Dollar Impact On U.S. Manufacturing Employment

Posted on July 8, 2019 by macromon

We have been busy on a piece evaluating the U.S. economy under the first 29 months of the Trump administration.  As I used to bark out selling programs as a young kid at Dodger Stadium, “You can’t tell the players without a program!” Similarly, you can’t measure the economy without the data.

Tweet and hype just don’t do it for us.  Show me the money data, Jerry!

Does the economic data live up to the hype as the “greatest economy ever?”  Stay tuned to find out.  Our comprehensive and positive analysis should be posted by mid-week.

Here’s Another Appetizer

Nevertheless, we came across a very interesting find tonight when looking at the monthly year-on-year change in the value of the trade-weighted dollar index relative to the 3-month moving average of the monthly change in manufacturing payrolls since 2014.   We found that when the change in the value of the dollar is lagged 9-months over the past 58 months, there is a -0.74 correlation with the 3-month moving average in the change in manufacturing payrolls.  Rather surprising to find such a relatively tight fit.

Yes,  we hear you:  “introduce and add leads and lags to torture the data until it confesses.”  Not our intentions and not looking for academic purity, however, just trying to find a better prediction model.  That, our friends is the M.O. of predictive analytics and algorithmic trading.

Theoretically, it also makes sense as manufacturers do not change their hiring decisions based on short-term moves in demand, relative price changes, or competitiveness.   A sustained move in the dollar for, say, over a one year period  may incentivize management to change production and hiring decisions, which then takes months to ramp up.

The chart reflects the relationship.  Note the change in the dollar (right-hand side) axis has been inverted. That is a move up in the red line is the 9 month lagged year-on-year weakening of the trade-weighted dollar index for that particular month.

Upshot 

During the first 29 months of the Trump administration, the economy created 485k manufacturing jobs versus the 128k during the last 29 months of the Obama administration.   However, during Obama’s last 29 months in office, the trade-weighted value of the dollar appreciated a massive 21.1 percent, a huge headwind for the manufacturing sector and the economy.

The same dollar-index has remained flattish, appreciating  only 0.4 percent in Trump’s first 29 months, though it declined almost 10 percent his first year in office, creating a nice economic headwind during his honeymoon period.

Also, interesting to note the S&P500 has pretty much gone nowhere since the January 2018 peak, up only 4.1 percent even in the midst of the all the Sturm und Drang over the past 360 trading days, including a mini bear market from September to December and a 25 percent plus rally since Boxing Day, the day after Christmas.

3-month MA Manufacturing Payrolls Down From 25k to 8k per Month

The three-month moving average of the monthly change in manufacturing payrolls has fallen from 25k per month in November and December 2018 to just not 8k after Friday’s payroll report.  We believe this, in part, is due to the lagged effect of last year’s dollar rebound.

Not also the level of the dollar does matter not just changes in or first derivatives, folks.   We have done several posts on the secular overvaluation – as in very expensive – of the dollar against almost every world currency based on the IMF’s purchasing power parity model.

Political Fallout

If our model is robust, manufacturing employment should remain weak until January 2020 as the lagged effect of the 2018 dollar rebound plays itself out.   We have no doubt President Trump will bring out the 2x4s to smack Jay Powell and the Fed upside the head in his effort to weaken the dollar.

We have no problem criticizing the Fed but the administration trying to stack or compromise the Fed’s independence?  That is a dangerous proposition.  As Joe, the only Joe (x/ maybe #5) once said, “confidence is a fragile thing,”  especially with respect to the money demand function.

Many of my friends maintain there is a major global dollar shortage taking place (we have to think and research it more before weighing in) and is not to about to abate anytime soon.  If that’s the case, don’t expect the U.S. manufacturing sector or employment to rebound with gusto anytime soon.  This will no doubt have major political fallout in those all-important rust belt electoral college states.   We sense President Trump senses that.

How ironic would it be if Larry Kudlow’s “King Dollar” puts him out of job in November 2020.

 

Trump_Obama_Manufacturing_Dollar

 

Trump_Obama_Trade Weighted Dollar Index_FRED

 

 

Posted in Dollar, Economics, Uncategorized | Tagged , , , | 13 Comments

Happy July 4th

Posted on July 3, 2019 by macromon

Have a great Independence Day, folks!   Enjoy the beach, BBQ, and fireworks but let us never, ever forget what we celebrate.

