Exporting A Higher Cost of Capital

Not investment advice.

“The love of money as a possession — as distinguished from the love of money as a means to the enjoyments and realities of life — will be recognized for what it is, a somewhat disgusting morbidity…”. -Keynes, 1930.

It’s difficult for a casino to go bankrupt, but under the right leadership, possible. Today’s disruption originates from that same casino leadership in Washington, and coincides with and is amplified by Silicon Valley. The gale force churns like a hurricane, sucking in everything in its path.

AI is fueled by science-fiction visions of a futuristic world and by greed; regime change is an effort to coerce a, in this case, vicious foreign government. The result is a credit binge combined with an oil shock. The hurricane forces higher borrowing costs and a wave of inflation on economies that, unlike the US, are not growing above trend. Higher rates on foreign economies will depress growth going forward and possibly lead to a more meaningful equity correction.

Consider a case study—Canada, though the same dynamic is also evident in countries from New Zealand to France, each with its own specific political twist. Canada’s bond yields have risen from about 3% to 4%, which is what you would expect in an inflationary boom.

The only issue is that the inflationary boom is in the US, not Canada. Below is growth.

There isn’t much inflation either; core CPI in Canada is around 2%. This is because Canada is not a meaningful part of the AI boom and is also not running a big budget deficit. Canada’s budget deficit is around 2.4%, as opposed to about 6% in the US. The US’s efforts to suffocate cross-border trade further hamper Canadian growth. Canada’s bond-market reward for the US’s truculent, guns-and-butter policy is higher borrowing costs and slower growth. Yes, geography is unfair.

It can seem odd that bond markets trade in sync, but they do. In part this is because the AI debt issuance is global. In May, Google raised C$8.5 billion and in June Amazon raised C$14 billion, or about one-third of net new Canadian corporate issuance this year. Over time, however, markets often revert to pricing that accurately reflects local conditions. On the chart below I show yields in the US, Canada, and Canadian unemployment. As you can see, as US yields sell off, Canada sells off, even if Canadian employment conditions are tepid. Obviously, the US (orange line) has sold off more.

The war doesn’t help. Despite news that the oil is flowing, the IRGC is a difficult opponent and can choose to escalate. Our measures do suggest that more oil is flowing, but a supply deficit remains. Tehran realizes now that the US has few military options to conquer them; defense is easier than offense. Thus the risk premium will remain in energy prices. Below are oil prices and the Canadian 10-year bond.

As bond yields move higher, the risk premium on stocks has dropped. The logical next step is that prices reset, either with lower stock prices or with higher bond yields; depending on the country, we might get a little of each, though, of the two, stock prices look more vulnerable to me.

Note to readers: I have several trips coming up and will publish when I can rather than my regular Friday cadence.

This document is strictly confidential and is intended for authorized recipients of “A Letter from Paul” (the “Letter”) only. It includes personal opinions that are current as of the date of this Letter and does not represent the official positions of Kate Capital LLC (“Kate Capital”). This letter is presented for discussion purposes only and is not intended as investment advice, an offer, or solicitation with respect to the purchase or sale of any security. Any unauthorized copying, disclosure, or distribution of the material in this presentation is strictly forbidden without the express written consent of Paul Podolsky or Kate Capital LLC.

If an investment idea is discussed in the Letter, there is no guarantee that the investment objective will be achieved. Past performance is not indicative of future results, which may vary. Actual results may differ materially from those expressed or implied. Unless otherwise noted, the valuation of the specific investment opportunity contained within this presentation is based upon information and data available as of the date these materials were prepared.

An investment with Kate Capital is speculative and involves significant risks, including the potential loss of all or a substantial portion of invested capital, the potential use of leverage, and the lack of liquidity of an investment. Recipients should not assume that securities or any companies identified in this presentation, or otherwise related to the information in this presentation, are, have been or will be, investments held by accounts managed by Kate Capital or that investments in any such securities have been or will be profitable. Please refer to the Private Placement Memorandum, and Kate Capital’s Form ADV, available at www.advisorinfo.sec.gov, for important information about an investment with Kate Capital.

Any companies identified herein in which Kate Capital is invested do not represent all of the investments made or recommended for any account managed by Kate Capital. Certain information presented herein has been supplied by third parties, including management or agents of the underlying portfolio company. While Kate Capital believes such information to be accurate, it has relied upon such third parties to provide accurate information and has not independently verified such information.

The graphs, charts, and other visual aids are provided for informational purposes only. None of these graphs, charts, or visual aids can of themselves be used to make investment decisions. No representation is made that these will assist any person in making investment decisions and no graph, chart or other visual aid can capture all factors and variables required in making such decisions.