It’s not fashionable but I really think that “Growth Beckons” is the story—rather than the inflation, stagflation, recession mantra that’s been drummed into our heads from pillar to post, noon to night, states Jay Pelosky of TPW Advisory.
From here that din almost sounds like irrational pessimism.
A lot depends on context for sure. Is growth slowing from 2021 levels—absolutely—but will 2022 GDP growth be slower than the five-year pre Covid average (2015-19) in the US and in Europe—absolutely not.
The US five-year average was 2.3% real GDP growth, for Europe it was under 2%. In contrast, 2022 US GDP is expected to be somewhere around 3% with the Fed at 2.8% and consensus at 3.5%. 2023 GDP is expected around 2.9%. The ECB forecasts 2022 European GDP growth at 3.7% with follow on GDP growth of 2.9% next year.
In Asia, China is expected to grow around 5%-5.5% this year while Japan is forecast to grow close to 3%, with similar growth rates for both expected in 2023. That would mark Japan’s best growth in a decade.
Thus growth, both real & nominal, is likely to be well above pre-Covid trend rates across the bulk of the global economy over the next two years, yet earnings are expected to be single digit in the US and Europe this year—a very low bar. Importantly, real rates remain deeply negative and are likely to remain negative for the next several years across the US, Europe, and even Japan.
As regular readers know, here at TPWA we expect growth to continue to surprise to the upside in the out years as well, contrary it seems to just about everyone on the planet.
But what about the war in Ukraine, surging energy prices, Covid’s assault on China, raging US inflation, and a Fed intent on wrestling back into its cage—aren’t these all-growth killers? Amidst all the talk of deglobalization, let’s use our Tri Polar World (TPW) framework to assess each of the three main regions.
While surging energy prices make for good headlines, we and others have noted how much less GDP is spent on energy and food on both a global, national, and per capita level today vs 20, 30, 40 years ago. Europe entered the war period with solid growth, record low unemployment, and a favorable policy mix with the ECB on hold and fiscal stimulus coming through via both its NextGenerationEU (NGEU) spending program (main disbursements in 2022-2024) as well as new efforts to bolster energy security and defense. German borrowing this year for example, will be the second most in the past 75 years.
Of particular note, is last week’s March primary PMIs from Europe featuring across the board BTE # from Services to Manufacturing through to Composite. Let’s also note the ten-year bund breaking above .5%, a few months ago it was deeply negative while one month post invasion, European equity has recaptured virtually all its post invasion losses just as history would suggest. Does any of that suggest recession?
March prelim PMIs were strong in Japan & the US with Composites in both up m/m. China just came out last week with stirring words of support for its financial markets, tech companies, property developers, and others. Action is needed and should come next. Its Central bank, the PBOC, is easing and is likely to ease further while fiscal stimulus this year will be significant. Yes, Omicron has broken through the Zero Covid defense but China has also been improving its ability to do micro lockdowns and bubble zones. Fears of a nationwide lockdown are likely to be misplaced as are expectations of a sharp slowdown.
In Japan, Covid restrictions are easing while the JGB’s threaten to break above the BOJ target rate of .25% as the yield spread between UST and JGBs lead to yen weakness and potential inflation, which one would have thought would be a good thing for Japan. A large fiscal stimulus is rumored to be in the works while Japan’s natural cyclicality is boosted by a sharp fall in the CNH/JPY rate. Japan’s real effective exchange rate is down 56% from its peak and back to levels last seen in 1972!
What about here in the good old USA? Well growth here is coming in BTE virtually across the board. Here too rates are rising with the ten-year UST at 2.4% while stocks recoup much of their recent losses & commodity prices signal continued demand. An environment that incorporates sharply higher nominal GDP, an inverted yield curve & deeply negative real rates without obvious excesses is likely to be tricky to navigate.
The US policy mix is much less favorable with large fiscal drag and a Fed intent on at least jaw boning markets into believing it will crush inflation. The jaw boning seems to be working with the two-year UST at 2.15% and threatening inversion, another favorite buzz word these days. Chair Powell says look at the short end, 3M-18M and there it is as steep as it could be (229 bps -BBG) while deeply negative real rates offset the inversion concerns. History shows its not commodity price spikes that cause recessions—it’s the Fed response to such.
Today, the equity market is telling us that growth is sufficiently strong to handle the anticipated Fed response—even now with two 50 bp hikes being priced into bond levels. The economy and equity market are giving the Fed the green light to tighten, knowing that an overly exuberant economy is the big risk, something that could force the Fed into a mistake. Such an environment maintains the Cyclical-Value equity trade in the US.
Continued commodity price appreciation—and not just oil, Natural gas, and wheat; but also Dr. Copper, iron ore, gold, etc. suggest growth not recession. The FX market tell, the A$/Yen cross, has broken out to a new high while commodity indices rock and bond indices create their own doomsday headlines…does that sound recessionary to you?
We expect the ebbing of Covid to have a much bigger impact on the global economy than the effects of Russia’s invasion of Ukraine. JPM notes that global mortality rates due to Covid have fallen from over 2% in 2020 to .4% ytd and .3% in Asia. Russia’s invasion knocked Covid not only off the front pages but even off the Fed’s statement—for the first time in two years Covid was not mentioned.
Covid’s ebbing is just starting to manifest and will do so in the coming quarters throwing into disarray the recession-stagflation arguments and setting the stage for further equity appreciation. Covid numbers in the US are at the lows and estimates suggest roughly 80% of Americans have some level of immunity.
We continue to favor the areas we have highlighted over the past several weeks: Europe, thematic disruptive tech, China, and gold. Japan looks to be catching a bid as well given its now increasingly cheap cyclicality.
As we start to look to beyond this year, into 2023, and the out years, our conviction grows in the case for a strong global growth trend, boosted by a global public & private funded cap ex boom (see latest US non defense capital goods x aircraft data—hockey stick) and productivity surge allowing for higher wage gains without inflation overheating, akin to our analogue—the US in the second H of the 1990s. An overly aggressive Fed, breaking the economy and stock market, is what stands between us and that vision becoming reality.
Its not a slam dunk, but just like for those Duke Blue Devil hoopsters last night, growth beckons as time passes.