E pluribus unum over and out!

Statue of Liberty.png

DecIndie

IN CONGRESS, JULY 4, 1776

The unanimous Declaration of the thirteen United States of America

When in the Course of human events it becomes necessary for one people to dissolve the political bands which have connected them with another and to assume among the powers of the earth, the separate and equal station to which the Laws of Nature and of Nature’s God entitle them, a decent respect to the opinions of mankind requires that they should declare the causes which impel them to the separation.

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness. — That to secure these rights, Governments are instituted among Men, deriving their just powers from the consent of the governed, — That whenever any Form of Government becomes destructive of these ends, it is the Right of the People to alter or to abolish it, and to institute new Government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their Safety and Happiness. Prudence, indeed, will dictate that Governments long established should not be changed for light and transient causes; and accordingly all experience hath shewn that mankind are more disposed to suffer, while evils are sufferable than to right themselves by abolishing the forms to which they are accustomed. But when a long train of abuses and usurpations, pursuing invariably the same Object evinces a design to reduce them under absolute Despotism, it is their right, it is their duty, to throw off such Government, and to provide new Guards for their future security. — Such has been the patient sufferance of these Colonies; and such is now the necessity which constrains them to alter their former Systems of Government. The history of the present King of Great Britain is a history of repeated injuries and usurpations, all having in direct object the establishment of an absolute Tyranny over these States. To prove this, let Facts be submitted to a candid world.

He has refused his Assent to Laws, the most wholesome and necessary for the public good.

He has forbidden his Governors to pass Laws of immediate and pressing importance, unless suspended in their operation till his Assent should be obtained; and when so suspended, he has utterly neglected to attend to them.

He has refused to pass other Laws for the accommodation of large districts of people, unless those people would relinquish the right of Representation in the Legislature, a right inestimable to them and formidable to tyrants only.

He has called together legislative bodies at places unusual, uncomfortable, and distant from the depository of their Public Records, for the sole purpose of fatiguing them into compliance with his measures.

He has dissolved Representative Houses repeatedly, for opposing with manly firmness his invasions on the rights of the people.

He has refused for a long time, after such dissolutions, to cause others to be elected, whereby the Legislative Powers, incapable of Annihilation, have returned to the People at large for their exercise; the State remaining in the mean time exposed to all the dangers of invasion from without, and convulsions within.

He has endeavoured to prevent the population of these States; for that purpose obstructing the Laws for Naturalization of Foreigners; refusing to pass others to encourage their migrations hither, and raising the conditions of new Appropriations of Lands.

He has obstructed the Administration of Justice by refusing his Assent to Laws for establishing Judiciary Powers.

He has made Judges dependent on his Will alone for the tenure of their offices, and the amount and payment of their salaries.

He has erected a multitude of New Offices, and sent hither swarms of Officers to harass our people and eat out their substance.

He has kept among us, in times of peace, Standing Armies without the Consent of our legislatures.

He has affected to render the Military independent of and superior to the Civil Power.

He has combined with others to subject us to a jurisdiction foreign to our constitution, and unacknowledged by our laws; giving his Assent to their Acts of pretended Legislation:

For quartering large bodies of armed troops among us:

For protecting them, by a mock Trial from punishment for any Murders which they should commit on the Inhabitants of these States:

For cutting off our Trade with all parts of the world:

For imposing Taxes on us without our Consent:

For depriving us in many cases, of the benefit of Trial by Jury:

For transporting us beyond Seas to be tried for pretended offences:

For abolishing the free System of English Laws in a neighbouring Province, establishing therein an Arbitrary government, and enlarging its Boundaries so as to render it at once an example and fit instrument for introducing the same absolute rule into these Colonies

For taking away our Charters, abolishing our most valuable Laws and altering fundamentally the Forms of our Governments:

For suspending our own Legislatures, and declaring themselves invested with power to legislate for us in all cases whatsoever.

He has abdicated Government here, by declaring us out of his Protection and waging War against us.

He has plundered our seas, ravaged our coasts, burnt our towns, and destroyed the lives of our people.

He is at this time transporting large Armies of foreign Mercenaries to compleat the works of death, desolation, and tyranny, already begun with circumstances of Cruelty & Perfidy scarcely paralleled in the most barbarous ages, and totally unworthy the Head of a civilized nation.

