Q2 Outlook: Will The 3Ts Snatch Defeat From The Jaws Of Victory?

The first quarter of the year had something for everyone; from January’s melt up to March’s meltdown the one constant was the return of volatility. A few weeks into Q2 and that volatility remains with us as financial markets gyrate to a new geo political tune on a daily basis. For all the angst the first quarter offered muted returns as global equities slipped slightly, bonds rallied a bit while commodities came off the floor to lead the multi asset pack.

In thinking about what Q2 might bring, it struck me that one can think of the outlook as akin to a three on three schoolyard basketball game. On one side we have the 3 Ts: Trump, Tech and Tariffs and on the other we have the 3 Es: Economic growth, corporate Earnings and investor Enthusiasm.  If the 3 Ts win it is likely that they will snatch defeat from the jaws of victory as the synchronized global recovery & robust financial markets give way to self-inflicted uncertainty.

To handicap the game’s outcome it makes sense to analyze the player matchups using both our Tri Polar World (TPW) framework and Global Risk Nexus (GRN) Scoring System to analyze the interplay between economics, politics, policy and markets. The 3 Ts in particular seem to validate the TPW theme of regional integration in Asia, Europe and the Americas. Once we run through the matchups we can isolate some plays or investment positions that we think might help win the performance game.


President Trump has freed himself from his handlers and is effectively running US domestic and foreign policy himself. Investors now have to come to grips with policy by tweet, policy that is capable of being reversed within a day, a week, a month or not at all. The President is effectively at war on three fronts: politically via the Mueller investigation, economically via the trade conflict with China and militarily via a potential conflict with N. Korea. This degree of conflict coupled with Pres. Trump’s very public policy process generates uncertainty, which markets hate. Thus, this type of policy making represents a valuation ceiling for global equities in general and US equities in particular.

This might not matter so much if the tech sector, the global equity market’s leadership sector, was firing on all cylinders. However, as recent weeks have shown, this is no longer the case.  Being hauled before Congress (in the case of Facebook) and having to justify a business model that no one seemed to care about before the 2016 US Presidential elections suggests that the political class is now aware that the tech industry has amassed both profit making and political power. This combination is unlikely to go unchallenged in the months and years ahead. Given that tech represents 25% of the S&P index (and 27% of the broad Emerging Market equity index) what happens to tech matters, a lot. 

The Cambridge Analytica data breach seems to have been the straw that broke the camel’s back, calling into question the seemingly inexorable rise of tech’s social media segment in particular. The tech ecosystem now resides squarely in the geo political space & not just for privacy reasons as the US and China square off on AI.  Europe sits between the two, seemingly content to play regulator in chief as exemplified by its upcoming GDPR (General Data Protection Regulation) policy. Governments around the globe seek more tax revenue from the big tech piggy bank while in China social media censoring reaches new levels. Competition is also increasing between the various tech segments suggesting a trifecta of tech concerns: privacy regulation, taxation and anti trust. Bottom line: increasing political confrontation around the globe suggests the tech sector’s unbridled pursuit of profits has reached its end game.

Thus the question of equity market leadership. We are on record as believing that global equity markets are early in the process of shifting leadership from the US to the non-US markets. Might we also be early in the transition away from tech led growth to sectors like Financials, Industrials and Energy perhaps?  Financials would seem to have the best claim for new leadership: representing 14% of the US market and 18% of ACWI, financials offer good earnings growth, attractive valuation and protection from currency fluctuation while benefiting from rising rates and a solid economy which supports both loan growth and bad debt reduction. Yet the investor response to strong Q1 US bank earnings has been decidedly disappointing to a bank bull such as myself (on both sides of the Atlantic). Sell offs on good news is rarely a positive signpost. Equity sector leadership remains an open question.

What about trade wars and tariff threats? So far it’s more threat than fight but financial markets, equities especially, are forward discounting mechanisms and so investors have been trying to price in what a trade war would look like. Most working estimates suggests the current state of play if implemented would shave off 20-30 bps of economic growth from the major actors suggesting the equity market reaction has been perhaps a bit excessive. Bond market failure to follow the equity market lead and rally in face of growth damaging tariff threats supports this sense.

No one really knows what the White House’s ultimate aim is, whether this is all for show and is simply a negotiating tactic or if there a real intent to punish China and limit its (rising) geo economic influence. Arguments can be made on both sides with the relatively smooth wrap up of the US – Korea trade pact & the US desire to declare victory in the NAFTA redo suggesting the former. However, on the latter side is the long history of Pres. Trump’s China trade views. For its part, China’s reaction has been quite measured, responding in kind to US moves on a parallel basis rather than leading or accelerating the process. Clearly China enjoys having the moral high ground as folks try to wrap their head around a US message that damns the WTO and claims everyone is taking advantage of it in a trade system it effectively set up.

Bottom line one should invest as if tariffs of some degree will take effect. Pres. Xi and Pres. Trump are mano a mano here and neither can really afford to blink. China is not going to give up on its Made in China 2025 program given its economic imperative to move up the value add ladder and offset its rising cost structure. The US would seem to have form in terms of its complaints about the challenges of doing business in China as well as the technology transfer issues. China may well be happy to lose a few trade battles that in actuality support its economic opening and rebalancing process. Early signs (auto/financial market opening) suggest this is the case. Worry about Yuan devaluation seems overdone especially given China’s petro Yuan iniatative. The good news is that room for compromise exists and both leaders have the wherewithal to make decisions should they wish to do so.


A feeling of frustration is understandable given how smoothly things seemed to be going just a few short months ago: the best synchronized global economic recovery in a decade or more, the Middle East's principal conflict between Sunni Saudi Arabia and Shia Iran potentially defused as the Iran nuclear deal took hold, revitalized global trade flows after a long post 2008 lull, a gentle unwind of Central Bank liquidity largesse and financial markets that while heated did not seem excessive. Victory over the post GFC slow growth  & deflation fears appeared at hand while the absence of bottlenecks and excesses provided hope for a sustained expansion.  Was it all just a pipe dream? Thus to the 3 Es.

The solid global economic growth recovery of 2016 to date appears to be cresting with 2/3s of countries running above potential (especially in Europe and Japan). Economic surprise indices have fallen sharply and in the case of Europe to five year lows (suggesting a possible rebound?). Retail sales on both sides of the Atlantic have disappointed while manufacturing PMIs appear to be rolling over across the globe, albeit from levels that still suggest expansion. In the US at least, weak demand would seem to be the culprit as soft real hourly earnings growth coupled with high debt levels and low savings rates impede consumption.

Europe’s apparent slowdown is harder to figure out; weather and political uncertainty given election issues in Germany, Italy and Spain have been named as culprits together with the ebbing of ECB QE and Euro strength. Yet, Europe’s current account surplus (and Germany’s) remains quite high, suggesting that the Euro is not overly strong. Such a surplus also suggests an opportunity for Europe to utilize fiscal stimulus to boost domestic demand and dovetail with the US fiscal stimulus to generate a real boost for the global economy. Recent above inflation pay deals for Germany’s public sector unions is a good first step.

Resurgent Europe, as it is known in the Tri Polar World, has a real opportunity to help itself and the global economy while reducing the risk of being picked on for its large surplus. Time will tell but the early 2018 read on the Macron & Merkel tandem is less robust than one would have hoped.  In addition to fiscal stimulus, there is a real opportunity to marry Macron’s vision of Europe with Merkel and Germany’s pragmatism especially around banking reform and the transition of the European Stability Mechanism (ESM) to a European monetary fund. The M&M twins need to grasp the nettle.

Earnings have been quite robust as noted in earlier writings ( 2018 Outlook: The Global Struggle Between Economic, Politics, Policy & Markets December 2017) and provide good support to current global equity levels. As Chart One indicates the combination of a roughly 10% decline in price coupled with a 7% or so increase in forecast earnings has brought the forward PE of the S&P down to 16.5 from roughly 20 a few months ago, positioning it as cheap as it has been in the past three years.

Chart 1: SPX Improving Valuation  

chart 1 - improving valuation.JPG









While tax-augmented earnings growth appears most robust in the US at roughly 18% for 2018, EPS growth (USD) in Europe and Japan at 12% and 10% are also robust. Furthermore, Chart 2 suggests that Europe’s relative valuation vs. the US have not been this compelling since the mid 1990s, which is saying something. Within European equity, the financial sector, a PGS preferred sector, trades at roughly one times book value and under 11x forward earnings. This represents a significant discount to the US banks as well as to Europe’s valuation at roughly 13.5x.

Chart 2: EU Cheapest vs. US Since the Mid-1990’s 

chart 2 EU best value.JPG

The set up heading into Q1 earnings season was quite attractive with markets having been beaten down by the 3Ts and investor enthusiasm, white hot back in January, having cooled significantly as Chart 3 suggests. This of course is good news as depressed sentiment provides room for things to turn around and inspire buyers to step in. While retail investor sentiment has clearly cooled evidence suggests hedge funds and the CTA community have also sharply reduced their long equity positions.

Chart 3: Bearish Sentiment Is Bullish

chart 3 - bearish sentiment is bullish.JPG

Much depends both on where the economic recovery goes from here together with the earnings path through the rest of the year and into 2019. Time is passing and by the middle of Q3 investors will be starting to turn their sights to US midterm elections & what appears to be a big Blue (Democrat) wave as well as the 2019 outlook and what it might offer. The shape of the global economic recovery will have a big role to play in that picture and here we come back full circle.

Tariff threats could lead to a rapid descent of C suite confidence thus leading to a reduced cap ex cycle that many have been counting on to increase productivity and hence sustain the global recovery. The absence of such would imply a global expansion and an aging US expansion in particular that is much closer to its end date than would otherwise be the case. The record number of times tariffs have been mentioned in Q1 earnings calls suggests this is a real threat to continued confidence and investment.

There are two hints of a silver lining however; first that such an ebbing of C suite confidence could lead to executives falling back on their old standby of stock buybacks which would support equity market prices and second, tariff threats and political uncertainty would likely lead the world’s Central Banks to adopt a go slow pace in withdrawing monetary accommodation which remains robust as Chart 4 indicates. In fact in recent speeches both Fed Chair Jay Powell and ECB head Mario Draghi used the term “patient” to describe how they expect their banks to act in the current uncertain environment. That is good news for risk assets

Chart 4: Global Liquidity Remains Robust

Chart 4 - Global liquidity remains robust.JPG


The pick up game between the Ts and Es suggests continued risk asset volatility coupled with moderate returns. Stocks and bonds remain range bound while commodities appear to be breaking out from a long slump. Real rates remain negative across the developed markets, suggesting one should not get too negative.

We continue to recommend overweighting global equities with the focus on the non-US developed markets of Japan and Europe. Within Europe we remain focused on the Southern Tier markets, which are less exposed to tariff risk and have been the star performers year to date ( GO SOUTH January 2018). Likewise in Asia we remain focused on Japan, the ASEAN markets as well as China, which has sold off aggressively as tariff risk is priced in. Recent reserve rate reductions in China suggest better liquidity, which should support stock prices as should the impending A share inclusion into the MSCI EM index. The Asian equity markets have been laggards recently suggesting a catch up opportunity.

