The oscillating nature of economic data and cross-asset market pricing has tried the patience of bull and bear alike, states Jay Pelosky of TPW Advisory.

The bulls have had to be content with roughly 10% gains YTD for global equities while the media drumbeat continues to hammer recession, rate hikes, and the utility of cash—notwithstanding its weak relative performance YTD.

The bears have had to be patient as the recession they had forecast to begin months ago, the most anticipated recession in history has yet to appear, at least in the US. Axios notes that the use of the R-word was down for the 3rd Q in a row & made only half the appearances in Q1 earnings calls compared to its Q2 2022 peak. Germany does seem to have slipped into the mildest of recessions over the past two quarters & yet the DAX is close to 52-week highs and is one of the better-performing markets YTD.

Some sell-side strategists have grown frustrated with the lack of clear direction and have started to flutter the towel if not toss it in the ring. Equity strategists at Citi, BofA, and MS Investments all raised their YE S&P targets this week, pushing out their recession calls yet again, now into 2024.

I guess a move like Nvidia’s will do that to folks, reinforcing as it does the Nasdaq break out to a new bull market. It also validates the AI innovation cycle and its potential near-term impact on companies. Well-respected technicians like Carter Worth have noted the S&P as being in a very tight (3%) trading range over the past six weeks—the tightest in the past five years; he sees an imminent breakout to the downside—we remain constructive and expect the market to break out and UP as we have noted for some time now. Patience…

We here at TPW Advisory are trying to be patient as we await the rotation we wrote about last week to manifest over the month of June. That rotation, from Big Cap Tech to Cyclicals, may seem crazy given the pop Tech has just enjoyed with Nvidia’s results. As we wrote recently, we are participating in sizable positions in the semiconductor space (our pick-and-shovel AI play). Datatrek reports that Big Tech trades at 1.1x forward PE to growth vs the S&P at 1.5x, while the Finom Group notes that on a price-to-book basis semiconductor stocks entered the year near historical lows, suggesting room to run.

To refresh, we expect the June Fed meeting to be the key—not just because the Fed will go on hold as we expect, given soft y/y comps for May inflation, but because the Fed will also raise its 2023 and 2024 GPD forecasts, validating our Middle Path thesis of falling inflation and rising growth. This, in turn, will force the recessionistas to give up the ghost and allocate some of that cash to take the S&P thru 4200 to 4300 and the start of a new bull market (+ 20% off Oct lows).

We believe the rotation is needed to help the whole market break out. As such we continue to hold a US equity barbell in our Global Multi Asset (GMA) model, with Big Tech on one end and Cyclicals on the other, including Industrials, Financials, Energy, Transports, and Homebuilders.

In our view, the three big drags on the US economy over the past year have been: the housing crash, inventory destocking, and big tech layoffs. All three are reversing with housing clearly having bottomed as new home builds in April rose 4% M/M and 12% Y/Y,  an inventory restocking cycle is about to kick off ( Target inventories are down 16% in Q1, Walmart’s down 9% y/y) which in turn will boost US Manufacturing PMIs back above the 50 levels and well, AI is all we need to say for Tech. Bloomberg notes its US Economic Surprise Index is at its highest level in over a year.

The rotation from destocking to restocking is also playing out in the Commodity space. We have been paying close attention here given that Commodities have yet to validate our view of an early cycle global economic recovery story. This week we noted GS laying the blame on “the largest commodity destocking the complex has ever witnessed”. It notes that end demand is not showing recessionary signs and posits that should recession concerns be misplaced, commodity prices will come roaring back. In fact, Goldman forecasts a 30% return for its GSCI over the coming 12 Ms. To support this view, Bespoke reports that the US crude oil draw last week was the third largest on record.

As we wait patiently new data comes in to reinforce our case—the most recent being growing support for the analog between the near future environment and the 2nd H of the 1990s when the US last had a productivity boom, high growth, and rising stocks. This is a POV we have long espoused so it's nice to see some reinforcing work.

Recall that early in that period the Fed raised rates from 3% to 6% before achieving a soft landing and kicking off the dot com boom. We have posited for some time that the return of Industrial Policy in the US and the acceptance of a slightly higher inflation rate by DM Central banks were two main factors that would shape the upcoming years. Add in AI and presto.

McKinsey has just come out with a study showing the potential impact of AI on US productivity and highlighting the immense implications of just a 1% higher growth rate over time. This study incorporates the 1% higher inflation rate we note above (from 2% to 3% target) and adds a 1% real rate so rates are roughly 4% while AI-related productivity boost drives real GDP growth to 3% leading household wealth to expand $48T more than under the stagnation scenario by 2030.

Along the same lines, the good folks at JPM just ran a study showing what happens when the S&P is up 8% or more over the first 100 trading days of the year as we are this year (May 24). The data shows that the rest of the year averages a 9% return with a 96% hit rate and the full-year returns average 25% with a 100% hit rate. We dug into the data a bit and noted that the five years from 1994 -1999 all qualified. Could we be setting up for something similar? Investors are not remotely positioned for such a setup.

Historical studies have not been that effective over the past few, ahistorical, years but as we move past Covid and its inflation spike and return to some semblance of normality perhaps historical studies like the one above may again provide some utility.

See that’s the thing about being patient—it allows one’s mind to relax. When relaxed, one sees things differently, the pieces fall together and the picture changes, providing more insight, not less. Patience is a virtue. So given that this musing may be one of the last things standing between you and the start of  Summer (who said good things don’t come to those who wait) we thank you for your patience and wish one and all a great normal summer!

Learn more about Jay Pelosky here.