He has constrained our fellow Citizens taken Captive on the high Seas to bear Arms against their Country, to become the executioners of their friends and Brethren, or to fall themselves by their Hands.

He has excited domestic insurrections amongst us, and has endeavoured to bring on the inhabitants of our frontiers, the merciless Indian Savages whose known rule of warfare, is an undistinguished destruction of all ages, sexes and conditions.

In every stage of these Oppressions We have Petitioned for Redress in the most humble terms: Our repeated Petitions have been answered only by repeated injury. A Prince, whose character is thus marked by every act which may define a Tyrant, is unfit to be the ruler of a free people.

Nor have We been wanting in attentions to our British brethren. We have warned them from time to time of attempts by their legislature to extend an unwarrantable jurisdiction over us. We have reminded them of the circumstances of our emigration and settlement here. We have appealed to their native justice and magnanimity, and we have conjured them by the ties of our common kindred to disavow these usurpations, which would inevitably interrupt our connections and correspondence. They too have been deaf to the voice of justice and of consanguinity. We must, therefore, acquiesce in the necessity, which denounces our Separation, and hold them, as we hold the rest of mankind, Enemies in War, in Peace Friends.

We, therefore, the Representatives of the united States of America, in General Congress, Assembled, appealing to the Supreme Judge of the world for the rectitude of our intentions, do, in the Name, and by Authority of the good People of these Colonies, solemnly publish and declare, That these united Colonies are, and of Right ought to be Free and Independent States, that they are Absolved from all Allegiance to the British Crown, and that all political connection between them and the State of Great Britain, is and ought to be totally dissolved; and that as Free and Independent States, they have full Power to levy War, conclude Peace, contract Alliances, establish Commerce, and to do all other Acts and Things which Independent States may of right do. — And for the support of this Declaration, with a firm reliance on the protection of Divine Providence, we mutually pledge to each other our Lives, our Fortunes, and our sacred Honor.

New Hampshire:
Josiah Bartlett, William Whipple, Matthew Thornton
Massachusetts:
John Hancock, Samuel Adams, John Adams, Robert Treat Paine, Elbridge Gerry
Rhode Island:
Stephen Hopkins, William Ellery
Connecticut:
Roger Sherman, Samuel Huntington, William Williams, Oliver Wolcott
New York:
William Floyd, Philip Livingston, Francis Lewis, Lewis Morris
New Jersey:
Richard Stockton, John Witherspoon, Francis Hopkinson, John Hart, Abraham Clark
Pennsylvania:
Robert Morris, Benjamin Rush, Benjamin Franklin, John Morton, George Clymer, James Smith, George Taylor, James Wilson, George Ross
Delaware:
Caesar Rodney, George Read, Thomas McKean
Maryland:
Samuel Chase, William Paca, Thomas Stone, Charles Carroll of Carrollton
Virginia:
George Wythe, Richard Henry Lee, Thomas Jefferson, Benjamin Harrison, Thomas Nelson, Jr., Francis Lightfoot Lee, Carter Braxton
North Carolina:
William Hooper, Joseph Hewes, John Penn
South Carolina:
Edward Rutledge, Thomas Heyward, Jr., Thomas Lynch, Jr., Arthur Middleton
Georgia:
Button Gwinnett, Lyman Hall, George Walton

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Payroll Prep

Posted on July 3, 2019 by macromon

Here’s a heads up for Friday’s employment number before we hit the beach:  1) Nonfarm payroll expectations;  2) today’s ADP release, and 3) commentary by Mark Zandi.

 

NFP

 

ADP_1

 

ADP_2

 

Posted in Employment, Uncategorized | Tagged , , | Leave a comment

QOTD: Erma On The 4th Of July

Posted on July 3, 2019 by macromon

QOTD: Quote of the day

Call me a traditionalist, a conservative, or what you will but I’m with Erma on this one.

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How Pepsi Once Became The World’s 6th Largest Military

Posted on July 2, 2019 by macromon

The days of the barter economy.

We had to do a double take with this tweet.  Even fact checked it.

I had a twitter debate last month with someone comparing current day China with the Soviet Union before the collapse in the late 1980s.  Are you frickin’ serious?

I will believe that when China starts swapping their new lunar technology, which just probed the Dark Side of The Moon, for buckets of KFC.

