Stability Wanted - $1T Reward

1620 words – a 4 minute read.

 A little more than a year ago we published our 2023 Outlook titled: Stability Ahead? As we enter Fall (first morning where I needed a jacket in NYC – 59 degrees) and start to look into 2024, stability does seem to be approaching, especially if one goes by the forward looking instincts of the financial markets.

A few #s that jumped out at me this morning; first was the VIX under 13 – its lowest level in roughly 3.5 years (the Covid Years + inflation and Fed response period). BofA reminded us that in September 2020, 3 years ago, NYC restaurants were not allowed to serve inside and NY students were not allowed to attend classes.

A second # which made even more of an impression is the MOVE Index which measures UST volatility – it hit 97 this morning – lowest since Feb 2022 when the Fed ramped up its rate tightening cycle.

The third # that struck me was in BofA’s flow report where it highlighted the $1T with a T inflow into US money market funds so far this year – on track for a record $1.4T inflow. Now some of that inflow is due to the higher rates folks can get post the Fed action but we would argue a big part is due to the uncertainty that has existed and manifested in the SVB failure, declining Y/Y S&P earnings and the weak performance of an oversupplied UST market.

Should stability manifest, and sure a Govt shutdown is also likely to be right in front of us but history says they don’t last long, so if stability returns  – no more Covid, inflation spikes, rate hikes, bank failures etc. etc. then we want to be thinking about two things – signposts along the way & then where in the cross asset global landscape will that trillion dollar reward money go. Another way of thinking about it  is via the AAII survey which has now gone a record 36 weeks with more bears than bulls – the next longest ( outside Covid) was 22 weeks in 1990 according to the FINOM Group.

Here we dovetail with our recent work on transitions and traction. Arguably we are transitioning to stability and during times of transition we want to focus on what gains traction  to help us understand where we are heading. In a BTV interview Monday we focused on four areas to assess that traction in a time of transition  to stability and the trillion dollar unlock. https://www.bloomberg.com/news/videos/2023-09-11/fed-will-double-2023-gdp-forecast-tpw-s-pelosky-says?sref=ftskAWJe

First is the continuation of the disinflation trend we have observed in both the US and Europe; second is the manufacturing rebound we foresee as robust consumers underpinned by a fully employed populace and real income gains drive the transition from inventory de stocking to restocking. Third, continued traction in the earnings revision process whereby rising earnings estimates support stock prices especially in the US – ROW can look forward to not only rising earnings but also near record low valuations, especially on a relative basis (China, Europe, Japan, much of EM). Fourth and finally, China itself with our focus on when the drips & drabs of policy support gain traction and underpin an economic pick up.

Should these four areas gain traction as we expect they will drive the transition from uncertainty to stability and further improve consumption on the consumer side and a desire to invest on the corporate side, all of which should support risk asset pricing.

Both are arguably already underway with clear signs of C suite shift from ever increasing buybacks to rising cap ex levels to deal with our long standing 3 Cs of Covid, Climate & Conflict. JPM notes that as of Q2 over 60% of S&P companies reported increased cap ex spending.

As we transition from a myopic focus on monetary policy to a focus on fiscal policy in the US and Europe, from deflation fears to an embrace of inflation in Japan and from Covid fears to consumption pleasures in China these four areas will serve as our measuring sticks. Speaking of the shift to fiscal focus, BofA notes the following: Global government expenditure on public sector, infrastructure, war, net zero commitments...$2.4tn in fiscal stimulus past 18 months across developed markets.

On the disinflation front we expect the Fed to be done raising rates with real rates at roughly 2% and falling rent prices providing support to a continued slow roll down of inflation. The ECB also looks to be done raising rates – we expect several months of very easy Y/Y inflation comps ahead which should relieve some of Europe’s angst. This week’s blasé cross asset reaction to both the US CPI print and ECB rate hike tell one all we need to know. The growing # of EMs that have embarked on rate cutting cycles (Peru the latest) reinforces this trend.

