What Comes Next?

1475 words – a 4 minute read.

Today’s Musings come straight from the set of BTV’s Surveillance show where I had the pleasure of guest hosting for an hour this morning. It was my first on set appearance in 4 years (pre Covid) and boy was I happy to be back. Not to spar with host Jon Ferro, though I always enjoy that, but to be escorted to the make up room where like magic, the past 4 years were wiped off my face and it was as if I had never left! Thanks folks!

I always enjoy the longer format shows because it gives one the chance to spread one’s wings and cover a lot of ground which for a global macro guy is the sweet spot. To prep I went through several recent Musings and Monthlies in order to address the various issues ranging from Nvidia & new ATHs in the US, a 35 year in the making new high in Japan, new ATHs for European growth and 9 straight days in the green for that “uninvestable” market known as China equity. Pro tip: any market said to be uninvestable is one to seriously consider investing in.

I began with our 2024 Outlook published in early November with its 4 for 24 macro surprises – all of which are playing out, especially #2-4: better productivity growth, a return to stability and the adoption of our early cycle thesis.

I then reviewed our Nov 10th “Fear Is Everywhere” Musings. Gonna take a victory lap for that one – pretty much nailed the Fall low and subsequent 20% up move that isn’t finished yet. I noted that the 4 factor, bullish set up we noted back then for US equity: sentiment, seasonality, positioning and technicals, has set up shop in China.

Next up was ”The Action Is Elsewhere  Musings (LINK) written roughly a month ago where we made the case to look outside the US and focus on some of the laggard markets. We suggested it was time for the US to take a rest and highlighted Asia including Japan and China as well as European growth & EM debt & equity as opportunities. Today, we note that over the past month Europe, Japan and China are all OPing the US, up 7-10% vs the US up 4%. It’s not just equity; EM local currency debt and Asian HY debt are both OPing the AGG ytd.

We received a lot of positive feedback for the Monthly: “The Past is Not The Present, The Present Is Not The Future” which focused on the speed of change, AI’s devaluation of the past & the dangers of depending on historical models in ahistorical times. More of a thought piece as the Monthlies tend to be (this one clocked in at 6k words with 30 charts & tables from 20 different research sources) its where we made the case for blue skies through 2026 and first went in print with our Trump will lose in a landslide POV. Plenty to chew on there.

Three weeks ago we wrote: “Wall St’s Failure of Imagination with exhibits A: 1.5% 2024 US GDP forecast, B: SPY YE 2024 target of 4980 and C: the laughingly wrong headed takes that Nvidia is just another Cisco and 2024 is a 1999 rewind. Nvidia’s 760% Y/Y Earnings gain and 16% single day move shows just how limited Wall St’s imagination really is.

One fresh thought on this subject is how the consensus believes globalization was good and deglobalization is bad and likely to cause higher inflation and weaker growth than would otherwise be the case. We plan to push back hard against this POV and argue that the shift from globalization to regionalization (what we have called since 2012 the Tri Polar World TPW – yes its in our name) is actually going to facilitate the blue sky global growth period ahead. Supply Chain realignment coupled with each region’s desire to have its own semi production process and EV production process is deepening regional economic integration in Europe, Asia and the Americas. Just look at Mexico, look at Poland, Vietnam, the Semi tie ups between South Korea and Japan etc. etc.

Last week we wrote: “Handoff” which argued that risk markets have executed a critical handoff from rate cut dependency to earnings driven market freedom and boy doesn’t it feel good! We pointed out that UST rates were back to November levels while the S&P is up roughly 20% with ACWI close behind. The correlation between rates and stocks has halved in the past month as markets take on board a BTE economic growth outlook which in turn has facilitated the removal of a critical inconsistency – namely the idea that we would get both 7 rate cuts & double digit EPS growth this year.

It is both very healthy and a sign of how strong this equity bull market is that the cost of pricing out 3-4 rate cuts was a two week pause in US equites. Nvidia’s results & its forward guidance (tipping point anyone) put an exclamation point on this transition to an earnings driven market and sets the stage for what’s to come.

So what’s next? We expect further evidence of a global economic early cycle recovery to manifest. Just this week alone we note surging Asian exports in Japan, SK &Taiwan, better US PMI manufacturing data which supports our view that the ISM Manuf index will soon break back above 50 while Bloomberg reports European private sector activity hit an 8 month high last month. We note GS reports that global manufacturing data continues to surprise to the upside & expect a global manufacturing rebound to develop as strong consumption growth further reduces inventories leading to a good old fashioned restocking led manufacturing up cycle.

From an investment POV we want to continue to own both the leaders & the laggards as we expect this bull market to pull up most segments before it is done. That means Tech, Cyclicals and Small Caps in the US, European Growth, broad market exposure in Japan and continued EM debt and equity exposure. Crescat notes that: "The rest of the world is currently as cheap as the US market was at the very bottom of the global financial crisis.”

EM and Commodities are the two segments we like most today for fresh money and note that Commodities are the best performing asset class YTD with GSG up 6% vs ACWI up 3% and AGG down 2%. Grizzle notes XLE is least correlated with Tech and has the highest capital return profile of any US sector. We continue to watch for USD weakness as a catalyst for significant asset allocation into both spaces over the course of the next few years. Bloomberg notes: “Options traders are the least bullish on the dollar against emerging-market currencies since 2007 as impending US interest-rate cuts boost the appeal of higher-yielding assets.”

China remains an OW from both an equity and HY POV. China property HY bottomed months ago as previously noted. Folks we respect like John Kovolos of MRA Advisors noted this week that China equity looks to be putting in a meaningful bottom. We had to laugh when we observed a recent Economist cover asking if President Xi can control the markets; the Economist cover contra indicator never fails – of course he can and he has with the Shanghai Composite up 9 days in a row & up YTD.

When the new Securities regulator is nicknamed The Butcher of The Brokers for his prior work in the space, when the #4 quant fund is frozen from trading for several days (imagine the SEC freezing Citadel or Millennium), one can’t help but think of the old Chinese proverb: “kill the chicken to scare the monkeys”.

Beyond the fear lies the opportunity. China equity sells at 8x PE with 14% earnings growth, (a China large cap growth manager we know reports a portfolio with 2023-2025 EPS growth of 28% trading at 14x 2025 EPS), sentiment is “uninvestable”, Lunar New Year seasonality is positive, UBS reports positioning is the “most extreme in recent memory” aka lightest ever and technicals are supportive (Ren Mac capitulation indicator hit). Taken all together it suggests one of the world’s best risk- reward set ups.

For those worrying about buying at the top China is your game – mean reversion alone and lack of correlation with the US suggest taking a look but here’s the kicker - KWEB at roughly $25 can triple before it gets back to its 2021 high of roughly $100.

Duke men’s hoops rounding into tournament shape with a big game tomorrow, check out frosh Jared McCain, nail polish & all! Good luck to the Duke fencing team competing this weekend at ACCs – LETS GO DUKE!