Wall St's Failure of Imagination

1475 words – a 4 minute read.

“What we’ve got here is failure to communicate”, a classic line from a classic movie starring Paul Newman– Cool Hand Luke. Now, there is no failure to communicate on Wall St, in fact, today’s Musings come straight from this morning’s 7 am BTV Surveillance hit. What is missing on Wall St today however is even worse, it’s a failure of imagination.

Having been involved now almost 40 years in the biz I am not sure why that is – to some extent I think it began when the hedge funds shifted their clientele from wealthy individuals to pensions who brought bags of cash but who wanted high single digit returns with low validity in return, thereby snuffing out the most aggressive players. The money was just too good. Hedge fund openings have collapsed.

More recently one can pick up any paper or read any screen about the death of the active manager, buried under a mountain of dumb, passive money. David Einhorn is quoted as saying markets are “fundamentally broken”. Well, have you looked at the abysmal performance of active managers over the past few years? Remember 100% odds of 2023 recession or the Cash is King calls. Such failures of imagination better explain why active managers are dying on the vine.

Much of Wall St has become a CYA business and that type of business is risk adverse & happy to fail as long as others are failing too, backward looking & failing in imagination.

Here are three examples of Wall St’s current failure of imagination. Consensus for US 2024 GDP growth is 1.4% even though 2023 GDP growth was over 3% and the Atlanta Fed Q1 2024 GDP Nowcast is roughly 3.5%. Here’s a second, Wall St’s YE S&P average target is 4861; i.e. 3% BELOW where the S&P is today. Here’s a third – the number of “informed” takes that the Magnificent 7 is akin to the dot com bubble of 1999 and Nvidia is the Cisco of its day.

The latter comments don’t stand up to even the most cursory of looks – namely the fact that the dot com boom was all hype and no earnings while AI is some hype but a boatload of earnings. The tech sector’s operating margins have more than doubled since 1999, from 10% to 25% and climbing. These tech companies are PRINTING money and Wall St is so far behind that stocks move 20, 30% when they report bc sales, earnings, margins are blowing out (6 of 7 have reported with av EPS gain of close to 45% y/y).

We are in inning 1 of the AI Revolution, a revolution that is going to touch everyone and everything, one that every major company has to contemplate how it will or is affecting its business today and in the near future.

In Nvidia’s case its like going to the casino, if you want to play you gotta have the chips. AI’s poster child is cheaper today than at any point in the past 5 years with a PE of 25x vs 5 yr average of 40x. Sam Altman is trying to raise billions to make his own chips bc he understands that w/o chips he won’t have a seat at the table. The Chinese recognize that too, so do the Europeans who are feverishly building up their AI capabilities. AI is just the latest example of how tech drives regional integration in the Tri Polar World.

One hears daily, the Magnificent 7 are in a bubble – really, a bubble? If one just looks back two years one will note that more than 50% of the 7 are up just single digits, yes 4 of the 7 (same for SPY). We have spent the past two years digging out of a global pandemic and all the chaos it entailed. Markets have yet to price in any of the appealing future we believe lies just over the horizon. A failure of imagination, of extending one’s horizon… to think forward, blue sky, out of the box. Sad.

At TPW Advisory we believe in focusing forward, full stop. Currently, we think it is time to broaden our horizons and extend our thinking beyond just the next 3 or 6 months, beyond 2024 to the out years, to 2024-2026 or so.

During those out years, we expect a period of macro stability supported by a global rate cutting cycle, abundant global liquidity (BOJ and PBOC both pumping, Fed to end QT), solid GDP growth, rising productivity and BTE earnings growth. As an old MS guy I hate to say it, but Goldman gets it: “calling for 2.9% GDP growth in 2024, and 2% or better through the year .. 2027.”

We extend our thinking to the out years largely because the speed of adoption enjoyed by our 4 for 24 macro surprises calls for it. From macro surprise #1, lower inflation, sooner than expected to surprise #2, BTE productivity growth, to the return of macro stability stepping up at #3 and concluding with macro surprise #4, that we are early cycle in a global economic recovery, not late cycle heading into recession, all are occurring in real time.

# 1 & 2 are making solid headway; next week’s US January CPI print is likely to be the 1st headline CPI under 3% in 3, yes, 3 years. US productivity growth is surging; last 3 Qs annualized at 3.9%, a pace last seen in the late 1990s which just so happens to be our analogue for the upcoming period. Productivity growth is the secret sauce that enables strong growth without inflation. As Dr. Ed Yardeni notes: “Unit labor cost (ULC) inflation was only 2.3% y/y during Q4 because the productivity gain of 2.7% offset some of the 5.0% increase in labor compensation. ULC inflation is the main determinant of the CPI inflation rate.”

The return to macro stability comes with the appealing Trillion Dollar Reward of cascading cash coming down the Everest sized MMF mountain, now well north of $6T, further underpinning risk asset markets. It also sets the stage for the new global growth cycle, demarcating the prior Covid chaos period to history and turning the page to something new.

The early cycle case is building at speed – from the upturn in the semi cycle to off season housing strength to ISM Manuf new orders breaking back above 50 for the 1st time in 17 months & heralding the imminent breakout of the ISM Manuf index itself. The visible pick up in Asian export activity is the tell with South Korea’s January exports up 18% Y/Y and Vietnam’s up 42% Y/Y.

When you pay attention data points pop up everywhere. Here are two from just this week, both from the WSJ. The N. American Logistics Manager index just reported that every metric it tracks was in expansion last month – a feat last seen in Sept 2019. Here’s the second, N American heavy truck orders last month rose 45% on a Y/Y basis.

A couple of closing thoughts: we updated our Global Multi Asset (GMA) and TPW 20 thematic models this week and as usual that entails looking at a ton of technical charts. Two things stuck out; first, the power of the recent US equity up move has brought the ROW with it as ACWI breaks to new highs & EEM recovers its 200DS level (even with 25% China weight; EMXC chart looks like ACWI).

Second, we are paying close attention to the relationship between TLT, the long duration UST ETF, and GSG, the GS Commodity index ETF. TLT is breaking down under its 200DS level while GSG is breaking back above its 200DR level. To our mind this is confirming the growth acceleration we note above as does IYT’s (US transports) break out. IYT just hit an ATH vs Utilities in the Cyclicals vs Defensives battle. We now look for USD weakness to confirm ROW recovery – Europe, China, Japan’s policy shift etc.

Market wise we note that China has all the attributes that made US equities so appealing back in early November: seasonality, sentiment, positioning and technicals are all supportive (Ren Mac’s trend model just flashed a capitulation signal on the CSI 300). The Govt wanted a lift before the Year of The Dragon is ushered in & they got it; when the new boss is nicknamed the “Butcher of the Brokers” one pays attention. We also note the emergence of a DM ex US Magnificent 6 (ASML, Toyota, SAP, Novo Nordisk etc.) and the appeal of EFG, an EAFE Growth ETF with the 6 well represented amongst its top 10 holdings.

Happy Super Bowl weekend! Hard to pick against Mahones and the Chiefs but we are pulling for the Niners! Enjoy the game!