The latest US retail sales data support the construct of a manufacturing recovery as does continued inventory de stocking and cap ex across the nonresidential space. Housing remains robust – talk about a need to restock inventory. We expect Manuf PMIs in both the US and China to break back above 50 in the coming months. China is almost there at 49.7 in August while the US Manuf PMI has been under 50 for almost 3 years – more than 2x the average period.

Here is the US Commerce Dept: Wholesale inventories in the U.S. fell 0.2% in July. It is the second straight monthly decline. The inventory-to-sales ratio fell to 1.39 months in July from 1.41 months in the prior month. This is the lowest ratio since February. With an improving new orders to inventory ratio, history suggests buying stocks when the ISM is under 50 but rising which is where we are likely to be in the coming months.

 A US consumer enjoying record Household Net Worth and real income gains alongside full employment is likely to remain a robust consumer. The Fed reported that US household net worth jumped to a record in the second quarter as the value of real estate holdings and stocks rose. Household net worth increased $5.5 trillion, or 3.7%, in the April-June period to $154.3 trillion.

All the above supports an improving earnings picture with Q3 forecast to be the first quarter with positive Y/Y earnings gain this year, a pace that is expected to pick up into 2024. FactSet currently has roughly 12% EPS growth next year as consensus. Improving earnings revisions is a global trend BTW, with all regions but China showing a pick up. We noted in that BTV interview that we expect the Fed next week to more than double its 2023 GDP forecast and raise its 2024 forecast as well.

One area we don’t expect to gain traction is continued USD strength – after 8 up weeks in a row we expect clear signals that the Fed is less likely to raise rates again to cool off the USD bounce which in turn should support offshore earnings. On the US equity market side our buddy JC at All Star Charts notes that credit and the consumer are both breaking upwards vs UST and Staples (HYG/IEi and XLY/XLP).

China has been a huge topic of discussion over the past few months with the Economist devoting back to back covers to its shortfalls – as a noted contrarian indicator, the Economist cover curse is almost itself worth going against. When one adds in the multitude of policy measures increasingly tailored to combustion and property – 2 sides of the same coin- one can feel pretty good on a six month view that China will soon be moving at a faster pace.

The data is increasingly  supportive of such with August’s trade #s, vilified in Western press but actually BTE and up m/m, today’s retail sales and industrial production numbers – both BTE and up M/M etc. Throw in record low valuation vs the US and record foreign selling of Chinese equity last month and the risk reward looks PG – at least from this armchair.  Alpine Macro notes that Chinese equity has already stopped UPing vs broad EM & DM; we remain OW Chinese equity.

Speaking of our positions we held our monthly portfolio meeting this week for our two model portfolios – our Global Multi Asset (GMA) and our TPW 20 thematic model – one clear takeaway was  that GMA leadership over the latest period was Commodity heavy – with four of our top five positions Commodity related led by URNM, as the climate focus found the mismatch between a growing need for stable baseline power and a lack of uranium supply. URNM also led the TPW 20 performance sweepstakes over the period.

It was interesting to note how GSG, our Commodity index proxy, rose 18% over the past three months vs ACWI up 1% and AGG down 3%. Over the past month however, GSG rose 4.5% yet the AGG only fell .5%, suggesting less worry over the inflationary impact of rising energy prices, with which we concur. To us this price action suggests that the stability we are looking for is starting to manifest itself in cross asset price action.

We made very few changes to either model – comfortable with our Equity OW, FI UW and Commodity OW in the GMA and our Future Tech OW in the TPW 20. New money areas of emphasis remain EM debt & equity and the Commodity space though the energy slice is O/B right here. Reach out if you would like to learn more about our Model Portfolio Delivery Service (MPDS).

Enjoy the first Fall weekend – we look forward to another Duke Football W and breaking into the Top 20 Football (not basketball) rankings! GO DUKE!