Nothing. This is a slow news week. Well, except for the war in the Middle East that could wind up sending Brent to $150 a barrel, even if the orange shit-gibbon doesn’t blow up Iran’s nuclear power plant. And if e did that, I bet $200 or more would the going price for Brent.

PART I – TEA LEAVES

There is a giant problem with trading, and that’s exogenous events. A piece of bad or good news (like a super-strong or super-weak jobs number) create their own instability. Sometimes these blips represent buying opportunities. The initial reaction is almost always to read too much into one reading, which may get revised in a future month. I’m not suggesting you do that, but rather don’t retire early or panic because of one number. The bigger problem are singular events that come of the blue (or nearly out of the blue) and create lasting impacts in the system. These are hard to model and can blow up your ideas pretty quickly. So, what’s my thinking on the Iran war… I mean incursion… whatever. Normally these events happen, they change things, and we move on. But now we’re stuck in limbo.

My first take, back in February, on the S&P 500 was we were in a trend channel. I drew the original channel as the bright yellow lines sometime in lat 2025. These are not exact but, when we get to the top of the channel, buyers tend to lose enthusiasm and they come back when we’re toward the bottom of the channel. it’s okay when drawing these lines not to include all the price action and to move them so they capture the majority of the price action. It’s also okay to re-draw them as the evolve. They represent rules of thumb as to when investors think it’s gone to far up or dropped too low. Although I had serious concerns about the labor market and the concentration in the Mag 7, the chart is telling me the rest of the market did not.

Then, the S&P 500 failed to make a higher high in February, which is when I added the orange (brown) line signalling resistance. That was at the end of January, when we get to 7,000 and then back off. However, selling seemed to crap out as well, with buyers stepping in around 6,800, so we have a support line in green. Now we’ve transitioned from an upward trend channel to a likely range between 6,800 and 7,000. There’s no evidence on the chart we’ve reversed trends. In February I didn’t now if this was a double-top (possible) or just consolidation after many consecutive months of upward travel. I tend to be more pessimistic, so I thought we might be rolling over. But the support line was holding through February. That’s the chart telling me the market wasn’t ready for a pull-back.

We have Schrodinger’s labor market, which is doing okay or poorly depending on when you look at it. Through February we’re just wandering around in the range. I attribute this period of indecision to the mixed number we’re getting and the first pangs of worry about AI build-out costs. The Fed doesn’t have to lower rates if the job market is doing well and the “last mile” on inflation is proving to be sticky. The inflation from tariffs hasn’t materialized in the way I anticipated (and I think others as well). But there are reasons why it may be working its way through the system. Therefore rates aren’t going to go up, but the likelihood of a cut is very low. These mixed messages makes a side-ways period seem completely logical. And barring any big change…

We attack on the 3rd, but the S&P stays in a range until March 6. At that point the attacks have gone long enough that it dawns on investors it won’t be just a series of air strikes. With oil going up, we drop out of the range. Now, that support at 6,800 tends to act as resistance. I’m not sure why that happens more often then not, but it’s a decent rule of thumb. Then I add a little line, marking what might be a new level of support around 6,600, where buyers seem to show up. I don’t think this will hold, but I’m watching it.

What does a chart do for me? It helps me understand market psychology. Every day the beliefs of millions of investors are reflected in the market prices. Some are doing nothing more than buying index funds in their 401(k) accounts. Some are gambling on 0 days to expiration options contracts. But their collective behavior comes together to set a price. I don’t expect a pattern to “play out” just because I see it forming. I expect to see the market behave and if I match it to a common pattern, anticipate what buying and selling pressures may be coming int he future. Some call it horoscopes for bros, but only if you treat (mistakenly) the pattern as constraining or predicting the future. All it tells me, is where the buying and selling pressure may lie. And if I can correlate that to other data, maybe get a better interpretation of how that information is moving the markets.

PART II – POLITICAL ECONOMY

I personally think that the Iran war isn’t going the way the Administration hoped. I think they expected the regime to be much weaker than it actually is and that US popular opinion would rally around the strikes. When the line at 6,600 continued to provide support at the outset of the war, I took it to mean that other investors also thought this might be over in a day or two. In my mind, and likely in the minds of others, that made this a buying opportunity, which is why the support worked. It’s only until we got signals this war… incursion… might last for longer, do we start to make new plans.

