Follow The Trail

1800 words – a 5 minute read.

It certainly feels like a spooky time out there in the big world as we write on Friday October 13th. As we wrote in our monthly client updates earlier this week, Fall is a great time of year: great NYC weather, its football season and equity market seasonality switches from very poor to very good. A lot to like in other words!

So, as we warned last week in our Monthly , one does not want to get swept away by all the negativity out there. Since that piece came out a week ago, the terrible events unfolded in Israel with fears that this weekend could see more death & destruction in Gaza. One can only hope that cool heads will prevail on both sides. Assuming the conflict does not spread to Iran we don’t see it as a major driver to risk asset prices.

It’s important to note that not all is bad on the geopolitical front – in fact one can argue that the single most important issue – how the US and China are getting along - is actually improving and is likely to improve further in the weeks ahead. A bipartisan group of US senators was just in China and met with Pres. Xi and the top Chinese leadership. This paves the way for Pres. Xi to travel to the US and meet with Pres. Biden on the sidelines of the Asia - Pacific Economic Cooperation (APEC) meet in November to be held in San Francisco. That’s VG news.

Nor is it all bad in risk asset land: here is John Kolovos of MRA Advisors this week: “Sentiment, seasonals, and oversold conditions have pointed to a forthcoming low in equity markets. Our sentiment composite gave a buy signal, and the percentage of oversold stocks in the US market reached climatic levels.  In addition, capitulation has occurred in rate-sensitive areas, specifically Utilities, which hit their third-lowest RSI reading since 1990.”

Nor on the economic front where revised US Govt figures suggest that US households have roughly $1T or more in excess savings than previously thought. From Bloomberg: JPMorgan Chase & Co. economists Michael Hanson and Murat Tasci ramped up their estimate of the savings buffer to $1.2 trillion, from $400 billion. “Excess saving may not be exhausted until sometime next year,” they wrote in an Oct. 6 report. Americans have also benefited from increased household wealth, courtesy of higher property and equity prices since the pandemic. This in turn led to: JPMORGAN: Our economist Michael Feroli “revised his estimation of 3Q #GDP from 0.5% saar (as of July 7th;) to 3.5% .. driven by the material improvement in macro data, ranging from consumers cash levels to corporate profitability.”

We remain focused on the path to stability and believe it or not the weight of the evidence suggests that we are making headway. Of course, we are in the middle of multiple transitions and we all know transitions can be a case of one step forward, two steps back. This is true in the asset space as well where the USD, rates and stocks are all fluctuating around key technical levels. Thus, our advice to follow the trail markers or signposts as we have been calling them for the past month or so.

In addition to football season, it’s also great hiking weather here in the Northeast US where its peak foliage season. I am sure many readers can relate to following the trail markers in the White Mtns of New Hampshire, being distracted by nature’s wonderland and experiencing a momentary flare of anxiety etc. before one of your buddies gets you back on the trail.

Our four signposts remain: continued disinflation in the US and Europe; global manufacturing recovery as we shift from inventory destocking to restocking (note: September US inventory-to-sales ratio fell to 1.36 months from 1.39 months. This is the lowest level since last October); continued earnings growth and China’s drips and drabs of policy stimulus finally gaining traction. All four appear on track.

US September CPI came in roughly in line, maybe a tenth higher than expected and certainly below the whisper number which was flat M/M. With gasoline and shelter prices being the main culprits its important to note several things: core continues to decline on a Y/Y (lowest since 9/21) and Q/Q basis (3.2% annualized Q3 vs 5.2% in Q1) while on the labor front, AHE on Y/Y basis are at 2 yr. lows.

The amount of progress in bringing down inflation has been impressive and the direction is clear even if non linear. Here in October, gas prices at the pump are falling on a near daily basis while shelter costs continue to decline and should be supportive of lower inflation prints in the coming months. None other than the San Fran Fed expects: “that shelter inflation will turn significantly negative by the summer of 2024”. We continue to think the Fed is done.

Manufacturing data continues to improve with China’s most recent Manuf PMI readings breaking back above 50 for the 1st time since March while the US ISM Manuf PMI hit 49 for the best # this yr. We expect to see that ISM # break above 50 in the coming months.  Here is a good data point from the WSJ: carloads of motor vehicles and car parts carried by U.S. railroads in the first week of October, up 18.9% from the same week last year following 15.2% annual growth in September, according to the Association of American Railroads.

