We Got Legs

1400 words – a 4 minute read.

Hi and welcome to the 1st Friday Musings of 2024! I hope all had a great break – I sure did!

Now it’s time to climb back up on the saddle and what better to do that than prep for a BTV hit as I did this fine Friday morning. After a two week vacation with a pretty well disciplined approach (no markets, no email) its been interesting to note what struck me as we came back hot via a model portfolio update this week.

Let’s start with our monthly cross asset technical review of 100 + charts – every holding, potential holding, across assets, all major indices. 4 main takeaways: Loved the SPY fake out in early Nov, breaking BELOW its 200D support before reversing and rocketing higher for 9 straight weeks – its an art not a science, people. 2nd, how nicely markets resolved their aggressive overbought condition at the end of that 9 week run – a quick 3-5% pullback and then boom up to new ATHs – respect. Third, very clear leadership breakout to new ATHs from several cyclical sectors: Tech, Semis, Housing etc. – lots of blue sky ahead. Fourth and finally note the breakout abroad – one of our 4 for 24 market surprises calls for non US OP and from Lat Am to Japan its on with multiple markets OPing the US in 2023. Lat Am led as the world’s best performing region while Japan looks like it wants to break to new ATHs after a 30 + year absence – don’t sleep on the Rising Sun!

The stat that captures it all for me? Nvidia, the poster child for the AI Innovation Age, up almost 400% from its 2022 lows, is the CHEAPEST its been in 5 years, trading at 26x EPS, down from a recent peak of roughly 84x and a 5 yr. average multiple of 40x. Bernstein calls it the “cheapest AI play”. Free cash flow is expected to total $100B over 2024-2025; Nvidia’s earnings are growing so fast its valuation is collapsing. Very bullish when the breakout leadership stock in the leadership sector is cheap. We got legs.

What about the macro? We see growing evidence that our 4 for 24 global macro surprises   are playing out. Quick reminder: lower inflation, sooner than expected is #1, BTE productivity gains is #2, return to macro stability is #3 and resolution of the early cycle vs late argument in favor of early is #4. Numbers 1 &2 have been playing out since we wrote our Outlook back in October (we tend to be early) so its growing support for #3-4 that is currently catching our eye.

Whether one wants to look at jobs, inflation, Fed action – the big macro drivers of the past 4 Covid related years – its all chill. Jobs data didn’t move the Fed needle last week; likewise, with yesterday’s CPI data while the Fed recedes into the background of market thinking. Sure, plenty of headlines and plenty of folks want to discuss it but it’s not the risk asset driver it was over the past year, at least not here at TPWA.

That’s a good thing. As we noted on BTV this morning, its not WHEN the Fed cuts but WHY it cuts that is important. Cutting bc real rates are too high as inflation declines is bullish for risk; cutting bc recession looms and the Fed is scared is bearish for risk. Given CPI of 3% and FFR over 5% real rates provide plenty of room for the Fed to cut whenever it decides to do so. Q4 Atlanta Fed GDP Nowcast of 2.5% and 2024 consensus GDP of 1% (we’ll take the over BTW) obviates the recession option.

Macro surprise #3, the return to stability and its consequent $1T reward unlock as some of last year’s MMF inflows reverse, is a key assumption of ours, one further supported by macro surprise #4, the closure of the cycle debate in favor of early cycle. Early cycle evidence is growing: we note the semi cycle upturn, the homebuilder upturn, the transportation pickup and even the manufacturing sector (new orders minus inventories with new cycle high) showing signs of life as all being supportive. FactSet notes that SPY took in $40B in December alone, the largest monthly inflow since its inception back in 1993.

We also note the significant policy shift from monetary to fiscal and the role of Bidenomics in generating a pick up in US manufacturing related construction to a level 3x greater than that of the last decade. This is a partial explanation as to why construction employment didn’t fall off a cliff as the Fed raised rates. More importantly from a forward looking POV, it strikes us that as these manufacturing facilities are completed they will need to be stocked with workers & robots, thus providing another leg up for the economy.

So now we turn to earnings season, noting Dr. Ed Yardeni’s point that the recession that counts – the earnings recession - took place a year ago with a modest 7% Y/Y earnings decline that ended in Q3 2023 when EPS broke into positive Y/Y territory. We expect Y/Y growth in Q4; at 1% consensus the bar has been set nice & low.

Our focus here at TPW Advisory is relentlessly forward and here the earnings news looks even better with FactSet reporting consensus double digit EPS growth for 2024 and 2025. Double digit earnings gains for the next two years is another reason why we feel like this risk asset move has legs.

What about all those risks you say? The non stop drumbeat and blaring claxons shouting geo politics, geo politics obviously never paid any attention to the Clocktower folks who have shown pretty convincly that geo politics rarely impacts risk asset pricing for very long. In our view, it’s a backhanded acknowledgement of our return to stability thesis that the big risks: US elections, so many elections around the globe, conflicts in Ukraine, in the Middle East, China – US tension, etc. are geo political in nature.

Given that the only bipartisan thing in DC is China bashing and it is an election year we expect more of just that. The good news? Down 3 years in a row, China is the cheapest big market in the world trading at 9x E with 2024 consensus MSCI China EPS growth of 14%. Here’s some more good news – Bloomberg’s China junk bond index (mainly property developers) have been catching a bid, now up 5 months in a row in what has to be one of the best kept secrets in financial markets. This suggests that the hole at the epicenter of China worries – its property implosion - has stabilized and reached a point that folks see upside.

So to summarize the “We Got Legs” POV: risk assets are breaking out to new ATHs led by cyclicals in the US suggesting an early cycle economy rather than a late cycle one. The AI poster child stock is the cheapest its been in 5 years. The breakouts are increasingly global in nature with multiple regions moving higher. We’ve got legs.

Improving macro fundamentals provide further support suggesting the $1T reward unlock could soon be in play. Double digit US EPS growth for the next two years, a floor under the China RE problem, possible bottoming of the EU economy, rate cuts, USD weakness. Maybe its just vacation hangover, but the case for positive risk on extending over the next several years is taking shape. It remains far, far from consensus (average Wall St YE S&P target is 4860) but that is a good thing; expect some bumps and bruises but hey, we’ve got legs. Here’s a quote from famed market technician Marty Pring: “Quite a lot of time left in recovery cycle!"

As we updated our two models – our Global Multi Asset (GMA) and our TPW 20 thematic model - we made limited changes. In the GMA we added to Credit within FI, resized and concentrated our Commodity OW, extended our Small Cap focus into Asia while remaining OW EM equity & debt. Our TPW 20 model remains AI focused on the Future Tech/Biotech side while continuing to focus on Climate across the clean energy, nuclear (URNM blue sky) and electrification process. Reach out to learn more.