Plus Ca Change

1860 words – a 5 minute read.

Trust all had a wonderful 4th! Our last Musings was titled R stands for Resilient, R stands for Rotation and boy did we get a hint of rotation after yesterday’s soft CPI print (1st CPI decline in 3 yrs. as shelter finally cools). Bespoke notes it was a record one day performance spread between Small Caps and Nasdaq while our buddies at All Star charts point out that IWM, the small cap ETF, hit a new 52 week high.

They say rotation is the lifeblood of bull markets and it sure seems like a broadening out and rotation to ex tech would go a long way to sustaining the bull. The groundwork has been laid with a healthy pullback and digestion of the ex tech space over the past few months, an adjustment via time not price, leaving all 11 S&P sectors above their 200 dmav.

Even within tech there has been some interesting rotation with Nasdaq hitting regular new highs even though the AI poster child and lead dog, Nvidia, hit its most recent high back in June. With earnings seasons now upon us and consensus calling for 9% Y/Y EPS growth (best since Q1 2022) as non tech earnings start to inflect upward it would seem both fundamentals and technicals are lining up. We remain constructive on risk assets.

That set up brings us to today’s title which is fancy French for saying: the more things change, the more they remain the same. It’s a favorite of mine and one that struck me the other day at the gym, which is where I get most of my titles. I was watching TV while huffing and puffing away and it was just more of the same – beating up on old Joe Biden. It’s been that way for weeks – the more things change, the more they remain the same.

What’s also remained the same are the two candidates’ poll #s for all intents and purposes. 538’s combo of polls has Trump ahead by 2% - well within the margin of error; Trump had a bigger lead in the Spring and Biden’s #s were lower then than they are today – after one of the most one sided media attack frenzies of all time (NYT has written over 190 pieces on Biden’s age and cognition since the debate – V few of them favorable).

For all the negativity heaped on Biden, he is still in the game and his opponent, who somehow escapes serious media scrutiny for his litany of lies, felonies, sexual predator acts and so much more, has not been able to pull away. This suggests that Trump’s poll numbers are capped & capped well below 50%.

Hated bull markets tend to be bull markets that carry on for some time, converting haters into buyers as time passes. Biden has to be the most media hated incumbent president in recent memory; certainly, the most hated among those with such a tremendous track record of success as a President. He has led the most successful Administration in terms of economic performance in modern history and yet the press feels duped and misled. 

Will Fightin Joe Biden have the same effect as hated bull markets and convert the press into buyers or at least two handed economists? The choice between continuation of the Biden economic policy mix vs Trump’s is an absolute no brainer.

Trump, the former President and now convicted felon, has a policy program (if you can call it that) that includes across the board tariffs that will raise inflation together with an un-American mass deportation policy that the Peterson Inst has reported with cause inflation to pick up even more as it dislocates the job market (most  immigrants work – who knew) pushes up wage pressures and slows the economy. This of course is before we discuss Project 2025, which Fintwit notes has been checked on social media more than Taylor Swift and the NFL!

Why the extended focus on politics? Well, the more things change, the more they remain the same. We have had several EU political contests of late, European Parliamentary elections a few weeks back and then the French elections more recently. In both cases the right wing was expected to make big gains with polls suggesting a right-wing landslide in France for example. And guess what, no such thing occurred. The polls were completely wrong, the right wing didn’t make massive gains in either Europe as a whole or in France.

But here’s the thing – from an investment perspective much of this is just hot air – a distraction, a way to lose focus on what counts (like this from Dr. Ed Yardeni: “the percent of the S&P 500 companies with positive three-month percent changes in their forward earnings has been increasing. The latter was up to 83.2% during the June 28 week. That's bullish for a broadening of the stock market rally, in our opinion.”)

EU assets are right back to where they were before all this political brouhaha, with the Euro around 1.09, European growth stocks near new highs (EFG) while the French – German bond spread has calmed considerably and French stocks have regained much of the knee jerk selloff. The more things change, the more they remain the same.

Will it be the same in the US over the coming months? That is the real Q. The rotation noted at the top is a very positive development given that many key players are underweight ex tech as one could tell from yesterday big moves in things like small caps and rate sensitive segments. BofA reports hedge funds have their lightest equity exposure since 2009!

