Straws In The Wind

1720 words – a 4 minute read.

Today’s Musings come straight from yesterday’s BTV hit notes, themselves a culmination of last Friday’s Monthly & this week’s model portfolio update & client note. All told from Friday to Friday we have written over 10k words (Monthly 7400, client note 1200, today’s Musings 1700) which is a lot!

We have really stretched our thinking, breaking new ground along the way. This process includes our distillation of 250 charts into 34 for the monthly, our TV prep & our review of close to 100 technical charts (all model holdings, BMs & potential adds) for our monthly model portfolio meeting. We may be wrong in our outlook but its not for lack of doing the work!

Speaking of outlook, we were pleased to see the head honchos of PE powerhouse Silver Lake use the same “pick & shovel” language for their AI focus as we have deployed. We continue to feel that’s the best way to play both the AI/Digital space (semis) as well as the physical space  (commodity miners). As part of our model update, we extended this line of thinking to include water and Nat gas as two additional elements that we expect to see surging demand on the back of the AI build out.

Today’s title reflects some recent data points affecting our two Investment Age catalysts: the 2 tech stack divide and what it means for the tech sectors in the US and China together with a potential USD rollover and its implications for EM and Commodities.

We have mentioned previously about how sometimes the penny drop from the Monthly is a gradual process; in this case the penny drop is the fusing of the Digital and the Physical worlds through the AI data center power/water demand linkage. Fun fact: mentions of data centers in Q1 earnings calls were 4x higher than in Q4.

This rings even more true when those straws in the wind include news that Europe’s AI leader Mistral is raising money at $6B valuation (only a yr. old – prior round was at $1B valuation) while news reports from Japan highlight a growing corporate focus on LLMs. AI criticality & every country’s demand for “sovereign” AI cannot be overstated.

We enjoyed seeing the great Stan Druckenmiller on the tape talking up copper and its impending shortage driven by the contrast between the speed of AI’s development versus the glacial pace of opening a new copper mine.  He expects the timing imbalance to lead to a significant copper shortage and thus a rapid and sizable upward price adjustment. We couldn’t agree more.

We wrote a Musings some weeks ago titled: Listen to Stoxx not Vox  suggesting that the market is who investors need to listen to not the commentariat. Well, listening to the market via our chart review process led us to notice some straws moving in the wind, namely that EM equity (China led) was the best performing region in the world over the past month, breaking out to new 52 week highs, alongside Europe and ACWX while the SPY remains below its recent high. China may be making a turn; it was up 2.5% in April while the US was down 4%+.

This market action might just suggest a change in global equity leadership – something that would lead to some significant allocation shifts. To wit, BofA just published a great chart highlighting that US stocks are at 50 yr. highs vs Chinese equity while Barron’s Big Money poll showed a whopping 4% of respondents are OW Chinese equity vs 57% OW US equity.

It might also suggest a change stirring in relative economic performance; perhaps an impending end to the latest bout of “US exceptionalism” tied to relative growth performance. JPM agrees with this point and has “tactically reduced USD longs”. Though one must note the Atlanta Fed’s Q2 GDP Nowcast is a rocking 4.2% so the US is likely to be just fine.

Our focus is on the ROW & the possibility that it may be starting to do better thereby shrinking this period of US macro outperformance which in turn could lead to USD vulnerability. Bespoke’s comments are a straw in the wind: “The Fed's CPI Nowcast estimate for May headline CPI is now at -0.1% MoM.  We haven't had a negative MoM print since May 2020.” That would switch up some dollar bulls. Global investors are heavily OW US assets, both stocks and bonds, with foreign buying of UST running at close to a $1T pa clip.

EM’s equity pickup comes mainly from China’s stock market rally given that China represents roughly 27% or so of the EEM index. That rally has been led by China tech, which All Star Charts notes just had its 2nd best 2 week period ever! We continue to think that the Chinese tech opportunity inherent in our 2 tech stack divide thesis is huge as the straws in the wind around this topic build up.

First there was the Intel news with the US stopping its ability to export certain semi chips to China. Today provides the latest example when after both Sec Yellen and Sec Blinken visited China to complain about China’s export of leading edge EVs, solar panels and wind turbines the hammer dropped with press reports of likely increased US sanctions/tariffs on such exports. Europe is likely to follow suit.

