We sense a change in the air—a sense that the old stories of rising prices and case counts, of shortage and disruption, have lost their bite and ability to move markets—it’s all in the price, states Jay Pelosky of TPW Advisory.
New stories of falling prices and smooth delivery systems, a normal holiday season with plenty of inventory are taking their place. The bearish take seems old, musty, and tired—the positive outlook feels new, fresh, and wired—the coming thing. We expect falling macro volatility and a growing sense of stability to support risk assets as 2023 unfolds. Headwinds—inflation, rates, the dollar—turn to tailwinds.
Near term, we remain focused on our three keys for the 2ndH—the pace of the US inflation declines, the path of Europe’s energy prices, and the success of China’s move off Zero Covid. All three are moving in the right direction. Longer term, our focus is on continued high nominal growth and the coming global cap ex boom we expect as both Govts and corporates focus on the needs and opportunities inherent in dealing with the Three Cs of Covid, Climate, and Conflict. The analog is the US in 1995-2000, this time it's global as our Tri-Polar World builds out.
We struggled with the uphill climb of inflation, rates, and the USD so enjoy the downhill run – while après ski is more our style the downhill comes to mind when thinking about the positive asset allocation outcomes stemming from falling inflation, declining rates, and a weak USD. A flattish US equity market coupled with a weak USD is the best possible setup for non-US equity outperformance. Our model portfolios remain OW and focused on EAFE and EM equity, Small Caps, Value and Cyclicals in the US, HY credit in EM and US, and commodities across the complex. Two areas of Focus for 2023—Climate and Innovation—both bombed out, both candidates to replace Big Tech as the new Growth spots.
While COP27 was a bit of a disappointment the corporate sector continues to invest heavily. Investors, distracted by the Fed, Covid, and Conflict are missing the upside from the single biggest global macro theme of this decade. The scale of the investment opportunity will become clearer as stability returns.
The lack of major imbalances across the consumer, corporate, and banking sectors suggests bearish takes on the economy will prove wrong. The most anticipated recession ever is unlikely to unfold as consensus expects. We remain focused on our Middle Way supported by high nominal growth and expect a cap ex boom to begin to unfold as macro volatility ebbs.
Wage-price spiral fears are overdone—if heavily unionized Germany with double-digit inflation settles for wage gains well below inflation it's highly unlikely to happen elsewhere. China is giving up its fast growth crown to SE Asia and India as growth leadership starts to spread. China, recognizing Covid’s negative growth impact, is moving to a light touch model which should unleash cashed-up Chinese consumers in 2023.
2023 should be a more stable year in politics across the US, with no midterms, Europe, no new wars, and China, Pres. Xi has his third term. Plenty will be written about geopolitical risk but with limited market impact as Europe decides how it wants to play the US-China split, made very real by the US semiconductor ban. Russia’s invasion has opened a lot of European eyes. Our Tri-Polar World thesis keeps clients ahead of the curve.
Gradual stability is the watchword here as well—the Fed and ECB will end their rate-tightening cycles which should allow parts of EM to begin their rate-cutting cycle. Fiscal policy remains active in Europe, less so in the ROW. Labor policy will assume a bigger role in policy debates as the best job market in 50 years runs into the need to push inflation down to 2%—we expect the job market argument to win but don’t expect to read headlines about it.
Declining macro volatility should be positive for risk assets, especially outside the US. Flat SPY next year (consensus) + a weak USD (also consensus) = the best setup for non-US equity outperformance in some years. We see opportunity across both EAFE and EM, which in many cases are at record cheap levels vs the US while completely under-owned.
BTE economic outcomes lead to continued OW of US and EM HY; we remain believers in the secular bull case for commodities and are positioned as such. As stability returns, we expect animal spirits to revive and see the Climate and Innovation spaces as areas of opportunity to replace Big Tech as the search for growth continues.