Crunch Time

College hoops just ended (March Madness now extends into April) & now its playoff time for both the NHL and NBA - there is not much better than playoff hockey – go Bs!

Playoffs = crunch time when reps are made and victors crowned. But crunch time extends beyond just sports to other facets of life as well – being under the gun at work, up to your eyeballs with the kids and yes in the markets too.

It’s that last one we will cover today – crunch time in the markets. Its crunch time as the Fed and other CBs come to the end of the most aggressive hiking cycle in over 40 years; its crunch time as the S&P comes to the end (we believe) of its long, 240 + day trading range around 4k & its crunch time at the iron sharpens iron contest we described last week.

That contest is between US sell side equity analysts who forecast accelerating earnings into YE and fixed income investors who forecast recession and rate cuts by YE with FFR falling from roughly 5% now to 4.6% or so on 12/31. One side will be wrong; Q1 EPS results suggests no sign of forward looking earnings being guided down while there has been some pricing out of rate cuts as bank fears ebb.

It's also crunch time for the Curtain of FUD (Fear, Uncertainty & Doubt) we highlighted in our recent Monthly and the bearish crowd who have embraced the FUD and drank the cool aid. Here is the latest BofA FMS which it termed the most bearish of 2023: “Investor allocation to equities relative to bonds has dropped to its lowest level since the global financial crisis as worries about a recession take hold”. See here for my description on BTV of the Spring WB/IMF meetings: https://www.bloomberg.com/news/videos/2023-04-19/imf-gloomsters-completely-wrong-tpw-s-pelosky-says-video?sref=ftskAWJe

What’s the old saying: Often wrong but never in doubt? The S&P has put in back to back quarters of 7% type gains and folks still are bearish, bank stocks have handled the recent spat of failures on both sides of the Atlantic with flying colors and yet folks are still bearish, Q1 bank earnings come in fine and yet still bearish, homebuilders rock but yes still bearish. Q1 cash inflows into MMF equaled $400B, the 3rd most in history behind Covid and GFC.

The curtain of FUD extends across the globe, even as inflation falls globally – of 34 countries tracked by Creative Planning only 2 are showing Y/Y accelerations in inflation. In Europe stocks have had a great run, sensing Europe’s economic recovery well before the investor community & leading global stocks higher.  April’s Composite PMI just came in today at 54.4 vs 53.7 forecast led by services supported by record low UER… sound familiar? PS, Europe exited winter with record high gas storage levels (you recall how winter was going to be the end of Europe right?).

Even in Asia, FUD rears its ugly head with China equity struggling to perform even as China’s Citi Economic Surprise Index hits a pre GFC high, Q1 GDP comes in BTE, March retail sales grow 10% Y/Y with 1% inflation and the property sector continues to demonstrate that it has bottomed with March new home prices rising for 3rd month in row and at the fastest pace in almost two years.

We do sense in recent readings that some folks are starting to cotton onto our high nominal growth world view. The FT’s esteemed Martin Wolf is one, noting in a recent piece how inflation is likely to settle at 2-3% and real rates around 1% for nominal rates of 3-4% and higher at the longer end. This comports with the Middle Path view we have espoused for roughly a year now – the path between high inflation and deep recession. 

Here is BofA: “almost all central banks on hold/close to end of rate hike cycle thus “locking in” high inflation (as is trajectory of government spending, deficits & debt).but secular inflation core reason US 10-year Treasury struggling to break below 3.5% 200-dma despite “peak CPI, peak Fed, impending recession” narrative; and new 3-4% inflation & rate regime inconsistent with 20x average PE for S&P 500 of past 20 years”.

Davide Serra of Algebris just wrote a VG FT piece arguing that EU banks are a great buy with superb liquidity coverage (160% for EU, 120% for US) and soaring earnings after years of negative rates leading to significant payout yields approaching 20% & dividend yields of 7% trading at the widest discount to broad EU equity in 15 years. We couldn’t have said it better.

How does it all play out you ask? We expect the Fed to go on an extended pause post May’s meeting (whether it raises rates 25 bps or not is secondary to the extended pause) and essentially validate a higher inflation rate as the utility of forcing rates ever higher in pursuit of a completely arbitrary 2% target was nullified with the recent bank failures as we discussed in Firebreak. 

The Fed pause will then serve as the catalyst for the S&P to break up and out of its recent trading range, breaking through 4200 and heading north, a forward looking discounting machine sniffing out economic acceleration into 2024. Earnings should provide an early indicator given 25% or so of S&P will report by todays close and 60% by end of next week – if we don’t see companies warning about an incipient slowdown (so far, nada) then the “imminent recession” call will get pushed out yet again.

At this point some bears will likely begin to capitulate and the calls to invest in cash, which massively underperformed in March (if it doesn’t work in March, a month with multiple bank failures – when WILL it work) will gradually dissipate, most likely after laying to waste many managers’ 2023 performance. 

Goldman notes that since 1982, the average 12 month S&P return post Fed rate peak is 19%. Carson Group notes that last week was the 6 month anniversary of the October low with the S&P up 15% which is below average for bear market bottom moves & highlights that a new bull market level, which is 4,292, is just 4.5% from Tuesday’s close at 4,109—not too far away.

This is far from a consensus view or even a popular one but it is one folks are gradually coming around to as the FUD curtain lifts and the realities of today’s global economy manifest. We see a clear  shift to our Tri Polar World construct of regional integration as supply chain realignment, tech investment and climate mitigation efforts coalesce under the rubric of the return of Industrial Policy in the US and its extension in the EU.

Asia is leading this desynchronized global economic recovery, the same region that lo and behold didn’t engage in massive rate hiking but rather has been serving as a source of global liquidity. Japan welcomes inflation after decades of deflation – expect YCC to end this year as average wage hikes in this Spring round averaged 3.7% - the highest in 30 years.

We note that Japanese equity is currently drawing the attention of both Warren Buffet and the aggressive folks at Elliott. Is Japan still the same old value trap – maybe not. When buyout guys and value guys both like the same market maybe its time for the rest of us to have a look. Our buddy Chase at Pinecone Macro recently noted how close the Japanese equity market is to a breakout.

Our mantra remains Fed on hold = USD weakness = ROW equity OP combined with commodities. US bonds will remain under pressure as recession calls fade and rate cuts are priced out. Credit should do well as GS suggests forecasting a solid 10% tightening in US HY spreads thru YE as the US averts recession.