Vote Of (No) Confidence
2330 words – a few commercials worth.
The holiday prep is well under way as we write our final Musings of the year while in the markets, it looks like the Grinch is trying to steal XMAS. First, Fed chair Powell & team boost their inflation target & cut the number of expected rate cuts in 2025 and then what appears to be a dual presidency of Musk & Trump led a call to shut down the Govt and remove the debt ceiling! A serial bankrupter calling for no borrowing limits – what could go wrong?
The quick answer is very much could go wrong and the sudden need to think about things like that has led to a quick, down & dirty little pullback. A vote of (no) confidence if you will. These votes are popping up all over the place – the original idea for the title came from the German no confidence vote earlier this week. But it could also pertain to the French political environment or the state of play in Canada or Brazil not to mention DC.
So, an overbought and excessively positive US equity sentiment environment coupled with an under the radar case of bad breadth runs into some policy U turns resulting in a VIX spike and a 3% SPY pullback & more like 5-7% for the hot stuff like Bitcoin, fintech, consumer discretionary and more. SPY & cross asset action more broadly reminds us of the August yen inspired freakout which took roughly two weeks to settle.
On the plus side, the record 14 days of negative breadth (more stocks down than up) tends to lead to positive results down the road (1978 case had 31% rally the following 16 months); ditto VIX spikes (SPY up on average 7% in the 6 months following the top 20 one day VIX moves – Wednesday came in at #2). It was the worst day for bonds since the Taper Tantrum of 2013 and worst Fed day since the turn of the century for stocks.
Technicians we respect suggest watching the 5600 level for SPY, the 500 level for Qs and the $240 level for the important semi sector (SMH). We will do just that.
Our view has not changed as a result of either the Fed dot plot shift or the pre inauguration return of the Trump policy by tweet storm. As we wrote in the Monthly we are focused on the Tri Polar World (TPW) competition to win the global heights of AI, Climate and Conflict. China has won the Climate fight and now the competition has shifted to AI and Defense.
Winning requires implementing the new industrial policy mix consisting of both fiscal and monetary support and public & private partnerships. Things are moving fast; it’s become very clear that for policy makers & CEOs alike it’s not just combining public and private support that is necessary but combining both and executing well that is the true bar to success.
It reminds me of American college football and a phrase that one hears often of how schools, staffs and teams need to be “in alignment” to be successful. As you listen to head coaches or ADs during the inaugural College Football Playoff (CFP) series (starts tonight – can’t wait), being in alignment is a phrase one hears often. Another oft heard phrase is: “playing at a high level”. One needs to have all aspects of the on & off field football effort in alignment to have a chance to play at the high level required to win the CFP.
Football wise, its hard to operate at a high level & be in alignment today given the transfer portal, NIL, donor fatigue etc. Investment wise, the same holds true for policy makers and investors. Its not enough to run big deficits or cut rates or provide subsidies to drive value added production. It needs to be done coherently or else investors take fright.
Brazil provides the downside example du jour. It’s 10% budget deficit has defined the outer limits of fiscal spending before investors rebel & sell the FX causing rates to spike and stocks to drop. Brazil is among the world’s worst performing equity markets with one of the weakest currencies this year. Press reports suggest it has spent roughly $17B this week to buoy the Real; it has some $350B in reserves so its likely to win that battle.
Personal side note: today is the 30th anniversary of the Mexican peso crisis when the peso lost 40% of its value in 6 weeks. I was Morgan Stanley’s Lat Am strategist, ranked #1 in II and got it completely wrong. Byron Wein (RIP), then US equity strategist, pulled me aside after a sweaty, shaky appearance in front of the entire MS sales force & gave me words to live by: “You can be wrong at the top and wrong at the bottom but you cant be wrong at both”. Amen.
What about the Fed one asks? We view Wednesday’s cross asset market action as an overreaction to a shift in the dot plot of 1-2 rate cuts next year. As noted the VIX, 10 yr UST bond and S&P all had one of their worst Fed days ever.
All this because the dot plot went from 3-4 rate cuts next year to two, even though the market had already moved to 2-3 rate cuts? A 3% S&P drop seems out of proportion. We have never been dot plot fans as it updates too infrequently for today’s fast moving markets while its track record is horrible.
We have been a broken record that its not when or how much the Fed cuts but that it cuts without recession that counts for stocks. The historical record is very clear on this. Fed cuts and no recession, stocks do great. Fed cuts into a recession & stocks sink. The Fed is saying growth is stronger than it expected, thus inflation will come down more slowly and therefore rate cuts will be fewer. Should growth slow then the Fed can cut. All that sounds fine as it suggests the double-digit EPS growth forecast for 2025 might have a shot at happening. Its all about the E.
What could be a worry is if the Fed has to shift to rate hikes because inflation not only doesn’t slow its descent but rises due to the policy mix favored by Trump 2.0. Apollo has 40% odds that the Fed hikes next year. This seems more likely today than it did 48 hours ago given the push by the unelected yet seemingly all powerful Elon Musk to reject the CR meant to keep the Govt funded through March. Musk’s Twitter platform has amplified his voice within the Republican Party voter base to OZ like levels (his 120 + tweets on the CR were viewed over 35M times in the first 24 hours).
