by the Mountain Valley Pipeline (MVP) which was only completed due to Congressional action in 2023 (see A Pipeline Win From The Debt Ceiling). MVP moves 2 BCF/D to connect with Transco for subsequent transit south to the Gulf coast. Another 0.8 BCF/D added capacity to a Transco line between Pennsylvania and New Jersey, although climate extremists tried to block this.

Building intrastate is usually simpler because the prior Democrat Administration had less power to intervene. The Matterhorn Express Pipeline connects the Permian to Katy, TX with 2.5 BCF/D in capacity.

Our growing LNG exports require more feedgas. Venture Global (VG) added the Gator Express pipeline which consists of two pipeline segments with 4 BCF/D of capacity to their Plaquemines, LA LNG export terminal. It illustrates VG’s vertical integration.

Most of the added capacity was in the Texas/Louisiana area supporting the Permian basin, with some in the northeast connected to the Marcellus and Utica shales. New England continues to deny itself access to cheap reliable energy, instead preferring to import LNG and reduce their reserve margins for power generation.

The growth in data centers will force a reality check on expensive, intermittent electricity. The PJM grid which includes mid-Atlantic states New Jersey and Delaware while extending as far west as Illinois and Kentucky estimates they’ll need 40% more power generation over the next decade.

The Midcontinent Independent System Operator (MISO) operates in a swath of central US states adjacent to PJM. They estimate their reserve margin during peak summer demand will drop from 17% to around 4% over the next eight years. There’s little doubt that reliance on intermittent solar and wind is increasing the risk of power shortages, since they operate with far lower utilization than traditional energy – typically 20-30%. Offshore wind can be a little higher but the US has almost none of it and it’s not relevant to MISO’s geographic footprint.

JPMorgan’s 15th annual energy paper, titled Heliocentrism is widely available and a rich source of insights. Mike Cembalest, Chairman of Market and Investment Strategy for J.P. Morgan Asset & Wealth Management, does world class research presented engagingly. For those without the time to read it, we’ll periodically include charts.

This one shows why Europe is slowly committing industrial suicide with energy policies that enable developing countries to increase their greenhouse gas emissions. California isn’t far behind. Their citizens are beginning to realize it.

We have two have funds that seek to profit from this environment:

Energy Mutual Fund Energy ETF

 

 

 

 

Greenpeace Picks The Wrong Fight

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In recent years climate extremists have become adept at weaponizing the legal system in pursuit of their dystopian aims. The Mountain Valley Pipeline (MVP), which was built to move natural gas from West Virginia to Virginia, faced extensive delays with only a few miles left, because climate activists were able to persuade a judge to vacate a previously issued permit. Billions had been spent, relying on the permanence of approvals issued by government agencies.

Nothing chills the appetite for construction projects more than the prospect of a legal fight of unknown duration. Eventually in 2023 Senator Joe Manchin from West Virginia, where the pipeline started, insisted that a bill to raise the debt ceiling include language stating completing MVP was in the national interest.

The pipeline was completed. But the extended project timeline helped limit the midstream energy infrastructure sector’s appetite for big projects, furthering the goals of the environmental extremists who had opposed it. However, several years ago we concluded that it also helped boost dividends and buybacks (see Pipeline Opponents Help Free Cash Flow).

Therefore, it’s appropriate that a $660 million jury award against Greenpeace USA in North Dakota seems likely to put them out of business. Energy Transfer (ET), who sued Greenpeace over damaging protests during the construction of the Dakota Access oil pipeline, doesn’t shy away from conflict. Their pugnacious chairman Kelcy Warren has a long history of falling out with regulators and even his own investors as we noted nine years ago during a dispute over preferred securities issued only to management (see Will Energy Transfer Act with Integrity?).

That dispute was also settled in court, in ET’s favor.

Greenpeace has pursued disruptive stunts such as illegally boarding oil rigs. They share the same ethos with Extinction Rebellion and probably inspired their acts to disrupt civil society, which include defacing works of art and walking on busy highways to prevent people from driving.

Greenpeace and their motley crew are experiencing the consequences of overreach. America will not miss their US affiliate.

The pendulum is swinging back.

Last year another group of climate extremists found a compliant judge to vacate a permit on which NextDecade (NEXT) was relying to build their Rio Grande LNG terminal on the Brownsville ship channel (see Sierra Club Shoots Itself In The Foot). The ensuing uncertainty about the project’s completion hurt the stock, raising NEXT’s cost of capital.

Last week the U.S. Court of Appeals for the D.C. Circuit revised its earlier ruling. NEXT duly rose, and we continue to think it’s an attractive investment.

In another positive development, the US Department of Energy approved Venture Global’s expansion of its Calcasieu Pass LNG terminal (CP2). Energy Secretary Chris Wright said, “The benefits of expanding U.S. LNG exports have never been more clear, and I am proud to be taking action to support the American people and our allies abroad with more affordable, reliable, secure American energy,”

Let’s just say we like his philosophy.

CP2 could export as much as 28 Million Tons per Annum (MTPA) of LNG, or about 3.7 Billion Cubic Feet per Day (BCF/D). For context,  feedstock to US LNG export terminals recently hit 16.6 BCF/D, a record.

VG’s stock duly rose on the permit approval. We think it remains attractively priced.

