True North

1430 words – a 4 minute read.

Transition periods are usually tricky and that’s certainly the case in today’s macro investment  landscape. The transition from a fixation on inflation and monetary policy to a focus on fiscal policy and a global manufacturing recovery is a sudden shift of gears that have left many scratching their heads.

Yet that’s where True North, the correct direction of travel, lies – at least from our armchair here at TPW Advisory.

As we wrote last week in “An Ode to Competition”, the first competition of the Tri Polar World (TPW) is Climate centric while also being the first such competition in the AI Age, which suggest things will move fast. Talk about competition and things moving fast – you college football fans been paying attention to the conference realignment craziness? Just wow!

Just like the leading football conferences, all three Tri Polar regions (Europe, Asia and the Americas) are highly motivated to compete – what is the alternative as extreme weather causes more death and destruction in more places while the opportunity presented by the AI Age in terms of productivity enhancement and competitive leapfrogging means one has to compete.

China leads in the Climate space, the US in AI as Europe grasps it can’t succeed by simply being the rule maker. Germany, with much to lose as its ICE auto makers fall further behind the EV revolution, is a good example, just announcing heavy state subsidies to convince Intel & TSMC to each build semi fab plants in country.

All this is likely to take years to play out but understanding the stakes helps one understand the policy reaction and thus the investment opportunities that are likely to fall out of the mix as a result.

That’s what we are focused on. Thus, the transition from Monetary to Fiscal Policy, from recession fears to manufacturing recovery & a global cap ex boom. From an investment perspective, we discussed rotating from Big Tech to Cyclicals several months ago and more recently have been discussing the “rolling rotation” idea as we laid out in the Monthly.

We are approaching the end of the rate hike cycle (10% odds of a September Fed hike post CPI print, 35% odds of an ECB hike) and expect the Fed to be on hold for a considerable period of time as it watches to see how inflation settles out – recall that Chair Powell has said he doesn’t expect 2% inflation until 2025. We are in the inflation at 2-3% camp in the high nominal growth world we expect to see in the years ahead. Our analogue remains the US in the 2H of the 1990s - only its global this time.

As inflation normalizes, we expect to transition from rate hikes to a rate cutting cycle led by Central Banks in Lat Am such as Chile and Brazil - both of which have cut rates in the past few weeks.

We are focused on two specific areas for the 2H; a global manufacturing pick up and an improvement in Chinese economic activity. We expect the following set up to play out in the coming quarters: as disinflation boosts real incomes and improves consumer confidence we expect a shift from inventory destocking to restocking. That restocking will drive a manufacturing recovery that will lead to a more balanced global growth path with both services and production more in line.

 The shift from destocking to restocking is a global one (note weak China imports and exports as one example). Here’s Barclays: “The data for June is consistent with the broad evidence of a re-Balance of supply chains / inventories and hence a wide de-stocking across most major end-markets.”

Straws in the wind are already suggestive of the transition to restocking with new orders picking up in the US and Europe, US summer rail & trucking data stronger than is seasonally expected, auto production picking up as supply chains untangle etc. There is a reason why Transports & Industrials (IYT/XLI) have broken out.

Q2 Earnings have come in BTE with blended 12 M forward earnings surging as analysts boost their #s, supported by solid margins with Q2 margins averaging 11.9% vs a 20 yr. average of 8.9% for the S&P. FactSet reports companies are forecasting a strong pick up in cap ex over the coming 12 months as investment starts to trump buybacks while JPM reports that Global Manufacturing PMIs have bottomed and reversed vs Services in all three Tri Polar regions.

Our second area of focus is a better 2H in China, a POV that is already under duress – I has the pleasure of being on BTV’s The Open show this morning and right after Jon Ferro asked me about our China view the lights in the conf room shut off – yep, when one is positive on Chinese equity they turn the lights off on you! 

We expect China’s dip into negative inflation to be short-lived (note core doubled to 0.8%, highest since January) and are focused on Govt efforts to boost consumer confidence which is sorely lacking as both the property & stock markets suggest. Q1 CD issuance totaled $766B, the largest quarterly issuance since 2015 according to Reuters (shades of the US MMF mountain). 

The Biden EO on US investment in China’s tech stack has finally been released and seems to be pretty finely tailored suiting the “high fence, small yard” strategy. It’s a good hurdle to get out of the way. Q2 earnings estimates are being blown away by the likes of Alibaba which trade at a fraction of the valuation of US peers.

Bloomberg notes: The rare pledge to “invigorate capital markets and boost investor confidence” at the July Politburo meeting — the strongest endorsement of markets by top leaders in at least a decade — is driving bets that Beijing will take steps to increase trading activity in the coming months. Here is BofA: “With one weak print after another, economic surprises in China have cratered to the 6th percentile of history. As a result, China Risk-Love hit the panic button on 21 July, for the fourteenth time since 1998 and the first time since March 2020, potentially signaling a floor to China equities in the short term. History tells us that prospective returns from such low levels of sentiment are typically robust (average of 26% in the next 12 months with a win ratio of 85%), although they are also typically accompanied by a healthy dose of policy easing.”

We updated our two models this past week and one clear takeaway was the solid increase in the # of holdings above their 200dmav. In our Global Multi Asset model (GMA) roughly 90% of our holdings are above their 200dmav with 70% of our TPW 20 model likewise above – this compares to roughly 75% of the S&P 500. Given our GMA is multi asset & our TPW 20 model focuses on Future Tech and Climate these solid technicals give us a lot of comfort that the pullback we have seen in the past few weeks is a healthy one.

The question is what to do with it? If our view of True North is correct then we want to follow our rolling rotation theme and look to add to EM and Commodities, two peripheral laggards that have recently started to act better. Commodities (GSG) have broken back above their 200dmav for the first time in over a year, led by oil which has undergone the same destocking as consumer goods even as demand picks up. We have added to our energy and uranium positions.

Here is JPM’s commodity view: “Commodities price in by far the highest risk of recession and stand out as under-valued, under-owned, and backed by compelling fundamentals and technicals.” This solid risk – reward outlook leads us to increase our already OW Commodity position.

We expect EM equity and debt to do well as the global manufacturing cycle picks up, as rates are cut and as investors grow more confident that just as 2023 did not bring recession neither will 2024.  We look for domestic investors to become more interested in their domestic equity markets especially in markets like China and Brazil – the same holds true for Japan in DM. We added to our EM equity holdings including China Tech & remain OW both EM debt and equity.

That’s it for me – off for 2 weeks of vacation – perfect timing according to the Stock Trader’s Almanac! Next Musings will appear on Friday Sept 1st!

Until then, stay frosty my friends!