Within the Americas the focus remains south of the border. Brazil, which has also sold off on political and trade related concerns, seems quite interesting as its economic recovery continues, inflation stabilizes, interest rates decline and earnings and multiples expand. An election looms this fall but Brazil has been enduring political risk for the past several years suggesting it is priced in. 

On a global sector basis we continue to recommend underweighting Tech and overweighting Financials, Industrials and Energy given strong earnings growth in the case of Energy and a global cap ex cycle in the case of Industrials. Energy stocks, particularly the oil majors, have lagged the crude rally which is supported by sharply declining inventory levels and rising geo political risk – a combination that would seem ripe for rising crude & stock prices. Small caps remain favored in all regions as a way to protect against currency movements and trade issues while also providing exposure to the production side of the global economy.

We continue to suggest an underweight position in Fixed Income driven by concerns over rising US Treasury supply coupled with reduced offshore demand. Rising currency hedging costs now eat up almost all the yield pickup UST offer foreign buyers. Expanding supply and a shrinking pool of buyers does not bode well for bond prices though its worth noting that only the US (among OECD nations) is forecast to increase its net debt to GDP ratio over the coming five years. It will be interesting to see if equities take rising long bond yields as growth positive. A steeper yield curve would be welcomed by banks (and the Fed).

Depressed yield levels & FX volatility mean that international sovereign debt is really a play on a weak dollar which bulging US twin deficits would seem to confirm. Given how low non-US sovereign yields are the currency tail is really wagging the fixed income dog. We continue to like US HY (favorable supply – demand, especially vs. IG) and preferred securities within the credit space.

In the Alternative segment we continue to recommend overweighting the Commodity sector given its late cycle characteristics together with depressed sentiment and lack of investor positioning, especially outside the oil space. We continue to favor the oil majors for their earnings and dividend/buyback capacity coupled with gold for the protection it offers against the uncertainties noted above.


Go South

Equity markets are on a tear – what’s an investor to do? My non-market friends tell me I must be making a killing while everything I look at (ex fixed income related) seems extended and overbought.  Go West young man is outdated, especially in today’s world; Go East is flavor du jour. Go North implies cold, dark winter. I say Go South investor; go south, south to the laggards, south to the lands leveraged to what the IMF is calling the broadest and best economic recovery in years if not decades.

There are few things better than a leveraged laggard and yet that is just what is on offer across the southern parts of all three of the Tri Polar World’s (TPW) main regions: Europe, Asia and the Americas. Europe’s Southern Tier, the Southeast Asian nations of Asia and South America within the Americas are all worth a look. Since the March 2009 low each has been a major laggard not only versus the US, the clear front-runner, but also within their respective regions. Most are extended on a short term basis but should be areas of focus on any pullback.

As Chart 1 shows the US equity market has been a dramatic outperformer since 2009, significantly outperforming the other regions. Yet as has been argued here for some time (2017 Global Investment Outlook: America First? December, 2016) last year was the first year since the crisis where the non-US markets outperformed the US in USD terms. As Chart 2 shows these periods of outperformance tend to last for some time, in fact an average of five years plus. We are at the beginning of a period of non-US outperformance; a period that should last for several years. 


The non-US markets are leveraged laggards in that they are the biggest beneficiaries of a sustained global growth recovery. In other words the longer the economic recovery lasts the better for these markets. In many cases their domestic economies have more slack than the late cycle US economy which is in its 9th year of expansion versus roughly a third of that for Europe and even less for Latin America. Thus more room for growth, more room for profit expansion, more room for offshore investment, and more political breathing space. Past periods of non-US outperformance support this thesis with the Latin American markets in particular demonstrating leadership. 


These markets are also beneficiaries of another trend that may be in its early stages – that of USD weakness. Solid growth combined with a weak dollar presents a very favorable environment for these markets. Our Global Risk Nexus (GRN) Monitoring System suggests that the US is late cycle in all four of its segments: economics, politics, policy and markets. A late cycle economy; political dysfunction and scandal with the Mueller investigation looming like a thunderhead. Oh and did I mention the upcoming mid term elections?

Policy wise the Fed leads the global Central Bank tightening process while ill-judged fiscal policy expands the twin US trade & budget deficits.  US equity markets are extended, expensive, overbought and over owned. Table 1 shows how the weak dollar has saddled non-USD investors with fixed income losses, helping to explain why Chinese and Japanese UST buyers may become scarce on the ground. Is it any wonder that European sovereign debt offerings by Italy, Spain and others are being met with massive demand? Did you know that the Greek 2 year bond now yields less than the UST 2 yr.?


Given the equity run since 2009 and the European worries since 2012 its no surprise that investors are very overweight US financial assets. This is starting to unwind as investors of all stripes begin rebalancing back into the Euro, the Yen and even the RMB. The weak dollar set up is very similar to the 2004 period when the Fed was raising rates while the rest of the world grew and the dollar fell. Dollar weakness is a flow story not a relative yield story; it’s a story of relative growth rates and asset allocation and it is arguably early in the process. With the USD breaking down technically, one can see another 10% or so downside, a prospect seemingly welcomed by the US Treasury.

One of the main benefits of the Tri Polar World framework is it allows one to look at the world differently, in this case, through regional eyes.  Davos observers have noted the clearest theme emanating from that confab, a theme encapsulated in a quote from Indian PM Modi’s Davos speech: “Everyone talks about an interconnected world but we have to accept the fact that globalization is slowly losing its luster. The solution to this worrisome situation is not isolation. The solution is in understanding and accepting change”. 

The Tri Polar World framework does just that. It understands and agrees that globalization has lost its luster, it accepts and provides a framework to incorporate change and given that we are investors it provides a solution which allows investors to make sense of, participate in and benefit from these changes.

Lets utilize the TPW framework to examine each main region in turn and identify the leveraged laggards.


We have been keen on Europe for well over a year arguing that Brexit & Trump would be bullish, not bearish, for European integration. Now that this has become somewhat common wisdom more is required. That means looking at Europe’s Southern Tier as a region ripe for outperformance. As Chart 3 illustrates, the region has woefully underperformed Europe itself since the crisis lows. Among the three, Greece remains deep in negative territory while Portugal is just turning positive; Spain is well in positive return territory but still lagging far behind Europe as a whole. Taken together they are barely positive almost nine years later. 


Europe itself is growing faster than it has in over a decade with January PMIs the best in 13 years. The Franco – German motor of European integration is starting to rev up and barring a dramatic reversal in German politics the M&M twins, Merkel and Macron, are ready to lead deeper integration.  Europe is finally emerging from its crisis period and recognizing the need to compete against the US and Asia, something French PM Macron understands perhaps better than any Western politician.

European economics are in great shape with a large current account surplus suggesting Euro strength will not hurt exports.  That same Euro strength will likely lead the ECB to go slower than it might otherwise go in raising rates as the FX effect dampens inflationary impulses. Economics, politics, policy are all in very good shape.

European equity markets are overbought in the immediate term but otherwise are in good shape with decent earnings growth, reasonable valuation and plenty of room to grow in offshore portfolios. Europe is effectively a value play given its low tech weight. In fact, broad EU equity has performed almost in line with Global value (GVAL) over the past four years. An incipient shift from Growth to Value could provide further support to the EU equity story. Banks (EUFN) long a favored sector, trade at a significant P/BV discount to US banks, have broken out and offer a hedge against inflation & Euro strength, while benefitting from higher rates and a better economy. European small caps (IEUS) also fit a similar bill in terms of the currency issue.

A Europe early in its recovery suggests that the real opportunity lies within the regional laggards, thus the appeal of the Southern Tier. Greece should exit its bailout program in 2018, has already accessed the FI capital markets and offers dramatic upside on a medium term view (near term GREK is overbought). Portugal (PGAL) is making headway on its recovery and likewise offers significant upside to a long lasting European economic revival. Spain (EWP) was just returned to investment grade by Fitch leading its most recent bond offering to be massively oversubscribed. Investors have ridden through the Catalan independence issue and come out the other side. The three markets combined represent only 6% of Europe’s equity market suggesting a significant overweight within a European regional portfolio on a 1-3 year basis.


Japan and China have been the two favored markets in this region over the past year plus and remain well thought of. Japan (EWJ) is exiting inflation, has a very cheap currency (fair value is considered in the low 90s vs. 109 to the USD today), is lifting the lid of the stock market’s long term “iron coffin”, has attractive valuation, good earnings growth and a stable political structure with PM Abe just returned for another term. Small caps (SCJ) are attractive as well here as an offset to Yen strength and a play on Japan’s industrial base.

China (FXI, MCHI, OBOR, DSUM) has been declared about to collapse almost too many times to count since the mid 1990s and yet its leading the way to Asian integration thru its Belt and Road Initiative (BRI), the Asian Infrastructure Investment Bank and numerous other fronts. As in Japan, President Xi has just been returned for another term focused on SOE reform (finally well underway), cleaning up pollution (likewise) & slowly deflating the debt bubble. 

But there is more to do in Asia. ASEAN, the Association of South East Asian Nations, is the fourth big player in Asia, joining Japan, China and India. ASEAN is where growth is really taking off and thanks to the wonderful world of ETFs there is a way to invest, namely ASEA. As Chart 4 shows, ASEA has been a dramatic regional underperformer over the past several years. ASEA provides exposure to Malaysia, Indonesia, Thailand, and the Philippines etc. all in one vehicle. As China moves up the value added curve with its focus on China 2025, ASEAN is the big winner, gaining investment, building its own consumer base while selling more to China’s rapidly growing domestic market – it is leveraged to the biggest trends in Asia. As with the European Southern Tier strategy, ASEAN represents roughly 9% of the Asian Pacific equity market; one should consider a significant overweight on a 1-3 yr. basis. 



It’s almost sad to watch the US struggle, at home, abroad, on domestic economic policy and foreign policy. America First is well and truly turning into America Alone, alone and asleep at the switch as the rest of the world moves faster and further. Michael Moritz of Sequoia Capital captured this perfectly in a recent FT op ed comparing Silicon Valley to China’s tech ecosystem (Silicon Valley would be wise to follow China’s lead).

Instead of using the NAFTA negotiations to deepen integration in the Americas & thus improve its competitive position versus Asia and Europe, America threatens to tear up NAFTA. Such a move would top President Trump’s decision to pull out of the Trans Pacific Partnership (TPP), itself going ahead without the US. That last phrase is something those of us in the US are going to have to get used to I am afraid. As an investor, one can only be thankful that the world is our oyster. First step is recognition, second step is action.

Investment opportunity in the Americas extends well beyond the US; there are all those markets South of the Rio Grande: Mexico, Brazil, Peru, Chile, Argentina etc. And again, in the wonderful world of global investing circa 2018 there is an ETF (ILF) that provides exposure to the whole region. As Chart 5 shows Latin Americas has been a massive underperformer relative to the US since 2012. But here too we may be on the cusp of a turn with LA performing in line with the US last year, even with the NAFTA threats, Brazil’s political woes, Chile’s elections etc. 


