As The Tri Polar World Turns: Stability Ahead?

1300 words – a 4 minute read.

2022 has been a heck of a year – a series of cascading crises ranging from Russia’s invasion of the Ukraine to a global energy shock exacerbated by Covid lockdowns in China & supply chain woes leading to an unprecedented Fed tightening cycle and a historically bad year for a 60-40 portfolio.

That’s now in the past - the question today is what about the future- what about 2023? While this monthly didn’t set out to be a 2023 outlook piece that’s what it has become. The full piece runs close to 6k words with 24 charts/tables from 16 different research providers. Enjoy!

The consensus is that 2022’s negatives will drag into next year with some calling for Armageddon. We see it differently. Our takeaway is that 2023 has the potential to surprise to the upside – to be a year of gradual stability as the crises ebb and the environment calms leading to declining volatility and the consequent ability to identify cross asset investment opportunities.

Think of it this way. EU Nat gas prices can pick up again but they won’t triple or quadruple as they did this year (currently at Russian invasion levels and falling). The Fed & ECB may raise rates next year but they won’t raise them as far & as fast as this year. China may continue its Zero Covid approach but with 2 week lockdowns a la Chengdu not 2 months as in Shanghai.

Market are forward looking and have discounted 2022 with rates, stocks and currencies priced for a 5% FF terminal rate. The silver lining in this year’s drawdown is that forward looking returns are the best they have been in years according to both GMO & JPMorgan.

We see 2023 as a reset year – a reset on the low growth, low inflation, low rate world that followed the GFC & a reset on the high multiple, high growth, US based equity leadership that came with it. 

Our outlook is for a more stable 2023 – a year of transition to a high nominal growth world led by public – private spending to deal with the 3Cs of Covid, Climate & Conflict. As the crises fade so will the correlation of one leading investors to assess opportunity outside the US as the dollar rolls over. Normality should bring seasonality, history & models back into investor tool kits.

We view the USD as stability’s biggest loser. As such, we remain focused on equity opportunities outside the US in EM and EAFE. Our US equity focus remains on Cyclical- Value such as Energy and Financials as well as SCs. We prefer Credit to Sovereign in FI with a focus on US HY & EM LC. Commodities remain in a secular bull market and we remain OW in our Global Multi Asset (GMA) model portfolio. Our TPW 20 thematic model portfolio remains Climate/Innovation focused – as Big Tech goes ex growth, these segments may begin new bull markets in the year ahead.

CLIMATE

COP27 begins next month and with Govts behind their pledge levels the private sector continues to move aggressively – especially on the transportation – EV side; thus deepening our regional integration, Tri Polar World framework with battery plant – EV production center tie ups in Europe, the Americas & Asia.

We reference several good pieces on Climate ranging from The Atlantic to Bloomberg Green to the just released IEA report – all highlight how fast things are moving and how aggressive the public – private spend cycle will be in the years ahead.

Climate remains the single biggest global macro theme of the decade & as such, the single largest segment in our TPW 20 thematic model. Investors would do well to pay attention. Our focus here is one of TPW Advisory’s differentiating factors. 

ECONOMICS

While bearish takes are everywhere the outlook for global inflation and growth is improving with JPM reporting global inflation rolling over from 10% to 5% and falling further in the year ahead. Global growth is expected to be 2.7% next year (IMF forecast) supported by the lack of major imbalances across the consumer, corporate or banking sectors.

Additional support comes from the desynchronized nature of both policy and growth – while Europe & the US tighten monetary policy Asia is not – while the US tightens fiscal policy, Europe & Asia are not. As such while Europe & the US slow Asia’s economic activity is picking up with Japan experiencing a cap ex boom.

As we roll into 2023 we expect more debate around the need to get to 2% inflation with respected voices such as Adam Tooze of Columbia making the case that slightly higher inflation in a highly indebted period is actually a good thing a la the post WW2 period. He joins the FT’s Martin Sandbu, TPW Advisory & others making this case – a case we expect the Fed to find persuasive in act if not word.

POLITICS

No shortage of political action these days - from the Monty Python sketch book that is UK politics to US mid terms, the Xi coronation implosion and this weekend’s Brazilian winner take all election.

Here too we struggle to think that 2023 will be a more dynamic year especially insofar as how politics impact markets – the UK can’t cock it up more than it did this year while its hard to see any China event having a more immediate market impact than Monday’s 15% drawdowns in China tech, leaving BABA and others trading at 1x sales – yes, 1x sales.

POLICY

We have written at length about the dangers of policy extrapolation, the move to two sided markets, the importance of an earnings bridge to get us over the inflation fire. We think 2023 will end the extrapolation phase & expect a year where policy makers catch their breath and assess the impact of 2022’s moves.

We do not see the systemic risks that others have raised – Euro weakness reflects the need to offset an energy shock while the Yen simply reflects the divergence between the Fed and BOJ. Japan welcomes some inflation and a weak yen is not an issue as long as it is orderly. The UK represents Brexit’s bitter harvest and is more a tempest in a tea pot.

MARKETS

Cross asset markets should benefit from a year of policy stability, of transition, of relative calm. Near term we see BTE earnings reflecting the high nominal growth world we have harped on all year. Coupled with declining inflation and falling rates this sets up for the traditional YE equity rally.

We remain very focused on the USD and see it as the biggest loser from a calmer environment. A weaker USD sets up non US equity opportunity across both EAFE and EM.  

We note for example that Japan is breaking out vs the US while Q3 Japanese EPS is running 22% ahead of year ago levels vs US flat to down slightly. In EM, China now sells at 8.5x EPS, Brazil sells at 6x. We note how EMFX has OPed DMFX and wonder if the post PPC China equity puke might mark the bottom in EM equity.

We like the risk reward in US HY and EM LC debt & highlight how US HY corporates front loaded their borrowing in 2020-2021 thus there is no refi mountain till 2025. The EMFX noted above underpins the local currency debt opportunity coupled with several EM having completed their tightening cycles – our equity OW Brazil being one.

A high nominal growth world with public – private cap ex across the energy, infrastructure and supply chain reshoring process sets up continued commodity upside. A weak dollar will provide a tailwind for such while inventory levels are scraping bottom from oil and its derivatives to copper and beyond.