No More Mr. Narrow Market

2,035 words – a 5 minute read on the way to the beach!

We had the pleasure of guest hosting BTV’s Surveillance show yesterday morning for the 6 am hour; as usual the prep work is reflected here.

 We covered a lot of ground during the hour ranging from the massive and sudden rotation out of Big Tech into Small Caps, thematics & more to the global & US economic outlook following retail sales and industrial production reports and on to the state of US politics with one of the anchors reporting from the RNC convention.

Anchor Jon Ferro made the point about how busy and hectic the market tone was and contrasted it with the memory of dull summers past. It’s all about Speed – a subject we have written about at length here at TPW Advisory. As a coda to this exchange, I recently had dinner with several former MS buds – both still V active in the markets - and one noted how its algos not humans running the day to day market action, so they move to levels immediately, something that is apparent in watching charts (SMH) as well as the daily action.

Back to the BTV hour, suffice to say our views were differentiated. We noted how just as the narrow market, bad breadth chorus reached a crescendo it rolled over into one of the strongest and swiftest reversals & broadening outs seen over the past forty years. Historical studies suggest when small caps beat Nasdaq as they have over the past week it usually signals the beginnings of a strong and sustained up move. The move even featured a Whaley Breadth Thrust which is considered an important technical indicator suggesting that for small caps at least the party is just getting started.

We note that the Fund Strat folks expect a SC move similar to last Fall’s near 30% up move, noting that the median PE is only 10x 2025 EPS, the space is massively under owned and carries a large short position. GS notes that the short position work off is in “very early innings”. Small caps also benefit from lower rates given that roughly 50% of SC debt is floating rate vs only 10% for LCs. Here’s Ren Mac: “the one-day surge in the Russell 2000 against the large-cap Russell 1000 on July 11th was one of the four largest since 1980.  And of the three prior episodes, all occurred near a climactic broad-market low – in 1987, 2009 and 2020". We remain invested in our Small Cap position.

It’s important to note that the broadening out move we have witnessed these past few weeks is not only small caps. As part of our monthly model update (this week’s action), we review the technical positions of all our holdings in both models together with the major indices and any potential adds we are considering. The charts tell a story of a significant broadening out of the equity rally – in other words, no more Mr. Narrow Market!

We want to put the rotation in context with this week’s pullback, led by Big Tech but including some profit taking in the spaces that has run hard over the past month or so. Much like the economic data flow there are considerable equity cross currents to navigate. We feel pretty comfortable that this is a healthy retracement that works off the excess sentiment that has materialized. We like the move from cooling off Big tech to cooling off some other areas – all of which sets up for a continuation of the bull. 

Big Tech fears should be eased by TSMC’s results which were extremely strong. Here is a Bloomberg quote from its CEO: “The demand is so high, I have to work very hard to meet my customers’ demand. We continue to increase. I hope some time in 2025 or 2026, I can reach a balance. The supply continues to be very, very tight all the way into 2025."

 Carson notes that its been roughly 350 days since the last SPY 2% down move & contrasts that with the 1994-1996 period (our preferred analogue) when the SPY ran roughly 530 days without such.

Within the US, one notes thematics are starting to work as lower rates & easy financial conditions work their magic with Bio tech, fintech and robotics all breaking out to new highs. Same for the cap ex space with PAVE, the infrastructure ETF and GRID, the smart energy system ETF, both hitting new ATHs together with XLI, the Industrials ETF. We are pleased to note all these ETFs are holdings in either our Global Multi Asset (GMA) model or our TPW 20 thematic model – several are held in both.

It’s also critical to note the rally to new highs is global with ACWI and EFA both hitting new ATHs while ACWX and EEM both hit new 2 yr. highs. Global upside is huge; over the past decade EEM is up roughly 5%, EFA 30% and the US 175%! Stocks like good economic growth & easing CBs – a solid combo – given that many segments have been correcting for months there is plenty of upside. The WSJ reports: “The S&P 500 has been in a bull market for 437 days and has risen 56% since its 2022 low. To put this figure in context, the average bull market since 1957 has lasted 1,141 trading days --Dow Jones Market Data”. So, this bull is basically a teenager!

We remain grounded by our four for 24 global macro surprises which continue to materialize with surprise #1, lower inflation, sooner than expected, playing out on both sides of the Atlantic. The ECB has already begun its rate cutting cycle & the stage is set for the Fed to cut as part of what JPM expects to be the most synchronized global rate cutting cycle in 40 years. 

This is a key support to the pullback not breakdown view – sure we may have some chop for the next month or so but Sept is likely to see both ECB and Fed cutting rates & reminding investors CBs now have our back rather than stepping on our necks. Axios notes: “The Fed's main policy rate is 2.3 percentage points above inflation over the past year, as measured by the Consumer Price Index. A year ago, when the Fed last raised rates, the Fed funds rate was 1.8 percentage points above inflation.” There is room to cut.