The problem with is there is no clear goal. And every day it drags on is another day that Iran can adapt to US tactics. Or Russia could smuggle in some shoulder-launched anti-air missiles (ManPADs). Or Iran gets super lucky and manages to seriously damage a US warship. Or we wind up with a bunch of Marines on the ground that can’t safely leave until hostilities cease, which this administration won’t do until Iran “surrenders.¹” It could be over tomorrow or a year from now. We just don’t know because we don’t know what we hope to achieve by being there. And every day of elevated oil prices is a day that both stokes inflation and dampens economic activity.

Are we looking at a buying opportunity, which it would be if hostilities cease quickly. The less damage to oil production, the faster fuel prices will move lower. I’m not an oil expert, but what I’ve read indicates that fields that stop production may take weeks or months to return to their full output. And the longer they’re stopped, the longer it takes to turn them on. And the more they’re bombed, the longer it will take to repair those fields. As I understand it, a one day interruption is no big deal. A one week interruption will leave a mark. Longer periods require a degree of rebuilding. But I don’t know that it will cease today, tomorrow, or next week.

It could be this drags on for many months. Especially if Russia is able to supply Iran with weapons. Fortunately, Russia is bogged down in Ukraine and can’t spare the materiel. China could covertly send arms, with the intention of creating a quagmire to pin down the US. They targeted 2027 as their “readiness” date for Taiwan, but this might present a unique opportunity, especially if they damage enough F-35s (which take months to repair). North Korea might want to arm Iran, but I’m not sure how they get arms there. The Houthis might start firing missiles again. But who knows? Shaheds are easy to make and the launcher isn’t much more than a couple of hours of welding tube steel, according to many sources. In addition to the fact many regional governments are easily bribed to look the other way while Iran smuggles in Western electronics for the Shaheds.

In fact, the weakness this ware demonstrates is the inability of the US to spin up production of key munitions. The excuse “we gave it to Ukraine,” is mostly bullshit as we gave older, sometimes about to be de-commissioned, equipment to Ukraine. And we didn’t have to pay to properly dispose of it, as the side of a Russian tank is a fine disposal sight. All China needs to do in a fight for Taiwan is to make through an initial period and then our destroyers are running home to port, to reload their vertical launch tubes (which we can no longer do at sea). And once the current stockpile is gone, new rounds only trickle in. And airplanes that are either lost permanently, as we no longer make that air frame, or take months of painstaking care to repair their stealth exteriors. In some cases it will take years for production to restart on a key munition.

War fighting aside, what do I do? Buying opportunity, prep for recession, or prep for stagflation. Who knows? Each one is essentially unpredictable. I’m mostly sticking tight, but I’m picking up some ex-US funds here and there. Mostly because this is likely to cause even further damage with our allies. Who we don’t need, but should totally come and help us out? Not sure how that works, especially since we did not consult with them and the energy costs are hitting Europe harder. That makes the long-term prospects for the dollar less bright, which is also what the administration wants. However, people did seem to buy dollars as a safe haven, as gold did not jump, and money moved out of the Euro. But if they did buy anything, it had to be short term debt, because the longer term yields are rising.

Also, I’m not seeing positive trends in US politics. The Republicans have largely abandoned rule of law at a broad, constitutional level. An extra-legal, internal power struggle will have lasting, permanent damage to the US economy and the status of the US as an economic engine. I don’t mean revolution, I just mean it’s decided outside legal norms with protests to force action and lawsuits to compel following the law. If there is a serious attempt to suppress voting, or invalidate entire House and Senate races, US politics could be seriously broken. Countries lend money to the US and people come here to start businesses because the US has been a rule of law country with business friendly policies. If that reputation is seriously damaged, the US ceases to be the cleanest shirt in the laundry. And that has implications for US interest rates, the dollar, and future US growth.

That would mean a defensive short term horizon, even though short term bonds are not paying enough to cover taxes and inflation. Long term bonds would loose even more value, as long rates move up. That will depress economic activity, especially if the dollar isn’t as valuable and fails to appreciate, given the higher rates. Nothing meaningful is being done on the deficit, and if the economy slips into a recession, we could exceed 7% of GDP in deficit spending. That limits the ability of the US to stimulate the economy other than to reduce rates. That will drive up asset prices (good for stocks) but will be fighting the higher rates implied by higher inflation and more instability. That might mean the Fed as to perform non open-market actions, such as buying securities or injecting money through the repo markets. Liquidity actions tend to be inflationary.

Sitting in cash through money-market accounts doesn’t look so bad until you consider the inflation risk if the Warsh Fed decides to lower rates and that stokes inflation. You would do better than stuffing it in your mattress, but it’s likely you would not keep pace with inflation. And your purchasing power would erode. If interest rates are low, that’s going to inflate the value of assets, like land. Housing prices would stop their slow slide and start going up again. However, holding and buying land requires a rule of law country. If you don’t have that, how can you be sure your claim to a piece of land would be honored. REITs with deep pockets would be the way to mitigate that risk, as they would be better connected to make any necessary bribes.

