Convergence

1520 words – a 4 minute read.

Happy Memorial Day Weekend! Summer has sprung in NYC and we are here for it! We started the holiday weekend off this morning with a 7 am appearance on BTV’s Surveillance show. Clients & regular readers know what that means – today’s Musings come direct from my show notes!

We began our 1st segment talking about Nvidia’s fantastic earning report and how it didn’t move the needle for anyone else as the S&P had its worst day in almost a month. We referred to last week’s Musings and our advice to focus not on the news but on the reaction to the news.

The Bloomberg hosts were only somewhat amused (understandable given they are in the news business) but it led to a good discussion as we noted that a 10% move on the day, while in line with past Nvidia earnings results, suggests to us that investors continue to underestimate the speed, scale and scope of the AI revolution.

We remain all in on the AI Age and note Nvidia’s revenues tripled Y/Y while net profits rose 7 fold – 7 fold in one year! It is immensely profitable with net margins close to 60%. If that’s not scale & scope we don’t what is. It also means that Nvidia remains a relatively cheap stock in the Mega tech space.

We continue to focus our investment attention on the “picks & shovels” of the AI Age which in the Digital realm means semiconductors. In the Physical space that means miners – copper miners, uranium miners as well as energy plays like Nat gas (UNG +35% P1M) and even clean energy which has caught a bid of late (ICLN).

The convergence of the Digital & Physical realms through the powering up of the data center build out is the power play (no pun intended). Data center power demand is set to more than double from 2023 levels by 2028. We agree with Nvidia CEO Jensen Huang’s view that data centers are the factories of the future – creating intelligence at scale much as the Industrial Age factories created machines.

After the commercial break the topic shifted to geopolitics and the woes of the Middle East. Host Lisa Abramovich read one of our quotes about how geopolitics is not a concern but a boon to those following the Tri Polar World (TPW) framework as AI, Climate & Defense (ACD – replacing the old 3Cs of Covid, Climate & Conflict) drive regional integration. Exhibit 1: even with all the ME angst oil was down 10% over the past month.

We followed up by noting similar outcomes with China saber rattling around the Taiwanese elections and the ongoing battle for Ukraine vs China tech & EU equity rallies. It is a particularly dangerous time to be investing by headlines. We want to focus on what the market is telling us (See Listen to Stox, Not Vox.

The market is telling us not to worry with both the VIX and the MOVE indices at one year lows, yes, one year lows. Why?  On the equity side its because of earnings folks – earnings have come in BTE, not just in the US but in Europe and Japan and China as well. Nvidia’s earnings got all the attention but PDD, one of China’s leading tech companies (owns TEMU) also reported and while not Nvidia level impressive it grew revenue by 135% Y/Y and earnings by 250% Y/Y.

With results like that stocks are going to be fine, especially if N12M forward earnings estimates continue their ascent. Finom notes that: “Historically, the lower the VIX, the greater $SPX annualized returns.” For good measure don’t forget Q1 US share buybacks were up 16% Y/Y.

On the FI side the MOVE index’s one year low reflects the collapse in inflation volatility & the resultant coming together of Central Bank and market views on the future path of rates. Moving on to Commodities, GSG, up 6% over the past month with oil down 10%, tells us that the global economic outlook is pretty good.

Here is where the convergence in the title comes in. Risk assets are signaling things are fine; converging with a global economic outlook that is improving and improving fast.

We go back to our 2024 Outlook piece & our 4 4 24 global macro surprises. We note #3 and #4 especially; #3, the return to stability (the VIX and MOVE data noted above) and #4, the early cycle outcome.  While the stronger than expected US May PMIs spooked folks a bit we noted Europe’s PMIs also came in stronger than expected - in fact the best in a year or so.

In our prep for this morning’s show we also noted today’s EU wage data – wage growth running close to 5% Y/Y. So, record low EU unemployment, 5% wage gains and an upcoming ECB rate cut – what’s not to love? No wonder the Euro has risen week after week, notwithstanding all the “dollar wrecking ball” talk. The left tail risk of European recession has been taken off the table.

We also reflected on the China real estate policy bazooka fired last week and agree with our former MS colleague Stephen Jen who called it the continuation of a wide policy U turn, one designed to save face for China’s leadership. Stephen notes and we agree that the real estate policy mix makes it clear that China has decided to put a floor under the problem; further  policy steps can be expected – most likely during July’s Third Plenum meetings. China left tail risk has also been truncated.

We noted with interest Jeff DeGraff of Ren Mac, one of Wall St’s most respected technicians, calling China’s equity market rally similar to where the US was in the spring of 2009, i.e. the GFC bottom. The list of HF mavens buying China equity grows longer by the day.

Along similar lines, we noted in today’s FT that Pierre Andurand, one of the commodity world’s most astute traders, is calling for $40,000 copper over the next four years (from $10-11k today). Caxton is just the latest global macro fund to write how excited it is about the copper opportunity. Don’t miss the forest for the trees; big players are making big calls – pay attention!

We are focused on the global economic convergence inherent in the early cycle global economic recovery. Such convergence reduces the degree of US economic exceptionalism, closing the growth differential gap just as investor focus shifts from rate differentials to growth differentials. We think this should impact the Rate & FX space and are on alert for USD weakness.

Japan provides one example. We note that 10 yr. JGBs have just broken though 1% for the first time in a decade – a decade. Furthermore, 30 yr. JGBs have broken above 2% for the first time in 20 years. Speaking for ourselves we would not want to be short Yen.

Its not just the absurdly undervalued Yen but also the Euro which has been up against the USD for 5 weeks in a row – telling us again that the European economy is picking up – not going into recession.

We expect USD weakness to spur the next leg of the uptrend in both commodities and EM equities. We view recent strength in both spaces in the face of a strongish USD as signaling the power of this move. As we noted last week, we are significantly OW both – the most OW both we have been in years and years. We note EAFE is close to breaking out of a 20 year range – yes 20 years, while EEM is breaking out to new 52 week highs and beyond.

We remain confident in our global macro blue sky outlook for the 2023 – 2027 period and highlight the recent IMF report forecasting no expected reduction in G7 fiscal deficits through the end of this decade. This suggests that the IMF has recognized the criticality for Govts of all stripes, in all locales, to have “sovereign AI”, to deal with climate change, to fund their defense budgets in a more worrisome (to some) world.

Add in cash rich corporates who smell the opportunity to restructure global supply chains into regional ones, who can drive cap ex the AI age requires (semis), who can try to offset the time gap between digital speed and physical speed (15 years to bring a copper mine on stream) etc. Yes, the Age of Investment sounds right. This global, sustained, investment spend, a cap ex boom, underpins and reinforces our multi year, global blue-sky outlook.

We position for this global blue-sky outlook in our two model portfolios via our “pick & shovel” semi & commodity positions while we position for a USD rollover with a significant EM equity OW. We maintain our 2 tech stack divide thesis which leads us to China tech and continue to invest in our TPW framework via positions in Poland, Vietnam and Mexico – three main winners in the regionalization of supply chains in Europe, Asia and the Americas.

Have a restful, relaxing and peaceful start to the summer!