Confidence Game

1945 words – a 5 minute read.

Confidence is one of those intangibles that folks talk about like they know it when they see it but then asked to define it they come up short. Confidence is important in life – confidence in one’s prospects, one’s future. It’s important in investing as well – confidence in one’s POV allows one to stay in an investment and ride the normal chop that accompanies it.

Charlie Ellis wrote one of the all time classic investing books on this subject titled: Winning the Loser’s Game. Confidence, when to have it, what to have it in, when not to have it, is key to investment success. This concept resurfaced a few days ago during breakfast with an ex Morgan Stanley buddy when my friend said the one thing people have to recognize today is that we are in a bull market for stocks, plain and simple.

Now, that’s both a confident statement & one that leads to lots of decisions that might otherwise not be made. Putting cash to work for example or not pulling the plug bc stocks are OB (my buddy again: OB conditions like we have today are bullish, not bearish) or going out on the risk curve to embrace sectors, countries, assets that seemed beyond the pale just a month or two ago.

We agree with his conclusion – hence our advice last week to leverage our humanity, sit on our hands & enjoy the ride. This is certainly easier to do when the data is supportive;  we have clearly enjoyed the recent flow of positive data. As I write, reactions to today’s PCE data are coming in and it seems like another pitch perfect report: core PCE BTE, ditto real disposable income growth. Can one say “soft landing” or as we have termed it for near 18 months now “The Middle Path”.

Notwithstanding the above, the world is far from confidence filled; in fact, picking any one of dozens of 2024 outlooks would suggest the exact opposite – the world is going (already has) to hell in a handbasket as the old saying goes. Not sure what a handbasket is but I do know we are not going to hell – or at least not yet.

No, the doomsters and dumpsters, the bear market prophets of woe & gloom, dominate the outlook space but thankfully not the reality space. We like to live in reality; as investors we are required by the markets to do just that. These outlooks suggest that there are many still among us who have yet to catch the confidence bug.

In their totality, the lack of confidence really stands out. StoneX notes that a consensus of 19 firms’ 2024 YE S&P targets lies only 3% higher even with EPS growth forecast closer to 11%. That is good news for the 2024 risk asset outlook. Same holds true of economists – Fintwit has been highlighting a table of 13 Wall St firms’ economic forecasts, none of which have economic acceleration penciled in for 2024.

Our buddy JC at All Star Charts argues that the lack of confidence is good news for the Santa Claus rally. His sentiment composite indicator which combines a number of readings shows “middling“  investor sentiment even after this big rally, suggesting to JC that there is room to go. As a reminder, Santa’s rally starts today and extends thru Jan 3rd.

One place clearly lacking confidence is China where consumer confidence remains deep in the dumps as does investor confidence as reflected in a slowly sinking stock market, no matter the policy mix, valuation level, relative performance etc. etc. A lack of confidence is clearly visible and hard to fight in the Middle Kingdom. We know as we have been bullish and wrong, causing us to shrink our positions a few weeks back once it became clear that even as other markets and assets rallied, China did not. We got the message.

As we navigate forward in reality, one confidence booster we note is how many of our 2024 macro surprises are starting to manifest even before we turn the page to the new year. We cited several examples last week and have more to note today. Beyond the clear evidence of macro surprise #1, lower than expected global inflation (UK, Germany, US), sooner than expected, we also have increasing signs of the return to macro stability, surprise #3 and its follow on, the $1T reward unlock we first wrote about more than three months ago.

The potential for all those 2024 fears to dissipate & be replaced by growing, reality based, data supported, confidence should lead to money coming out of the massive $8T global MMF mountain. This prospect in turn gives us a lot of confidence that risk asset price dips will be shallow and should be bought. Fintwit notes: “last Friday, the S&P 500 ETF, $SPY, saw its biggest single-day inflow on record, at $20.8 billion. Dating back to the ETF's inception in 1993, this has never been seen.”

We also note C suite optimism is growing; here’s Glassdoor: “CFO optimism about the economy rose to 58.0 in Q4 '23, up from 50.5 in Q2 '22 (lowest since '11). This has helped closed the largest gap in optimism about their own businesses vs. the economy overall in ~20 years. “Recession for thee but not for me" sentiment is easing.”

We may be at the turn & note growing consumer confidence (US Conference Board survey best since July). As one of our preferred Bloomberg columnists, Conor Sen, put it: “consumers like the combination of surging stock prices, plunging mortgage rates, falling gas prices, and low unemployment.” He goes on to note that on the Civiqs site sentiment about current economic conditions has finally hit its highest level since 2021. A more confident consumer = a consumer willing to spend.