It’s hard to argue that Latin America is in great shape in any of its four segments: yet its economies are improving and are leveraged to the global economic recovery through commodity demand and US demand. In past periods of non-US outperformance, LA markets have been top performers in part because of that commodity exposure. LA is early in its economy recovery with Brazil just emerging from recession; there is plenty of room to grow. On the political front there are elections in both Mexico and Brazil this year and coupled with the policy mix of NAFTA it is clear that Mexico at least will face some challenges. 

Brazil is the more interesting case (EWZ, EWZS).  Following a deep recession, inflation is at almost record lows, bringing down interest rates which in turn pushes money into both domestic & foreign equity. Brazil has long been seen as a very cheap equity market due mainly to sky high real rates. As Chart 6 shows, that dynamic is in flux. As real rates shrink, the economy grows, the currency trades towards fair value, earnings pop and PE multiples expand. Unlike much of the rest of the world which is searching for inflation, Brazil welcomes lowflation. It’s a compelling story.



Before closing it’s worth pointing out that there are laggards on the asset class front as well. It is true that both equity and fixed income have done well in the past few years. A global 60-40-equity/debt portfolio was up roughly 15% last year and up roughly 9% per annum over the past three years. Arguably this benchmark will face tougher sledding in the years ahead as the sustained global economic recovery allows Central Banks to slowly raise rates, which in turn implies the 40% fixed income portion will struggle.

As Chart 7 points out the gap between stocks, bonds and commodities has also been vast over the past 5 years. In our 2018 Outlook (2018 Outlook: The Global Struggle Between Economics, Politics, Policy & Markets December, 2017) we highlighted the appeal of the commodity space, arguing that it had been thru a period of significant underperformance and as a result funds were closing, sentiment was horrible and the stage was set for relative outperformance, especially given growing inflation concerns. Opportunities exist in broad commodity exposure (DBC), nat gas (UNG) given China’s growing demand, and precious metals (GLD) among others. The ETF ecosystem has really fleshed out the commodity front; something that is likely to prove very useful in the years ahead. 


Hopefully the above provides some food for thought and the charts/table are useful. More exciting advances to come in the months ahead. Stay focused my friends.

2018 Outlook: The Global Struggle Between Economics, Politics, Policy & Markets

I was tempted to title this article: More of the Same Please Part 2 after the piece from this past June (2H Outlook: More of the Same Please, June 2017) but it felt a little too cute. The more of the same strategy has worked very well but it is likely to be more wishful thinking than reality over the coming twelve months. Investors are likely to face more drama next year, which is not exactly a tough call after this year’s abnormally smooth ride.  2017 was a simple three-decision year: get and stay invested with a bias to non-US equity.

Given the near existential business threat faced by active managers from the continued Rise of Passive its no surprise that investors of all stripes have joined the party: hedge fund net longs are at near record highs, CTAs are close to record equity exposure, there are signs of growing retail enthusiasm, short interest in SPY is at multi year lows and mutual fund cash balances of 2.8% are close to record lows. Recent intra market gyrations provide an opportunity to take some profits & stress test one’s portfolio while providing a harbinger of 2018.

Yes, 2018 is likely to be a more challenging year. Many equity markets are at multi year, if not all time, highs, credit spreads are tight and many investor segments are fully invested. Equity market valuations are less supportive (though thanks to robust EPS growth, global equity trades at a lower PE today than a year ago, even after a 20% up move – a stat you never see in all the “bubble” articles) and the pace of EPS growth is showing signs of tailing off. 

More importantly, a number of supportive tail winds are morphing into headwinds; including declining US stock buybacks, dollar weakness turning to stability/strength, Central Bank liquidity starting to reverse and China credit fuelled growth turning into tough love deleveraging. All of the above imply a more challenging return outlook; investors should raise their volatility expectations and lower their return assumptions.

 How should one think about 2018? At PGS we believe in making the complex simple. The Tri Polar World (TPW) framework’s three main regions: The Americas, Asia and Europe provide a good place to start while the Global Risk Nexus (GRN) monitoring system and its four part prism of economics; politics, policy and markets ensures that all bases are covered. As usual, we will wrap up with some ETF focused asset allocation and portfolio positioning thoughts.


Not to give away the plot in the title but it does seem like the Americas suffer from a fair number of ills, especially on a relative basis. The US economy is clearly late cycle with the historical record suggesting close to 95% odds of a recession over the next two years. Yet near term recession risk seems limited given 2.5% economic growth (above potential), benign inventory and credit conditions, subpar inflation, decent job growth and muted wage pressures.

South America is earlier in its growth cycle with Brazil just coming out of a deep recession, one that perhaps has finally put the nail in the inflation coffin (pension reform key here). Mexico is having to hedge its NAFTA related bets, raising the minimum wage above inflation, developing new trade lines and in essence trying to protect itself from its capricious northern neighbor.

While the economic outlook seems benign the politics just look ugly right across the Americas. In the US, the Mueller investigation draws closer and closer to the White House, raising the stakes for next year’s midterm elections. 2018 brings Presidential elections to Mexico and Brazil as well as a number of other South/Central American countries. Rather than deepening & extending the world’s most significant corporate value added supply chain, NAFTA negotiations continue with very little sign of forward progress. Central America struggles with its own socio-political upheaval.

Politics bleeds into policy on both the fiscal and monetary side. Deficit financed tax cuts in the US are unlikely to meaningfully boost economic growth though corporate earnings will benefit. These are “because we can not because we must” tax cuts and arguably will make the job of a newly constituted Fed board much more complex given the need to decide on the fly how quickly to raise rates amidst a balance sheet unwind. Policy wins in the US have been reduced to a two-week spending bill extension to avert a Govt shutdown. Contrast this with growing talk of a United States of Europe by 2025 or China’s Made in China 2025 program and one can understand the Inactive Americas moniker.

Fiscal and monetary policy interaction will set the stage for US financial asset performance. Growing slightly above potential and near full employment, it seems clear that the economy does not need such stimulus. Thus inflationary pressures may build leading to a faster and more aggressive Fed tightening cycle. With the 2-10 yr. yield curve already under 60bps and continued strong demand for safe, long duration assets, the risk of a Fed inflicted yield curve inversion is non trivial. Given a tapped out US consumer with a personal savings rate of just over 3% and little sign of wages picking up the economy will be looking for a late cycle cap ex expansion to drive growth. Such a cycle would be at risk to a rapid rise in rates.

What does all this mean for markets?  One possibility is a test of the thesis that stocks can do well in a rising rate environment.  Another is that solid earnings growth continues to underpin equities while bonds toggle between Fed driven rate hikes at the short end and a demand supported long end. Stocks and bonds could also both sell off leaving long only managers out of luck and hedge funds finally having a market they can outperform in. Such an environment would threaten the popular risk parity strategy. 

This backdrop also implies 2018 will follow 2017 as another year of non US DM outperformance versus the US equity market.  This would be in keeping with global equity leadership changes of this nature – when different regions take the baton they tend to hold it for several years at least.  US equity also faces a leadership question; tech has been the big leader but analysis of the Trump tax plan suggests tech will be one of the least benefited sectors. Rising rates could hurt it while the animus towards Big Tech continues to grow. Election year talk could turn to anti trust discussions, a potential multiple contractor. Leadership will have to come from tax cut winners in the small cap space (IWM) & sectors such as Industrials (XLI) boosted by a cap ex up cycle, financials (XLF) bolstered by deregulation, energy (XLE), boosted by supply-demand improvement and perhaps telecoms (IYZ) the biggest sectoral EPS winner from the tax cuts.

After wrong-footing many with its current year weakness, the USD should be a more reasoned chap in 2018 remaining range bound versus the Euro and weakening against the Yen. An active Fed increases short rates while safe haven demand supports the long end leading to a pancake flat yield curve.


The Big Four Asian economies: China, Japan, India and ASEAN are all in pretty good shape. As noted recently (ETF Investing with the Global Risk Nexus System, November 2017), China’s decision to not verbalize a GDP growth target for the coming five years frees it up to deal with its many imbalances. Japan is demonstrating how to make lemonade out of lemons as its shrinking population leads to 40 + year highs in the job seeker to job ratio while inflation starts to creep up (core CPI +0.8% y/y) and Prime Minister Abe presses the bet with calls for 3% wage gains in the upcoming shunto. 

ASEAN continues to benefit from rapid growth in many of its countries while e commerce drives integration and the development of a thriving venture capital and private equity scene, funded primarily out of China. It is an excellent example of the TPW’s three steps: each region’s growing ability to self-finance, self produce and self consume. India seeks to regain the upper echelon growth rates it enjoyed a few years ago while also working to clean up its banking sector.

After the 19th Party Congress and Japan’s snap elections, Asian politics should be much smoother in the year ahead.  Both Pres. Xi and PM Abe are set in office for the next several years at least. This provides Asia with significant competitive advantage versus Europe and especially the US/Americas. Concerns about Chinese expansion and the continuing worries over North Korea are likely to remain in the background.

Political stability manifests itself in the policy realm as well with the Abe/Kuroda team continuing to drive Japan’s growth and inflation boosting policies including the BOJ’s now famous yield curve control (YCC) policy mix. Q3 GDP growth of 2.5% y/y is well above potential suggesting rising inflation, rates and a stronger Yen. 

In China, Pres. Xi and his team work to liberalize the financial sector, delever & rebalance the economy and institute supply side reforms to cut down on pollution and reform the SOEs. Building off its recent tremendous success in developing global tech brands, leveraging its OBOR policy and focusing on its MADE in CHINA 2025 program, China is well positioned to further its internal adjustment process. Expect more SOE defaults which should boost productivity, growth and earnings. Financial sector liberalization will be a major story over the next few years. China’s policy mix epitomizes the TPW designation “Proactive Asia”.

What are the financial market implications of a smoother outlook across the board? Attractive risk adjusted returns for one, especially in Japan (EWJ), which offers compelling equity earnings growth and valuation with potential for yen appreciation for foreign investors. 2018 could be the year the Iron Coffin Lid is finally lifted in Japan. Deeply undervalued (FV at 90Yen to the USD), a safe haven currency in times of trouble, Yen exposure makes a lot of sense. Such exposure can also be found in Japan’s small cap space (SCJ). China’s booming tech sector as well as its banks and domestic demand plays (consumer confidence at 20- year highs) remain long-term themes (MCHI, FXI). Both countries remain well off their all time highs and offer a wide selection of opportunity. ASEAN markets (Thailand, THD, Indonesia, EIDO and Malaysia, EWM) present interesting opportunities as does India which boasts forecast EPS growth of close to 30% next year (PIN, INDU).


Job growth at a 17 year high suggests its fair to say Europe’s economy is doing quite well. Where it could do better is in providing more demand for the rest of the world given it’s near 3% Current Account Surplus, led by Germany’s surplus of close to 8% of GDP. The hope is that broad job growth across Europe leads to increased consumption, which stimulates imports and generates more demand for the rest of the globe.

Europe’s great worry has been its banks and here the news is looking up. Credit growth is expanding while the non-performing loan (NPLs) mountain finally starts to shrink. The European economic recovery, roughly a third as old as the US recovery given its 2011-2012 recession, has several years to run, absent an ECB policy mistake that on present form seems quite unlikely. 

