Another short week that feels like an extra-long one, states Jay Pelosky of TPW Advisory.
Maybe because I attended my first in-person conference in over two years this week, complete with canceled flights, weather delays, and an extra 12 hours of travel time on my return, getting me home last night just after midnight.
The good news is that I had plenty of time to think, catch up on my reading, and muse about what is going on across assets and around the Tri-Polar World. What I came up with is encapsulated in today’s title: sometimes the news doesn’t have to get better, just less bad.
It’s a throwback phrase from my Morgan Stanley days and comes from my old boss, the well-respected MS strategist, Barton Biggs. Back in the 1990s, before Twitter, social media, etc. the news came from fewer sources but still impacted markets. Barton’s point was a reminder that markets are forward-looking and will take the advent of a trend and run with it. A corollary is the famed: “the bad news is in the price” market comment. Yesterday’s Nasdaq (NDX) action sure suggested just that as it rallied hard in the face of Microsoft’s Q2 warning. The COBE Volatility Index (VIX) under 30 and the UST MOVE Index back under 100 for the first time since mid-March suggest the same.
A news flow that gets less bad tends to occur before the news gets better. It's part of the bottoming process, much as today’s technical analysis suggests that the bottom is not yet in. It may not be in—we usually find that out after the fact—but it seems like we are in a bottoming process where the news is getting less bad, much bad news is in the price, and risk assets are accordingly acting slightly better. LPL notes that in the prior five worst starts to the year the average return for the rest of the year averaged close to 20% vs an average rest of year gain of 5%.
Recent examples of less bad news and market response ripped from the headlines of the day include Chinese Tech which is up roughly 40% from its mid-March low. Now the news isn’t great, Q1 earnings were subpar and Q2 is unlikely to be much better given much of it was shanghaied by the Covid lockdowns. Nonetheless, it is getting less bad as witnessed by the likelihood that the aggressive regulatory attacks since last Fall have now been called off and Shanghai has reopened.
European equity provides another example—after 100 days of fighting, the news from the battlefield isn’t great with Russia seemingly making a little headway in the East. On the energy front (the most direct channel to financial asset prices) the EU has agreed to embargo Russian oil. When the war began Brent crude spiked to $135 on such fears—now it is actually happening and Brent remains a good $20 below that high at $117. News is not much better but clearly is less bad. The Euro is up off its recent low and EU equity is up roughly 10% from its March low.
A third example comes from the innovation space where good news remains scarce but valuations have come back to historical levels and below (ARK Innovation ETF (ARKK) at six-times revenues) as tech moguls and VC stars counsel cash hoarding and layoffs. Coinbase’s decision to rescind existing agreed job offers by email could end up as the poster child for a new cold world in tech land. Yet ARKK bottomed (so far) in mid-May and is up over 20% vs Nasdaq up less than 10% from its recent low.
I attended the Inside Edge ETF conf this week and spoke on a panel focused on the investment opportunities in thematic investment. Judging from the sparse crowd at our session, the admittedly very bad price action in the thematic space has resulted in a real lack of interest. As noted last week—clearly not the time to market but perhaps the time to invest. Walking off the stage I tried not to take it personally as I was surrounded by absolutely no one—I felt better when I saw the same happening to my fellow panelists. It’s the space, not us.
We believe that the innovation space, first into the bear market some 15+ months ago, now down 70% give or take, cheap and high growth as the FANGS go ex growth, is attractive both for a tactical (no recession) bounce and as a strategic play on the new, new world of high nominal growth we outlined in our monthly—note Q1 US nominal GDP was 6.5%.
One idea which continues to resonate is the potential public market impact of the upcoming bloodbath in the private equity/VC space. This is especially the case for the late-stage segment, as the above public market derating hits the private market. The IPO exit is closed and down rounds lie ahead. Inklings are already apparent with Fidelity, for example, announcing significant markdowns of some private market holdings while Refinitiv’s VC index is down over 50% ytd. This could provide a moat around the public innovation companies as private companies fight to survive allowing the public companies to gain market share.
Does one sense a pattern here? That might be because all the examples come from areas of the market that are showing signs of relative strength amongst the carnage. For example, from March first, ACWX is off 4.9% vs SPY down 6.5%. Non-US is outperforming, even amidst a strong USD and steady outflows from international equity funds, especially European & China funds (MS has Europe at 12x PE and China at under 10x E).
One of our key themes is the upcoming leadership transition from US tech-led equity to non-US value-led equity; through the fog of war and bear market talk, it is becoming discernible. Another key theme is the long-term case for innovation and thematic investing which we deploy in both our flagship Global Multi-Asset (GMA) model portfolio as well as our TPW 20, 100% thematic model. While many counsels hanging out in defensive sectors we see more downside than upside there—if recession they will get hit, if no recession they will be sold. As the news gets less bad we expect the famed bear market correlation of one to break down. Non-US equity, innovation, and thematics, have already been hit and represent the opportunity set.
Updating the models this week is a regular part of our investment process. Following the publication of our Monthly, it became clear that the GMA top ten performer list was heavily populated with non-US equity. In the thematic model, the relative winners were Climate-related, especially in the EV space. Perhaps more importantly, after several months where the majority of the TPW 20 ETFs UPed the Nasdaq, the May period saw 14 of the 20 positions outperform, suggesting that we may be in a basing process.
One area where the news continues to be bad and which acts like it is the Crypto space—its failure to bounce with Nasdaq recently is quite worrisome as is its failure to pop on good news (Fido opening its 401K space). As a result, we have bitten the bullet and exited the Crypto space altogether in our GMA model, and shrunk it to a toe hold in the thematic model. As noted last week, we have lost faith in the story & think that should markets continue to work higher we have plenty of exposure that will perform.
After taking our TPW 20 Climate exposure to almost 2:1 vs Future tech, we are starting to step back into tech and added a Cloud position this month, something we have been watching and waiting to do for several months. Valuations have become much more reasonable while demand remains robust.
Within the GMA model, we used our Crypto proceeds and others to initiate that Cloud position and build on our infrastructure and tech exposure. Within our very UW FI sleeve we added to the US HY position established last month; given a record five straight down months and average yields over 7% we believe we are getting paid for the risk.
While the market oscillates between inflation and recession fears we remain wedded to the “middle path” view. May’s jobs report, especially the AHE, suggests wage growth has peaked, easing inflation fears while global PMIs and US ISM data imply decent growth rather than imminent recession. Soft landing rather than hard, growth scare vs recession suggests a news cycle that is less bad and on its way to getting better. Europe’s May Manuf PMI was 54.6—gangbusters no, but less bad when compared to a 2H 2019 pre-Covid av of 46.4. China’s May PMIs while still below 50 (not good news) were still BTE (less bad) and likely to break above 50 this month.
As we see it, easing inflation takes the pressure off the Fed to tighten until something breaks; a Fed that can course correct reduces the likelihood of recession which in turn suggests a bottoming process rather than a further earning cut driven leg down in equity markets. As we finally begin QT, loosening financial conditions, stable oil, a gradually weaker USD, and reopening in China all suggest that while the news has yet to get much better it is indeed getting less bad while much is in the price. It’s a start.