But it’s the growing evidence of macro surprise #4 that is really starting to float our confidence boat. Macro surprise #4 argues that the great debate over what lies ahead: late cycle and evergreen recession vs early cycle & global growth upturn will be resolved in favor of the latter.

We wrote last week about the positive feedback loops starting to manifest in the US economy, citing examples like the positive inflation surprise leading to rate declines which creates a sharp pop in housing starts and mortgage applications. One also notes a surge in refi activity which puts $ in people’s pockets supporting consumption and hence growth. Single family housing starts just hit an 18 month high while mortgage applications for new homes rose 21% Y/Y last month. That is economic acceleration by definition.

Another example surfaced this past week in the semiconductor space where Micron came out with a positive outlook on the semi cycle as inventories have been worked off and AI driven demand starts to pick up. Micron’s CEO repeated his “prediction that 2024 will be a rebound year for the industry, setting the stage for record results in 2025.” This suggests that the semi cycle, which is an early cycle indicator, has bottomed and is likely to pick in the next several years.

Thus, homebuilders and semis are both suggesting early cycle not late. We note the freight market is starting to tighten as supply and demand return to equilibrium. Fintwit said it best: “Step 1 of economy firming: lap the destock at constant demand, and you start the restock cycle with Inventories in a better place. Lower rates => hold even more inventory => new orders up. New housing about to boom. Biz cycle is motion: PMIs higher soon.” Here’s a straw in the wind from the WSJ: 234,449 Carloads carried by U.S. railroads for the week ending Dec. 16, up 6.5% compared with the same week last year, according to the Association of American Railroads. Acceleration, not decay & dismay.

We utilize our 4 for 24 macro surprises to help keep us tethered to reality. As such, we have growing confidence in our investment mantra: lower inflation > lower rates > weaker USD = non US equity and Comm OP.

Stock market internals (defensive sectors continuing to lag) also suggest early cycle yet investors are positioned for late cycle, even today. Still long cash, OW bonds and interestingly from our POV, deeply UW Commodities.

We enjoy reading BofA’s famed Fund Manager Survey (FMS) report in part because of its survey breadth but also because of its charts and tables. One that caught our eye this week noted that investors are more OW bonds vs Commodities’ than at any point in the last 15 years. Bernstein goes on to note the massive OP of Materials vs AGG over the next ten years (2008-2018).

Today’s early cross asset response to the PCE data was illuminating in that bonds barely reacted suggesting that much of inflation’s good news is in the price. Bonds have rallied further & faster than we expected given our growth view and we would expect the 10yr to reverse back towards 4%  in the near term.

From an equity perspective we note that we have basically gone nowhere for the past two years – the 5th longest drawdown in S&P history and one that allowed for the digesting of all that has transpired during that period in the interim. The question is where do we go from here?

We note a few things: starting point for SPY valuation suggests it will be an earnings driven appreciation game; not so in the ROW where under ownership & valuation remain supportive for double digit type gains in the years ahead. Small caps offer significant upside opportunity in both the US and ex US and as the folks at MRA Advisors note outside of the mega caps, many stocks count to 20% upside moves on a go forward basis. Small caps seasonality best mid Dec through early March according to the Trader’s Almanac.

As we observe the trajectory of our 4 for 24 macro surprises we note that Commodities is one asset class that has just begun to rally across the complex from miners to energy. The lack of broad market confidence in the growth outlook for 2024 (US 2024 consensus GDP growth is 1.2%), reinforced by the lack of Chinese consumer confidence, has held commodities back from joining the risk on party of the past 8 weeks or so.

We continue to expect commodities to join the party and have been heartened by what we see transpiring in the copper space for example or the oil space. Barchart notes: Hedge Funds have reduced their oil net long positions to the lowest ever recorded (data going back to 2011). The FT reports that: “copper demand surged over 6% y/y in the first eight months of 2023 while recent weeks have seen 750,000 tonnes - which is 3% of global copper production - erased from 2024 production forecasts.”

We see commodity upside in virtually all scenarios minus a hard landing for which there is no visible support at all. The lack of confidence necessary to boost supply coupled with the early signs of confidence stimulating demand suggest the real opportunity today is in the commodity space. We remain OW both EM equity & Commodities – both require confidence in the outlook which we have & which we hope you share.

Well, that’s it for us. Vacation beckons and we are here for it! Thanks for reading and supporting and even disagreeing with TPW Advisory this past year. We look forward to more of the same in 2024. Back in your in box on January 12th.

Merry, Merry, Happy, Happy!