As such the US now faces an imminent Govt shutdown – a shutdown no one foresaw two days ago. Add in Trump’s call to eliminate the debt ceiling – perhaps his effort to wrest the mike away from Elon- and it gets Grinch like. As we noted in the Monthly, Trump 2.0 will be a lot like 1.0; an old Trump is unlikely to learn new tricks – thus we recall the policy by tweet, his late stage insertion into much debated Congressional topics which he promptly blows up and which resulted in two Govt shutdowns in hist 1st term in office.
Today, these threats come roughly a month BEFORE Trump even takes office. Investors have gone from Fed has our backs and Trump tax cuts & deregulation yeah to the Fed is on hold and may have to hike while Trump cheerleads a Govt shutdown over XMAS. Given the very weak performance of inflation type plays: energy, copper etc., it seems like the deficit issue is what’s pushing rates up. Put in this light the selloff makes sense.
It certainly has made for an interesting week to have our monthly model portfolio update meeting. Its important to stick to the process and that’s what we have done. We went through a boatload of charts and numerous takeaways presented themselves. We have already covered the market’s bad breadth. Part of this is rotation driven as tech takes the baton back, thus the focus on the Qs and SMH noted above.
Part of the bad breadth we are less clear on; we noticed some clear deterioration in a number of our holdings across the commodity space as well as the non US equity space. Post Wednesday’s selloff the energy space in particular is massively oversold with XLE and IGE both at 14 day RSI levels last seen at the Spring 2020 Covid lows. Hard to believe but its true.
The miners are also struggling and many are under their 200d support levels including URA, COPX, GDX etc. We note however that GSG, our Commodity BM, looks much better than many of its constituents and is flirting with its 200d resistance level (led by Ag). We want to see GSG break back above that resistance line to confirm our view of a growing global economy.
UST bonds are locked in a downtrend; we continue to see no reason to own sovereign debt in the new industrial policy age. Having said that in the near term they are very oversold & due for a bounce. Credit remains fine in both DM and EM. Equities remain the best looking charts among the big 3 asset classes of stocks, bonds and commodities; the tech led US remains the best looking equity chart.
Outside the US, ACWX & EFA have both fallen under their 200d support levels while EEM just broke below yesterday. We are watching these closely to see if our view plays out that the time is approaching for the non US equities to shine. The trend favoring US stocks is well entrenched. EEM, led by China, looks the best of the non US markets and both did better than the S&P the past few days. Asia’s overnight response was also very muted with markets including Japan, China and the broad Asia Pacific indices roughly flat Thursday. That’s very good relative performance.
Many suggest waiting until Q2 to buy non US equity – that might be late. Things happen quickly these days. We note that China, represented by FXI, is outperforming the S&P over the past year. We would guess very few investors would expect such a result. It aligns with our view that both the US and China are stimulating their economies & competing in that TPW competition we spoke of at the top. China is well above its 200D support level; we look for it to lead EM back above its resistance levels signaling better days ahead for non US equity.
We expect Europe to join in this TPW stimulus process more aggressively next Spring once the German elections are held and the new Govt eases the debt brake. We believe this is a done deal given the state of the German economy, the implosion of its leading edge auto makers (note potential Honda – Nissan tie up) and the general state of play. We expect German stimulus coupled with the stimulus related outcome of China’s March NPC meeting to help drive the commodity complex higher.
We think there is a reasonable chance that at the same time investor concerns over the likely policy chaos in DC could lead to investor outflows from heavily over owned US assets resulting in USD weakness which would further support commodities & EM assets. Given that Trump favors a weak USD we expect the Admin would be fine with that outcome. Current USD strength is unwelcome; if DXY breaks above 109 we may need to reconsider our weak dollar view.
We expect the US equity market weakness of the past few days to be over relatively soon much as the Yen inspired selloff last August resolved itself in a matter of a week or two. We note the VIX is already down sharply to 21 or so while the UST MOVE index never broke much above 90 unlike in August when it popped to 120 along with the VIX spike.
Could SPY go down another 5% or so – yes of course. The SPY is down roughly 3.5% from the high it reached earlier this week; support is around 5600 or so, another 6% down so roughly a 10% correction which would set up the bounce early next yr when Q4 earnings expected to be roughly 7% Y/Y come through. Given the 3% growth path the US economy seems to be on that earnings target seems reasonable.
What about the Santa Claus rally? It could still happen though the 2 Grinches Musk & Trump might just steal XMAS which would give rise to the fear that it Santa doesn’t show then the bear will. We continue to expect single digit type upside for US equities next year with ROW generating mid double digit returns led by EM. Our friends at Pinecone Macro had a great chart recently showing that EM EPS growth next year is expected to be better than DM, the first time since 2020 when EM also OPed.
We stood pat in both our Global Multi Asset (GMA) model and our TPW 20 thematic model updates, in part because of the environment and in part because we continue to see a path for our thesis to play out. Namely, better global growth leads to a commodity pick up and better non US equity performance as the USD weakens and Europe (Germany) and Asia (China) stimulate while the US slows. This should also allow thematics like future tech & the Climate space to break out of their hibernation and move higher much as we have already seen with Crypto & Fintech.
Thank you for your support this year & all the best for the Holidays and 2025! Back in your inbox Jan 10th!