The third area of good economic news lies with Greece and its potential to draw a line under its bank related woes. Having returned to growth (2018 GDP forecast to grow 2.5%) and with an agreement with its EU and IMF creditors seemingly in place, Greece should be able to exit the EU-IMF aid program in mid 2018. Strong enough to offset a near 10% appreciation of the Euro vs. the USD, with a functioning credit system and a return to good standing by its southern periphery, Europe is in quite good economic shape.

While not quite as robust, the political outlook is much better than a year ago when the argument that Brexit & Trump were bullish for Europe (2017 Global Investment Outlook: America First?, December 2016) was a decidedly minority view. Today Europe waits for the Germans to get their political house in order after the very unGermanlike failure of coalition talks. The good news is that Germany’s two least EU friendly parties, the AfD and the FDP, are now both out of the coalition discussions. This suggests that should the CDU and SPD come to some arrangement, Europe could be the big winner (United States of Europe) as the SPD pushes Chancellor Merkel to fully embrace the Macron project, restoring the France – German European integration motor and setting the stage for more ambitious policy.

The policies necessary to complete the remaining 25% or so of the EU institutional framework are known & ready to be put into place. What is needed is the political will. Economic recovery and its beneficial impact on the banks and the NPL problem should encourage Europe to complete the banking and capital markets union as well as converting the European Stability mechanism into a European Monetary Fund. There is a limited time frame for these actions to take place, namely the next 18 months or so before campaigning begins for the 2019 European Parliament elections. 

The tech space is one other area where Europe urgently needs to consider its policy options. Europe seems intent on carving out a regulatory role as opposed to a corporate champion role. Clearly regulating Big Tech is an issue of some salience. But whether one looks at tech unicorns on the private side or tech sector weightings in the public markets, Europe is falling further and further behind Asia and the Americas. 

Europe does offer a mid cycle economy with a second stage booster driven by the integration process. No other region offers such a powerful one –two potential punch.

What does this suggest for markets? For dollar-based investors, European financial asset performance in 2017 was flattered by the Euro’s near 10% appreciation versus the USD. 2018 is likely to offer a more paired return profile with both local currency and USD returns in good shape led by solid earnings growth and attractive valuation. Europe’s lack of technology shares, which was such a blow to 2017 performance, should be less of an impediment this coming year while the Southern periphery of Spain, Portugal and Greece should offer the better return profile within the region. Banks continue to be appealing on a sectoral basis while fixed income is unlikely to offer the stellar USD returns provided this year.


Lower global equity return assumptions (+5-10%) and a tougher environment for fixed income performance suggest investors should review and where appropriate rebalance their portfolio positioning. Entering 2018, equity remains favored over fixed income; having an allocation to cash also makes sense. The out of favor commodity complex, down six of the past seven years and down 5% over the past month could be an area of opportunity. Sentiment is horrible, funds are closing, China growth slowdown pessimism is overdone and US shale worries miss the new focus on profits rather than production; all suggest commodities are worth a good look. The global economy has room to grow over the next few years; a procyclical exposure to energy and metals coupled with a defensive exposure to gold could prove both portfolio supportive and a good inflation hedge (DBC, IXC, GLD).

Regional equity allocations favor Asia (AAXJ, ASEA) and Europe (EZU) over the Americas (SPY) given the economic, political and policy comparison made above. Small caps are favored over large on a global basis given their heavy industrial weight and exposure to regional growth in Asia and Europe (IWM, VSS, SCZ). EM equity exposure is increasingly folded into the regional approach; within EM equity it is very important to note the near 27% weight of tech within the index. 

Overweighting the non-US markets is a carry over from 2017; the difference in 2018 is likely to be that USD weakness plays a much less important role in non-US performance. Expect Yen strength and a range bound Euro to allow underlying economic and earnings growth to drive Europe’s equity market forward. The true test: can non-US equity outperform in a down US equity market may have to wait; modest US equity appreciation & relative underperformance could be just what investors need to expand their non-US equity allocation.


In Asia, Japan remains the preferred market with a focus on small caps (SCJ) given the expectation for yen appreciation, which also suggests switching from hedged Japan equity (DXJ) to unhedged (EWJ). China (MCHI, FXI) is also attractive within Asia given its continued profit growth, market opening and development of its tech sector.

Japan’s YCC policy may be eased somewhat as the year progresses, allowing the 10 yr. JGB rate to break above the zero bound, bolstering the yen and perhaps stimulating some domestic allocation shifts into equity. Local currency debt in Asia (ALD), including China (DSUM), may also offer some interesting opportunities.


Within Europe the southern periphery could be the area of best opportunity next year. Spain (EWP) with its robust growth rate, Portugal (PGAL) where 10-year rates have halved and Greece (GREK) with its hoped for exit from its aid package could all add to European (EZU) performance. Financials (EUFN), which did quite well for much of the year but lagged badly in Q4, remain attractive given the backdrop described above.

In fixed income sovereign rates are likely to rise as growth continues, economic slack is taken up and the ECB ponders pulling back on the monetary spigot. Euro area high yield (HYXU) is unlikely to be as good a performer in USD terms as it was in 2017 though fundamentals remain solid.


Within the Americas, Brazil (EWZ, EWZS) looks most interesting given its nascent economic recovery, inflation collapse and the potential for further interest rate declines. Should Brazil be successful in curbing inflation then the huge inflation premium built into its fixed income markets should gradually bleed away, allowing equity valuations to rise (there is a reason why Brazil has long been among the world’s cheapest equity markets) and perhaps sending domestic Brazilian investors abroad. Argentina (ARGT) seems to be getting is economic house in order and could be an interesting opportunity. Mexico, an early favorite last year, faces NAFTA and election related risk.

US equity is unlikely to have as good a year as the one just ending as headwinds become stronger. Having said that earnings growth is likely to be solid; corporate tax cuts are likely to elongate the profit cycle, leading consensus EPS to be around $160 or + 15% which puts the market at 16x forward earnings; pretty good support for a small up year. It is likely to be the same in fixed income space though as elsewhere in the developed markets the supply demand balance suggests continued strong demand for safe, liquid, long duration assets. The search for yield is getting long in the tooth and the areas to find it are becoming few and far between. At this point USD EM debt (EMB) and financial preferreds (PGF) are among the most attractive. Roughly $1T in global bank related debt issued post crisis matures next year – finding a suitable replacement is going to be quite difficult which could bode very well for PGF.

Well that’s all for now. Have a wonderful holiday and all the best for 2018!


The Tri Polar World (TPW) framework developed by PGS provides a differentiated view of global economic development driven by regional integration in the three main regions of Asia, Europe and the Americas (Tri Polar World 2.0, March, 2015 ). Over the past several years, this framework has proven particularly useful in thinking through issues such as Brexit, Trump/NAFTA and China risk-reward. 

The TPW framework is underpinned by our proprietary Global Risk Nexus (GRN) scoring system, which analyzes each of the three main regions, as well as the globe, through a four-factor prism: economics, politics, policy and markets. Each of the four factors incorporates several substrata that are scored on a regular basis. Examples include: potential growth rates in economics, structural fragmentation in politics, policy implementation risk and various fundamental, technical and quantitative inputs within the market segment. 

Employing ETFs as the instrument to complete the global multi asset investment process represents the simplest, most transparent & low cost way to execute the opportunity set that falls out of the TPW/GRN structure. This is true at both the global and regional level. Incorporating the TPW, GRN and ETFs in a three-step investment process simplifies the complex and frees up thinking time for original idea generation, communication & implementation.

In an ever more complex world of big data sets, disruptive technology, fractured politics, radical policy and yet super mellow financial markets, the GRN system has become a key component in how we stay abreast of, think through and weigh key Tri Polar World issues. Thus it seems appropriate to go through the process in this month’s write-up so that future reference can be met with deeper understanding. 

Lets walk through the GRN first in Proactive Asia, then Resurgent Europe and conclude with the Inactive Americas. The global outlook will come next month in the 2018 Outlook. For time and space purposes the global market segment is integrated within the concluding Asset Allocation and Portfolio Strategy section.



Two recent statements regarding economics in Asia really struck home. The first for what was not said and the second for what was. In the first instance, President Xi’s recent Party Congress address failed to enumerate a specific growth target for the coming five years. This breaks with past behavior, frees the Gov. from having to employ subpar tactics to meet an artificial growth target and recognizes that China’s potential growth rate has shifted lower. The new focus on the quality of growth and sustainable development over breakneck and heavily polluting growth seems like the right approach as China matures into a middle-income country.

The second comment was by newly re elected Japanese Prime Minister Abe who called for 3% wage hikes in the upcoming “shunto” (spring wage offensive). This degree of specificity is quite unusual, replaces past vague exhortations and reflects an empowered leader ready to turn necessity (poor demographics) into a positive (higher wages) to drive Japan’s growth profile forward. Japan’s success in ending deflation (2017 Outlook, December, 2016) under Abe and Bank of Japan (BOJ) head Kuroda has set the stage for a sustained period of economic growth.

Perhaps of greatest significance is that both statements reflect economic reality, something often lacking in politicians’ utterances on matters economic. 

Asia today has three growth drivers: China, Japan and ASEAN, a combination of ten states with roughly 650M in population and close to $3T in GDP, making it as large as the sixth largest economy in the world. India sits in reserve; combining 70% capacity utilization levels with a youthful demographic, it represents Asia’s growth upside. Asia’s three large growth drivers and a fourth in reserve stand out relative to Europe and the Americas.


A year ago, political turmoil in China represented a potential black swan risk for global financial markets. Post the recent 19th Party Congress, that risk has been replaced by the potential reward of a “new era” in China, one in which China takes a leadership position in global affairs. The vision outlined in Pres. Xi’s address represents a dramatic change from past, more conservative Chinese thinking. It reflects a grand strategy that extends far into the future (2050) and reinforces the existing One Belt, One Road (OBOR) project. Finally, it lays down a marker for the rest of the world that China has a plan to become a “leading world power” and is focused on its execution (China Has a New Grand Strategy, The Diplomat). 

Coincidentally, I have just finished reading China watcher David Shambaugh’s 2012 book: China Goes Global, which argues that China is a “partial power”. China has made impressive strides in the intervening five years, particularly in the brand and soft power categories via its tech sector. Today, this brand building stands in sharp contrast to the US in areas such as climate change where China is turning a necessity (choking pollution) into a virtue (global climate change leadership). 

China is no longer the partial power it was, nor is it yet a full global power but that is now the clear objective. The fact that this has been written into the new Party Constitution effectively means all future leaders will need to follow this grand strategy. The importance of this change should not be underestimated.

PM Abe’s re election in Japan reinforces the soundness of Asia’s political structure. Like Pres. Xi, PM Abe has already been in power for five years and it is quite possible that he will remain in power through the 2020 Tokyo Olympics. Political continuity can go a long way to reinforcing good decision making in the policy realm. The contrast within the political sphere between Asia and the other two regions could hardly be sharper.


Assessing Pres. Xi’s new policy could be a paper unto itself. Having read several, a number of key points do stand out. The SOE reform focus on mixed ownership recognizes that adding debt to heavily indebted companies is unlikely to be a solution; perhaps injecting private capital and expertise could do better. Of course there is risk to the private companies but from a top down perspective this seems like a step in the right direction. Likewise the significant focus on quality and environmental sustainability. Moving up market represents China’s future growth path.

