Iron Sharpens Iron

1767 words – a 4 minute read.

Today’s title comes from the O line room @ dear old Duke. As a former member of that group, I always like it when the big fellas lead. Iron Sharpens Iron was a social media quote from a Duke O lineman noting that when new O line guys come in via the transfer portal they make the existing guys better – just like iron sharpens iron. A little research shows the phrase goes back to Biblical times and implies we are better together than separately much as one iron blade by itself gets dull, two iron blades working together stay sharp.

There are many such iron vs iron opportunities in policy and market circles these days – IMF/WB outlooks vs Larry Summers is one, US sell side equity analysts’ 2H earnings acceleration outlook vs bond investors positioning for 2H rate cuts, another. A big one is expressed by the trading range around S&P 4k that is getting long in the tooth as longs & shorts fight it out while Central Banks prepare to shift off the most aggressive rate hiking cycle in 40 years and an Asian growth liftoff competes with slower US and EU growth. TopDown Charts may encapsulate it best with a record reading of its Bullish Technical & Bearish Fundamentals index. Iron sharpens iron – I like it.

It has been roughly one month since the SVB failure and subsequent sale of Signature Bank here in the US and the shotgun sale of CS in Europe. These bank failures served to exacerbate the Fear, Uncertainty & Doubt (FUD) curtain we highlighted in our Monthly takeoff of the Wizard of Oz. These bank failures also served to reinforce recession calls & positioning across equity & fixed income assets, now augmented by worries about credit crunch, deposit flight etc. etc.

We continue to think much of this is FUD based fear mongering, now reinforced by the just released IMF and World Bank outlooks which likewise call for slow growth this year and incorporate the lowest 5 yr. forward global growth estimates (3%) since 1990. The two entities have clearly adopted the FI markets’ framework of a return to the low inflation, low growth world that predated Covid.

A good buddy & fellow market professional in attendance at the WB/IMF annual meeting reports pervasive negativity & FUD noting that a survey of those in attendance recorded 85% as expecting a recession in the next 12 months. Money quote: “Never seen such bearishness in 30 years of attendance”. Like Davos it usually pays to go against the WB/IMF consensus.

At TPW Advisory, we have taken the other side & strongly believe this outlook is incorrect. In particular, it fails to take into account the major policy changes we see unfolding behind the FUD curtain. These include DM Central Banks’ willingness to accept a slightly higher inflation target (3% or so), the return of US Industrial policy after a near 70 year absence, Europe’s growing integration across energy, defense, tech & climate, the end of Japan’s YCC policy and China’s economic policy shift from fixed asset investment & export led growth to domestic demand led growth.

Taken together, these policy shifts should lead to a cap ex boom & higher global nominal growth path which, as we have discussed since early last year, will in turn help underpin corporate revenue and profit growth which are both expressed in nominal terms. As we enter earnings season, Bloomberg consensus views Q1 as the S&P earnings trough with a -8% Y/Y EPS performance followed by a 4% Y/Y decline in Q2, flat Q3 before high single digit EPS growth in Q4 and low double digit EPS growth in Q1 2024. Notwithstanding today’s “earnings recession” headlines – my God will they never give up…we expect Q1 earnings to beat this low bar. Today’s bank results suggest we are off to a good start though it’s the outlook that counts.

Given those estimates it is obvious that the sell side does not see a 2H recession which puts it at odds with fixed income investors who clearly do. The FI investor POV is most clearly expressed by the FFF pricing in multiple 2H rate cuts to end 2023 with a FFR of roughly 4.3% vs 5% currently. While iron sharpens iron, someone usually wins the battle; it will be interesting to see which group has it right – Wall St sell side equity analysts or fixed income investors – one group is likely to be wrong.

Our bet is that the sell side has it right and the US will not fall into recession this year in large part because of the unfolding policy shifts we note above, especially the public – private nature of the Industrial Policy spending which protects it from any prospective the credit crunch; fears of which appear quite overblown to begin with. US nonresidential construction in February was up 17% Y/Y while the backlog of US nonresidential projects under contract but not yet started was 9.2 months in February, more than a month longer than February 2022, according to the Associated Builders and Contractors Inc.

