No Need To Chase

1325 words – a 4 minute read.

We have written extensively about  cross asset market dynamics going back to Things I Don’t Understand  last October to Stocks & Bonds - Only One Can Be Right to last week’s Two Steps Forward, One Step Back. It seems fitting to unite these thoughts this week when the US narrative flipped from recession and rate cuts to no landing, solid growth and no rate cuts but rather more rate hikes.

We covered this dynamic in our most recent Monthly: Narrative Speed  where we discussed how narratives are flipping faster than ever and the avalanche effect of small changes leading to one big cumulative moment when the script is flipped. In this most recent case, we had several US data points: jobs, inflation, retail sales, manufacturing etc. all coming in stronger than expected leading to this abrupt shift in narrative.

 BofA’s FMS survey is always a good herd indicator – remember “the year of the bond”? Its most recent report noted that recession odds peaked at 77% in Nov and had fallen to 24% last week -  the lowest since last June. We have gone from the most anticipated recession ever to worrying about a too hot economy and the Fed needing to raise to 6% - all in matter of weeks – narrative speed…

This narrative shift coincides with seasonality that suggests a period of digestion for US equity as our friends at All Star Charts point out. A messy February fits right in with the normal seasonal pattern of the SPY. Given the sharp cross border equity rally of the past few months this is a normal and healthy development in our view. To wit all major equity indices are up over the past 3 months led by Europe and China up roughly 12% leading to ACWX up 7% OPing the SPY up 2%.

YTD, the performance data have a tighter fit with ACWX  & SPY both up roughly 6%. What’s also interesting is the fixed income performance with AGG and TLT both flat over the 3 month and YTD periods as bonds have given back all their start to the year rally – something we discussed recently with Jon Ferro on BTV  where we suggested the bond rally was a head fake & more recently when we noted that bonds had been turned back by their 200DR levels. 

The surprise has been the strength of Big Tech even in the face of the bond selloff with QQQs up roughly 12% YTD. We continue to think the US will underperform the ROW given its heavy tech weight which should serve as an anchor in a world where the US does not fall into recession and the Fed does not cut rates but rather goes on an extended pause. After all the recent machinations, Marc Chandler of Bannockburn tells us that the FFR futures are still pricing in a 25 bp hike in March and a slight likelihood of rate cuts in Q4 2023.

Here its worth noting that of the many Fed voices speaking to markets neither Bullard nor Meister are voting members and so their more hawkish views should be taken for what they are (views) rather than implying what the Fed will do policy wise. Our view is that the strength of the US economy has been overstated by the recent data points; we expect continued disinflation over the coming quarters especially given the weight of the shelter component and the known path of that data coupled with easier y/y comps in coming months.

Amidst all the back & forth in the US our Tri Polar World framework keeps us abreast of continued progress in Asia towards economic recovery and a new, China led, growth cycle. Already Asian liquidity has proven to be supportive of global risk assets with both the BOJ and PBOC injecting significant liquidity into their markets. The folks at CrossBorder Capital recently wrote that according to their analysis China has added 3.5x the liquidity provided over the past 2 years in just the past 2 months!

On the Covid front, China’s CDC has reported that Covid related deaths are down 98% since the January peak which jives with various mobility indicators ranging from air traffic to auto and subway usage. It further reported that over 90% of the population has had two vaccine shots so significant headway there as well. One can salt these #s to taste but the direction is what counts & China is moving past Covid which is V bullish for global growth & risk assets.

In addition, we noted several recent pieces of good news on the China property front including the first upgrade of a China property company’s outlook by a major rating agency (S&P Global Ratings – Longfor from Negative to Stable) since mid last year as well as the first month since August 2021 where China new house prices did not fall. As a reminder we see China going for growth via domestic consumption as policy makers recognize the link between property prices, consumer confidence and consumption.

All this gives us confidence in our view that China and Asia more broadly will lead a desynchronized global economy into recovery and a new growth cycle as the year progresses. Thus, we remain OW both Japanese and Chinese equity in our Global Multi Asset (GMA) Model. We are OW EM assets as well; here William Blair’s recent note caught our eye as it noted that the EM equity bear market at over 600 days has more than doubled the average bear of under 300 days. It went on to suggest: “The EM bear market is long in the tooth in terms of time, price, and multiples. Earnings expectations have already been cut, and many EMs are well ahead of developed markets in monetary tightening.” We agree.

On the DM side, we note the likely new BOJ Gov Ueda will take over from Gov Kuroda at the April BOJ meet. We expect a gradual loosening of YCC, the beginning of a JGB bear market and significant domestic allocation shift to equity. Japan’s MOF data suggests this process has already begun noting that Japanese institutions sold a record $181B in foreign securities in 2022, buying $231B of domestic bonds (soon to be underwater). JPM notes there is a further $2T that could be sold and figures that the current .5% yield on the 10 yr. JGB is more attractive than the -1.3% yen hedged yield from 10 yr. UST. Maybe the bond supply demand argument is not as clear cut as some imagine. We expect some domestic reallocation out of bonds into stocks.

As we have suggested, we do not feel capable of trading in and out of the markets as narratives flip and assets skip. We have a POV, are positioned for it and see it playing out. As such we want to ride though the digestion phase, expecting cross asset volatility to decline over the course of the year as macro vocality ebbs, CBs shift from rate hiking to pause and in EM, the beginnings of a rate cutting cycle. This ties into our FI focus on HY where we noted JPM just CUT its FY 2023 US HY default rate from 3% to 2% while keeping FY 2024 at 2.5%.

Thus, one does not need to chase but when markets pull back and one’s thesis remains intact then that’s the opportunity to establish, build, flesh out positions at attractive entry points as the trading community dumps that which has given them double digit returns in mere months.

We discussed this and more in Wednesday’s inaugural FutureProof Webcast with Marta Norton of Morningstar and Barry Ritholz of Ritholz Asset Mgmt. It was a good discussion that could have gone on for hours but was a tight 50 minutes. Please enjoy the discussion here.