Clarity

1200 words  – a 4 minute read.

Clarity is often sought but rarely found. It is like the spire of the Empire State Bldg. swirling in the fog – now you see it, now you don’t.

This is especially true for those of us in the investing business, seeking to make sense of rapidly changing economic, corporate and market environments while steering towards a vision of the near future. TBH, it’s one of the most exciting things about doing global macro, when clarity strikes it can be almost blinding.

Clarity doesn’t often just appear out of mid air, though sometimes it does. Most often it’s the result of the process, of doing the work. In the case of this Musing, it comes from the process - the client notes I wrote this week after our monthly model portfolio review and the prep notes I put together for last night’s hits with BTV Asia and Bloomberg Radio.

What follows then is triple filtered thinking; in the drinks business triple filtered usually goes for a premium price. In this case please enjoy- feedback welcomed.

My tactical outlook is that we are on the cusp of lower than expected inflation readings, notwithstanding todays BTE US jobs #. The Q4 ECI data was one of the first straws in the wind;  used car prices are likely to be next as the semiconductor chip shortage eases and new model production picks up (GM planning roughly 40% increase in 2022 y/y production).

A pick up in auto production is an example of what else to expect in the near term, namely BTE growth data. Q1 will be a marked slowdown from Q4’s strong growth data; the Atlanta Fed Q1 nowcast is for GDP growth of 0.1%. I expect Q1 to be a head fake & look for growth data to start picking up and see the jobs # as one of the 1st inklings on that front.

So while the market worries and whispers about yield curve (YC) inversion I expect the opposite to occur, namely YC steepening as the short end rallies with lower inflation readings and the long end sells off on better growth combined with growing competition for investor assets from positive yielding Sovereign debt from Germany to Japan and beyond. The AGG ETF hit a new low today and is quite oversold.

The 10 yr. German BUND yielding close to 20 bps and the 10 yr. JGB at the same level for the 1st time in 5 + years is suggestive of a global growth pick up which in turn suggests a lifting of the cap on UST long rates driven by negative yields everywhere else. The combo of BTE US growth and higher than expected non US Govt debt yields spells higher UST LT rates and a steeper curve.

A steeper curve will drive a continuation of the rotation trade we have seen kick off 2022; a rotation from Growth to Value in the US equity market and from US equity leadership to non US equity..

As I noted in my latest Monthly: Kabuki Time, these are the key questions investors need to answer – are we at the end of the decade + tech equity leadership in the US and US equity leadership on a global basis? I believe the answer to both is yes. 

Yesterday provides a good example – Nasdaq down over 4%, US Value (IUSV -a top GMA holding) down less than 1%. YTD, Nasdaq down roughly 12%, SPY down 6%, ACWX US down less than 3%. As I wrote over a year ago, we are in a Golden Age for Asset Allocation.

The set up for non US equity leadership seems close to perfect. History suggests that the S&P will be +/- 5% in 2022 following a January like we just had. That is a perfect outcome for non US equity leadership – we all know that if the S&P is down 15%, all markets will fall; likewise if the S&P is up 15%, no one will care about the ROW.

In addition, the policy mix is much better outside the US; US faces fiscal drag & Fed tightening – Europe enjoys significant fiscal stimulus thru Next Gen spending while the ECB is on hold. Japan has a massive fiscal package supporting what is likely to be its best growth in a decade while China’s PBOC is easing. A weak USD, as typically coincides with a Fed rate tightening cycle, will provide a significant tail wind. Non US markets are historically cheap vs the US, are under owned and will likely offer higher EPS growth. We are significantly OW non US equity in our Global Multi Asset (GMA) Model with our “Look to the East’ and “China 2022 Glide Path” themes. 

Strategically, my focus remains on the 2023-2025 period; I see the 2H 1990s as the historical analogue given it is the last time the US had a cap ex boom and productivity led surge that allowed for higher than normal wage gains without inflation getting out of hand. While the cross asset markets are priced for a return to the anemic pre Covid US GPD growth of 2.3% (5 yr. av up to and including 2019), I think there is room for a better outlook of say 3% real + 3% inflation as infrastructure & climate mitigation spending on a global basis lifts US and global growth to a higher plane.

Should this outlook come to pass one will look back at the current state of Disruptive Tech equity as exemplified by ARKK and say wow – I should have bought the heck out of that. In a bear market for the past year, having more than halved with capitulation selling over the past few months, I think the bear market in Disruptive Tech/Thematics is close to over. We put our $ where our mouth is with our TPW 20 Model update, putting cash to work across a number of thematics.

In the weird but true category, I spend a fair bit of time reviewing the technical outlook for our existing positions as well as our somewhat lengthy watch list during every portfolio review session. One thing I noted in this week’s session was how all the US Cyclical- Value ETFs bottomed last year on Jan 29th 2021 and then rallied 30% + on average into late Spring before Delta came and smacked it back. This year the bottom (ok, to date) was Jan 27th… history doesn’t repeat itself but it rhymes sometimes. Could we be on the cusp of another big Cyclical – Value run as Omicron fades, growth data picks up, Q4 EPS come in BTE (Japan +31% y/y, US +29%, EU + 17% via JPM) and conviction grows that Big Tech is no longer the place to be? Smart money says NFW but I think its possible; it sure would be great for our GMA model.

Tom Brady announced his retirement this week while Coach K of Duke basketball fame takes his last road trip over to Chapel Hill tomorrow. These guys have clarity… thanks Tom & Coach K.

Lets Go DUKE!