I have been consistently vocal in my bullish outlook for risk assets for much of the past two years. Of course, I have tried to pay attention to the risk factors, recalling the wise example of Barton Biggs, my former boss at Morgan Stanley, who usually travelled with a pile of reading, most of which he would tell me countered his own POV.
Barton had a long and distinguished career and one of the ways he did it was by looking at all sides. I have tried to do the same. Recent Musings have highlighted reason for optimism for risk assets and pessimism for safe assets. Now, in the spirit of giving thanks for a solid risk on year, I would like to lay out the risks as I see them today.
For simplicity’s sake, let’s use our Global Risk Nexus (GRN) ordering system with its focus on Climate, Economics, Politics, Policy and Markets. I will employ a point – counterpoint style.
Overall, I remain very impressed by the cross asset capacity to prick bubbles and create “potholes” to ride through. To wit, Chinese equities have been blasted, bonds have been busy blowing up macro hedge funds while in commodities oil is down 4 weeks in a row & iron ore is off 28% (check out the LT chart – an amazing selloff). Crypto bulls are so busy paying up for stadium rights and trying to buy a copy of the Constitution that BTC has sold off close to 20% in a week or so.
The good news is there is no shortage of reading material on today’s risks – in fact, risk warnings are everywhere. Its the Bulls who would seem to be in short supply.
CLIMATE & COVID
A clear long term risk is that not enough is being done fast enough to avert a catastrophe for the entire human race. A more NT risk is continued extreme weather events creating mass migration that overwhelms governments and upends pricing across key commodities.
COP26 may not have been all climate activists hoped for but it was far from a nothing burger. The Covid Speed model - global intellectual & financial capital focused on a single issue – is very much in play with Climate. Investors have a real opportunity to help the globe and themselves by investing in the Climate thematic (TPW 20 model’s single biggest segment).
Re Covid – it is truly proving endemic with more lockdowns in parts of Europe creating fears of another tough winter. Could widespread Covid lockdowns throw the global economy back into recession?
The Economist’s Global Normalcy Index is at its post Covid high while Oxford Economic’s US Recovery Tracker is back above pre Covid levels. Combatting Covid requires accelerating the global vaccination process; the reopening trade (JETS) has repriced back close to July’s initial Covid discounting levels.
Worries of an imminent US recession are on the rise driven by a huge gap between consumer & investor confidence coupled with the latest Univ of Michigan confidence survey recording the worst durable good buying conditions in decades. Fears of a continued growth slowdown in China create uncertainty around my synchronized global expansion scenario.
The Atlanta Fed’s Nowcast for Q4 GDP is tracking at over 8% y/y growth and while very volatile, is usually directionally correct. US Services PMI just hit a record high; Citi ESIs are turning up across the Tri Polar World; extremely low inventory to sales ratios, record household net worth, rock bottom rates & cash flush companies all suggest a recession is unlikely.
China is likely to be on a “glide path” in 2022 in the run up to the Party Congress that will most likely give Pres. Xi his 3rd term. A full policy quiver, strong FX, and a well laid out path to quality growth suggests 4-5% real GDP growth next year.
US midterms and Presidential elections in Brazil highlight 2022’s political calendar coupled with a new German coalition Govt and the aforementioned China process.
Wild cards: An incapacitated Pres. Biden could throw US politics up in the air in front of midterms which would then likely see strong Rep gains in the House and Senate leading to years of gridlock. Pres. Xi is denied a 3rd term and China descends into turmoil.
Pres. Biden, suffering in the polls, has signed his physical infrastructure bill and the House just passed his Build Back Better plan. Recent Chinese political activity suggest it’s a near certainty that Xi will get a 3rd term. Both US & China are focused domestically - watch for possible tariff easings in the coming months.
Central Banks are being accused of losing the inflation plot with markets pricing in ever more aggressive action, particularly in the US and Europe. Fed tightening cycles end bull markets – could one also end the global expansion before it even truly begins?
Markets have already priced in close to 3 Fed rate hikes next year and 1 in the EU. The BOJ and PBOC are likely to be on hold or even ease in the latter case. The Fed has a 4 step process in hand: taper, accelerate taper, hike and then perhaps hike again. On the other hand, supply chain snafus and energy price spikes are already unwinding; could inflationary fears turn to deflationary worries?
US equities are up close to 25% and have set over 65 new ATHs so far this year. Clearly we are in a bubble – look at NFTs and by the way, what’s a DAO doing trying to buy the Constitution? A USD break out could suck even more global capital into US assets leading to a blow off top (BofA FMS notes global investors are the most OW US equity in 8 years). JPM notes UST are pricing in growth 3 points below its forecast - what impact would a rate spike have? Would a Crypto crash matter?
Q3 Earnings have been robust – over 40% y/y gains in both the US and EU. Top line growth has been over 10% in both and margins remain close to all time highs. Companies have pricing power and are using it. SPY sells at roughly 19-20 times 2022 EPS – rich yes, bubble? BofA’s global EPS indicator expects 10% EPS growth in Q1 2022.
When the S&P ends a year up 25% or more the next year has been up 12 of 14 times with an average gain of 11%, fitting my 1995-1999 analogue.
Real rates are negative, close to record lows and supportive of risk assets, especially long duration growth like Big Cap tech. Demand for LT yield remains insatiable offsetting rate spike fears. The twin engine equity market I have written about all year remains intact.
The ROW has yet to break out – Japanese equity has fallen sharply in USD terms and Chinese equity is down almost 10%, EM debt & equity have been a real disappointment.
On the Commodity side the LME notes that all its main metals have spot prices above the futures something not seen since 2007 and suggestive of strong demand while metal stocks (DBB, PICK) test support. Likewise, OECD oil inventories are close to a 7 yr. low.
Dreams of a Web3.0 new world crash on the shores of aggressive SEC regulation. Possible but not probable as SEC takes its time while Crypto puts facts in the machine.
Bears make the case that inflation is too high, the Fed needs to act NOW and in so doing will cut short the economic recovery and cause a true selloff in the equity markets.
Bulls see inflation as transitory & Covid as endemic not shutdown worthy, 2022 as a year of relative normality and clarity with a synchronized global expansion, solid EPS growth and real opportunities in Commodities, Thematics & the Asian laggards. I am with them.
What did I miss? What is your top risk?
I cover a number of these issues in yesterday’s 10 minute video interview with Spain’s leading business TV channel Negocios.
Have a wonderful Thanksgiving – we have much to be thankful for. No Musings next week as I plan to be supine with turkey leg in hand (that’s if my 2 teenage sons don’t get them first). TGIF!