In Canada the CEOs of their biggest energy companies pushed for improved regulation with speedier approvals which will draw investment and increase production. Canada has long struggled to get its oil and gas to market and needs to diversify its trade links away from the US.

Last week saw a lot of positive news for President Trump’s favorite sector. But our high point was lunch with long-term investor Glenn Hamilton and his lovely wife Ruth, who visited us in Naples from Miami. Theirs is a wonderful American success story. From humble beginnings in Ohio, Glenn became what he describes as a serial entrepreneur, having founded and sold several companies.

Today Glenn runs Amerimet, a full-service metals processor, distributor and exporter of aluminum coil & flat sheet based in Miami. He recently transferred ownership to his employees via an ESOP, which he preferred over a sale to private equity even if it meant passing up on a higher valuation.

Glenn hasn’t only had good timing in business. He increased his investment in midstream energy during the pandemic when crude oil prices briefly turned negative. He figured they couldn’t go much lower. We enjoyed a most convivial lunch discussing energy and Republican politics at Campiello, a popular Naples restaurant. My wife and I look forward to seeing Glenn and Ruth again before too long.

We have two have funds that seek to profit from this environment:

Energy Mutual Fund Energy ETF

 

Unloved Tariffs

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There are few parts of America redder than Naples, FL.  Kamala Harris signs were nowhere to be seen last year. Florida has shifted from purple to red in recent years. A friend once received hostile comments from a local who noticed his Connecticut license plate, demanding that he not relocate but should keep his liberal policies in the northeast.

In fact, it’s Republican voters who are heading south. New Jersey is more blue and poorly governed as a result.

Golf clubs in Naples are more red than Naples itself. And yet, even here you’ll find grumbling about tariffs. Nobody is yet disavowing their vote, but equity market volatility is unwelcome to wealthy retirees. This bothers them more than the price of eggs.

My friends here own a lot of stocks.

Some breezily say the rapid policy changes that can occur twice in one day are part of a sophisticated negotiating style honed in New York’s real estate market. Others aren’t so sure, and in any case dealing with countries is not the same as haggling with banks who have lent you money. Discerning a strategy from frequent tactical shifts relies heavily on subjectivity and is challenging the most devout MAGA followers.

If Naples golf club members are unenthusiastic about tariffs, support in the country is shallow.

The S&P500 has lost the gains achieved following the election, at least for now. The US runs a trade deficit of over $900BN. We buy a lot of stuff. So it’s plausible that an aggressive posture on negotiations could lead to improved terms of trade. Canada’s domestic banks dominate and are highly profitable. I’m sure JPMorgan could compete there if allowed.

The EU could surely use cheaper energy, and increased natural gas imports from Russia are implausible no matter what a few German politicians may suggest.

Midstream energy infrastructure has held onto its post-election gains, since it’s less exposed to tariffs as well as being within Trump’s favorite sector. Some may be surprised to learn that the Alerian MLP ETF, AMLP, is outperforming the sector as defined by the American Energy Independence Index (AEITR).

Although this might sound like rare praise from your blogger for AMLP, experienced readers know better. AMLP’s market-beating performance of recent weeks is due to its limited exposure to natural gas (see There’s No AI in AMLP). Power demand from data centers and increasing LNG exports have supported broad midstream for over a year. AMLP’s light natgas exposure and MLP concentration held it to a 22.6% return last year, less than half the AEITR’s 45.5%.

Natural gas oriented names have lagged recently on fears of slower demand growth from data centers and LNG, both of which seem unwarranted to us.

AMLP’s outperformance is because of its shortcomings.

And AMLP now has a healthy unrealized tax liability which will continue to drag on results when the sector performs well (see AMLP Has Yet More Tax Problems).

Data from Wells Fargo shows that large cap MLP valuations are relatively unattractive versus large cap C-corps.

This doesn’t mean MLPs are expensive in absolute terms. Energy Transfer yields 7.1%. It is rated overweight by Wells Fargo’s Michael Blum who likes their 8.6X EV/EBITDA and sees a 28% total return over the next year. Large MLPs are cheap, like c-corps. But from here, c-corps will probably do a little better given their relative valuations.

The S&P Global Clean Energy Transition Index is down 13% since the election. Trump’s attempts to reel back $BNs under the Inflation Reduction Act and his hostility to windpower have not helped sentiment. However, I can report that our neighbors on the Jersey shore (a red part of a deeply blue state) are ecstatic that offshore wind turbines they regard as unsightly will not be spoiling their view any time soon.

Renewables have been a lousy investment for years – it didn’t start in November. Prices peaked in January 2021, around the time of Joe Biden’s inauguration. What followed was capital destruction on an epic scale. S&P Energy Transition has returned –20.0% per annum. Those investors who confused socially conscious investing with the real thing can hardly blame Trump.

If solar and wind really produce such cheap electricity, why hasn’t the sector done better?

Midstream energy as defined by the AEITR and representing the traditional and reliable part of the sector, has returned 25.7% per annum over the same period.

Venture Global has bounced following a 60% collapse after its mis-priced IPO. We made a modest investment on weakness, but more importantly co-CEOs Michael Sabel and Robert Pender also bought. Seems like next time this company wants to sell stock you might want to wait.

The threat of tariffs will unfortunately remain for Trump 2.0. But perhaps their implementation will be more carefully considered and less negative to the stock market.

We have two have funds that seek to profit from this environment:

Energy Mutual Fund Energy ETF

 

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