Trees don’t grow straight to the sky, states Jay Pelosky of TPW Advisory.
So why would one expect stocks to just keep soaring after one of the more aggressive three-month moves in history, especially among non-US DM or EAFE (All Star Charts notes EAFE doubled SPY performance since October)? The US has enjoyed the January trifecta as we wrote about last week which has a perfect track record of higher stocks a year out.
We had the chance to discuss this on Bloomberg TV with Jon Ferro Monday and noted that stocks had gotten ahead of themselves as investors priced out the recession, long bonds rallied and tech stocks burnt the shorts. Jon and I had a good back-and-forth as to how TPWA missed that tech move and why. I noted that no one gets them all and that given our view of no US recession we did not see the US bond rally as sustainable, nor the Big Tech rip nor the non-US weakness as the USD joined in the rally.
We continue to view the USD as a key factor here as does one of our favorite technical analysts, John Kolovos at MRA Advisors, who sees the USD chart as the most important to track. He sees it having rally capacity back to 106 on DXY but views the medium-term direction as falling to 96. We share that view as does another favorite, my old MS colleague and former FX strategist, Stephen Jen, whose Dollar Smile framework leads him to expect dollar weakness in the year ahead.
Here at TPW Advisory, we expect the surprises of 2023 to include a rate-cutting cycle led by EM Central Banks coupled with the start of a new global growth cycle originating in Asia as China goes for growth, Japan exits decades of deflation while India continues to grow and SE Asia benefits from all of the above. The data is turning supportive fast a la Narrative Speed. To wit, all but one SE Asian country had rising Manufacturing PMIs in January. European and Chinese leading indicators are moving sharply higher while JPM reports that over 80% of countries globally have rising Service and Manufacturing PMIs, up from 20% only four months ago.
As such we want to play a long game this year in two senses—one we want to be long risk and two we want to hold it through the ups and downs of Wall St’s old two-step dance. Some, smarter and faster than us, can trade in and out—more power to them—others are frozen in the same recession, bear market POV they had a year ago while some like us are setting their portfolios for a new world of high nominal growth led by a public-private partnership focused on dealing with the Three Cs of Covid, Climate, and Conflict.
President Biden made the case for exactly that in his State of the Union speech. He made it abundantly clear that the US has a real opportunity to develop its economic leadership by coming together to address the challenges laid bare by the upheaval of the past several years. We believe that as the macro backdrop stabilizes and financial market volatility ebbs, Climate, for example, will reassume its rightful spot as the most important macro theme of the decade. It’s worth noting here that US states’ rainy day funds have grown significantly over the past few years and now total almost $140B, the highest level since the late 1980s.
Over the past nine months or so, we have used our three keys to assess the action in our Tri-Polar World: the pace of energy prices in Europe, the path of US inflation, and China’s move off Zero Covid. The past few weeks have brought about some updates. In Europe, natural gas inventory levels are well above historical levels thanks to a warm winter, conservation, and an aggressive search for new sources. This sets up a better 2023-24 economic outlook than expected even a few months ago. Yes, EU equity finally rallied in response and yes a pullback is normal, healthy, and an opportunity to build positions.
In the US, investors or more appropriately traders are whipping things around first pricing in a recession, then pricing out the recession, and now pricing in stronger-than-expected growth with the new hot trade being a bet on 6% FFR. I mean, pick a side fellas, KC or Philly? As an old lineman, I got Philly which dominates both sides of the line of scrimmage. We expect continued declines in inflation, including next week’s January report, and for the coming months as y/y comps are very supportive and inflation’s six-month trend is around 2% annualized.
As we noted on Bloomberg, we look for a flattish SPY this year (+/- 5-10%) based on our outlook for no recession, a Fed on hold post another hike, unattractive long bonds and equities capped by big tech weight, low EPS growth (agree here with Dr. Ed Yardeni’s view for operating earnings growth of roughly 5% this year, over 10% next) and high starting multiples. This leads us to OW the non-US equity markets, both EM and DM.
One of which is China which has had a rip-roaring equity rally over the past few months and is now in the digestive phase – the same applies here as we noted in Europe—pullbacks normal, healthy, and an opportunity. The update here is provided by JPM who points out an ebbing of concern around a second Covid wave as China approaches herd immunity suggesting that all the horror stories of Nov through early Dec about mass death etc. were just that, horror stories.
As we have written about pretty extensively over the past month or so, we like Japan as well as China, and here too the news is getting better. We focus here on wage growth and what that is likely to mean for economist Kazuo Ueda, the newly chosen BOJ Governor, and his approach to YCC. Winter bonuses rose over 7% Y/Y while Y/Y December wage gains were 1.9%, the most since 1997.
We anticipate a significant adjustment to YCC particularly if the Spring wage season leads to a pickup in wage growth (BOJ expects roughly 3% vs 2.2% a year ago) which in turn would solidify Japan’s exit from deflation, create the context for a bond bear market and a subsequent domestic investor shift out of bond into stocks. We remain double-weighted in both equity markets in our Global Multi-Asset (GMA) Model.
Speaking of the GMA we updated our two model portfolios, the GMA and our TPW 20 thematic model, this week. Part of our process includes reviewing the technical outlook for every position, the major indices and any potential adds. Three things stood out from this exercise; first, the sharp shift from 2022’s condition where many of our holdings were under their 200daymav to the current state where over 90% of our ETF holdings are above their 200daymav. This is unabashedly good news. In several cases, January’s strong thrust led to holdings breaking above their 200-day for the 1st time in over a year.
Secondly, the recent pullback has allowed many overbought conditions stemming from that rip-roaring really to be worked off. We did not have a single holding with an ST RSI above 70 or below 30...so in essence neither overbought nor oversold. Thus, the old two steps. Finally, it’s well worth noting that while every major equity index is above their 200-day main bond indices, few are not and remain capped by that overhead resistance and reinforcing our view that the bond-tech stock rally was a head fake. As such, we made very few changes to our models, and content to play the long game.