The BOJ’s yield curve control (YCC) policy has been a success and is likely to become part of other CB’s tool kits in the years ahead. The Peoples Bank of China (PBOC) has also been quite active in dealing with the large build up of domestic debt. Recent comments by PBOC Gov. Zhou about a potential “Minsky moment” in China caused market flutters but the read here is that the reference was meant to demonstrate China’s stability thus making the case that the time is right to open its financial markets. Greater foreign involvement in China’s domestic financial markets while allowing Chinese investors to begin to globalize their portfolios will create two-way flow that is likely to be among the most important financial market developments of the coming decade.



It is hard not to look at Europe and be impressed by how well its economy is doing; especially relative to expectations a year ago when it was all post Brexit doom and gloom. Today, Spain’s most economically important region can declare independence and markets just yawn with Spanish stocks & bonds both up in October. That’s what a strong economic recovery can do.

With EU Q3 GDP running at 2.5% y/y, the unemployment rate finally breaking 9% (8.9%), and strong exports belying worries over unanticipated Euro strength, the economic picture across the whole of Europe is quite robust. Inflation well below the 2% target is the only fly in the ointment, something Europe shares with much of the rest of the world.


Just when one thinks European political risk can be laid to rest along comes Catalonia, superseding the election of French President Macron as well as the return of German Chancellor Merkel albeit in a yet to be formed coalition government. Catalan elections are set for Dec 21st and the failure of separatist parties to unify their list bodes well for Spanish unity. Hopefully the benefits of time will cause both Madrid and Barcelona to find a face saving way forward. Notwithstanding Europe’s recent robust economic recovery, it’s no surprise that the scars of the financial crisis and nearly 10 years of subpar economic activity continue to influence Europe’s political landscape.

Political concerns in the southern periphery coexist with those in Europe’s eastern region where Hungary & Poland push back against some of the perceived Franco German objectives for a deeper European union. The real political question is whether Germany will act in support of Pres. Macron’s well-articulated vision for Europe’s future. Forward momentum in the political space is critical for Europe to retain its Resurgent moniker and not slide back into its old Reactive mindset.


ECB Gov. Draghi has maintained his famous way with words articulating a policy to “downsize” the ECB’s QE program rather than “taper” it. The ECB’s deliberate unwind of QE is unlikely to be finished before Mr. Draghi's term ends in 2019, a perspective greeted calmly by European cross asset markets.  In Europe as well as globally, the surprisingly synchronized global economic recovery has eased concerns over monetary policy realignment while also reducing concerns over the lack of fiscal stimulus, now rightly seen as much less necessary than was thought even one year ago.

Regulatory policy, especially around Big Tech, is an area where Europe has been quite active under the leadership of Competition Minister Vestager. Yet, Europe itself really needs to move forward on its Digital Single Market (DSM) project in order to become competitive in the tech space. Tech represents only 8% of Europe’s stock market, well below its weight in the other main regions. In addition, Europe’s financial sector continues to face regulatory scrutiny with a particular emphasis on its NPL problem. Properly addressed, movement here could really improve the banks’ operating environment and perhaps kick off a much needed consolidation process. Q3 earnings demonstrate much remains to be done.



An aging but still reasonably robust US economic recovery could be boosted by a Latin American recovery that began only a few years ago.  Latin America is currently working off what appears to be a capacity glut built up during the commodity boom years of 2012-14. This is particularly true south of Mexico, which continues to struggle under the weight of NAFTA and election uncertainty.

Within the US, concerns exist about the ability of the consumer to continue spending as the savings rate has dropped to around 3%, a level last seen in 2007. Unemployment levels close to 4% would suggest budding wage growth and hence further consumption gains but the hours worked canary has yet to sing; the economy will likely need the business side to support it in the guise of a late cycle capital expenditure boom.


The contrast between the politics in Asia and even Europe vs. the Americas is quite stark. The US boasts (if that’s the right word) the first indictments of the Mueller investigation, a hyper partisan environment in Washington and the apparent fragmentation of its two main parties all leading to the potential for political gridlock through the 2018 midterm elections. An early test will come in December when Congress needs to pass a spending bill to avert a Gov. shutdown. 

South of the Rio Grande lies Mexico’s Presidential elections next July followed by Brazil’s Presidential election in October.  Suffice to say that politics in the Americas look by far the worse of any of the Tri Polar World’s three regions.


The likely next Fed chair, Mr. Jay Powell, is widely seen as a safe pair of hands to implement the Fed’s policy mix of gradual balance sheet shrinkage and rate hikes. For all the Fed related ink spilled, the Fed seems like yesterday’s story with the economy rightfully the real driver of financial markets through the earnings cycle. Furthermore, a flattening yield curve, made flatter as the short end prices in a December rate hike while the search for long duration, safe assets anchors the long end, would seem to tie the Fed’s hands somewhat.

Regulatory policy could impact financial markets going forward. Tech, the stock market’s leadership sector, is under growing pressure to spend more in order to rein in bad actors while also having to defend its business practice as quasi monopolies. A recent FT editorial called for new anti trust legislation to counter Big Tech’s growing tendency to buy up smaller innovators. As yet there is little public support for greater regulation of the social media giants and thus little push on Capitol Hill. Watch this space. Banks, on the other hand, could benefit from regulatory relief, particularly as it pertains to return of capital.

Fiscal policy is also front and center in the US; some sort of tax cut package is likely to be passed by Spring in order for Republicans to have something to run on in the 2018 mid term elections. Sizable tax cuts would seem to be more a case of because we can than because we should, especially given early reads suggesting a $1.5T increase in the budget deficit over the coming decade. Yes, tax cuts could give the aging recovery a booster shot though arguably the most acute need for fiscal stimulus was several years ago.

C suite policy may hold the key for the US economy in the year ahead. Certainly the feeling in the room must be much better than a year ago when Brexit and the election of Donald Trump meant great uncertainty. Today, the US and global economy continues to expand, Brexit woes have been contained to the UK and Pres. Trump is somewhat of a known entity, all of which could perhaps set the stage for a late cycle cap ex boom that could drive the economy forward.



As noted previously, the only bad asset allocation decision this year has been to not be invested (More of the Same Please, June, 2017). With a 60-40 Global Balanced portfolio up over 10% ytd, it’s been hard to be wrong though somehow global macro hedge funds are flat.   Equity has outperformed fixed income, non-US equity has outperformed the US, credit has outperformed sovereign and commodities/ alternatives have been relatively uninspiring.

Equity markets in particular have been able to climb a towering wall of worry including the Mueller investigation in the US, North Korea saber rattling in Asia and Europe’s politics, not to mention the prospect of QE switching to QT. Even the apparent revival of the great man theory of politics: whether it be Trump saying I am the only one that counts, or Putin coyly refusing to say whether he will run again or Pres. Xi not putting forth a successor or Crown Prince Mohammad bin Sultan purging his rivals, together with the increasingly authoritarian tone in political language haven’t spooked financial markets.

Why not? As discussed in previous pieces, it would seem that investors are correctly focused on what the most synchronized global economic recovery in decades means for corporate earnings and hence stock prices. Q3 earnings to date have been quite robust, especially in the non US Developed Markets where Japan for example is enjoying year on year EPS growth of roughly 15%, with valuation at a significant discount to the US. It is hard to see a major equity correction with robust earnings growth, easy financial conditions, Central Banks that promise to go slow and investors (such as those macro hedge funds noted above) who need to get invested prior to year-end.

An early stage, low inflation, synchronized global economic recovery supports Equity over Fixed Income. The Global Risk Nexus work noted above clearly favors Asia and Europe in terms of both politics and early cycle economics relative to the Americas. Within the market structure component stronger earnings growth and cheaper valuation further support the non US DM versus the US where tax cuts seem in the price. Mexico, long a preferred market, has been reduced as it unfortunately now seems plausible that Pres. Trump could sign NAFTA termination papers in the hopes that Canada and Mexico will give concessions during the six-month pre termination window. This dangerous game would follow the Iran certification playbook; the combination of NAFTA and election risk means Mexico’s risk-reward has deteriorated.

In terms of specific opportunities, hedged Japan equity (DXJ) remains a (currently overbought) favorite as does unhedged European equity (EZU) (Peering Through the Mist, August 2017). As economic recoveries broaden and deepen small cap stocks seem interesting in the US and abroad (VSS) especially given the heavy weighting attached to Industrials.

Within FI, credit remains preferred over sovereign and US over non US. In doing some work on non-US fixed income ETFs two interesting opportunities popped up. One is European HY (HYXU) and the other is China RMB denominated fixed income (DSUM). Why would one invest in HY that yields barely 2% (as EU high yield does)? Because the spread over Gov. is roughly 240 bps, well above 2007’s all time tights of 180bps while defaults are falling and the supply/demand dynamic remains favorable. Across the Pacific, DSUM offers a 4% + yield and a play on potential RMB appreciation which seems plausible given China’s high interest rates, desire to move up market and growing importance within global indices.

Commodities remain of interest given the synchronized global recovery plus supply concerns across a number of items. The last commodity up cycle was driven by China demand; the current one may be supported by China supply constraints. Last month we highlighted a broad commodity ETF (DBC) (Fall Forward, October, 2017). Here we note a large cap global energy ETF (IXC) that sports a 3%+ divided yield and represents a good play on a reduced US rig count, a likely OPEC production cut extension and Saudi upheaval. In addition sentiment towards commodities remains bleak with commodity funds closing left & right and CTAs short. Blackrock, for example, just shut its commodity fund because there were no longer enough underlying managers – the crème de la crème – to fill the portfolio). 

A major investing challenge today is the one-way nature of markets, be it tech stocks and the S&P on the upside or Mexico and GE on the downside. GE for example, was down 10 days in a row recently. Perhaps the lesson is not to be afraid to buy even after things have moved up because they are likely to go higher and don’t be afraid to sell down because it’s going lower. This lesson won’t hold forever but could well last through year-end.

Fall Forward

Fall began last week here in the US, even thought the weather seemed like summer and so did the performance of financial markets. The case for a continuation of strong 1H performance laid out in these pages last June ( 2nd Half Outlook: More of the Same Please June, 2017) has played out with a global 60-40 portfolio returning roughly 3% for the quarter and close to 10% ytd.  The question for today is what’s in store for Q4?

Much will depend on the ability of the best global synchronized economic recovery in decades to offset the onset of quantitative tightening (QT) as Central Banks, led by the Fed, begin to row back some of their easy money policies. There is no shortage of additional concerns: US tax reform potential, the US – North Korea standoff, building Gov. pressure on Big Tech and political uncertainty in Europe and Asia. Climbing the proverbial wall of worry has been a hallmark of this bull market as has low volatility begetting low volatility. Will it continue? My short answer is yes.

Lets utilize the Tri Polar World (TPW) regional framework to consider these various concerns, most of which fall under the four categories of our Global Risk Nexus (GRN): economics, politics, policy and markets. As always we will end up with some portfolio strategy and asset allocation thoughts.