Wow, as I work through it, this is what I think investing as a citizen of a country like Argentina must look like. The investing world outside the US is starting to look better than the options inside the US. Just like many countries find their internal markets are not as lucrative as external markets. If only we’d had a long tradition of being a rule of law country we could fall back on…

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This is not investing or investment advice to you, or anyone. It’s is provided for your entertainment purposes only. And if you are investing, contact a professional before making any decisions. Buying and selling stocks, futures, or any investment is a risky activity and can cause you to lose money, including the principal which you invest.

1. I genuinely think they don’t understand what this means. I think they say “unconditional surrender” because it sounds cool at that’s what we did in what they thin of as the mega-awesome WWII. ↩︎

The Producer Price Index (PPI) came out hot again. Higher prices for producers may or may not be passed onto consumers. For businesses that can pass on the costs, that implies higher inflation. (They raise their prices and the consumer accepts prices going up). For businesses that cannot pass on the cost, that implies lower margins. (Their costs go up and they have to absorb those costs). Either way, it’s going to put pressure on the job market.

Let’s say it’s the former, and the costs are just passed on. The Fed is going to look at the inflationary impact and make a decision about rates, or possibly liquidity. They will try to prevent an inflationary spiral, where those cost increases accelerate. I’m beginning to suspect that the current rates are near “r*” or the neutral rate. Where lower rates are stimulative, higher rates are restrictive, but these rates are close to neutral. And there is no absolute r*, it’s just what makes sense for that economy.

The Fed will be combating deficit spending, which stimulates demand. We take out a lot less in taxes than we inject in spending and that is goosing the economy. And there are plans to increase that spending by a 45% increase in DoD spending. We’ve had deficit spending, and at high levels, for so long I’m certain we’d fall into a recession if we just reduced deficits to a more sustainable 2% of GDP. Rates would go up to slow economic activity and account for the additional stimulus that would come from more deficit spending. So far Jerome Powell and the FOMC has done what I thought was impossible, reduce inflation without sending unemployment to 8 or 10 percent. The next round may not go as well.

Next, let’s look at what happens when margins shrink. Margins are the difference between revenue and expenses. As expenses go up, margins (and profit) shrink. Firms generally react by reducing costs. The first thing that go are travel and perks. But those are normally not a big part of the budget (or shouldn’t be). Next, speculative projects are cut or sold off, such as the AI team hired to bring chat bots to your lawn care business. Once sales start to fall off, because all other businesses are reducing their spending, you don’t need as many workers. Now it’s time for the large-scale layoffs.

Of course, many businesses are aware of the pattern and want to get ahead of it. Their very clever staff economists know that business will fall off in a few months as other businesses are spending less. The try to front-load some of the layoffs to coast on what will be accumulating inventory to try to avoid larger layoffs later. And all layoffs lead to morale problems. If many companies do this, it’s a self fulfilling prophecy, right? We all expect a recession in three months, so we all lay of 10% of our staff now, to avoid firing 15% or 20% later. Guess what happens? We guarantee a recession.

What do I expect from Warsh when he takes over? First, the Federal Open Market Committee chairman does not set policy. It’s a vote of the board. But I don’t know what Warsh is going to do or how he’ll throw the decision making into disarray at the behest of Trump. So we might get a degree of chaos we won’t need. But let’s say he push policy toward lower rates and we get inflation. I suspect that may not be unwelcome among Trump and the rest of the leadership, along with the oligarchs who back him.

Higher inflation is a back-door default on the US debt. A default normally means non-payment of interest or principal. (Which is something I would not put past the administration – with regards to not paying interest to foreign bond holders). There inflation adjusted bonds, but the bulk of the market just takes inflation into account when they’re calculating an acceptable price for the bond. That’s based on a stable inflation rate of around 2%. I have 10 year bonds yielding 4.9 to 5% and that’s fine in a 2% inflation regime. I get 5%, the government takes about 1.5%, inflation takes 2%, leaving me a 1.5% real return at zero risk every year for 10 years. If inflation shoots up to 5% and stays there, now the math is ugly. The government still takes its 1.5%, Inflation now takes 5%, and I’m left with a real return of -1.5%. What would I do if I saw this as a possibility? Move away from long-dated bonds. That means selling long duration bonds (as the market is currently doing) and driving the interest rate up.

