Don't Miss The Forest For The Trees

1450 words – a 4 minute read.

As the entire investing world awaits Jay Powell’s Jackson Hole speech (Bloomberg reports Asian traders will pause Friday night revelry for the speech while I will be opining on Spanish TV) it strikes me that the old adage – don’t miss the forest (the real important stuff) for the trees (the details, distractions like Powell’s JH speech) is really applicable to today’s investing world.

I am a big believer in clichés and adages because they have stood the test of time; this one has stood for almost 500 years with its first English language usage dated as of 1546.

I think its particularly relevant for today’s investor given how much media there is and how relentless and omni focused it can be, just 24/7, all encompassing until it moves on. This makes it very difficult for one to see beyond the glare, to stand in against a media dominant POV and to in essence be a long term investor.

Its part of the “Market Speed” construct  I wrote about several months ago. The markets, long known as forward discounting machines, have sped that discounting process up considerably, driven by advances in technology across trading algos and execution capabilities and exacerbated by a growing absence of institutional, two way liquidity. 

As I discussed with Mexico’s leading pensions (Afores) last week this suggests that one should not try and trade these markets but rather ride through them in all but the most extreme circumstances, taking advantage of being a LT investor which only becomes more valuable IMO as time goes on.

Today, there are several specific places where I think the title adage really stands out. All relate to the Big 3 questions for the 2nd H we outlined in our latest Monthly. Set up in a Tri Polar World fashion, the first question was the pace of the US inflation decline; the 2nd, the path of EU energy prices and the 3rd, the pace at which China grows post Covid Lockdowns.

While Jay Powell’s speech represents the trees, he highlighted the first question & suggested the Fed needs to see a string of lower inflation numbers before declaring victory. July’s core PCE data, released just before Powell’s speech, came in BTE at a Y/Y rate of 4.6%, a nine month low. We remain of the view that inflation’s decline will surprise in its speed, focusing on sharp and consistent declines in US gasoline prices (down 70 days in a row), used car prices (about to turn negative on a Y/Y basis), growing retail discounts, ebbing supply chain concerns etc. Equities are quite weak post speech, giving back recent gains albeit on light volume. 

We expect September to mark the last of the Fed’s front loaded 75 bp hikes and for that to mark a USD peak – that’s the forest. Markets are pricing in roughly a 70% chance of 75 bp hike. Furthermore, as labor & housing prices soften, we expect the Fed to validate the high nominal growth world we have been discussing for months by declaring victory when inflation reaches 3%, secure in the support provided by aggressive US fiscal tightening and well anchored inflation expectations.

The 2nd question puzzles me to be honest. I don’t get why EU energy prices keep going up and up, some 25-40% per week even as reports confirm that efforts to fill Nat gas storage in prep for winter are well ahead of schedule across most of Europe, including Germany which has seen all time highs of Nat gas inflows & yet is where prices have soared the most. 

The argument seems to be that even with great progress on storage should Putin stop gas supplies mid winter Europe will be in the deep freeze. Strong Q2 earnings and sales growth (nominal growth in EU too), solid Q3 economic activity to date and great success on the storage front – none of it seems to matter. Nor does data from Gas Infrastructure Europe which reports 10 of 17 EU countries are already at 80% or more of their storage capacity – the 80% target BTW, was set for Nov 1st – so well more than two months ahead of schedule & yet gas prices continue to soar.

I get that the worry is what happens in Q4 (Russian oil import ban) & Q1 2023’s full winter effect but in an effort to keep the forest in view shouldn’t one also see the potential for continued, very low Russian supplies and an ok winter? Note that while Russian gas supply has fallen by 70% & folks expect it to full stop, total gas flow to Europe is down only 5% vs last Fall as US LNG & other sources make up the difference leaving total supply relatively stable over the past year. Does Putin really want to try the West’s resolve in such a blatant and public manner? 

It strikes me that EU energy prices are setting up for a massive crash in the coming months, one that will likely rival lumber’s 70% decline if not worse. Nat gas supplies down 5% yet Nat gas prices up 1,000%? What am I missing?

Commodity price spikes always end the same way, by coming down as fast as they went up. I struggle to see how this will be any different. Once its clear that EU can get through the winter without major power rationing etc. energy prices will collapse, the Euro will rally hard and so will EU equities. BofA reports a near record 28 straight weeks of EU equity fund outflows – the turn will be aggressive.

In China’s case, the trees obscuring the forest consist of the myopic focus on the property sector. We have been invested in an Asian HY ETF for much of this year; it has about 30% in China property exposure & pays about 9% USD annualized on a monthly basis. So far it has not worked and we are down on the position. Having said that over the past month and particularly over the past few weeks, when the trees reflect day after day of negative headlines about China property, the forest shows this ETF to be among the best performers in our 28 ETF Global Multi Asset (GMA) model portfolio.

An adage we use a lot is to let Mr. Market tell us, not us try to tell Mr. Market – here Mr. Market is saying all this property bad news is known and has been known for months and months (remember Evergrande? That was a year ago!!!!). What Mr. Market is telling us if you peer through the trees to see the forest, is that China is drawing a line under the property sector – it is too important socially and economically. Thus rate cuts, rapidly expanding M2 money supply, improving credit impulse & a $29B bailout out fund to ensure unfinished but paid for houses get finished which should in turn improve sentiment and thus prices which should lift developer equity prices and capacity to raise new funds.

We want to use weakness to add to risk assets. Seasonality suggests US Mid Term year lows occur right now with average gains of 30% over the next 12 months. We remain of the view that the USD is a key catalyst for the next big move in risk assets and that the USD move is tied to the end of the Fed front loading and inflation roll over in the US together with the roll over in European energy prices. 

We see EM assets as the next real big opportunity in a high nominal growth world validated by the Fed & supported by a global cap ex boom to confront the 3Cs of Covid, Climate & Conflict which we expect to support the secular Commodity boom and broad EM assets. BofA calls the Short USD, long EM trade, the 2023 trade - we think it may unfold sooner than that.

It's been a busy week for TPW Advisory on the media front: on Monday we joined Jon Ferro on Bloomberg TV for this fun exchange at the 28 minute mark ,   on Tuesday it was Bloomberg Radio for this 7 minute  chat with the Asia team and we capped it off Wednesday with a Bull – Bear debate on steroids hosted by OpenExchange. The debate lasted 30 minutes & gives one both sides of the market – my bullish take on global cross assets and Jeff Huge of Alpha Insights, a technician with an Elliott Wave focus, delivers the bear case (2700 on SPY by YE). It’s well worth the watch!