What A Difference A Year Makes

1433 words – a 4 minute read.

H’tip to the Bespoke folks for today’s title; they used it earlier this week and I thought let’s use that & so here we are.

It’s a very useful exercise to think about where we were a year ago, where we are today and more importantly what the road ahead might look like. Our job is to keep up with and even surpass a forward looking discounting machine that incorporates all the thinking of all those participating, I mean the global financial markets. Talk about HI!

A year ago, US inflation was spiking (May 2022 CPI rose 0.8%% y/y), inflation expectations were soaring and a spooked Fed was beginning its run of four straight 75 bp hikes. Investors were bearish, stocks, bonds and commodities were weak, cross asset volatility was rising and recession calls were mounting.

Here we are a year later: inflation is falling as quickly as it rose (Credit Suisse notes May – June 2023 inflation fall = to one of biggest 2 month falls in past 70 years), inflation expectations are at 2 year lows, the Fed is on hold & investors are bullish. Over the past year, in USD price terms, cash is virtually flat, ACWI is up 14%, bonds (AGG) are down 2% and Commodities (GSG) are down over 20%. Talk about forward looking.

As I write global stocks are finishing up their best week in three months & are up sharply ytd led by non US stocks in Europe & Japan, US tech & Lat Am. The return to stability we foresaw in our 2023 Outlook published last October has manifested with VIX under 15 (33 a year ago), and the Move index under 110 (138 a year ago). It’s the same in Europe, the VIX equivalent is down roughly 50% from year ago levels to under 15.

The most anticipated recession EVER remains nowhere to be found & our advice to stay patient has been rewarded as the expected equity rotation we wrote about a month ago starts to manifest in both markets & our two model portfolios.

The Middle Path between high inflation and deep recession that we have trod over the past year is now becoming apparent to most, even the Fed. Ditto for the high nominal growth world and its beneficial effect on earnings which as a gentle reminder are denominated in nominal currency.

Segueing to the present, one asks what our main Fed takeaway was?  Not the pause – that was widely telegraphed – but the update of its economic forecasts. Here the Fed essentially validated our high nominal growth path – first by more than doubling its 2023 GDP forecast to 1% and second by noting inflation would average roughly 4% for the year resulting in nominal GDP of roughly 5%. The ECB replicated this in its updated forecasts noting, as the Fed did, a longer path to low inflation and penciling in nominal growth of between 3-4% this year and next, roughly double its pre Covid levels.

This means two things: one, forget about US recession this year and two, forget about returning to the pre Covid world’s low growth and low inflation environment. As we wrote about in Birth of the New  we are not going back to that pre Covid world but rather moving forward to leverage the battle against the 3 Cs of Covid, Climate & Conflict in order to enter a new period of global growth fueled by the public private partnerships springing up all around the world and enhanced by the productivity potential imbued in the AI innovation cycle. Think 2H 1990s.

Clients & regular readers know our relentless focus forward is a key differentiator for TPW Advisory. So how do we see things playing out?

We agree with the FFF pricing in YE FFR at 5.1% - no recession = no rate cuts; furthermore, we agree with MS that the Fed is done raising rates. We expect inflation will be well under 4% y/y after the June print which comes before the July meeting, notwithstanding the 65% odds priced in for a July rate hike.

We dismiss the dot plot completely – it has almost no utility as predictive piece of data. We are not alone in this POV – here is Bloomberg: “analysis by Bloomberg shows the median forecast rarely, if ever, coordinated with actual policy rates (dashed red line). Dot plot medians tended to overestimate policy rates—sometimes by a wide margin”. We remain in the higher for longer rate camp thus our significant FI UW in our Global Multi Asset (GMA) model.

We note that US housing has bottomed, that the inventory destocking prevalent in both the goods & commodity spaces should shift to restocking in the months ahead, pulling UP the ISM Manuf PMIs to services rather than vice versa while the job market continues to cool.

We were struck by this WSJ data point from today: “126,978 carloads of motor vehicles and auto parts carried by North American freight railroads in May, up 15.3% from last year and providing the highest average weekly carload volumes for the sector since September 2020, according to the Association of American Railroads”.  We note one of our US Cyclical holdings, IYT, is  up over 9% P1M.

We continue to be guided by our mantra: Fed done = USD weakness = ROW equity OP coupled with thematic & Commodities. We have spent much of this year building up our EM equity positions in Lat Am, China and SE Asia as well as a large position in EM local currency debt. We note that Citi’s Global Earnings Revision Index has turned up meaning upgrades are outpacing downgrades for the first times ince 2021. It caught our eye that US PPI is now some 300 bp below CPI – 2H margin expansion anyone?

We expect some of the Lat Am Central banks to start a new, global, rate cutting cycle which will help drive cross asset pricing in the year ahead. Brazil, for example, has the highest real rates in the world! JPM notes it’s Brazil Economic Surprise Index is at an 18 month high while growth estimates have roughly doubled since January to 1.7%.  The S&P just upgraded its rating outlook from stable to positive. May inflation just beat estimates at roughly 4% y/y vs ST Govt debt (SELIC) at 13.75%. Is it any surprise that Brazilians are keeping their money at home leading to the Real rallying vs the USD? No, it is not. Mexico’s FX & stock market have been global leaders all year yet its REER remains competitive while its forward PE remains among the lowest in the past 30 years according to our friends at Emerging Markets Investor.

The PBOC is already leading the way; we expect Brazil, Chile, Mexico and other CBs to follow suit in the months ahead. As we wrote in last week’s Musings  we are excited by the upside we see in many of the thematic charts we have looked at recently – many, many positions have been basing for a year, many have been through the fire of the past 3 years and are back to levels of 4-5 years ago.

We remain steadfast in our view that as stability returns & America’s New Industrial Policy continues to build, Climate will regain investor attention as the single biggest global macro theme of the decade. More broadly, we believe that any dips should be bought; we are coming out of the longest period of investor sentiment in the history of the AAII survey. As such, there is so much cash on the sidelines & the sentiment shift so rapid that many, many investors are well behind their BMs and as such will be buyers on any weakness.

In other words, having been patient, having been accused numerous times of being pollyannish, do NOT sell too early & BTFD! Pullbacks are healthy. The upside, in US cyclicals, in EM debt & equity, in thematics, in commodities, are significant and will be attained over the coming years.

Notwithstanding Barron’s new bull cover, here’s some data to stiffen the spine. FactSet notes cash inflows to ETFs are running at 4 year lows. BofA’s FMS notes Commodity positions are at 3 year lows while those surveyed hold a US IG overweight vs HY that is at an 8 year high. Even Goldman has caved on its bullish oil outlook; we are OW both Commodities and HY in our GMA model. Its an exciting time.

Enjoy this picture – granted its over 2 years but makes the point. https://www.axios.com/newsletters/axios-am-bd8b7ea8-4ef5-4928-ae7f-3bc77dcd49e1.html?chunk=3&utm_term=emshare#story3

Happy Juneteenth… enjoy the long weekend!