Interestingly it was not broad credit that did well but homebuilders (XHB) and instruments that would benefit from a Fed rate cutting cycle like CRE & mortgage related segments. We own ACRE for example in our Global Multi Asset (GMA) model; it was up close to 6% yesterday. We also note the potential for thematics to benefit from lower rates and easier access to credit – Bio tech seems to be leading that charge (GMA holds XBI, +5% yesterday).

Given our global macro surprise #1, lower inflation, sooner than expected, is playing out on both sides of the Atlantic (EU 2.5% Y/Y) and given that June was the 1st month in almost 4 yrs. without a major CB raising rates, a Fed rate cut, now firmly penciled in for September, would confirm that we are in a synchronized global rate cutting cycle. JPM expects it to be the most synchronized rate cutting cycle since 1985 (almost 40 yrs.!) with 80% of the world’s CBs cutting rates by Q4.

That in turn, helps sustain surprise #3, return to stability (VIX at record low for July in an election yr.) and underpins surprise #4, that we are early cycle in a global economic recovery, not late. Here’s Ren Mac: “Global manufacturing PMIs point to a continued rebound in factory activity through June. By our count, 60% of manufacturing PMIs that we track are in expansion territory. This is the highest level since mid-2022.”

Note, we wrote these surprises as part of our 2024 Outlook in late October 2023. The more things change, the more they remain the same.

What worries us here at TPW Advisory is the rising risk of a Fed reversal over the next 6 months or so. We expect the Fed to cut in September, given the inflation & jobs data it risks being irresponsible if it doesn’t cut. But what if Trump wins (we don’t expect him to); will markets panic and price in the inflation rising, growth slowing, Trump economy at risk of stagflation or worse? Trump’s first term was a picture of fiscal incontinence – adding almost twice as much to the national debt as Biden has. A 2nd Trump term would likely be worse.

The number of well respected economists (16 Nobel Laureates) and firms like Moody’s & the Peterson Inst etc. that forecast such an outcome suggests the risk is real and not priced in – especially in the USD and rates. Here's a quote from the Peterson report: “Real GDP would be reduced by 12 percent if 7.5 million workers were deported and by 2.1 percent if 1.3 million were deported.” Goldman Sachs economists modeled Trump's tariff proposals and found they would add 1.1 percentage points to the U.S. inflation rate and subtract half a percentage point from GDP growth.

We got a taste of the risk to the long end of the UST curve right after the now infamous Presidential debate when yields at the long end of the UST curve bounced sharply higher (TLT). Now higher rates would seem to be USD supportive but one can envision an environment of rising rates and a falling USD as massively OW & suddenly fearful foreign investors take some USD off the table.

Would the Fed be bounced into a rate hike? Deficit fears already exist in the US; Trump’s plans - especially his desire to extend his tax cuts - risk blowing the deficit wide open. Would investors conclude US policy is frozen or chaotic or uncertain? Would DXY turn tail and break under 100? Would non-US equity markets finally take leadership? The choice between continuation of the Biden economic policy mix vs Trump’s is an absolute no brainer.

One area to pay attention to in the next few weeks is China; its Third Plenum starts next week and while the outcome is pretty much up in the air (Bloomberg & FT had two stories over the past few days – stories with completely different takes on the likely outcome) China is an important component in how the global economy and financial assets perform on a go forward basis.

We received a portfolio update this week from a long-standing China growth stock manager – one of the most experienced in the business. Her portfolio trades at 17x forward (2025) EPS with expected EPS growth rates of 28%. Of great interest to us at TPW, her large cap growth focus has been an underperformer YTD as China equity has been led by SOEs. Quite different from the US big cap leadership. US stocks have the Fed put; China stocks have Big Govt which cracked down again on shorts & quants this week.

We remain constructive on our two tech stack divide thesis which suggests China tech (KWEB – also a GMA holding) is the real global tech opportunity as China ensures China tech is for Chinese companies, much as the US is doing here. The difference is China tech is loathed, trades at a massive discount to US peers and competes in an ecommerce market that is 2x the size of that in the US growing twice as fast. 

These are some of the issues we expect will be focal points in the 2nd H of the year and ones we expect to be paying close attention to here at TPW Advisory. There is always something to study, learn, price and invest in – that’s the beauty of the game – plus ca change.

TGIF people!