The Fall calendar for the US is absolutely jam packed: the onset of the Fed balance sheet reduction, tax reform, the North Korea standoff, NAFTA negotiations, Big Tech & the Russia investigations to just name a few.

The US represents the front line for the potential trade off between tightening monetary policy and fiscal stimulus as the Fed begins its balance sheet reduction process amidst the Trump Admin’s tax reform/stimulus rollout. A trade off between reduced Central Bank largesse & fiscal stimulus seems like a good one, especially given the underlying support of a solid global economy. To wit, if not now, when?

The Fed has clearly delineated its plans and financial markets have responded with appropriate calmness, pricing in a December rate hike and the start of balance sheet reduction later this month. The USD has stabilized, interest rates have risen and stocks have taken it all in stride.

Fiscal stimulus seems likely to be a 2018 event given scant details and a short legislative calendar prior to year-end. Deficit hawks have morphed into pigeons, suggesting significant potential for tax cuts to provide a late cycle boost to an ageing US economic recovery. This boost may well also support other late cycle economic activity like cap ex spending and rising M&A activity.

Big Tech has become a big issue for legislators around the globe. Privacy concerns, Russian spy worries, wealth concentration and monopoly fears have combined to put a target on the back of the biggest sector in global equities. Calls for more taxation, regulation and company spending to prevent such abuses from reoccurring are in the air.

How this plays out remains to be seen but two points are warranted. First, big tech in the cross hairs of Gov. is not a US only concern; Europe, under Competition Director Margrethe Vestager, is carving out a role as tech regulator (maybe because it lacks big tech champions) while China’s big tech companies are running into Gov. pressure across a range of fronts including being compelled to buy minority stakes in poorly performing SOEs. Second, tech’s weight in various stock indexes around the globe means investors really need to start paying attention.

Two other issues bear observation. First is the North Korea standoff where two men who rarely hear the word “no” confront each other. President Trump has already made it very clear he does not like to be told what to do or say. His nemesis, Kim Jong-Un, is a 33 yr. old dictator who disposes of those who tell him no. Pres. Trump’s upcoming China trip, perhaps in late November, may offer the best chance for some type of negotiated settlement.

Ongoing NAFTA negotiations also bear watching.  Three rounds of talks have concluded with very little visible progress. Timing here is also very tight given the electoral calendar in both Mexico and the US.  Financial market reaction has been muted to date but this is an important area to observe, especially for Mexican equity holders (2017 Global Outlook: America First? Dec. 2016). Hopes for a breakthrough extension of NAFTA to encompass all of South & Central America did not even make it on the table, reaffirming the Americas“Inactive” title in the Tri Polar World narrative.


Just when one thinks the all clear signal can be given for European politics the Germans, yes the Germans, spring an election outcome surprise. Chancellor Merkel is returned for a 4th term but with diminished power, the far right (AfD Party) enters the Bundestag and coalition building, always a struggle (av time = 90 days), will likely include the Greens and FDP (the so called Jamaica coalition). The good news is the potential for more domestic spending offset by possibly reduced maneuvering room on EU integration.

Thus talk of French President Macron moving from EU integration junior partner to leader as Chancellor Merkel focuses on the home front. Time will tell; Macron has been quite vocal while Merkel continues to see deeper European integration as her legacy. The integration message is at some odds with what is happening in Spain where the Catalan independence referendum vote was marred by some heavy-handed police tactics. This too will take some time to decipher with Madrid and the EU saying the referendum was illegal and Catalan passions inflamed by the police response. It is interesting to note that while 90% of those who voted, voted yes to independence, only 42% of those eligible to vote did so. 

EU integration does seem to be moving ahead at the corporate level. M&A activity in the steel sector with Thyssenkrupp – Tata and in rails with Siemens - Alstom suggest EU corporates understand the need to develop European heavyweights to protect regional market share and gain global heft. Further such cross border/intra regional M&A activity is likely in the financial sector among others.

Europe’s robust economic recovery coupled with an expectation that the ECB will move quite slowly in reversing its current momentary policy mix supports a positive outlook. As the economic recovery deepens, with manufacturing PMIs at 6-year highs, bond yields have also started to move higher, reflecting better growth. Equities have taken the yield back up in stride, recognizing it as confirming a robust economic recovery rather than as a threat to the economy.

Viewed through the GRN lens, Europe gets high marks for its economics, a slight mark down in its politics, continued solid grades in its policy settings and an appealing set up in financial markets.


Between Japan’s snap election and China’s long awaited Fall Party Congress, politics are likely to be front & center in Asia as well. As in Europe, solid economics provide a benign backdrop. Policy outcomes, especially in China, could impact markets. All of the above provides more grist for the GRN mill.

Opposition party disarray among the new Party of Hope suggests the October 22nd snap election is PM Abe’s to lose.  Abe has sweetened the pot with an $18B fiscal package. Market concerns are likely to revolve around BOJ leadership where rumors are swirling about Gov. Kuroda’s longevity. Given Japan’s robust economy and confidence (as expressed in the BOJ’s Tankan survey) at a decade high, the election is unlikely to cause great changes in the economy or financial markets.

China’s Party Congress could well be a different story with significant policy shifts likely to materialize in its aftermath. One area to watch closely is in the financial sector particularly around the issue of capital flows. Given stable FX reserves and currency, there could be a real opportunity to loosen restrictions on public market inflows and outflows, helping to deepen and broaden China’s growing financial markets.

A key tenet of the Tri Polar World is each region’s growing ability to self finance; the recent success of a $7B USD bond offering by China Postal Savings Bank illustrates Asia’s growing ability with 97% of the take-up from regional investors.

The coming five years will likely witness the rising weight of Chinese companies in non Chinese portfolios and concurrently the rising importance of non China holdings in China based portfolios. ETFs are likely to be the preferred vehicle for these flows as Asian and European capital markets catch up to the US in terms of ETF activity levels.


The third quarter continued where the first half of the year left off with the only bad decision was to not be invested. How long this state of affairs lasts is anyone’s guess but the thesis that low volatility begets low volatility and above average returns (as discussed in 2H Outlook) has held true with September recording the lowest volatility for the month in almost 50 years (1970). Where does opportunity lie for the remainder of the year?


Seasonality offers a near term guidepost. Upon entering Fall, equity markets exit the year’s worst seasonal period. Different market technicians have different end dates for this seasonal period of woe but most agree it ends by mid October at the latest. S&P 500 strength during this historically poor return period is leading market technicians to forecast 5%+ returns in Q4. This seems high but would be in line with the returns suggested by the low volatility studies noted above. Dips are likely to be shallow and should be bought.

Over the medium term, fiscal policy could provide further support, boosting earnings. Year /year US real earnings growth is running at 13% versus the historical average of under 2%.  Q3 forecasts are for 6% y/y EPS growth in the US, which suggests a low bar. Outside the US, earnings have been quite strong and are expected to remain so given the synchronized nature of the global economy. In addition the very gradual nature of equity market appreciation means that few parts of the market look extended.

Broadly speaking equity continues to be favored over fixed income and non US DM equity over US equity. Hedged Japan equity (DXJ) is favored over Europe and within Europe regional exposure (EZU) is favored over single country exposure. Spain (EWP), Europe’s fastest growing major economy and a favored market, has sold off and is now oversold for most conditions minus a full split.

On a sectoral basis, the tech sector is worrisome given its precarious political position around the globe.  IT has been THE leadership sector and now represents 23% of the S&P and an astounding 27% of EM equity (EEM).  Interestingly, tech’s weighting in Japan (13%) and Europe (8%) is much less and represents another reason why one would want to overweight the non US DM equity. Q4 represents a good opportunity to take profits in tech.

Big Tech risk suggests finding potential new leaders could be very profitable. The US Industrials (XLI) sector remains a top prospect with its bellwether GE (single largest position) looking to make an important bottom. A cap ex boom, fueled by tax reform and symptomatic of late cycle economic activity, could well propel Industrials forward through out the Fall.

US small caps are also appealing (Peering Thru the Mist, Aug. 2017). IWM was up roughly 8% in September after trailing all year. Industrials, small caps and financials could all serve as leadership this Fall and offer attractive risk – reward profiles given their lack of performance for most of the year.

Outside of the US, Japan and Europe continue to look appealing with hedged Japan equity (DXJ) breaking out of its 2017 trading range. Japan’s appealing mix of attractive valuation, very strong earnings growth and improved corporate governance could spur inflows (foreign investors have been large sellers ytd) especially if political worries cap enthusiasm for Europe. 

Japan looks set for several years of good economic experience as record low unemployment leads to wage gains and improved consumption. The PGS view that 2017 could represent the year of inflation in Japan suggests potential corporate pricing power, something not seen for some time.  Risk – reward looks compelling.

European equity has moved in fits and starts this year amidst a better than expected economic performance. As The Economist laid out post the German elections one can either be a pessimist or an optimist on Europe; I remain a steadfast optimist and believe the upside for European investments remains quite significant. Solid economic growth, a fairly valued Euro, continued ECB policies and strong earnings growth all support equity prices. Financials(EUFN) remain the most attractive sector in a rising rate environment.

In EM equity the focus remains on China (MCHI) which benefits from sizable tech exposure (a main beneficiary if investors choose to move away from US tech) as well as banks set to benefit from relaxed PBOC cash reserve rules. Tech and financials combine to equal 63% of MCHI. Mexico exposure remains intact (EWW) though concerns are likely to grow as we approach the 2018 electoral cycle.


On the fixed income side the story remains much the same with credit more appealing than sovereign and USD exposure preferred versus non-dollar. Specific positions such as financial preferreds (PGF), High Yield (HYG) and USD EM debt (EMB) remain quite compelling. There are tons of reports suggesting fixed income is in even more of a bubble than equities supposedly are – a good piece of MSCI research caught my eye lately which analyzed 40 years of data and concluded that US equity and fixed income were only “moderately expensive”. 

That seems right to me; the Fed may want to raise ST rates but will be limited by lack of supply and continued strong demand for long duration safe assets offered by the long end of the UST curve. Yield curve inversion is not something the Fed is likely to want to manufacture.


Commodities represent an area of new interest following last month’s small cap discussion. Heretofore the focus has been on gold/silver (GLD/SLV) for defensive purposes. It now looks like the broad commodity sector could be setting up for a good move. Here’s why: China’s economy has stabilized, major segments (oil, industrial metals) are approaching better supply – demand balances, multiple commodity hedge funds are closing, CTAs have gone net short and the charts look pretty compelling. As a portfolio diversifier and inflation hedge the space deserves some consideration with a multi commodity ETF (DBC) likely to work best.

Well, one could write all day but its Fall & that means apple picking season… enjoy the fresh fruit!

Peering Through the Mist

I was working on an eclipse analogy but saturated media coverage plus it being a bit of a bust here in New England put an end to that. Then I woke this morning to find the view obscured by a shape shifting, light altering combo of mist & fog. It struck me that as investors we often find ourselves peering through the mist of data and a deluge of information, trying to avoid pitfalls/drawdowns and seeking the clarity in both outlook and positioning similar to when the sun breaks through and all is revealed.