But the real damage to the bond is the principal of the bond drops in real value much faster. The price of the bond includes the principle to be returned in 10 years. After 10 years of 2% inflation, 1,000 USD is not worth about 817 dollars in real terms. That’s accounted for in the price of the bond, along with the stream of payments and the expected inflation rate. That doesn’t mean I get 817 dollars in 10 years. I still get 1,000, but it has the spending power for 1,000 today. And that’s the difference between nominal and real. If the economy just treads water (little real growth but it’s growing at least as fast as inflation), inflation will shrink the value of the bonds relative to GDP. If the nominal GDP goes from 30 trillion to 60 trillion in 20 years because of 3.6%, but no real growth, then you are no better off than you are today. However, any assets that have a fixed denomination, like cash an bonds, are worth half as much.

We currently have debt at about 120% of GDP. If we inflate the dollar at 3.6%, and we don’t add to the debt, that debt will be 60% of GDP in 20 years¹. Of course we’ll add to the debt, so we won’t cut it in half. But we make interest on the debt a smaller and smaller part of the budget in real terms. Nominally, the amount of interest will still increase, but the nominal size of the budget and the economy will increase faster. It’s as if we decided to reduce the interest paid on the bonds. But, if we actually just paid less interest, that’s a default.

Nothing is guaranteed and it could be that Warsh and the oligarchs backing Trump decide money is important and keep the system functioning in good order. We get inflation, interest rates go up (maybe not as much as I think they should, but enough). Inflation calms down and we lower rates to get people working again. (And jack up the price of assets like land, housing, and stocks – something the oligarchs love even more than statutory rape). And I sell my long bond positions for nothing. But, with inflation at about 2.5% to 2.7%, as we’re currently seeing, my real return on those bonds is cut in half or basically gone. A money market or long bond is basically keeping pace with inflation at this point, until we see inflation drop to 2%. And even “good Warsh” won’t want to irk his boss by pushing for that.

1. There’s a rule of 72 which say that if you multiply the interest by time, and it’s 72, you double in value. So an investment returning 7.2% for 10 years doubles in value. Or the US GDP growing at 3.6% for 20 years, doubles in size. ↩︎

Next week’s key news will be

Tuesday – Home sales
Wednesday – CPI
Thursday – Housing starts and permits
Friday – PCE, Durable goods, JOLTS, and personal income.

It’s going to be a data-heavy week, with Wednesday and Friday being big news days. What to watch for on CPI is if it confirms the PPI reading we saw Friday, the 27th. JOLTS will give a read on the market for jobs. But if CPI is in the same direction, the job market will need to be significantly weaker before a rate cut.

I’ve met and seen several people that spend time with LLMs and think this is going to fundamentally change the economy, to the point we’re going to get massive increases in productivity and massive dislocation. And there is therefore a justification in the intense build-out of AI infrastructure. If you spend a trillion dollars today, you will get many more trillions in benefit in not the distant future, but the near-term future. And while they might say the power problem needs to be solved, or we need social policy to manage the economic dislocation, the don’t question the primacy of building more data centers, faster.

Ed Zitron has done a fantastic job of taking apart the holes in some of the financing. And they are substantive. But I’m going to make a slightly different argument. One based on how realistic it is to believe LLMs will change the world around us. And for this, I will assume that the products of LLMs do not face a quality issue. That they write code, screen plays, or generate images very well.

First, take a look around and look at all the things you’ve bought that have nothing to do with computers. Like your sofa, the lamp next to you, or the dishes in your cupboards. The production of many of these things, where possible, is already automated. There is already a built in limit as to how much LLMs will impact the world because the vast majority of the world is not computerized. Would new robots based on LLMs improve the world by making good cheaper through automation?

Take your the IKEA Billy Bookcase. IKEA sells about 7 million of those every year. The process of getting that Billy from a plant in Indonesia to your house is automated. From the production of the sheet goods, to their cutting, their packaging, in the warehouses, on containers, and so on. Maybe a human had to take a fork-lift to put it on a shelf at IKEA, and you had to lug it up the stairs from your car, but it is already highly automated. Your car is the same. Most of what is done is already automated. On a car like my Honda Accord, its is probably less than 10% of the cost and may be as low as 5%. We are already highly automated and becoming more automated, even in the absence of LLMs.

What drives the development of better robots is not just software, it’s also better materials, better design, better motors, better sensors, better ball-bearings, and so on. We’ve been making and using industrial robots for decades, and are now more cost effective than not just skilled workers like welders, but unskilled workers, like people packing boxes with stuff to mail. That is already true today and done mostly without LLMs (although other types of AI have helped). LLMs will only partly help us with parts of the discovery of new materials, designs, or meta-materials to make these robots more cheaply or with greater capabilities. AI technologies in use since the 1970s, like evolutionary algorithms, already help design and build lighter and better structures (for example).

