Looking Back to Move Forward

1665 words – a 5 minute read.

Today’s Musings come straight from this morning’s 8 am BTV Surveillance show hit notes. The focus was on the IMF’s “tepid twenties” outlook (the crew were on location in DC), the Israel – Iran tit for tat and the risk that we could be heading for a 1970s style oil shock led inflationary period.

Before we get to those meaty subjects, host Jon Ferro also noted our Tri Polar World framework and asked me to elaborate on it which led to today’s title. Some of this week’s reading, particularly around the IMF’s “tepid twenties” growth outlook & its fears of a tariff, protectionism & deglobalization led weak growth period set the stage for a trip down memory lane.

We introduced the Tri Polar World (TPW – yes, it’s in the name) construct back in 2010-11 so almost 15 years ago now. It was written in response to the post GFC period of global policy maker abdication to the Central Bankers. This led me to suggest proactive policies to foster regional deepening in the world’s three main regions of Asia, Europe & the Americas could be a potential driver for global growth. This thesis was based on the observation that each region was demonstrating a growing ability to self finance, self produce and self consume. (Those curious can visit pelosky.com under the TPW tab for much, much more.)

These three abilities have exploded in each of the three regions during the post Covid years leading us to identify the 3 Cs of Covid, Climate & Conflict as catalysts for each region’s growing focus on ensuring it has what it needs in key areas. Talk about the power of 3!

While corporates have led, especially around supply chain regionalization, this has gradually translated into national/regional policy thus today’s headlines about industrial policy, reshoring, fiscal deficits etc. etc. The current focus on AI and EVs has led to each region’s desire to ensure it has semi fab capability, EV production capability, EV battery production capability etc.

Today’s tariff policy for example is leading Chinese EV makers to set up shop in Europe and the Americas, in just the latest evolution of each region’s ability to self produce. We see Chinese PE companies funding new rounds of China focused AI investment as the latest self financing example.

The third stage is self consume and here we note the evolution of a separate China tech stack as the US and China gradually freeze the other’s tech companies out of its information ecosystem. We believe this will create huge opportunities for Chinese tech companies in China and see Apple for example as the main US loser with its YTD smartphone shipments to China down over 30% as Huawei and Xiaomai gain ground. Thus Tim Cook to India & Indonesia as the stock breaks down.

We note EU policy makers discussing the need for a “paradigm shift” to stay relevant in the coming economic, social and political competition; a paradigm shift that requires European countries to do more together, to raise money jointly to fund defense, climate tech spending etc.

When asked on air how to invest in this evolving TPW we noted the 2 tech stack idea  (Splinternet) as one of our top suggestions – one we have written about recently. IMF research stating that China is likely to represent 21% of global growth over the coming 5 years – more than the G7 combined and almost double the US’s 12% just reinforces the opportunity set.

So as a global macro investor it seems incumbent on one to invest in China, the world’s single biggest source of growth with an E Commerce market twice that of the US, growing at double digit rates according to Krane, with a population nearly 4x larger & an economy growing at nearly double the US growth rate (China’s Q1 GDP growth BTE at 5.3% Y/Y).

Trivium notes: “The software and IT sectors – broadly covering China’s tech industry – grew by 13.7% y/y in Q1, up from 11.2% in the previous quarter.” When one adds that China tech is selling at a roughly 40-50% discount to US tech & its tech companies, like their US peers, are cash machines buying back stock hand over fist, the story just gets better (in last 2 weeks Alibaba, Ten Cent and JD have all announced major stock buyback programs). KWEB has OPed XLK over the past month though it did break back below its 200 dmav this week – it needs to reclaim it soon.

When talk turned to the Israeli overnight strike on Iran we were reminded to listen to markets as we wrote some weeks ago  – in this case Brent crude is down 5% from its high 2-3 weeks ago, suggesting more theatre than fight.