We remain strongly of the view that we are in the early innings of a global cap ex boom to deal with the 3Cs of Covid, Climate & Conflict and view the negativity around global SC realignment as completely misguided as investment for EV battery plants and semi fab plants etc. rises in each of our three Tri Polar regions: Europe, Asia and the Americas.

Earnings are up next as we note solid US bank earnings kicking us off. Given that Q3 US GDP is likely to have run at a 3-4% annualized rate we expect Q3 to be the first Q in a year where Y/Y EPS is positive, setting the stage for BTE results coupled with reinforcement for the double digit EPS growth now being penciled in for 2024. Here’s Deutsche: “.. Macro growth in Q3 was solid and we see this driving earnings growth into clearly positive territory on a yoy basis (4.9%) and, more importantly in our view, the level of earnings up sequentially for a third straight quarter to a new high.” 👀 [Chadha].

FactSet reports that analysts expect profits among S&P 500 companies to rise about 7.8% in the fourth quarter and 12% in 2024. Focus on the earnings picture – it is what drives stocks, not geopolitics, not rates, not talking heads – earnings and if earnings are fine then stocks can rise without multiple expansion. As we have discussed, the ROW offers room for both EPS growth & multiple expansion.

Finally, there is China where we continue to pound the table on it as the world’s best risk reward trade into YE given the exceedingly well known and hence discounted risks leading to a record wide valuation discount to US equity. That’s not all:  there is also record foreign selling of equity in August followed up by well above average selling last month as well, leaving foreign investor exposure at the lowest level since 2020.

Bloomberg reports that “pessimism is such that “short China equities” emerged as one of the biggest convictions among money managers in the latest Bank of America Corp. monthly survey.” Folks keep asking about China property as if they don’t know that the China RE bonds sell for pennies on the dollar and stocks are down 95%. Talking head point, yes… market moving point, no.

Catalysts for a run up into YE include very easy Y/Y comparisons given Q4 2022 marked China’s most intense lockdown phase. EU & US experience suggest it takes a year for post Covid consumer confidence to recover – that time frame is right around the corner for China. The Govt continues to make clear it seeks both structural & cyclical change with the latter focused on boosting consumption.

We updated out model portfolios this week as is our process (Monthly first – get all our thoughts in a row, followed by our model portfolio review & update & culminating in our client communication – that’s the TPW way) and noted several things of interest (well of interest to us at least).

Point one, virtually none of our holdings or BMs came close to the October 2022 low during the correction of the past few months – ACWI for example remains a solid 15% above that level. Point two, many holdings did retrace back to the March 2023 SVB lows and bounced nicely; it’s worth noting that XLF did not even get to those levels. Point three, Tech is the clear leader and the US likewise with SPY holding its 200 dmav while ACWX broke below led by EEM and EFA.

One of the more interesting points to us was that China and China tech in particular (KWEB) has been OPing US tech over the past 1 and 3 months. So tech leads stocks and China tech leads tech. Bonds remain in a deep bear market – we view the aggressive repricing seen over the past few weeks as simply the most recent Market Speed example. In just a few weeks the bond market gave up on its cherished recession call and has realigned with reality – that’s a good thing as long as nothing breaks in the process and we don’t think anything has or will.

UST bonds are in their worst bear market in perhaps ever and yet BofA’s fund manager survey reports 34 straight weeks of inflows into USTs for a total of $158B YTD vs $110B into stocks -  who are these masochists? We remain completely out of UST as we have been for the past two years – avoiding virtually all of the bear.

When it comes to tech we are with well known Wedbush tech analyst Dan Ives: “I think we are going to have an eye-opener type of parabolic move up in tech going into year-end,” says

Ives. “I believe tech rips higher from here.”

We didn’t make many changes to the model – added to our China & US tech holdings and Uranium in our Climate sleeve. We put our $ where our mouth is. Reach out to learn more about our Model Portfolio Delivery Service (MPDS).

I had the pleasure of being back on Schwab’s Morning Trade show with Oliver Renick Wednesday – take a look.https://schwabnetwork.com/video/disinflation-continues-global-manufacturing-revival-in-2024

Stay on the trail & enjoy the view.