As The (Tri Polar) World Turns - September 2018
MACRO THEMES
Three macro issues stand out as we exit Summer (here in the US) and prepare for Fall. As befitting the Tri Polar World, each region: The Americas, Europe, and Asia has one issue.
The first and arguably the most important is Fed chair Powell’s Jackson Hole speech where he noted that he saw no signs of inflation overheating. That statement opens the door for the Fed to pause, either after hiking later this month or following a possible December hike. Either way we are now much closer to a pause in the Fed’s rate hiking cycle than we have been since the tightening cycle began. This has implications for the USD, gold & EM assets among others.
Chart 1: MSCI Eurozone Relative to US
Source: Datastream, JPM
Europe’s issue lies not in Turkey but in Italy. The talk out of Rome suggests that the country’s budget discussions are likely to be less problematic for European financial assets than feared. This is in large part due to Italy’s need to issue or roll over some $60B in debt between now and year end. Given this need it is highly unlikely the new coalition government will agree to a blowout budget that spooks the bond markets and creates a rollover nightmare. Remember politicians exist to get reelected; blowing up the Govt in the first six months in office is not the way to go. Near record European equity outflows coupled with the huge performance gap between European equity and US equity ( see Chart 1) suggests a little good news could have significant beneficial effect on European asset prices.
Chart 2: Gross Issuance Sold as % of Total Annual Funding
Source: FT Research
Our third macro point to bear in mind comes from Asia, more specifically China and its currency. There has been much DC chatter about China’s capacity to let the Yuan weaken in order to offset the likely imposition of US tariffs on an additional $200B worth of Chinese exports to the US. Yet the recent decision by China’s Central Bank (PBOC) to reinstitute counter cyclical factors in setting the Yuan path suggests the opposite; China wants to ensure it can maintain control of its currency. Thus the likelihood that China would visibly take more control over the FX setting in order to let it weaken defies logic as it would invite US charges of currency manipulation. Once the tariff decision is made some sense of quiet is likely to return to the US-China relationship as both sides seek to dial down the pressure.
As we enter Fall, seasonality remains a concern for equity assets while continuing to favor UST and gold. The first half of the year it was all about the US and tech; we continue to look for some convergence in performance as the year progresses.
PORTFOLIO STRATEGY AND ASSET ALLOCATION
Given our positive global growth outlook we continue to favor global equities over bonds and maintain positions in alternatives.
Within fixed income our bias remains toward long duration UST and US HY credit: positive seasonality, trade risks and limited signs of inflation support the UST position while favorable supply – demand characteristics, declining default rates and the lack of repayment mountains support the contrarian HY credit position. Recent EM debt woes suggest an area of opportunity - we initiated a position in USD EM debt, an asset that correlates strongly with UST but provides a significant yield pickup. Our expectation for better EU growth leaves us with minimal exposure to non-US sovereign debt positions.
On a regional equity allocation basis we have added to our US equity position with a Defensive bias. We have removed two long standing positions that have done well: US small caps and global energy.
Europe remains our favored regional equity allocation & we remain exposed to core European equity as well as small caps and financials.
We have added to our Asian equity exposure after its recent travails suggested an oversold condition.
Within alternatives we remain biased to oil and gold. We shifted our method of exposure to add an MLP position which provides a yield pickup in the context of expected stable oil prices. We continue to follow Dr. Copper closely and are looking at the Agriculture complex as a possible area to add to in the coming months.
Plenty of risks remain: the sentiment sapping threats of a trade war, the US mid-term elections & the Mueller investigation, the potential for an overly aggressive Fed to invert the yield curve (though history suggests equities can do fine in that scenario), or an EM liquidity issue. While no longer new per se many of these risks are hard to handicap, thus our decision to hold cash, gold and a significant UST position.
GLOBAL MACRO SUITE PORTFOLIO CHANGES
Global Macro Multi Asset (GMMA)
We exited our US Small Cap position after its great run and added to our US Defensive exposure through several factor tilts.
We added to our Asia ex Japan exposure after its sharp selloff. We removed our global Energy position which has been a great performer in the portfolio
We added to our High Yield Bond position and believe it will continue to benefit from solid fundamentals & the search for yield.
On the sovereign side we slightly reduced our long duration UST position and eliminated our unhedged non US sovereign exposure believing that better opportunity exists in the USD EM debt space where we opened a position.
Within Alternatives we exited our broad commodity exposure in favor of a more direct exposure to the US energy complex via an MLP position.
Global Macro Income (GMI)
In the sovereign space we reduced our positions in UST and non US sovereigns while switching our EM LC debt position into a USD EM debt position.
Within the corporate credit space we added to US IG credit.
Furthering our multi asset approach to the GMI portfolio we initiated a position in Gold to go along with our existing MLP position.
Global Macro Equity (GME)
In keeping with our approach to position consistency within our various portfolios we exited the US Small Cap and Global Energy positions while consolidating our Defensive sector selection in several factor based ETFs, leading to the removal of positions in Utilities and Healthcare. We also initiated a position in US MLPs.
Outside the US, we exited our Latin American equity exposure while in Asia we trimmed our Japan exposure and added to our non-Japan Asian exposure.
We hope you find this new piece of value and look forward to engaging with you on a monthly and quarterly basis.
Jay Pelosky, CIO & Co-Founder
TPW Investment Management
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