Buy The Laggards

1572 words: a 4 minute halftime read.

Today’s Musings come straight from my BTV surveillance prep notes for this morning’s 7 am hit. They follow on from the prep work done earlier in the week for an hour long podcast with Macro Hive (Link below). All of the above have been informed by our monthly model portfolio meeting likewise held earlier this week. In other words, we are fired up & ready to go!

We have written about this summer’s tricky markets in Trickster, advised clients to Stick To the Process, suggested that investors Zoom Out, Not In and discussed our view of Rotation Not Recession in last week’s Monthly. 

We have made the point and reiterate here that the keys for Fed watching are not the size or pace of the cuts but rather the larger picture (zoom out) of whether the Fed is cutting into a recession or not. That’s key because history is so clear; when the Fed cuts and there is no recession stocks average mid teens returns over the next yr. When there is a recession, stocks lose roughly the same in the following year.  JPM notes that when the Fed cuts with the SPY within 1% of an ATH stocks are up every time over the next year, averaging in the  mid teens. History is clear & speaks volumes.

Powell spoke of “recalibration”, of shifting focus from defeating inflation (our macro surprise #1, lower inflation sooner than expected – check) to protecting employment. He described a long cycle of rate cuts extending into 2026, noting that the elusive R* is well above post GFC levels and closer to 3% which is the Fed’s terminal rate, a level futures markets are right in sync with.

An elevated R * is a good thing, suggesting the GFC related scarring has healed at home & abroad. We believe the Fed is achieving a soft landing for the US economy, an economy growing at 3% in Q3 according to the Atlanta Fed, with no major imbalances, flush consumers and cashed up corporates. Here’s Schwab: “Household net worth is growing by 7.1% year/year (as of 2Q2024) which is the strongest growth at the start of a cutting cycle going back >30 years”.

A soft landing suggests a return to stability (macro surprise #3  – check) and stability implies sustainability which syncs up with our global macro blue sky outlook for the 2023-2027 period. We noted the WSJ column today suggesting that the Fed is on track to repeat its 1995 soft landing; we agree, the 1995-1999 period has been the historical analogue for our global macro blue sky outlook for quite some time.

This in turn suggests that even the most ardent recessionistas will have to throw in the towel or find a new profession… after all, the recession call, now at least two years old, has coexisted with SPY returns of over 20% in 2023 & YTD – in other words time is running out for bears to keep their jobs. We have spoken many times about the famed Money Market Mountain (MMM) which totals well over $6T in the US alone. A return to stability and bear capitulation implies money coming off the sidelines sustaining both the bull market and the US/global economy.

We think its critical for investors to zoom out and focus on the long game, not the next Q or even the next year but rather the next several years as we argue with our blue sky thesis. We see two strong trends supporting this view – one in the global economy, one in risk markets. The fact that the global economy has absorbed a rapid rate hiking cycle without recession ( 2022 – 2024) is super impressive. The fact that ACWI and SPY have hit new ATHs while the bellwether sector and stock, tech and Nvidia, are well off their highs is also impressive and suggests a lot of underlying strength. We want to listen to stocks not vox (another piece from earlier this year - all available on our website at pelosky.com under Musings – we have receipts).

So how to invest given all the above? Well, we just had our monthly model portfolio meeting so let’s review our key takeaways.

Since there is no recession and one is unlikely in the immediate future we want to take advantage of the recent cross asset dichotomy where USTs and commodities priced in recession and stocks & credit did not (credit was the tell that recession fears were overblown). As such we want to sell the recession story winners (aka bond sensitives like XLU as BofA notes most OW since 08  & long duration USTs) and buy the recession losers (aka Commodities). Seasonality remains a concern and could give us some nice entry points.

Now truth be told we have had this set up all year (UW FI, OW Comm) and it has not worked. Part of playing the long game is having patience and besides we can’t trade with the machines so we stick to our knitting and if things don’t work out for a bit we are prepared to ride through that. But we don’t want to turn one mistake into two and sell our commodities at rock bottom levels vs stocks and buy long duration bonds after a rip higher.

No, we want to continue to lean into the lagging commodity space given our view of an early cycle global economy (our macro surprise #4) coupled with clear evidence of low inventory levels in oil ( Cushing anyone) and copper, not to mention uranium. Gold miners are the leader here and we remain invested. Here’s 3F – energy experts: “we are now, basically, at max pessimistic speculative positioning.”

We note that BofA believes large investor allocations to commodities are at a 7 yr. low while hedge funds are reported to be the most short commodities they have been in over a decade.  We like the set up a lot and think Commodities could really shine as Fed & global rate cuts continue, USD weakens and supports commodity pricing. BofA:” The commodity secular bull market in the 2020s is just getting started as debt, deficits, demographics, reverse-globalization, AI & net zero policies are all inflationary,” the BofA strategists said.

Also note its the only asset class priced for hard landing.

A weak dollar should also support non US equities and this another laggard area we want to focus on. When we reviewed our charts this week we noted ACWX remains a solid 10% or so below its ATH vs ACWI at ATHs, led by the US. We also noted EEM trails EFA and China trails EEM. We believe Fed cuts can open the door for more aggressive EM rate cuts including in China (note China now largest holding in EMLC).

We were asked about our China view on BTV this morning and defended our two tech stack thesis which argues that China and the US are walling off their respective tech stacks from one another. We believe this leaves the huge and growing China tech market to Chinese tech companies which trade at fractions of their US tech peers valuations, are buying back stock hand over fist and are breaking new ground in AI. BABA just announced its newest LLM is now the world’s best performing open source LLM while announcing price cuts of up to 85%.

 We also noted that KWEB, our preferred play here  popped over 4% yesterday and broke back above its 200dmav,  let’s see if it holds. We continue to think the risk reward in holding China tech is very appealing. Here’s an illustrative quote from Amundi’s head of AA: “ impossible to convince our clients “ to have any exposure to China…” no one is interested in buying Chinese assets. I have never seen such a big pushback among all our clients.”

We also want to own laggards like US Small Caps which historically OP in the first six months following the first rate cut. We also like the thematic set up here and note bio tech, fintech, cyber, robotics and others that looks appealing having been basing for several years (note our TPW 20 thematic model focuses on future tech and Climate).

We also want to hold onto our winners and there have been many given recent equal weighted S&P leadership: financials ( EUFN & XLF), consumer discretionary ( Amazon & Tesla anyone) & Industrials are ones to note here. We think the next surprise (which we discussed in the monthly) is for the ISM Manuf PMI to shock the world  (or at least the bears) & break back above 50;  we note how the recent Empire St and Philly Fed Manuf surveys have been much stronger than expected. We also hold onto SMH, our pick & shovel AI play. AI is a global game, every country and company needs to play – we want to play via the semis.

If it sounds like we own everything that’s not quite right but we are fully invested with no cash and so yes we own a lot – that’s what we learned one is supposed to do in a bull market.

Enjoy the Macro Hive podcast: we cover all the usual suspects plus the US presidential race and end with Bilal asking me a cultural question and me responding with a discourse on the new world of college football in the NIL era. GO DUKE! https://www.youtube.com/watch?v=z1j9_bv3LpI