In the late 1980s, Russia’s initial agreement to serve Pepsi in their country was about to expire, but this time, their vodka wasn’t going to be enough to cover the cost.

So, the Russians did what any country would do in desperate times: They traded Pepsi a fleet of subs and boats for a whole lot of soda. The new agreement included 17 submarines, a cruiser, a frigate, and a destroyer.

The combined fleet was traded for three billion dollars worth of Pepsi. Yes, you read that right. Russia loves their Pepsi.  – Business Insider

 

Posted in Economics, Geopolitical, Uncategorized | Tagged , , | 14 Comments

The Clash Of Generations Is Here

Posted on June 30, 2019 by macromon

Don’t know if you caught the Democratic debate the other night, which featured Bernie and Joe, who could be the grandfathers of some of the younger candidates that were on stage, but it also confirmed the arrival of what we have been writing about for years, the Clash of Generations. 

 

Congressman Eric Swalwell was one the young Democrats on stage with Bernie and Uncle Joe last week.

If you missed this Atlantic piece, it is definitely a must-read,

Boomers Ruined Everything.png

 

Money Quotes: 

In a variety of different areas, the Baby Boom generation created, advanced, or preserved policies that made American institutions less dynamic. In a recent report for the American Enterprise Institute, I looked at issues including housing, work rules, higher education, law enforcement, and public budgeting, and found a consistent pattern: The political ascendancy of the Boomers brought with it tightening control and stricter regulation, making it harder to succeed in America. This lack of dynamism largely hasn’t hurt Boomers, but the mistakes of the past are fast becoming a crisis for younger Americans.

…Boomers didn’t only make rules that nudge young people out of homeownership. They also made new rules restricting young people’s employment. Laws and rules requiring workers to have special licenses, degrees, or certificates to work have proliferated over the past few decades. And while much of this rise came before Boomers were politically active, instead of reversing the trend, they extended it.

...The most glaring example of this growth in regulation and control is also the easiest one to pin on Baby Boomers: the incredible rise in incarceration rates. Even though murder rates are today at the same levels they were in the 1950s, the imprisoned share of the population is higher in America than in any country other than North Korea. We imprison a larger share of the population than authoritarian countries such as Turkmenistan and China.

…Even young Americans today who are free from prison are nonetheless in bondage to debt—sometimes their own debt, in the form of rapidly growing student loans or personal and credit-card loans. But on a larger scale, the problems of entitlements, pensions, Social Security, Medicare, and federal, state, and local debt are becoming more severe all the time. Already, in places such as Detroit, Illinois, and Puerto Rico, where political rules make flexible solutions hard and the population is aging very quickly, massive debt restructurings loom large. But around the country, the pressures of long-term obligations will grow.

…Making these payments will require fiscal austerity, through either higher taxes or lower alternative spending. Younger Americans will bear the burdens of the Baby Boomer generation, whether in smaller take-home pay or more potholes and worse schools.

Furthermore, the basic demographic balance sheet is getting worse all the time, increasing the relative burden on young people. Working-age Americans are dying off in alarming numbers.

Boomer_Age Mortality

[Take a minute and study the above chart.  Probably some of the saddest data I have ever seen.  These data are often overlooked and ignored from the comfort of the gated retirement communities.]

…The odds of a 32-year-old dying have risen by 24 percent in the past five years, even as death rates among older Americans are about stable. Baby Boomers are living longer even as the workers who pay for their pensions are dying from an epidemic of drug overdose, suicide, car accidents, and violence. 

…If leaders in business, education, and politics want to solve these problems, they can. Whether the gerontocracy in charge today wants solutions may be another question altogether. – The Atlantic, June 24th

Our Warning In July 2011

We posted the following in The Clash of Generations  way back in July 2011,

How long before the young realize they’ve had their future stolen from them by the baby boomers?   The answer to this question will determine your defined benefit pension,  social security and medicare benefits.  Reality meets [the boomers] at sunset.  – GMM, July 2011

Now.  They are woke.

We also exhorted boomers in an even earlier post to, as a metaphor, give up their country clubs for muni golf courses in order to free up resources and give the young a fighting chance.  It is a social investment for the boomers, after all, the younger generations  will determine the fate of their underfunded pensions, social security, and medicare programs

Monetization Coming

We do think the young will choose monetization to finance the shortfalls and debts the boomers have bequeathed them as the case gains political credibility through the rise of Modern Monetary Theory.