We always say its not the news but the reaction to the news we want to study. As we approach noon, KWEB, our preferred China tech play, is roughly flat while LIT, the Lithium battery and EV ETF, is down roughly 3%. Pretty small beer for KWEB suggesting, as we have opined many times, that those who fear such sanctions are not invested in China tech.

There is additional news regarding China’s beleaguered residential RE market. This has been in freefall for several years and is a big reason, together with weak stock prices, why Chinese consumer confidence is so low. Hangzhou, one of China’s leading cities for policy action and home to Alibaba and Ant, has just announced the removal of all restrictions on residential RE. JPM notes: “secondary property transactions are improving with Shenzhen reporting a record number of units sold in April and in Shanghai a sales revival in high end residential units.” A Bloomberg Intelligence gauge of Chinese developer shares has gained 28% since mid-April on hopes for further easing. A bottom in China’s housing market bottom would be significant for commodities.

We note China’s April exports came in BTE overnight led by surging exports to SE Asia which more than offset declining exports to both the US and Europe. Total Q1 trade (X and M) between China & SE Asia was more than China trade with either the US or Europe. This is another signal of supply chain regionalization and deeper Asian integration – both hallmarks of our Tri Polar World framework.

So China’s housing market may be bottoming, its economy is getting better (Citi ESI trending up since January, April Composite PMI close to one year highs), Asian demand is picking up as reflected by those surging Chinese exports while SE Asia’s April Manuf PMI remained positive at 51.

If European stocks are telling us anything with new 52 week highs its that Europe’s economy is starting to recover. MS just upgraded both their earnings and growth forecasts for this year and next. We also note a pick up European Nat gas prices suggesting better industrial activity. We expect the ECB to cut its rates next month and continue to feel that rate cuts will be seen as pro growth, pro Euro & thus anti dollar.

In Japan there is a growing sense (straws in the wind) that the BOJ will move to raise rates, perhaps much faster and higher than the market expects. A recent Bloomberg article quotes FI experts from Vanguard and Pimco making the case for the BOJ to raise rates by roughly 75 bps btwn now and YE with the 1st hike next month. The twist is that the swaps markets are only pricing in 25 bp of hikes for the whole year.

The MOF has already intervened and made clear it does not want to see the dollar/yen rate above 160. Yet, a recent BofA survey found that not a single response expected a yen rally to even 150 (155 today) so not even a 3% move. This is with Vanguard being quoted as saying fair value for the yen is close to 100 and short yen positions at all time highs. The dollar is very ripe for reversal much as China tech is very ripe for rerating. We & our clients are positioned for both!

While many look forward to Nvidia’s earnings day on the 22nd we are focused on next Tuesday when both BABA and Tencent report. Krane notes that China’s internet companies as a group now sport 3-5 year forward EPS growth forecasts of 30%, nearly double that of several years ago. FactSet reports China equity overall sells at 9x forward EPS, a 20% discount from its history.

The FT reports that: “Four Chinese generative artificial intelligence start-ups have been valued at between $1.2bn and $2.5bn in the past three months, leading a pack of more than 260 companies vying to emulate the success of US rivals such as OpenAI and Anthropic.  All four leaders have attracted funding from Alibaba, which has emerged as a key backer of AI start-ups as it looks to replicate the success of Microsoft’s big bet on OpenAI.” 2 tech stack divide indeed.

As we wrap up lets touch on our models – especially our Global Multi Asset (GMA) model. Following last week’s introduction of The Age of Investment which has resulted in further confidence in our global macro blue sky 2023-2027 outlook we have made some model changes.  As a result, we are now double weighted in the commodity space and triple weighted in EM equity vs BM.

Ok, 10k words later, we are ready for the weekend. Can the Rangers close it out – they look strong, maybe even a team of destiny. What about the Knicks, next man up. Can Boston’s teams redeem themselves after a few bad playoffs? Here’s to the TV, playoff hoops/puck & the couch!

Enjoy the BTV clip; I come on at the 29 minute mark. https://www.bloomberg.com/news/videos/2024-05-09/bloomberg-the-open-05-09-2024?sref=ftskAWJe