The Battle Lines Are Drawn

1350 words – a 4 minute read.

TGIF for sure – these are busy weeks for TPW Advisory given our process of writing our Monthly at month end (5k words, 20+ charts & tables from 16 different research sources) then reviewing/updating our two Model Portfolios (Global Multi Asset flagship & TPW 20 thematic) complete with client notes this week BEFORE writing today’s Musings!

Add in this week’s Fed meet and today’s job report and our heads are spinning & eyes bugging out… so let’s take a deep breath and muse on.

First thing that comes to mind is Chair Powell’s press conference where he once again flipped markets from green to red with the power of his words.. every parent should study him because “listen to my words” works so well for him – when our kids were young I do not recall my words having the same effect. Do you?

Different folks are focused on different parts of the presser but our focus was on Powell’s comments regarding the asymmetric risk the Fed faces between doing too little and letting inflation rip and doing too much, crushing the economy to get inflation down to the 2% level. Powell noted that in the latter case the Fed can always cut rates and yes we should all be happy that the Fed & ECB are well off the zero bound. Powell further noted that if the Fed does too little, it risks letting inflation get out of control – an asymmetric risk he & the Fed are unwilling to take.

This is where we see the battle lines being drawn because there is a growing body of opposition to this perspective. This opposition focuses on the value of having the best DM job market in roughly 50 years & its importance given the political – class divides roiling the West. We see this as the coming policy fight between those who are willing to crush the economy to get inflation to (a completely arbitrary) 2% target and those who see more value in keeping more people employed via an inflation rate of say 3%.

We have a clear dog in the fight – as we wrote in the Monthly  we stand in the latter camp, along with the FT’s Martin Sandbu, Adam Tooze of Columbia Univ & Olivier Blanchard, former IMF chief economist among others. We expect the Fed to gradually move in this direction as well, noting the twin benefit of inflating away the debt (see post WW2 policy mix - sure to become a big political issue now that interest expense is lapping the US defense budget)  coupled with tight fiscal policy, well anchored inflation expectations, no sign of wage price spiral and continued secular disinflation.

This then sets up, as regular readers know, for two things – first, a rollover in the USD as the Fed’s front loading ends and second the gradual unfolding of BTE high nominal global growth aided by a public private cooperative focus on dealing with the 3Cs of Covid, Climate & Conflict. This in turn will stimulate a cap ex boom supported by improved productivity thereby underpinning better growth, moderate inflation and sustained full employment.

This ties into our expectation that 2023 will be a year of increased stability, a return to some level of normalcy in our sped up 2020s. Many are still extrapolating the crises of the past few years into the future – we think we are coming to the end of these crises and the out years will feature less dramatic policy action.

We note today’s US jobs data as supporting this thesis with Pantheon highlighting the AHE on a 3M average basis increasing at .3% or 3.9% annualized while the private sector quits rate has rolled over hard – signal to noise. Bringing AHE down towards 3.5% supports 2-3% inflation and will allow the Fed to cool its rate hiking jets while paying verbal homage to the ultimate 2% target.

We see a USD rollover as key to unlocking global cross asset allocation opportunities ranging from non US equity to Commodities and on. We spent a fair bit of time walking thru this scenario building exercise over the past week as we updated our two models. We remain OW global stocks, UW global bonds and OW commodities in our GMA model. While UW US equity, our small cap and value tilts have led to virtually all US equity selections OPing SPY.

We continue to focus on EM equity; post elections, we remain very keen on Brazil and note the Real looks like it will have a 4 in front of it very shortly; we also feel like China has been vastly O/S post PPC and note that our Shanghai based contacts are much more constructive on the new leadership than mainstream media. To us its pretty simple – the deal in China is economic growth for political acquiesce so Xi and team tanking the economy just doesn’t resonate.

A weak USD, China recovery & low to non existent inventories across the commodity space (JPM notes its October Global and Ex-China Commodity Inventory Monitors are at the lowest level for the month on record) all equals a nice set up…wow, check out PICK today.

Two last points – as we move towards a more stable environment the traditional investment methods of seasonality, models etc. could well start to work better than they have over the past few ahistorical years. The tell here is likely to be a sustained up move into YE as we enter the best 3 months of the year for stocks which tends to be even better in mid term years. Fundstrat’s Mark Newton sees 1962 as the analogue suggesting another 10% + of upside into YE.

We note the VIX is at a 7 week low at 24 & below its 200dmav, that the MOVE index is under 140, earnings are solid across the DM while the Atlanta Fed Nowcast for Q4 US GDP growth is north of 3%.  With markets having already priced in a FF terminal rate of 5% we see asymmetric upside to a Fed that validates that level going forward reducing macro risk and allowing markets to start pricing in the other side of these trades.

Secondly, if US Big Tech is going ex growth then this coupled with a weak USD supports US equity UP while also setting off a search for the next growth opportunities. We see two areas of potential interest – one is the Innovation Space which is trying to base and come out of a tough, 18 month long, 70% + bear market… cheap, under owned, best positioned to drive the global cap ex cycle. The second is the Climate space – we wrote extensively about it in the most recent Monthly – underneath all the angst about the Fed, inflation, rising rates, recession etc., the reality is that the push to clean energy is taking off around the globe supported by both public and private sector alike. COP27 may be filled with doubt about missed national targets but the on the ground action is very exciting especially around EV and energy storage supply chains. We expect Big Oil to be active in clean energy M&A as its cheaper to buy rather than build a clean energy portfolio.

We tied all this back into our models via adds to the bio tech space which is breaking out along with Healthcare in general; biotech represents the innovation space in healthcare (we expect Big Pharma to be M&A active). Secondly, we added US industrials which are breaking out & which we see as big beneficiaries of the reshoring, nearshoring process taking place across the tech stack and EV production processes.

Huh, having written this I feel better… more optimistic.. ready in fact for tonight’s big football game: DUKE at BC. For 5-3 Duke, a W = bowl eligibility!!! Coach Elko, staff & team have done wonders in year one: Duke football ranks top 5 in the nation for most improvement on both Offense (#4) and Defense (#3)… GO DEVILS!