Global macro surprise #3, return to stability, has also manifested in record low VIX and MOVE levels together with a collapse in inflation volatility. Here is Ironsides’ Barry Knapp: “our measure of price stability, the standard deviation of annualized all items CPI, has been steadily declining to the 4Q19 average of 20bp. Inflation volatility persisting below 50bp annualized is relatively rare; it occurred in the early ‘60s and in the late ‘90s, and both periods were very favorable investment environments in terms of real capital investment and equity market valuation, earnings and returns.” Already, the famed $6T money market mountain is starting to melt; StoneX notes that 1st H fund flows into equities rose over 60% Y/Y.

Finally, we see surprise #4, our early cycle not late thesis, playing out as Ren Mac notes that 60% of the global PMIs it tracks are in expansion mode; the highest percentage in 2 years. A synchronized global rate cutting cycle, expanding global industrial production & continued robust consumption should support sustained EPS growth in the US and abroad. Another fundamental reason why one wants to stay involved in cross asset risk markets.

There is always a fly in the ointment or in the house over summertime; our concerns center around a 2nd Trump term.  We will leave the convicted felon, insurrectionist, likely treasonist, fraudster and possible pedophile issues to the side (though come Nov we expect voters won’t). As investors we are focused on his likely economic agenda with its call for a weaker USD, mass deportations impacting the labor market, massive tariff hikes and continued tax cuts all of which suggest fiscal incontinence, slowing growth and rising inflation. Multiple independent studies have concluded the same: GS, Moody’s, the Peterson Inst, 16 Nobel Laurates etc. all have concluded the Trump economic policy mix is a negative for the US economy.

The contrast with the Biden record couldn’t be more stark with the US standing as the envy of the DM with its best in class post Covid growth and inflation results. Our global macro blue sky view encompassing the 2023 – 2027 period is pretty dependent on a Biden re election which remains our expectation notwithstanding the sustained media frenzy around the President. 

Its hard to square that media frenzy with the fact that polling site 538 has Biden winning the electoral college 277-263 (best since May) while the average of polls indicates a tight race, one well within the margin of error. We stand by the fact that Trump is deeply unpopular and has never cracked 48% of the vote; we highly doubt he will do so in this election either. The RNC convention viewing # are down sharply from 4 years ago; Trump’s acceptance speech was far from a home run etc. etc.

So, while NT we remain constructive on risk, our medium term concern (next 6 months) is that the equity market broadens out, the Fed cuts and then Trump wins and the USD goes south – the most over owned financial asset in the world takes a tumble, as markets price in Trumpian fiscal incontinence and the Fed finds itself in a box, having to raise rates just after it started to cut. We note Bloomberg’s reporting that China was a major seller of US financial assets YTD, especially UST. Could it be the signal amidst all the noise?

 We plan to do more work on this issue in the months ahead as we see the USD as the key that will determine which way bonds, stuck in a trading range the past 18 months or so, will break; if rates back up and bonds sell off one could see further dollar weakness as foreign investors lose confidence in US economic policy making while noting better days on their home shores. Dollar weakness is exactly what Trump, his VP and his trade team are calling for – TPW Advisory says be careful what you wish for. Higher rates would also challenge the thematic space.

Bottom line, we do not see the need to make many changes to our model portfolios. Our GMA remains fully invested as it has been for some 18 months or more now. OW global equity, deeply UW FI with zero UST exposure. We remain OW commodities which have failed to follow oil higher of late (GSG). We note copper is off close to 15% from May highs as China’s 3rd Plenum seems to have been a damp squib. Such a pullback remains healthy in the context of an early cycle global expansion that includes massive clean energy investments (if not soaring clean energy stocks). We did add back a position in Bitcoin to reflect the USD risk noted above.

We remain believers in our two tech stack divide thesis and are watching KWEB closely as it fights to stay above its 200dmav ($27). We take comfort from the following: “exclusive analysis from Bloomberg Economics forecasts the hi-tech sector will account for 19% of gross domestic product by 2026, up from 11% in 2018. Combining what Beijing has dubbed the “new three” — EVs, batteries and solar panels — the proportion of GDP swells to 23% of GDP by 2026, more than enough to fill the void from the ailing real estate sector, which is set to shrink from 24% to 16%.” The fact that virtually all this growth will be the province of China tech companies suggests an appealing risk reward set up.

In the case of our TPW 20 thematic model we remain sharply UW the renewable energy space which presents the sharp dichotomy between surging investment coming online with slumping stock prices due to excess capacity. This allows the model to deepen its positioning in the Future Tech space as well as infrastructure which we added to this month.