Start leaving bids on a one to two-year view
In the last week, the thematic model portfolio has been adding to longs in Chinese technology behemoths Tencent, Baidu, and Alibaba, covering a 5% SPX short and covering some short calls in the QQQ. The increase was marginal. Off current delta it was around 11% in net length to 41% net long stocks, but it was more a sign that developed and emerging market equities are reaching levels where we are comfortable with adding to long exposure on a one to two-year view. As scary as it may seem, it is time to dust of the “buy on dips” playbook.
As I outlined above, the news flow regarding US / China trade is going to get much worse before it gets better. However, any broad-based selling pressure will provide you with opportunities to buy the names, equity and credit, that you have been eyeing for months now, especially in EM. For us, that is Chinese tech and banks, Asian semis and Korea in general.
How can I be so certain?
How can I be so confident that buying dips will work again this time? Haven’t I just inked a scenario for a trade war between the US and China with a $150bn of reciprocal tariffs? Allow me to outline why it isn’t different this time and investors should use weakness to snap up quality assets.
1) The developed world and the vast majority of the emerging world has cash rates that remain below neutral. Where is neutral? Tough to say but given the growth, profits and corporate default outlook, it certainly isn’t at current levels for the US, Japan, Europe, ASEAN and China.
2) Rates below neutral will ensure that the extraordinary growth and profit outlook will maintain. Strong growth and low rates imply negligible default rates.
3) Despite the Federal Reserve and US government being a sizable net seller of securities, the world remains chronically short of quality yielding assets. A statistic I have regurgitated for months now is that in 2007, according to the IMF, the world had $15.8tn of investment grade securities that yielded over 4%. Now, there is less than $1.8tn. Even with $2tn of additional US supply over the next 2 years, the lack of supply remains acute and this will mean a continued demand for all quality assets, across the risk spectrum. The multiple paid for all asset classes, especially in EM, is going to continue to rise, as low default rates see investors remaining comfortable moving out the risk curve.
4) Inflation is nowhere to be seen. The calls for a bond bear market have been loud and look as premature as they were in 2015, 2016, 2017 and today. Where is the wage and commodity inflation that the vigilantes have spoken about? It is yet to reassert itself and frankly, I do not believe it will. You are aware of my structural disinflationary biases. Tech and demographics continue to be underestimated regarding their deflationary impacts on the global economy and I see nothing to abate this. The Atlanta Fed wage tracker has fallen and is back at levels witnessed in 2015. The same lack of inflation exists all over the world, yet bond market bears keep call for its imminent rise. They have been wrong.
5) All this implies that the cost of funding is going to remain incredibly low, yield curves will continue to flatten, and the unwinding of central bank balance sheets will be slow and orderly.
6) The growth consequences of a US / China trade spat are very long dated. Of course, if it does spiral out of control, one cannot discount the effect that could have on sentiment, but the realignment of growth will take many quarters to play out. Yes, there is a potential inflationary impact of higher consumer goods prices but, like higher energy prices, it would likely be viewed by the Fed as a tax, in a similar vein to the impact spiking oil prices has on consumers. $150bn of mutual tariffs, while undeniably large, isn’t going to have a devastating impact on either the US or Chinese activity. At 1.5% of the Chinese economy, it is hardly crippling and can be more than compensated via an inevitable fiscal spending program should growth sputter.
I boil it down to this. Has the growth and profit outlook changed appreciably in the past two months? For me, the answer is categorically no. As such, global equities, especially in Asia, look attractive.
Founder, View from the Peak
IND-X Advisors Limited