Welcome Mr. Bunny

1560 words – a 4 minute read.

Which Mr. Bunny you ask… well it could be Bad Bunny, the Puerto Rican rapper or Monty Python’s classic killer bunny or perhaps a cameo from our own bunny, Mr. Wallace. But I am referring to the Year of the Rabbit, which begins with the Lunar New Year, Sunday Jan 22nd. The Year of the Rabbit calls for a year of longevity, peace & prosperity. After 2022, the third worst year ever for a 60-40 portfolio, all we can say is welcome Mr. Bunny – you are right on time!

It has been a pretty good start to the year for risk assets and it could be setting up to be quite a prosperous year, notwithstanding the Wall St strategist consensus for a down S&P or worse yet, all those stale bears calling for 3000 on the S&P. The Carson Group reports that after a down year, the trifecta of a Santa Claus rally (check), the 1st five trading days of January being up  (check) and January itself finishing up the full year results would make Mr. Bunny proud: up 100% of the time, up double digits 100% of the time with an average gain of 27%.

While historical analogues fell flat last year, overwhelmed by Fed action, we do expect less Fed & more stability ahead. This should allow these historical relationships to regain some validity. Note we are not calling for a 27% return type of year for the S&P. Rather, we expect a flattish year which coupled with a weak USD should stimulate further outperformance by non US equity.

Our 2023 view is quite simple & straightforward. As US inflation declines the Fed will have less work to do. 2022 headwinds turn to 2023’s tail winds; NDR reports that its global recession indicator has begun to roll over and notes that the best returns tend to coincide with high and falling recession risks – which makes sense.  We expect reduced volatility (VIX now under 20, MOVE index under 120) to lead to improved risk appetites. Fundstrat came out last week with some interesting work suggesting the VIX is much more important for how equity will perform than earnings, noting that following a down year, a declining VIX leads to positive equity returns regardless of earnings.

 We expect the USD to be the main casualty of this outlook which will cement the reversal of the decade long run of US financial asset OP, a trend reversal which begin in the 2H of last year. The prior regime of US equity OP led by Big Cap Tech is over and unlikely to return any time soon. ACWX, led by Europe, has broken out above its 200DR (70% of ACWI markets are above that key technical level). EM equity has recently joined the party, kickstarted by China & outperforming SPY by roughly 800 bps over the past three months. European equities are off to their best two week start to a year ever. We expect a multi year run of non US equity OP.

Here at TPW Advisory, we have focused for some time on this shift, overweighting EAFE for the bulk of last year and then building an EM equity OW over the past few months. Our positive view of things has been shaped by our unique geopolitical construct, the Tri Polar World, which helped us develop the 3 keys to focus on last summer: the pace of US inflation’s decline, the path of European energy prices and the ability of China to move off Zero Covid.

Much of the risk asset move of late has been underpinned by the speed & direction at which these keys are moving, especially in China. China’s Zero Covid about face has been as abrupt a change on a key issue as we can recall, spurred on by the recognition that the export sector was weakening and that growth was falling to unacceptably low levels.

This shift has been matched by shifts across China’s economic landscape, including for example, relaxing regulatory curbs on the big tech companies (Ant IPO saga) and most importantly, easing up on the property developers. Here, the 3 red lines drawn in 2020 have been relaxed as China starts to untangle the knot between housing, consumption & economic growth. Its important to keep in mind that China has the most policy flexibility of any big economy with room to cut rates and stimulate spending.

These economic policy shifts have been accompanied by a geo political tilt away from China’s recent aggressive approach to the outside world towards a more cuddly bunny type approach. For example, one of China’s leading “Wolf Warrior” diplomats has been reassigned to some non descript role as China seeks to repair ties with key European markets & pushes back against the US effort to cut it off from the upper levels of the semiconductor chain. On all three fronts: Covid, the economy & diplomacy, China is making major changes which makes us sit up & pay attention. We suggest you do the same.

We expect China to recover quickly and help power the world economy away from the recessionary shoals, notwithstanding recent World Bank, Davos and other late & immediately out of date global recession type reports. As a former Morgan Stanley guy it pains me to admit that Goldmans recent move off its recession call for both the US and Europe is the right approach. Expect more to follow.

Several weeks ago we wrote that China’s move off Zero Covid is the single biggest positive for global growth one could ask for. Much as the US and then the European consumer has been able to tap trillions in Covid enforced savings to bolster economic activity, we expect the same in China where McKinsey has noted excess savings of $2T and Matthews Asia, a top firm, has suggested $5T. China will buy much from Europe, helping Europe avoid recession while also returning to the skies to travel after being locked up for the past 3 years. Japan in particular, will be a major beneficiary of the return of the Chinese tourist.

While China looks to jumpstart its growth engine, Europe has also moved very quickly with Dutch nat gas prices more than halving over the past month. Data suggests Europe may well skirt recession. Germany’s 1.9% GDP growth for 2022, out today, suggests that Q4 growth was basically stagnant while Europe’s November IP rose 1% vs the Bloomberg consensus for a 0.5% contraction. Citi’s global economic surprise index has been rising while its global inflation surprise indicator has fallen sharply.

The US has been the slowpoke versus China and Europe but even here the action has picked up of late with December’s jobs and inflation data both supporting the soft landing scenario we have written about since August (Middle Way). Its not just one data point either – taking the last six month of US inflation data gives one a run rate of under 2% inflation. As inflation falls away, real wages are growing (real AHE of 2.3% three month annualized as of December), suggesting that when coupled with record low unemployment the scope for a consumer supported soft landing is growing. As we wrote in Enjoy the Downhill the trend is now our friend.

Markets are now pricing in a 25bp hike by the Fed at the beginning of February as well as multiple rate cuts by the end of this year. We agree with the former & question the latter; expecting rather a long pause by the Fed as it ascertains the impact of its aggressive tightening cycle. Given we do not expect a recession we also do not expect to see rate cuts in the US. We do expect the EM Central Banks to lead the shift from a massive, global, rate hike cycle (something like 300 rate hikes last year) to rate cuts in 2023. Once the Fed goes on pause and underpinned by the weak dollar, we expect EM CB’s to begin to cut rates, supporting EM equity & LC debt.

We updated our model portfolios this week, both our Global Multi Asset (GMA) and our TPW 20 thematic model. While down for 2022, they both OPed their respective BMs and are positioned for continued non US equity OP, Credit OP in FI and a continuation of the secular bull market in Commodities. Thematically, the focus remains on Climate where we expect the combo of US & EU public and private sector spending to return Climate to the top of the policy agenda as inflation fades. Many investors remain way behind the curve – to wit, in JPM’s most recent client survey, roughly 2/3s of clients said they expect to CUT equity exposure in the coming weeks.

Within the non US universe, our geographic focus has shifted somewhat from Europe which was our big focus last year towards Asia where we have continued to build both our debt & equity exposure. Asia should lead the global economic recovery in 2023 & 2024 with China, India, SE Asia, Japan all leading the way. As a result, we now are double OW Japan and China equity and have close to 20% of our GMA model invested in EM debt & equity.

Enjoy the Year of the Rabbit & reach out if you would like to learn more.