As The Tri Polar World Turns: Forward
1434 words – a 4 minute read.
It’s a strange time; the calendar says May but the NYC weather feels like March; time is passing but we don’t seem to be making much headway. The Fed likely feels the same – the most aggressive rate hike cycle in 50 years and inflation remains above target. Recession calls, as they have for the past year, continue to dominate the economic outlooks.
We continue to think a big move is coming and remain firmly in the no recession and stocks break out and UP camp. We continue to think it is in fact different this time, that the current cycle is sped up and moving much faster than most appreciate. We are early cycle in a global economic recovery – not late cycle and about to fall into a DM recession.
A fly in our ointment is the US regional bank sector; our Firebreak view was that a few failures here was actually a positive in that it would keep the Fed from overtightening and damaging the real economy. Should we be wrong, should it metastasize and generate a true credit crunch (still very unlikely in our view) then we will most likely be wrong in our no recession call. XLF needs to hold the $30-31 level for us to feel good.
When none other than Stan Druckenmiller says it’s the most confusing time in his career, we suggest such an environment puts a premium on being open minded, on respecting the weight of the evidence & having a wide funnel for evidentiary purposes. Staying in front of things and focusing forward remains a key tenet of ours.
We continue on the journey to a new bull market; as earnings come in BTE and forward estimates are raised, as global economic data continue to point to growth while inflation slows, & as the USD weakens. We see opportunity across the global cross asset space.
We provide 25 carefully selected charts & tables from well over a dozen research providers to help make our case.
CLIMATE
Climate mitigation is becoming a powerful tool to reshape the Tri Polar World and its regional configurations, especially via efforts to realign global supply chains into regional ones across the EV and semiconductor spaces, among others. Mexico is the big winner here so far.
It is also driving the return of Industrial Policy to the US and in turn pushing Europe to up its own industrial policy game. The IRA is drawing in significant new investment from around the globe with US companies accounting for less than 40% of the $46B in new investment announced in the 8 months since the IRA was passed (41 major new projects announced).
While investing in public Climate vehicles has been frustrating of late we remain of the view that as the FUD curtain lifts Climate investing (not ESG) will be an alpha generator given its unparalleled scale and global scope.
ECONOMICS
Housing and inventories were the two big drags on the US economy over the past year. We believe both have bottomed and expect them to turn into growth drivers in the coming quarters.
We note that the ISM Manuf decline in the US has stretched for 26 months vs an average of 17 months – bouncing around 47 over the past four months, Barclays expects an imminent bottom and a YE level of 53. On the housing front we note existing homes supply of less than 3 months (50% of average) and given most have mortgages well under current market levels the only way to get a house is a new build – good for homebuilders (hitting New ATHs) and construction workers but not bears.
We expect a restocking cycle to begin shortly while inflation continues to decline as it does so given that the freight industry is at a standstill, pricing is low, supply chains are unsnarled and commodity costs have eased. Nonresidential construction continues to be a powerful driver of economic activity – another Industrial Policy plus.
The same holds true for Europe: record low unemployment, an April PMI Composite reading of 54.4, the best in roughly a year, cheap FX and energy prices that are well below pre Russian invasion levels. Europe is poised for growth.
China remains the global economic locomotive – notwithstanding it’s April Manuf PMI falling back below 50, the Composite remains solid at 54. A key focus area for us has been the property sector which reported its 3rd straight month of rising home sales in April while May Day travel levels were off the charts, +100% y/y, + 20% vs 2019.
Japan looks to be finally winning its decades’ long fight against structural deflation. At least that was the takeaway from KKR’s Henry McVey (another MS bud) who concluded just that after a recent visit, the latest in his 30 + years of traveling to Japan.
POLITICS
President Biden will run for reelection and early polls project him as a sold winner vs both former Pres. Trump (if he is able to stay out of jail) and current Fla Gov DeSantis (whose political instincts seem questionable given his fight with Disney).
In a recent speech deemed important by the DC Beltway, National Security Advisor Jake Sullivan laid out the framework for a Biden 2nd term: “It is a time to build at home & abroad. This will require a major reorientation of both domestic and foreign policy”. This time is different.
POLICY
Monetary policy remains front and center in both the US and Europe, off to the side in both Japan and China. The market has taken Chair Powell’s post meeting presser this week as hawkish – we think it just makes sense: no recession = no imminent rate cuts.
The average holding period at the terminal rate is 7 months which suggests a cut by YE, not July. It strikes us that the bond market is just recycling the same script from past movies and not appreciating the different nature of the current environment.
The jobs market continues to be robust in both the US and Europe as well. Today’s print of roughly 255k new jobs together with sharp downward adjustments to prior months suggests a stable job market. A cooling jobs market is fine – a collapsing one is not.
We expect BOJ Governor Ueda to use the YCC study period to gradually move off this policy, leading to Yen strength and further reinforcing our weak USD view.
China’s economic rebound continues with robust domestic demand visible in record train trips taken over the May Day holiday. China continues to provide the world with liquidity and has plenty of room to ease policy should it need to do so. It’s interesting that China leads the global economy having been among the least aggressive states in terms of policy stimulus.
Our view remains one of a world where inflation settles back into a slightly higher range than the 2% target as the spread of public – private investment across climate, tech and supply chain realignment creates a dynamic unique to the current cycle that investors ignore at their peril.
MARKETS
Earnings come in BTE, analysts raise their forward estimates, corporate forward guidance is the strongest in years. Should inflation continue to fall profit margins may even expand - something not on anyone’s dance card.
We posit that time is fast running out for the bearish scenarios to come to fruition. If October was not the low then the bear market is already among the longest in US history. We continue on a journey to a new bull market in global equity led by non US markets both DM and EM.
Our investment shorthand remains the same: Fed on hold = USD weakness = ROW outperformance. Gold had its best monthly close in history – we continue to hold GDX viewing slightly higher inflation as a feature not a bug of the coming years.
We remain OW Equity, UW FI, especially DM Sovereign, seeing no appeal to 10 yr. UST yielding 3.3% given our outlook for no recession and slightly higher inflation. We remain OW Commodities and note that the weakness here puzzles us and is one of the few areas not (yet) confirming our POV.
We have traversed beyond Covid and are now moving beyond its subsequent inflation spike. What comes next is NOT a return to the 2010-2020 period of low growth and low inflation but a period of high nominal growth, blessed by the major CBs and sustained by a global cap ex boom to meet the moment in climate mitigation, tech dispersion & conflict prevention.