Well, I can’t promise to reveal all but I can offer my Global Risk Nexus (GRN) framework to assess the key variables of economics, politics, policy and markets. Combined with my Tri Polar World (TPW) global growth model of regional integration in the three main regions of Asia, Europe and the Americas, we can try and chart a course through the mist and fog of global, multi asset investing.


I am contemplating a possible GRN scoring system, contemplation which has helped me think through what has happened in the US these past few weeks. If one were to score the politics and policy variables of the US on a scale of 1 to 5 with 5 being the best it would suggest the US at a 1.

Its hard to imagine a worse week for the Trump presidency than the one just passed; its also hard to conceive of a month worse than the one just completed given staff turmoil & turnover, the health care fiasco, Charlottesville and its aftermath, the war of words with N Korea, the collapse of the Presidents’ councils & the encouragement of a Gov. shutdown, all serving to deepen speculation on who and what is next.

Impeachment would be worse but remains a low odds prospect that would occur only after the 2018 midterm elections and a Republican loss of the House; itself an open question given that President Trump remains popular among Republican voters. In the interim, the personnel focus is on Gary Cohn, head of the President’s National Economic Council, who is expected to stay in post until President Trump names him as the next head of the Fed in early 2018.

On the policy side, a jam-packed Fall calendar awaits. Key Congressional issues include the passing of a budget and the raising of the debt ceiling in order to keep the Federal Gov. operating and avert a potential default on UST. The deep divides exposed over the past few months within the Republican Party itself as well as between the President and Congressional leaders suggest neither of these issues is likely to be easy. 

If achieved then there is the long hoped for tax reform, which at this point seems quite unlikely at least this year. And yet, Republicans running for office next Fall need something to run on and tax reform looks like the only game in town. The DC mess seems pretty well discounted, creating a potential positive surprise on tax reform. Depending on what tax reform actually looks like it could revive the hoped for transition from pure monetary policy to a joint venture between monetary and fiscal policy which at this point appears stillborn. 

With the Fed’s Jackson Hole confab focused on Fostering a Dynamic Global Economy the reality is that Central Banks are shifting from a major tail wind for risk assets to a modest headwind, making that joint venture all the more important. As an aside, the way to foster a more dynamic global economy is simple: embrace the TPW, deepen regional integration and foster each region’s growing ability to self-finance, self produce and self consume.

On the regional integration front, the opening of NAFTA talks has already revealed some “deep fissures” between the US proposal and those of Canada and Mexico. President Trump’s continued shout outs to build the wall are unlikely to be helpful in this context. The integration of value added corporate supply chains across the US – Mexican border are some of the most significant in the world suggesting little will be done especially given US midterms and Mexican Presidential elections next year. From a TPW perspective, the US is missing a huge opportunity to extend NAFTA southward and deepen the integration of the Americas (Expert Insights: The Rise of the Tri Polar World, July, 2017).

The net result of all this political dysfunction has been to introduce a bit of volatility into illiquid summer markets and spark some healthy profit taking in equities. USD and small cap equity weakness would suggest the “unmoored” Trump Presidency outlined in my 2017 Outlook piece (2017 Global Investment Outlook: America First? December, 2016) has been pretty fully priced in.


I was struck by the number of Chinese companies on the recently released Fortune 500 Global List. China had the second largest number of companies on the list with roughly 110 vs. 130 for the US, 50 for Japan and less than 10 each for the other BRIC countries. Chinese companies on the list include the large banks & state owned enterprises (SOEs) but also a growing cohort of tech companies. Amazingly, Chinese banks constitute four of the top five most profitable companies in the world (though its likely much of that profit will be used to write off bad debts in the years ahead).

Much has been written about China’s geo political leadership of the Asian region in areas ranging from trade to financing to the OBOR project but it seems clear that the focus needs to broaden to the corporate level. Global investors are going to have to pay a lot more attention to Chinese companies in the years ahead… they are too many and too big to ignore.

While global investors need to start really honing in on Chinese companies, reports suggest that individual Chinese investors may soon be allowed to invest abroad, a subject broached a few years ago but put on the back burner once capital outflows accelerated in 2015-16. Renewed stability in the capital account may facilitate investment outflows by individual investors in the years ahead, something that may even come out of the upcoming Fall Party Congress. 

Investment flows to /from Chinese financial markets in the next few years are going to be a huge story given that China’s debt & equity markets are in the top three globally while China investor home bias is close to 100%.

Of course Asia also includes the Korea conundrum as well as sabre rattling between China and India and the growing importance of the ASEAN economies. For all the ink spilled on N Korea and its risks to the US and S Korea its pretty amazing to see that the won/USD rate has been roughly flat while the South Korean stock market, up over 25% ytd, sold off only 5% or so. Such calm would seem to imply that investors either expect all sides (there are at least four) to act rationally or they are dangerously complacent. I favor the former.


Europe remains the most attractive region over the next 3-5 years as political populism ebbs, enthusiasm for the EU rises, the economy continues to recover and the Franco-German European integration motor restarts. 

Growth is both widespread and better than expected with cap ex the best since the financial crisis. This has led to a bond sell off, Euro strength & an equity market marking time. German elections next month should set the stage for a positive outlook into year-end.

One of Europe’s key challenges lies in its need to develop big tech winners a la the US and China. Instead Europe seems to be seeking the role of global tech regulator with key countries pushing Brussels to lead the way.  Offsetting this is the larger role President Macron seems to be seeking for France and its tech aspirations. European tech is a key area to focus on the years ahead. It is hard to see Europe remaining resurgent if it doesn’t place the tech sector front of mind and not solely from a regulatory perspective.



The request for “More of the Same Please” (2nd Half Outlook: More of the Same Please, June 2017) has worked out pretty well to date, with non-US developed markets (DM) equity sustaining its outperformance vs. the US. I continue to believe we are in the early stages of a multi year shift in global equity leadership from the US to the non-US DM.  

Some of this relative outperformance can be placed at the doorstep of US political disarray and policy inertia to the extent that so far in Q3, long duration UST are outperforming the S&P. A Fed that leads the CB parade out of QE coupled with the Fall legislative calendar laid out above and more challenging 2H earnings comps suggest a US equity market that is likely to mark time in the months ahead. Seasonality is also a concern.

Non US DM positives include a better economic environment outside the US, better earnings growth and room to grow those earnings, more attractive valuation and continued underownership coupled in both Europe and Asia with a more vital regional integration effort. Japan and Europe remain attractive with the key question being whether to hedge the FX risk or not. I remain unhedged in European equity (EZU, EUFN, EWP) and hedged in Japanese equity (DXJ), which has worked in Europe but not in Japan.

Yen sentiment is at extreme bullish levels suggesting good prospects for at least a tactical reversal which could lead to more interest in Japanese equity. Japan is enjoying its broadest economic recovery in several years as domestic demand revives, inflation picks up and the global economy enjoys its most synchronized recovery since 2007. Earnings growth is running at roughly 20% y/y and valuation remains compelling while foreign ownership has plenty of room to expand.

Emerging Markets have done very well this year on both the debt and equity side. A go slow Fed backstopped by an administration in turmoil leading to a weak USD has all been good news for EM. At this point it is hard to see how it gets much better suggesting a Neutral position helped by some specific country selections in China (MCHI) and Mexico (EWW) that remain appealing.

The main equity worry at the moment regards the tech sector, which has been the leadership sector in many markets. The concern is that tech seems to be in the cross hairs of governments in each main region: in the US because of its size & role in social media, in Europe because of the regulatory focus Europe is adopting (Google fine etc.) and in Asia where China’s leadership is making it clear to the tech mavens who is really in charge. It’s hard to quantify this risk but it seems real and one that must be considered from both a tech sector and a broad market leadership perspective.

Potential sector leaders in the US include Industrials (XLI), which would benefit from growing interest in capital expenditure spending. This potential is underlined by a recent Philly Fed survey suggesting companies have their most aggressive plans to boost cap ex since 1984. GE, an Industrial sector bellwether, is flirting with 52 week lows, offers a 3% + dividend and may be worth a look. European sector leadership remains the banks (EUFN) that both hedge Euro strength and benefit from rising rates. In Asia tech, consumer and OBOR related plays remain appealing.

There may also be an opportunity to position in US small caps (IWM) for a surprise legislative achievement in the tax space; the weak dollar has been a boon to large caps and the potential exists for a dollar rally. A tactical trade out of large caps and into small might be the surprise trade of the 2H. Small caps are roughly flat year to date, have been sold pretty aggressively and are testing significant technical support… worth a ponder.


The focus here has been on USD fixed income with particular focus on USD EM debt (EMB), US High Yield (HYG), preferreds (PGF) and mortgages (REM). In local currency terms both Asian and European bond market returns have been roughly flat year to date while US Agg is up close to 4% and USD EM up roughly 7%. 

Credit is late cycle and HYG is down so far in Q3 suggesting a caution flag at the least.  On the positive side, recent significant outflows from HY ETFs do suggest the bond bubble/stock market bubble talk may be misplaced.

There continues to be more demand for long duration safe assets than there is supply; it’s a structural issue that is unlikely to change in the near term. With JGB rates capped by the BOJ and EU sovereigns heading higher to reflect the better economy, EM sovereigns and UST offer the only game in town.


Gold and silver remain important portfolio hedges in case bad stuff happens; continued outperformance Q3 to date is no surprise given what has already been discussed. 

The real question in this space is the industrial metals rally with Dr. Copper up 36% over the past year and 11% Q to date while zinc, iron ore and other metals have also rallied sharply. Is Dr. Copper suggesting another leg up in the global economy fueled by the cap ex pickups noted above or is the move supply related or perhaps just a head fake? I lean toward the former but hesitate to jump in after such a run.


Infrastructure continues to do very well, especially in the limited public equity ways to invest. This remains a huge global theme that will play out over years. Another area of opportunity lies in the logistics sector as discussed previously. XPO, one of the largest US logistics companies, is off roughly 15% from its recent high after some profit taking and may present an interesting opportunity. There are few ways to play either theme, especially logistics, a growing sector that I have taken to referring to as the “pick & shovel of the Ecommerce Age”.

All in all, plenty to peer through… enjoy the last few weeks of summer… Fall is gonna be busy! 








2nd Half Outlook: More of the Same Please

It’s hard to argue with 1st H 2017 returns. Global stocks& bonds are up; led by non-US equity and US/EM fixed income.  Commodities have disappointed, with oil down and gold up. In FX land, the story has been muted USD weakness and Euro/EM strength. Global balanced benchmarks of publicly traded securities are up roughly 10%; private assets continue to see better inflows than performance.  All in all, it’s hard not to just say that one will take more of the same thanks very much!

In fact that may be just what one should say (and expect in the 2H) but in order to feel comfortable doing so one needs to understand both the factors that have led to this point and what the 2H risks to such a stance might be. The Global Risk Nexus (GRN) framework remains the preferred way to analyze the interplay between economics, politics, policy & markets before concluding with portfolio implications.


The global economy remains on a gentle, broad based upswing across both developed and emerging economies, supported by still buoyant Central Bank provided liquidity, easy financial conditions, rising employment and benign inflationary conditions. The synchronized nature of the upswing & the lack of visible, large excesses in the global economy suggest this low growth, low rate, low inflation steady state can be sustained at least though year end absent a policy mistake.

