Look To The East

1,070 words – a 3 minute read.

YTD cross asset market action stuffs what seems like a full year’s worth of volatility in two weeks with enough diverse data points, market spikes (rates) and drops (Nasdaq) to leave one’s head spinning. It goes without saying that a spinning head is not conducive to great investing!

Thus the need for a plan, a framework, a replicable process to keep one grounded amidst the storm. No guarantees that one’s process is going to always work (in fact it won’t) but it should provide one comfort when navigating rough seas.

We have such a process with our Tri Polar World framework, Global Risk Nexus & our Monthly writeup, Model Portfolio Review and client communication process, all of which has taken place since the year began.

Our January Monthly  The Fog Lifts, laid out our view that Omicron will mark the beginning of the shift from pandemic Covid to endemic. 2022 will be a year of gradual clarity, allowing for an early cycle, synchronized global expansion fueled by higher than average nominal global growth and sustained by negative real rates within the DM. This combination: higher nominal growth rates and sustained negative real yields provides a solid backdrop for earnings growth and risk asset price appreciation.

JPM notes the 9% consensus 2022 US EPS growth estimate but points out that the nominal growth rates it expects this year (roughly 5-7%) typically comes with 15-20% EPS gains – suggesting upside earnings surprises over the course of the year. We expect strong consumer demand, inventory rebuilding and a cap ex boom coupled with an accelerated, tech inspired, productivity surge to lead to a period of above trend global growth a la the 2H of the 1990s – this time though it will be global given infrastructure needs, fiscal spending in Europe, Japan and elsewhere and climate mitigation. 

Current market performance is in fact tracking most closely with that of the 1995-96 period – a coincidence perhaps but perhaps a signal as to what is coming in the years ahead (1995-1999 analogue > 5 straight years of 20% + SPY returns) – a prospect that is not at all in the price of virtually any financial asset anywhere.

Our Musings  a month ago was titled: Sell the Rumor, Buy the News… more recently we have noted our sense of peak Fed hawkishness. Wednesday’s CPI print provided a perfect illustration of both. A 7% CPI print, the highest in 40 years & yet bonds rallied, stocks rose, Commodities soared and the USD rolled over with its weakest days in 6 months.

The USD is the key – sustained USD weakness (as we expect and as has occurred during the bulk of Fed tightening cycles) will catalyze flows into the ROW, give Commodities another leg up, reinforce yield curve steepening and facilitate the Growth – Value rotation.

It strikes me then that from a Tri Polar World perspective we should be looking to the East, east to Asia, to Japan which has been all but ignored by investors, east to China which was one of last year’s worst performing equity markets. Asia is the laggard region both in terms of economic recovery as well as stock market performance – if we are to have a synchronized global expansion then Asia needs to participate and as such we should be quite well rewarded for our significant cross asset Asian OW. Foreign investors now hold roughly 5% of China onshore equity and 10% of CGBs vs 0.5% and 5% in 2017. For some context, note that after a decade + of US financial asset OP, foreign investors now hold roughly 40% of US equity and 35% of UST.

Writing this I confess to a little bit of foreboding given that some years ago, 2018 to be exact, I had a similar geographic portfolio bet on which I called Go South, South to SE Asia, Southern Europe and S America based on an expanding global economy. That strategy fell foul to a Fed tightening cycle into a late cycle global economy. 

Today however there are significant differences : first, we are early cycle in the global expansion; secondly, the global economy is at a sharply higher nominal growth rate as noted; third real rates, even after the US back up of the past few weeks, remain negative, unlike 2018 when real rates were already positive before the Fed started to hike and finally in 2018 the USD was strong as opposed to rolling over as it is at present. On a DXY basis some forecasters are calling for the USD to decline from recent highs around 97 to the low 80s, a 15% decline.

My former MS colleague, Stephen Jen, was out with a note today discussing China’s monster trade surplus and strong, well supported RMB, noting that he could see it break 6 to the USD over the course of this year (now 6.35). The Japanese Yen is at a 6 year low vs the USD – JPM notes that it is at a record low on a real effective exchange rate basis.

Perhaps most importantly, Japan and China (and that’s what I mean by Look East) are capable of implementing their own policy mix unlike the Go South countries. We expect significant fiscal policy easing in Japan & the best growth in over a decade and have noted China’s full policy quiver as part of our China 2022 glide path thesis. Recent weak inflation readings in China could set the stage for easing ahead of the Lunar New Year celebrations at month end. China’s recent shift from Zero covid to dynamic clearing is a great example of policy flexibility.

Everyone is worried about inflation – should it perk up in Japan it could stimulate a wholesale domestic reallocation from bonds to stocks – 5 year JGBs yields are already at 6 year highs. Everyone is worried about China property risk – should domestic investors conclude property is no longer the one way street it has been then stocks become the next place to go.

We see limited downside and significant upside to these markets over the course of this year -  a perspective that came through in our recent model portfolio update sent to clients over the past few days.

Today marks the one year anniversary of TPW Advisory’s launch – thanks to all for your support, questions and engagement – onward!