As The Tri Polar World Turns: Kabuki Time
850 words – a 3 minute read
EXECUTIVE SUMMARY
Record breaking real rate move has led to breakage across assets, especially in US growth stocks. We believe we are close to the end of this correction based on sentiment, positioning, speed, history and the lack of credit contagion or growth concerns.
The Fed, like us, doesn’t believe 2022 is like 2018 which brings both good and bad tidings for investors. The bad? A Fed put strike price is well below current levels. The good? High nominal growth, negative real rates and slowing but not slow growth means equities should stay afloat as growth reprices. Fed drama a lot like Japanese Kabuki theatre of old complete with rowdy audiences, read, markets.
The real questions are two fold: have we just seen the beginning of the end of Big Cap Tech /Growth stock dominance and if so the end of US equity leadership? IF so and we think the answers to both questions are yes – then portfolio strategy and asset allocation are going to look quite different.
CLIMATE
2022 will be the year of the EV. It may also be the year when multiple time frames line up: public market appetite post selloff, legislative timetable given US need to fund climate, EU Next Gen and Japanese/Chinese decarbonization focus.
ECONOMICS
Growth – how much? Inflation – how high? These are the operative questions. Global growth, while slowing from stimulated 2021 levels, is far from slow. US – EU growth to be roughly 3.5-4% vs pre Covid 2.3% av ( in US). Japan to have best growth in a decade; China is easing to support its growth outlook.
Inflation – a worry in Europe and the US, not so much in Japan and China. EU inflation looks to have peaked in December, recent US ECI data suggest fears of a wage price spiral will be unfounded. US inflation should peak in coming months and decline sharply into YE. One year forward inflation swaps suggest 3.7% inflation at YE.
What about 2023-2025? Will we head back to pre Covid slow growth as markets forecast or is there a chance at a brighter future a la 2H of the 1990s driven by a cap ex boom, productivity surge that is augmented by global spending on climate mitigation – we take the over.
POLITICS
China 2022 glide path, lots of action in Europe and US mid terms suggest a busy year. Asia just launched its Regional Comprehensive Economic Partnership (RCEP) driving further Asian integration in our Tri Polar world.
Russia pressure on Ukraine also fills the pollical capitals of Europe with concern – serving to drive Europe closer together, furthering its own integration process, a process to be extended with an updated Stability & Growth Pact.
Political gridlock remains the operative word in DC – time is running short for the Biden Admin to get things done before mid terms. Watch Brazil in the other major pollical race in the Americas.
POLICY
While the Fed joins the ranks of the tightening CBs, the PBOC goes its own way and enters an easing cycle. We believe markets are well ahead of what the Fed is likely to do this year and expect 2, maybe 3 rate hikes vs the 5 that are priced in to markets. We expect the ECB and BOJ to stay on hold.
Fiscal drag will be one reason why the Fed will take it slow once it achieves liftoff in March. No such issues elsewhere with Europe’s’ Next Gen fiscal policy kicking into high gear, Japan to set unveil a large fiscal package to fund digitalization & Climate mitigation while China keeps its options open, including on Zero Covid.
MARKETS
Credit spreads, Commodity prices suggest equity market turmoil will not disrupt the early cycle global economic expansion we expect to see as Covid fades to endemic and clarity makes itself known.
Four differences between 2022 and 2018: early cycle vs late, high nominal growth vs low, negative real rates vs positive and a weak dollar vs strong.
Three counterintuitive, Fed tightening cycle, market relationships to keep front of mind: Fed tightening leads to weak USD, strong US equity prices and rising gold prices.
Can the broad SPY hold in while Growth rerates? Can the ROW perform with an S&P flat to up-down 5-10% in 2022? These are the questions to ponder.
We don’t subscribe to the bear market talk, notwithstanding an equity market that can’t seem to hold onto a daily rally ( hinting at the degree of HF carnage perhaps?). History shows a 100% hit rate for a higher S&P six months after such a sharp correction from new ATH to 10% drawdown.
If the 2H of the 1990s analogue develops the devastation wrought on the thematic space across disruptive tech etc. might be one of the great entry points for LT investors. US small caps trade at a 20 year low on a relative valuation basis.
We remain OW equity with a focus on Value, Cyclicals & SCs in the US and Europe, Japan, China in the ROW. Remain UW DM Govt bonds, look for Bund to hold above zero & JGBs to break .2% in coming months. Remain OW across the Commodity complex.
Enjoy the snow if you are in the NE US! Everybody please enjoy the weekend - been a heck of a month!