A form of a “People’s QE” is inevitable, in our opinion, and that is why we totally disagree about the end game with the deflationistas, who, suffer from recency bias and have probably never spent a day, much less a week, in an economy suffering from hyperinflation.

Zero interest rates for an extended period (as in five and ten-year slogs, ala Japan)?  Not U.S. market rates, folks, if there are any remaining, which is questionable, we do concede.

America is not a net saver, has been dependent on foreign savings to finance is public and private deficits for years, and its net international investment position (NIIP) has crossed over the $10 trillion deficit mark in Q2 2019.

Investment postion

This compares to NIIP surpluses in Japan and Germany of around $4 and $2 trillion, respectively.

Contemplate for a moment the long-term consequences of the above chart for, say, the exchange value of the U.S. dollar.

Hayek May Be Prescient Yet

Frederick Hayek understood demographics and the aging population would be at the mercy and charity of the young,

In 1960, Friedrich Hayek predicted in The Constitution of Liberty “that most of those who will retire at the end of the century will be dependent on the charity of the younger generation. And ultimately not morals but the fact that the young supply the police and the army will decide the issue: concentration camps for the aged unable to maintain themselves are likely to be the fate of an old generation whose income is entirely dependent on coercing the young.” It hasn’t turned out that way at all—a salutary warning that it is much easier to identify generational conflicts of interest than to anticipate correctly the political form they will take. – The Coming Generation War,  The Atlantic 

Just some more potential political conflict to stuff in your pipe and smoke, folks.

Not sure if the younger gens will wrestle the power torch from the gerontocracy in 2020 but they will someday.

Boomer_Generations

Boomers best be kind to the Millenials, X, Y, Z, and Alpha generations.

They are woke, not happy, and left of the salad fork.

Posted in Debt, Demographics, Uncategorized | Tagged , , | 13 Comments

SBNN: BMW

Posted on June 30, 2019 by macromon

SBNN = Song Before Night Night

Must admit this is the only BMW I have ever owned.   As in (B)ob (M)arley & the (W)ailers.

When I lived on the UYupper West Side (are there still Yuppies?) in a different era, my neighbors said their BMW was an acronym for (B)reak (M)y (W)indow.

Get Up, Stand Up, folks.

 

   Hat Tip:  KD

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Huawei’s American Suppliers Set To Rock The Casbah, Or Not?

Posted on June 30, 2019 by macromon

Here are some of the top American suppliers to Huawei that should Rock the Casbah in Monday trading after Trump’s rethink the Chinese company is a national security risk.

It’s still not clear what the Trump-Xi Osaka handshake and agreement mean, however.  And it appears the walk back is already beginning as the administration is taking on pipe from both the left and the right for its apparent cave to get the Chinese back to the table.

White House economic adviser Larry Kudlow says U.S. President Donald Trump won’t back off national security concerns after agreeing to allow U.S. companies to sell some components to Chinese telecommunications giant Huawei.

Kudlow told Fox News Sunday and CBS’ Face the Nation that Huawei will remain on an American blacklist as a potential security threat.

He said any additional U.S. licensing “will be for what we call general merchandise, not national security sensitive,” such as chips and software generally available around the world.

Some Republican senators criticized Trump’s announcement Saturday, describing the company as a threat to U.S. national security. In a tweet, Sen. Marco Rubio of Florida called the move a “catastrophic mistake.”  – CBC

Equivocal Tweets Coupled With The Ambiguity of Stock Values

Tough trading with an Equivocator In Chief tweeting ambiguous and cryptic messages all with the goal to goose the stock market, which, by its very nature, has equivocal and ambiguous valuations.   See our must-read and timeless Ambiguity of Stock Value post.

The Ambiguity of Stock Value

Stock prices are likely to be among the prices that are relatively vulnerable to purely social movements because there is no accepted theory by which to understand the worth of stocks….investors have no model or at best a very incomplete model of the behavior of prices, dividend, or earnings, of speculative assets.  – GMM,  Dec. 2010

The default is always markets do like to go up.