We updated our two model portfolios this week (our Global Multi Asset (GMA) flagship & TPW 20 global thematic model); as part of our process we run through the charts for all our holdings, the broad indices and any new ETFs we are considering. This is a useful exercise, especially when the fundamentals are in such dispute as they are today. Price can tell us a lot.

Our main technical takeaways include that the broad equity & Commodity markets have already recovered all their post SVB declines and in many cases are back above their pre SVB failure levels suggesting very low concern about recession, credit crunch risk etc. Junk-bond spreads peaked at around 5.5% last September and ended the year around 4.9%; the post SVB peak was 5.2%. They're now at 4.7%. Most traders believe spreads would rise significantly during a severe recession, so falling spreads reflect a calmer view about potential economic danger ahead. On the UST side, the MOVE index broke under 120 today and is firmly back in the channel of the past 6 months – it peaked at over 200 during SVB.

Numerous equity charts reflect a double bottom occurring last July and October that corresponded to many positions falling below their 200D support levels. Subsequently the majority of our holdings and broad equity/Commodity indices have recovered back above their 200D support levels – a clear technical positive. In this regard March served as a good test; ACWX and EFA never broke their 200D support last month, reaffirming their global equity leadership position while the S&P did and subsequently recovered.

The broad equity gains YTD (ACWI +8%) coupled with commodity gains do not suggest imminent recession which remains the broad consensus call. The other consensus call is to invest in cash which is among the worst performing assets YTD; cash even underperformed in March – if cash doesn’t outperform when banks are failing, one has to wonder when it WILL help. Meanwhile cash is a big drag on performance YTD, for those who hold it. Our two models are fully invested.

We are watching two indices in particular for go forward guidance; one is the Barclays AGG which is holding just above its 200D support – we expect it to break support as bonds price out recession and rate cuts in the coming months, capping Big Tech equity & validating our no recession call. Along the same lines, we are watching for our Commodity index (GSG) to break back above its 200DR level – both need to happen to confirm our BTE global growth outlook.

We note the continued decline of the USD which just hit a new YTD low this week; $ weakness remains a key theme of ours and a driver to our non US equity OW and EM bond allocations. Speaking of EM one of the more interesting performance relationships we noted was that over the past 6 months EEM and SPY have performed in line with each other – not what the man on the street would expect. We have been building an EM equity and FI OW over that same timeframe & expect these assets to outperform the US this year.

As Covid fades and we pass through its inflation fall out, we are positioned for our “Middle Path” thesis to unfold.  We take comfort from the positive risk asset performance in March – the same month as the worst bank failures since the GFC and risk is UP. What does that tell you? It tells us to look behind the FUD curtain to better days ahead. We note that recent data releases including the March jobs & inflation reports support the Middle Path thesis as does March’s Global Composite PMI release at 53.4 (Feb 52.1), a nine month high.

We also expect the long, 240+ day trading range (average 255 days) during which the SPY has been chopping around the 4k level to end with the May Fed meeting as the catalyst.  We expect the Fed to go on hold next month – either with or without another 25 bp hike. The main takeaway is going to be the Fed on hold post May. That in turn should lead to continued USD weakness, EM rate cuts, non US equity OP and the SPY breaking up and out of its trading range rather than breaking down and testing last Fall’s lows. John Kolovos of MRA Advisors notes 4200 as upside resistance.

As such we want to continue to reward strength in the GMA model and so made a small number of changes this month (available only to TPW Advisory clients). We remain OW equity, UW FI and OW Commodities with a focus on non US equity (OW both DM x US and EM) and credit over sovereign in FI. Our Commodity OW stretches across the complex from energy to industrial metals and on to gold miners which topped the performance charts over the latest period. As the macro outlook stabilizes, we expect Climate to recapture attention as the single biggest global macro theme and remain OW in our TPW 20 thematic model. Reach out if you wish to learn more about our Model Portfolio Delivery Service (MPDS).

I had the pleasure of attending a spring football practice down at Duke a few weeks back – high end athleticism, energy and coaching were all on display… iron sharpening iron as the big fellas worked in the hot sun.. still inspiring after all these years.