Coffee Dynamics Will Make For Bitter Political Choices And An Opaque Investment Climate In The Future: The Geopolitical — Stock Market Connection

The triple whammy of geopolitical tragedy and investor risk aversion and volatility has battered the bulls in 2022 and consequently led to a negative positioning which computers and shrewd traders have taken advantage of during bear market rallies. The move up since Thursday morning’s lows is the most potent example of counter-trend bullishness and is likely to fade as interest rates remain high and geopolitical risks remain stratospheric. The financial markets effectively revolve around the central metric of fear, the value of the $US, and the outlook for currencies remains bearish. I see the inability of EM nations to rally as key to painting the recent equity rally as easily reversible. But the bulls have control now and it will likely take a move to the upper bound of S&P 3800 before they lose energy. The volatility risk premium points to a higher market over the next few days, but my technical reading of key stocks in the S&P 500 is bearish. Yesterday's cross-asset action brought one positive factor for US stocks. The US yield curve is falling and in the current context that is bullish. But there was also one negative factor across global asset classes. Inflation expectations are rising based on measures of Treasuries and TIPS. Expect the S&P 500 to rise to 3800 then fall steeply again.

Geopolitical risk is both unusually high at the moment and consequential for socioeconomic trends extending years out. The War in Ukraine can be ended in short order but the extirpation of Russian chauvinism and malevolence will take years. What can’t be resolved in the foreseeable future is reversing climate change, as this requires both cultural changes and technological growth. Cultural change can be roughly measured by evaluating political dynamics and here the picture is truly negative, as evidenced in the most important election to come before the US midterms, namely the runoff in Brazil.

The fight between Lula and Bolsonaro represents a nasty choice of discredited politicians who have no ideological bent toward globalization. Both are populists and rely on Brazil’s low end exports to maintain voter satisfaction, heedless of Brazil’s need to move up the food chain of value-added exports. Brazil exports commodities much more so than value-added goods and is highly dependent on Chinese demand. Rather than emulate the similarly diverse USA the Brazilian economy and social structure are redolent of statism, uneven competition and polarized cultural views. America’s culture wars yielded Trump but Brazil’s yielded a hyper-Trumpist who openly admires military dictatorships of years past.

With a population skewed to the young and poor educational prospects Brazil needs strong commodity markets just to maintain its aspiration of being an irenic society like the US. But climate change will demand deep cultural and political changes and the system isn’t structured for that and its two most popular politicians are unlikely to govern with foresight. An article in the acdemically-inclined Conversation paints a clear example of ecologically-declining prospects for Brazil’s most esteemed commodity export, coffee.

“Coffee may be a major casualty of a hotter planet. Even if currently declared commitments to reduce emissions are met, our new research suggests coffee production will still rapidly decline in countries accounting for 75% of the world’s Arabica coffee supply. Arabica coffee (Coffea arabica) is one of two main plant species we harvest coffee beans from. The plant evolved in the high-altitude tropics of Ethiopia, and is hypersensitive to changes in the climate. If we manage to keep global warming below 2℃ this century, then producers responsible for most global Arabica supply will have more time to adapt. Brazil, Colombia and Ethiopia are the world’s top three producers of Arabica, and the crop has crucial social and economic importance elsewhere, too. While there are ways farmers and the coffee industry can adapt, the viability of applying these on a global scale is highly uncertain.”

Neither Lula nor Bolsonaro possess the inclusive ideals and economic foresight that could turn Brazil into a more competitive society that relies less on commodities and more on human capital. Both will react to difficult export conditions with protectionism and statism, as Brazilian governments of every stripe have been wont to do for nearly a century. The turn to Bolsonaro would be worse simply because his cultural atavism is even more prone to statism than the socialistic ideology of Lula.

Whether the Far Right or Far Left wins on October 30 will have no discernable impact on global equity markets; rather it’s the decline in confidence such a polarized election yields that incrementally raises the discount rate for global equities. The fall of the Soviet Union coincided with a raging bull market where the equity risk premium (ERP) continued its long-term decline. Depending on what model is used the ERP has been lower in 21st century than anytime since the ultra-confident early 1960s. This can’t be tied to domestic factors like macroeconomic balance, or productivity, let alone population growth rates or voter satisfaction or equality. Rather it’s the combination of technological acceleration and globalization of capitalism. A reversal of the ERP trend in future would most likely be caused by retreats from globalization and Brazil is a test case for this. Should Bolsonaro win or Lula govern from the Left it would signal that autocracy and protectionism are back in vogue and equity investing that much harder.

My current positions include a large cash position, Goldman Sachs (GS), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), and the inverse levered ETF SPXU, all of which nets out to a meaningful short position in equities.