Watching Broadcom (AVGO)

Broadcom is the large-cap ($115 billion) stock we will be monitoring closely to see if the market really believes the G20 Osaka Sino-American handshake on Huawei and by extension the credibility of a potential U.S-China Trade deal.   A close above its all-time at 323.20, 12.28 percent from Friday’s close, would be nice confirmation the markets believe.

About to get even more interesting.  Stay tuned

Huawei’s Suppliers

Huawei American Suppliers

Huawei Global Suppliers

Broadcom The Stock To Watch

Broadcom

Posted in China, Trade War, Uncategorized | Tagged , , | Leave a comment

Charts That Validate Stocks Are In The Process Of Topping

Posted on June 30, 2019 by macromon

The S&P 200-day rolling return is an interesting chart but not much in the way of signals with the exception to illustrate the S&P500 does not fall out of the sky and enter bear markets after a strong 200-day run.

Bear Markets

Bear markets usually begin with a topping process, after all, markets are cold-blooded beasts and adapt and rationalize their bullish biases to negative news and deteriorating conditions.   Until they don’t.

Inertia is innate in the stock market, in part due to Wall Street’s and the buy side myopic focus on the year-end bonus, but if equities can’t break out after making several local tops (see the second chart),  caveat emptor and be warned something is rotten in the state of Denmark.  

We remain medium-term bearish on U.S. stocks based mainly on macro valuations as the charts below illustrate there is not much room for stocks to run from here.   Unless “this time is different”  and trees stocks don’t do grow to the sky. 

Surely, the S&P500 will rally tomorrow on the announcement of the restart of China trade talks.   Is it sustainable?

Will the Trump concession on Huawei to get the Chinese back to the table, which is very bullish for the company’s American suppliers, soon be offset with concerns the Fed may now rescind some of its dovishness?

In our June 26th post, we stated,

Our best guess, however, is given President Trump’s low approval ratings moving into an election year, he is highly motivated to kraft some sort of truce or Potemkin China trade, which will be sold as the “greatest deal ever,” to give the market one last boost.

An S&P top of around 3025-3060 would repeat the topping zip codes of past history.  — GMM, June 26th

Key Levels

Given the topping behavior of the 2000 and 2007 bears (the Sep’18 bear market was short and barely cleared the bar, down 20.2 percent peak to trough),  an S&P top in the range of 3000-3100 would be consistent with recent history and the nominal highs made in 2000 and 2007.   These levels are in the range of around 1-5 percent above the May 1st and June 21st high.

Until the S&P clears 3115, we will maintain our medium-term view that investors should be reducing risk by selling into strength.  If the index does clear the key level, it will be time to suspend disbelief and move to the Venezuelan model of stock valuation.

A bear market could also ensue with time.  Stocks could churn and burn around these levels for years.  As of Friday’s close, the S&P500 is only 2.4 percent above its January 2018 local peak.

In the short-term, we have relatively high conviction traders will remain lathered up on the prospects — emphasis on prospects —of a China trade deal and Fed easing.  We don’t and won’t fight that.  No strategic shorts put out until the mid-3000 level unless the markets show clear signs of breaking.

Scalping the market with short-term buying and selling is a different story.  That’s getting harder and harder with the rise of Auto & Algos (AA), however.

In the long-run,  we shorts are all dead.

As always, we reserve the right to be wrong.

 

S&P_200day_Return

Topping Process

Bear Markets

Initial Tops & Pops

S&P_table_Jun30

 

Stocks Expensive Based On Macro Metrics And History 

S&P_Macro_Metric_Jun30

S&P_Macro_Metric_2_Jun30

 

Posted in Equities, S&P500, Uncategorized | Tagged , | 1 Comment

On This Day: One Wrong Turn & History’s Biggest “Butterfly Effect”

Posted on June 27, 2019 by macromon

This post seems more relevant than ever as many believe the initial conditions of today are very similar to those of the Spring and Summer of  1914.

One wrong turn, one small change in initial conditions can change the course of history enormously.

Originally Posted on June 27, 2017

The butterfly effect is the concept that small causes can have large effects. Initially, it was used with weather prediction but later the term became a metaphor used in and out of science.