That leaves the impact of LLMs to the service economy. And in the service economy there are limits on what is actually automated. A policeman is a service worker, and cannot be automated. Firemen cannot be automated with a chatbot. Your doctor can be augmented with an LLM, but still has to see you in the office. The nurse inserting an IV cannot be automated away with an LLM. An LLM can’t clean your teeth. Or wash your car (something that has been almost fully automated for decades). Can an LLM translated “The Brothers Karamozov” for you? Yes, but maybe miss some of the nuance of Russian to English translation. But it would work fine for news stories, business emails, or technical documents.

Let’s be generous and assume that 25% of the economy is computerized or computer adjacent, such that developments in computers will directly translate into improvements in that field. And by direct, I mean that a computer is used in the process, like accounting, engineering, controlling machinery, and so on. That means a 100% improvement in productivity will have a maximum impact of 25% on GDP. (Long term real growth in an economy is roughly productivity + population growth¹).

But of that 25% of the economy that could be improved by LLMs, because comptuers are very involved, not everything needs or uses what LLMs bring to the table, Of that, how much can be improved with an LLM? Let’s say half of that is either simple automation, like a point of sale system, industrial robots, accounting software, or other systems that are already automated with normal code. And that, at best, only part of their function is improved, so we cut the total impact in half. Now, the largest impact is 12.5%.

If we take a look at a job like writing software, we realize that’s only part of an engineer’s time. Maybe 1/3 is spent in meetings, 1/3 spent figuring out what to build, and 1/3 actually building it. Some weeks are spent 80% coding, but some weeks are spent 0% coding. LLMs can’t really tell you want to build, so let’s assume that doctors, lawyers, and all other professions will be improved as much as coding, and cut that 12.5% down to about 4%. A 4% bump in productivity is still HUGE! But we all know LLMs are not 100% effective and require some amount of re-work, prompt tuning, and we need to actually look at the outputs to make sure it’s going well. So maybe that 4% is actually closer to 2%. I say this because there is much more code-churn on AI generated code than human code (as my example). So if we do it once, we’re likely to have to do it over in the future.

Two things can be true at the same time. That the impact of LLMs on the over-all economy can be so small it’s lost in the month to month noise, and in specific fields they are transformative. Take, for example, LLMs that have come up with proofs of open math questions. At some point someone still has to verify the proof. (And it has happened that an existing proof was later found to be incorrect – sometimes decades after). An LLM proposing a new meta-material based on being fed hundreds of studies and papers still requires someone to figure out how to produce it and test it. It still must be verified in the lab and in real world use. And, like when humans read the same papers, the LLM could have gotten it wrong because the underlying papers suggested the wrong conclusion.

There are about 160 million workers in the United States. All engineering disciplines (including civil, electrical, mechanical, aeronautical, etc) account for 6 million workers. That’s close to 4% of the labor pool. It’s easy for people to think every other worker is a software engineer, but that’s far from true. There are 8.3 million construction workers, about 5% of the labor pool. And there are about 17 million in hospitality, 10% of the labor pool. How many people are going to want a steak made by an LLM invented recipe (knowing it could change any time), cooked by a robot? It might be a delicious steak, but would consumers want it? And knowing that, would they spend $40 to $50 on that steak (a price at a nice steak house)?

But the costs of building out LLMs isn’t just paid by software developers. And the systemic risk to the economy of driving this much investment, this quickly, into one technology is borne by everyone. It’s at the point where it chokes off the investment in other technologies by absorbing vast amounts of capital. Companies running LLMs are pushing to burn more fossil fuels faster, to power their data centers. The belief is that it is so transformative, it will change … everything, even if people can’t really explain how. And the transformative impact on the economy just isn’t there. But, when the bubble bursts, and companies find themselves with billions of worthless debt used to finance empty data centers, everyone will be tapped when the government has to step in an ensure credit markets continue to work.

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This is not investing or investment advice to you, or anyone. It’s is provided for your entertainment purposes only. And if you are investing, contact a professional before making any decisions. Buying and selling stocks, futures, or any investment is a risky activity and can cause you to lose money, including the principal which you invest.

1. Note that I said real growth – meaning outside of inflation. Nominal GDP should increase (long term) as inflation + productivity increases + population growth. Real growth is when we factor out inflation and just focus on the improvement in living standards. However, if you don’t control inflation, and your population isn’t growing, you will wipe out the effect of productivity by swings in the price level. ↩︎