 The topic also provided a good lead in to discuss our Commodity sector OW with positions across the complex from energy to gold, to uranium and on to the recent big winner, copper.  We had a position in ag but mistakenly exited it. The risk of a 1970s inflationary period was raised; we pushed back hard noting that today the US is the world’s leading oil producer, that the ME has millions of barrels of spare capacity and longer term we are moving ever faster into the renewable energy age.

BofA produced some great tables this week showing the various asset class returns over the past 5 decades including the 1970s. Gold was by far the best performing asset during those disco days followed by stocks. No real surprise there – the precious metal that has been an inflation hedge forever and stocks as the modern inflation hedge.

We were interested in the 1990s performance because as regular readers know we see the 2023 -2027 period as being similar to the 1995-1999 period in the US; the difference being this time its global given our TPW thesis. The best assets to own in the 2nd H of the 90s were tech stocks then stocks in general and commodities.

That resonates & is in line with our Global Multi Asset (GMA) flagship model’s current allocations; heavily OW equities and Commodies paid for by a deep UW of FI.  We note that in the current risk asset correction, the commodity space has been a solid hedge against both US inflation & ME conflict fears as copper, gold and ag are all up 10% or more over the past month. GSG is up 2% while ACWI is down 2.5% led by US tech which in turn has been led by semis with SMH down 4%. AGG is also down 2% led by long duration UST as TLT is down 5% for the month, 10% YTD and 15% over the past year.

TLT’s performance tells us we are early cycle in a global economic recovery (macro surprise #4), one supported by a global rate cut cycle (NOT Fed led), abundant global liquidity, solid earnings growth and a rapidly globalizing stock buyback cycle. BTV opened this morning’s segment quoting last week’s Musings and our comment that we would be happy to trade rate cuts for earnings growth – we stand by that POV.

Recall 3-4 weeks ago it was all bubble talk with BTC surging, tech ripping, Truth Social (whatever that is) skyrocketing. Now with a healthy pullback all that crazy talk has ended. That’s a feature not a bug. We have gone from overbought to arguably oversold while Credit, Comm and EM equity performance (in line with ACWI) all suggest global growth is fine. News out of Germany suggests European growth is picking up while China has been the best performing major stock market over the past month down 1% vs. Europe down 2, SPY down 3% & TOPIX down 4%.

The 2nd idea we left the BTV folks with was our AI and energy barbell thesis. This really interests us as we see both sides having major legs. Notwithstanding some NT weakness from TSMC etc. the longer-term view on AI remains very robust; we expect it will fuel the semi space for years to come. Speaking of fuel, AI will also require enormous amounts of energy. We believe we are very early in both the AI and Commodity Ages.

The Nov – March risk asset run up exploited the NT opportunity set; folks who were behind the curve raced to catch up (we wrote “Catch Up Is Ok” a month ago) which of course ended in a Willie E Coyote move right off the cliff. Thus, the froth has been cleared; we remain focused forward, looking back at our TPW history to move forward in developing our TPW insights which include the view that every global investor needs to be adequately exposed to all three regions as each increasingly generates its own growth profile – right now the global investor base is heavily tilted to the US.

That’s been the right place to be; today’s question is will it be the right place going forward? The USD will likely play a major role here. We like the 3 legged TPW stool as both an investment approach as well as a global operating system. We view it as much more stable than dependence on the US consumer or Chinese stimulus.

Last thought – the IMF does a 5 yr. forward global growth forecast – we saw the chart this week – it’s a doozy, moving from north of 4% in the early 2000s to a near 5% peak just before the GFC and a straight shot lower ever since. We think the current 3% outlook will turn out to be incorrect in hindsight given our much more optimistic take on the 5 year forward view from 2023 on. We want to use our TPW look back to move forward process, not the IMF’s version. We see a BTE global growth cycle as presenting real opportunities for risk assets and look to healthy pullbacks as opportunities to identify and add to positions as suggested above.

Happy halving!