As The tri Polar World Turns: Extrapolation & Beyond
840 words – a 2.5 minute read.
EXECUTIVE SUMMARY
A gut wrenching, double digit equity decline amidst a global bond selloff and unprecedented FX gyrations leads one to conclude that extrapolation has been the name of the game.
Whether its extrapolating inflation trends, Central Banks’ response, King Dollar’s rise, UK’s tempest in a teapot or weak economic data into recession, its been all the rage bc its been pretty much the right thing to do.
The question is – will it continue to be the right thing to do? We don’t believe it will & argue that many of these trends are primed to either ease or reverse in coming months.
In the interim, risk assets are cheaper in many cases than they have ever been with sentiment the worst, positioning the lightest and risk appetite the lowest as we exit the worst seasonal period and enter the best.
Therefore, as hard as it has been, we are sticking to our conviction in a high nominal growth world that will support earnings and risk assets around current levels. Bottoms are a process not a date or level.
CLIMATE
VCs see “gold rush” time post passage of the US Inflation Reduction Act (IRA) with its $370B in climate fighting spending in the decade ahead.
Public – private partnership will multiply this number – recent US DOT funding for interstate highway charging system coupled with Hertz – BP joint venture for a nationwide charging network is a good current example.
ECONOMICS
Inflation is job one for US and EU Central Banks but not for the BOJ or PBOC, a point that gets lost amidst the global central bank hiking fever stories.
US rents appear to be rolling over, joining food, fuel, used cars, retail goods (NIKE) while supply chains clear and transport costs plummet. The weight of evidence favors inflation #s easing in the coming months. It will fun to extrapolate that!
Europe’s inflation problem is energy driven and will require more rate tightening which should support the Euro while fiscal support means any recession will be mild.
Asian growth is picking up, ranging from Japan with today’s data showing BTE retail sales, industrial output & housing starts to China’s PMIs above 50 & on to ASEAN’s forecasted 5% GDP growth. We have a desynchronized global economy & that’s a good thing.
POLITICS
US mid terms could deliver a surprise given concerns over abortion and MAGA candidate quality (or lack thereof).
Brazil goes to the polls – expect a Lula victory either now or at month end while Bolsonaro accepts the result.
Italy’s right leaning coalition needs EU financial support – expect moderation not crazy town.
Pres. Xi will get his 3rd term and extend his rule thru 2027 – focus on Politburo makeup.
POLICY
The UK tempest in a teapot is not systemic but is representative of Govts’ realizing they need to spend money to protect citizens from the 3Cs of Covid, Climate Change & Conflict.
This realization is not UK specific. It is supportive of the high nominal growth world we have discussed at length supported by a global cap ex boom and underpinned by a productivity surge a la the US in 1995 -99, a period jumpstarted BTW via a soft landing. This time we expect it to be global.
The policy changes coming forward will be the ebbing/reversal of the current trends noted at the top. A surge in real yields & tightening financial conditions suggests the Fed may be at the front of the line.
MARKETS
It’s not a loss until you take it is a useful reminder in the current market context. We continue to believe we are in a bottoming process and note that the Innovation, China tech names that led us in back in Q1 2021 and which bottomed in the Spring have not made new lows over the past few weeks.
Equity valuations have gotten to extreme cheap levels on the sector – US energy, financials, the country – Brazil and the regional level – Europe.
We have been very bearish DM Sovereign debt and illiquidity and volatility keep us away. We continue to favor US credit and EM debt.
King Dollar has swept all before it but somewhat uniquely EM FX has held up much better than DM FX. Importantly, DM FX weakness is not systemic. Euro weakness reflects its energy shock while Yen weakness reflects BOJ’s YCC policy and subsequent yield gap blow out. We believe EM FX outperformance may be a harbinger for a cross asset turn away from US assets.
It’s not been easy holding a positive view of things this year, this month or even this week. Yet it doesn’t feel like now is the time to hit the sell button and rest easy - rather it feels like now is the time to hold the line, stop extrapolating and start thinking forward.
Enjoy Wednesday night’s Bloomberg TV clip & check out the full monthly replete with 24 charts & tables from over 16 different research sources.
TGIF – enjoy the cool, Fall weather!