In chaos theory, the butterfly effect is the sensitive dependence on initial conditions in which a small change in one state of a deterministic nonlinear system can result in large differences in a later state. The name, coined by Edward Lorenz for the effect which had been known long before, is derived from the metaphorical example of the details of a tornado (exact time of formation, exact path taken) being influenced by minor perturbations such as the flapping of the wings of a distant butterfly several weeks earlier. Lorenz discovered the effect when he observed that runs of his weather model with initial condition data that was rounded in a seemingly inconsequential manner would fail to reproduce the results of runs with the unrounded initial condition data. A very small change in initial conditions had created a significantly different outcome.  — Wikipedia

On this day in history, June 28, 1914, 105 years ago to the day, the driver for Archduke Franz Ferdinand,  nephew of Emperor Franz Josef and heir to the Austro-Hungarian Empire,  made a wrong turn onto Franzjosefstrasse in Sarajevo.

Just hours earlier, Franz Ferdinand narrowly escaped assassination as a bomb bounced off his car as he and his wife,  Sophie,  traveled from the local train station to the city’s civic city.   Rather than making the wrong turn onto Franz Josef  Street, the car was supposed to travel on the river expressway allowing for a higher speed ensuring the Archduke’s safety.

Yet, somehow, the driver made a fatal mistake and tuned onto Franz Josef Street.

The 19-year-old anarchist and Serbian nationalist, Gavrilo Princip, who was part of a small group who had traveled to Sarajevo to kill the Archduke,  and a cohort of the earlier bomb thrower, was on his way home thinking the plot had failed.   He stopped for a sandwich on Franz Josef Street.

Seeing the driver of the Archduke’s car trying to back up onto the river expressway, Princip seized the opportunity and fired into the car, shooting Franz Ferdinand and Sophie at point-blank range,  killing both.

That small wrong turn,  a minor perturbation to the initial conditions, or deviation from the original plan,  set off the chain events that led to World War I.

Archduke_Jan27

Stumbling Into The Great War
Fearing Russian support of Serbia, Franz Josef would not retaliate by invading Serbia unless he was assured he had the backing of Germany.   It is uncertain as to whether the Kaiser gave Franz Josef Germany’s unequivocal support.   Russia, fearing Germany would intervene, mobilized its troops forcing Germany’s hand.

The great European powers thus stumbled into a war they didn’t want through complicated entanglements and alliances, and miscalculation.  Russia backing Serbia;  France aligned with Russia,  Germany backing the Austro-Hungarian Empire;  and Britain, who really didn’t have a dog in the fight except for her economic interests, aligned with France and Russia.

Later the U.S. would enter the war due to Germany’s unrestricted submarine warfare threatening American merchant ships and the Kaiser floating the idea of an alliance with Mexico in the famous Zimmerman Telegram, which was intercepted by the British.

Of course, some will argue that the Great War in Europe was inevitable

The great Prussian statesman Otto von Bismarck, the man most responsible for the unification of Germany in 1871, was quoted as saying at the end of his life that “One day the great European War will come out of some damned foolish thing in the Balkans.” It went as he predicted.  – History.com

Nevertheless,  maybe the course of history would have been different if not for that wrong turn on June 28, 1914, which created the humongous butterfly effect, which we still are experiencing the consequence to this very day.

The botched Treaty of Versailles sowed the seeds the for World II.  The War contributed to the Russian revolution and eventually the Cold War.  The redrawing of borders in the Middle East after the Great War created the conditions for the instability and breakdown into tribalism the region still experiences today.

A map marked with crude chinagraph-pencil in the second decade of the 20th Century shows the ambition – and folly – of the 100-year old British-French plan that helped create the modern-day Middle East.

Straight lines make uncomplicated borders. Most probably that was the reason why most of the lines that Mark Sykes, representing the British government, and Francois Georges-Picot, from the French government, agreed upon in 1916 were straight ones.  — BBC News

If Franz Ferdinand had not been murdered on this day in history,  that conflict between the Serbs and the Austro-Hungarian Empire may have been contained to just the Balkans.   Maybe.

The butterfly effect.  Think of how many small events, decisions, mistakes, one small turn, or “minor perturbation” in plans have had enormous consequences in your own personal life.

Update:  It is the rising geopolitical risks, rapidly shifting global economic tectonic plates, and collapsing post-war global order that keeps us up at night and pose the greatest threat to the world economy and stock markets.  We believe the probability of a major bear market — down 40 percent plus — in the next 6-12 months is much, much higher and a galaxy away from most traders and investors’ radars.

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