Foggy Weather

1250 words – a 3 minute read.

Global cross asset market action is really stretching one’s inventory of analogies – we have already employed the two steps forward, one step back analogy so now we are going to use the traffic in foggy weather one.

It came to me when I was biking to work (big NYC City Bike fan) the other morning and as usual I looked up to the Empire State Bldg. as I rode up Broadway (yes, I know, going against traffic – what else is new). Some days it is a beautiful sight; the early morning sun striking the top of the spire; other times, low hanging clouds scud across the tip. This particular morning it was as if the Emp (as I affectionally call it) did not even exist – it was completely shrouded in fog.

Recent market action suggests that the fog analogy can be extended to how folks drive in foggy conditions – they slow down, speed up, stop & go, move to the middle lane or right lane on the highway, follow other cars but give plenty of room because of the risk of chain reaction crash that one reads about every spring.

That seems to be where we are in the markets – slow down, speed up defines Dec & Jan. Here in February, the view ahead seems obscured by swirling mist and fog and so folks have slowed down & dialed back their enthusiasm as the bull bear sentiment indicators suggest. Bonds have sold off and are now down for the year while commodities have been weak including oil & natural gas as well as Dr. Copper who had a fender bender this week.

Stocks have given back a fair amount of their gains especially in the US – importantly when one reads thru the cross asset action one notes that Non US equity has held up even as the rate back up has led the USD to rally back towards the 105 DXY level. We have long held that the USD is the key to our view of non US equity & Commodity OP vs US equity & USTs.

One of our favorite technical analysts, John Kolovos of MRA Advisers, has highlighted the 106 DXY level as key to a potential shift back towards USD strength which would be a headwind for non US assets, especially EM debt & equity, as well as Commodities. We are watching these levels together with sustained non US equity OP carefully.

US fixed income has sold off pretty aggressively with rates backing up 50-60 bps across the curve over the past month. Many FI instruments are approaching oversold conditions driven by stronger than expected data points around the turn of the year. Markets have already discounted the strong January jobs report, retail sales, slightly stronger than expected CPI print and now today’s stronger than expected PCE and consumer spending data. A lot of bad news is in the price.

Talk about foggy conditions: many (Bloomberg consensus) continue to worry about US recession in Q2-3 though bonds seem to have priced that out for now; others worry about an overheating economy and the Fed needing to raise FFR to 6%.

Here at TPW Advisory we remain on the Middle Path view we first laid out last summer – neither recession nor overheating but rather an environment where inflation continues to decline (one month does not a trend make) driven by falling goods prices in 1H 2023 as y/y comps look good vs the start of the Russian invasion one year ago today.

The 2nd H of the year should see sharp falls in shelter inflation as the already observed fall in rents finally make it into the CPI data. Finom Group notes that US rents have fallen for 8 months in a row through December and are down by nearly half from peak. On the recession watch side Citi’s US Economic Surprise Index continues to show positive upward direction while sub 50 PMI readings should start to turn up.

This Middle Path outlook seems solid to us & therefore worth holding onto even in foggy conditions – in other words one can still drive the car down the road, just carefully. While driving one keeps an eye out for familiar landmarks to give comfort.

We continue to find our landmarks & visible signs of improvement outside the US. Rising PMIs above 50 across Europe and Asia are one such example, European consumer confidence up five months in a row & at one year highs as winter ebbs, energy prices fall and demand starts to pick up, is another.

We have noted the surge in Chinese liquidity provisions and highlight the PBOC’s vow to implement a “targeted and forceful” monetary policy to support domestic demand. MS notes that home sales in Beijing are running at nearly double the rate of late 2022. We expect more policy action in China coming out of the Govt Work Report (GWR) due in a few weeks & continue to view the world as edging into a new global growth cycle led by Asia in general and China in particular.

Of course, much depends on the Fed and US asset price direction. A lot has been priced in: 3 more 25 bp rate hikes thru June with a terminal rate over 5.3% and virtually no chance of Fed rate cuts – quite the change over the past month as noted above. Arguably, equities have hung in there pretty well given such an aggressive rate back up.

We would argue as the folks at All Star Charts do that one reason for this solid equity performance is that earnings revisions continue to turn up from their Fall 2022 lows. Notwithstanding all the Q 4 earnings angst the % of US companies with rising FY estimates is increasing not decreasing. They also note the Euro Stoxx 600 breaking out to new 52 week highs. China’s earnings season has just begun with very strong results from the leading tech companies.

We continue to expect a flattish year for US equity given limited EPS growth and high starting valuations coupled with the likelihood of higher for longer rates which will cap Big Tech’s upside which in turn anchors the S&P. That environment is perfect for non US equity OP particularly as  ROW equity markets don’t have many of these issues. They are cheap vs their own history and relative to the US, they are much more cyclical and value heavy than the S&P and in many cases once its clear the Fed is done – by mid year at latest in our view, then we see scope for the beginnings of a rate cut cycle led by EM Central Banks.

Today’s foggy conditions obscure this outlook for many and perhaps slow its unfolding but not its outcome & therein lies the opportunity. For those with a longer term perspective the current seasonally expected pullback we wrote about last week offers a pretty good opportunity to build positions in spaces that ran away from one in January. For those like us who are fully positioned then it’s a step back to allow for a re set. As long as technical levels hold we remain comfortable doing just that based on our fundamental view outlined above.

We had the opportunity to discuss these issues on BTV’s The Open show with Jon Ferro earlier this week – we come on at the 6 minute mark. Enjoy the clip.