Policy risk exists mainly in the US where the Fed is leading the globe’s Central Bank normalization charge. Other Central Banks in the news (ECB, BOE) are more smoke than fire. With its 4th & most recent rate hike, the Fed has brought the short-term rate structure close to underlying core inflation, a much more comfortable place for the Fed to be relative to a year ago. The Fed now has optionality; it can ease should a shock occur while the long end of the UST curve has absorbed the normalization process like a champ, thus reducing the risk to the real economy and financial markets.

The Fed should be feeling pretty good right now and thus is likely to go slow in regards to both future rate hikes and balance sheet normalization. The shape of the yield curve combined with the absence of the fiscal – monetary policy joint venture we expected this year makes such a careful stance all the more necessary. Even the IMF, in its recent downgrade to US GDP forecasts (2.1% this year AND next vs. prior 2.3% and 2.5%) noted the lack of progress on the fiscal side. 

The other source of policy risk would seem to lie across the Pacific via China’s efforts to rein in its financial sector. For all the ink spilled on China credit crunch risk, the reality would seem to be a well-targeted approach allowing for the continuation of a near steady state of affairs with low inflation, decent economic growth, good profit growth, a stable currency (helped by a crackdown on outflows but still) and a growing number of globally relevant technology companies.


The political action has been mainly US and EU led, something that is likely to continue though the 2H will include China’s important Party Congress. In the US, the Trump administration has clearly been of the “unmoored” variety rather than the “full bore” variety discussed in the 2017 Outlook piece (2017 Global Investment Outlook: America First? Dec 2016). Very little has been achieved in the First 100 days or since. A focus on repealing Obamacare has led to several months of fruitless activity casting tax reform and fiscal stimulus into the wind or at least into 2018. 

It seems unwise to expect much from an understaffed (by choice) Administration, operating under a cloud of Russia related uncertainty and led by a President who is himself the focus of a special counsel investigation.  To date, the surprise is that such an outcome has been just fine for US financial assets. 

Examined from a Tri Polar World point of view however, all this US thrashing about means it is in danger of falling behind a revitalized Europe and a proactive Asia. The opportunity exists to deepen integration within the Americas by extending NAFTA to include South & Central America; unfortunately there seems little liklihood that such a forward thinking path will be adopted.

The political breeze blowing across Europe has whisked away worries about populism’s rising tide and replaced them with a sense that sunny days are here again. What a difference a year makes! Brexit is the bane of the British while the M&M team of French President Macron and German Chancellor Merkel strategize about how to best deepen European integration. Elections are forthcoming in both Germany and Italy; the German elections are being fought on who is more supportive of deeper EU integration while Italy should benefit from its best economic outlook in a decade or more.

The news in Southern Europe is also uplifting. A positive outcome in Greece together with a clean up of weaker banks in Spain and Italy suggest a positive policy tilt as well. The weak bank and NPL problems long bedeviling Europe are finally being faced. While sausage making is never pretty the outcome usually tastes pretty good and so it is the case here. European senior bank debt insurance is now priced at levels last seen in 2011, suggesting a Continental lifting of bank sector risk.

Europe’s robust economic recovery has occurred sans credit; cleaner, healthier, more consolidated banking systems should provide further leverage. Rates should rise, helping savers & banks alike. More needs to be done to clarify the bank resolution process and to develop a common deposit insurance process that will finally break the link between bank debt and sovereign credit. Yet, when viewing the Tri Polar World’s three main regions through a GRN framework, Europe stands out as having the most upside in the years ahead.


Absent being cashed up and bearish, it was pretty hard to go wrong in terms of asset allocation during the first half of this year. Is the 2H likely to be the same?

One of the best pieces of research I have seen of late was a report noting that in past periods of limited S&P drawdowns (under 5%) in the first half of the year, 2H US equity results tend to be quite positive, averaging roughly 8% which is well above the average 2H return. In other words, low volatility begets more low volatility unless there is a shock to the system. This suggests one should look to add on pullbacks especially if they are driven by Central Bank concerns.

However, one should also focus on what those possible shocks could be. The most visible economic risks, a Fed policy mistake and a China credit crunch, have already been covered. Let’s add two more, an earnings shortfall and a Black Swan risk of war in the Gulf leading to sharply higher oil prices and a potential inflation shock. Of the two, an earnings shortfall is the more worrisome given the importance of earnings to global equity markets. 

Earnings risk stems from the reliance on the easy comps generated by the energy sector’s recovery from last year’s oil price collapse. Oil, now down 20% from its recent peak and facing US inventory levels well above five-year averages, implies much tougher comps in the 2H. An additional concern revolves around the likelihood that CEOs reduce 2H outlooks given US policy inertia. A reduced pace of stock buybacks in the US provides another reason for concern.

One of the keys to understanding the current earnings environment is that capital is being rewarded more than labor, driven in part by the spread of disruptive technologies across more segments of the economy, which limits wage gains and arguably boosts earnings & financial asset prices. This is true in both the US and Europe where unemployment is at an eight year low but wage gains are running at roughly 1.4% pa. If wage gains were to rise sharply then profits would fall and interest rates would rise, neither of which would be good for risk assets.

The Black Swan risk of war in the Gulf is non trivial given the recent breakdown in relations between Saudi Arabia, its allies and Qatar, home to the US’s largest military base in the Middle East. At the very least, this crisis threatens the Gulf Cooperation Council (GCC) and illustrates why the Middle East is not an active part of the Tri Polar World thesis. Potential conflict risk also exists in the Korean Peninsula which has the potential to draw in the US and China.


The case for non-US equity outperformance vs. the US remains intact; an overweight position in non US DM equity should be maintained. An unmoored Trump Administration leads to policy inertia, C suite hesitation, earnings risk and a poor risk reward profile.  In comparison, a revitalized Europe and recovering Japan both offer better earnings growth and more attractive valuation. The non-US equity markets remain in the early stages of taking global equity leadership from the US (From Fluke to Fact: Is the Anti Trump Trade Sustainable? April 2017). 

A real question for US equities is where is the leadership to come from? Financials remain hostage to a slow rate rise environment while technology seems to be on the cusp of rolling over. US equity exposure should be concentrated in sectors where there is change at the margin such as Industrials (XLI) where a new cap ex cycle is getting underway or where performance has been muted such as Consumer Staples (XLP). 

Europe’s positive news flow has been matched with equity market profit taking, a healthy state of affairs that sets the stage for another leg up in the 2H of the year. Broad regional exposure (EZU), country specific ETFs such as Spain (EWP) and sector specific ETFs like the banks (EUFN) all remain attractive. Banks will benefit from the NPL clean up, increased lending, rising rates and further consolidation.

An overweight European position has many supports: shrinking political risk, new impetus on bank cleanups, a large amount of economic slack, attractive valuation, powerful earnings growth and lack of investment alternatives (10 year Bunds yield .35%) all suggest a favorable risk reward profile. Sovereign bond yields should rise in Europe as political risk falls and the economic recovery deepens; stocks should see rising rates as supportive, especially in the bank sector. Euro strength, up 8% or so year to date, is far from worrisome levels (1.20 +). The ECB is likely to be very slow in removing its accommodation though an end to negative rates would be a plus.

Japanese equity also looks appealing. A 1st H laggard, due perhaps to a stronger than expected yen, Japanese corporates are undergoing a governance revolution leading to a greater focus on shareholder returns while benefitting from better global & domestic growth. Attractive valuation, underownership, especially by foreign investors and very strong earnings growth support an attractive risk reward profile. Hedged equity remains the favored way to allocate (DXJ) as the BOJ will remain very accommodative.

Emerging market equities have done well after a long period of underperformance. Within a neutral position, selectivity matters; favored markets remain Mexico (EWW) and China (MCHI). Mexico’s economy remains robust with great upside in the consumption story while political risk (elections in 2018) should not manifest in the near term. Corporate profit growth in China is running over 20% y/y, valuation is attractive, foreign ownership is light, the market remains well off its highs and its technology companies are becoming more and more important on a country, regional and global basis.


Within fixed income the focus remains on USD investments including High Yield (HYG), Preferred (PGF) and USD EM debt (EMB). The search for yield continues and is likely to remain in place through the end of the year and beyond. There is more demand for high yielding assets than supply, a condition that is also likely to remain in place for years to come. The Fed’s balance sheet normalization process is likely to be a very gradual and drawn out affair.

FX volatility has been near record lows supporting carry trades and local currency EM debt in particular. The Mexican peso for example is back below Nov 2016 level versus the USD. A gentle drift upward in the Euro and downward in the Yen should leave the USD range bound through year-end.

Within commodities, gold and silver (GLD, SLV) remain appealing given the black swan risks noted above. Oil seems caught between growing supply and slowing rates of demand growth. Technology & capital markets have combined to cause near term pain via US shale production while the longer-term case for autonomous electric vehicles suggests limited upside.


On the private side, the issue seems more capital than ideas. Little sticks out as attractive with PE firms sitting on a record $1.5T in dry powder, hedge funds underperforming and real estate buffeted by the changing nature of retail, the glut in high end residential and the copious amounts of capital looking to invest in the industrial space. Logistics remain interesting but small. Infrastructure suffers from having far more capital to deploy than projects to invest in, while private debt is likewise oversupplied with capital. Opportunities are more niche related, which is problematic for the large pools of capital struggling to make their targeted returns (Market Environment Driving Asset Owners to Revolution, April 2016).

One would like to have something punchier to say but… this time it feels different, it feels like more of the same.





As the world turns, so do the various inputs that move markets. Over the past year or so, investors has migrated from a laser focus on policy (mainly monetary/CB related) to a world where politics is front and center.  A gentle upswing in global growth, sufficient to boost earnings but not shock yields, has facilitated a positive return environment..

Politics can have both good and bad implications for markets. At the moment, politics are descending like a cloud over the US while representing a rising sun in Europe. Our Global Risk Nexus (GRN) framework, which analyzes the interplay between economics, politics, policy and markets is well suited to examine what the combination of healing economics and hard to model politics means for asset allocation.

Let’s begin with an assessment of the US, then move to Asia, Europe and a side trip to EM land before concluding with what it all means for asset allocation and portfolio strategy.


The US has been in the grip of heavy-duty political intrigue for the past several weeks as current events stimulate memories of Watergate & impeachment. Plenty of ink has already been spilled on these issues but several points bear noting.

First, many of the White House troubles represent self-inflicted wounds ranging from the Flynn affair to the firing of FBI Director Comey to the release of confidential intelligence. Candidate Trump’s treatment of the press and the intelligence agencies virtually ensured such self-inflicted wounds would be vigorously reported – reporting that is unlikely to change. The costs of these self-inflicted wounds range from turbocharging the human resource challenge (the administration remains woefully understaffed) to encasing the legislative agenda in cement.

Second, the bulk of these self-inflicted wounds come from the President himself and thus are likely to persist. The President is inexperienced in the ways of Washington and is being outplayed in its parlor games. He is out of his element and furthermore, his element has not prepared him well for the challenges he faces. At 70 years old, the President is unlikely to change while his personal history works against him; as the CEO of a family company he is unused to criticism and has never been bound by shareholders or a strong board.

Finally, the naming of former FBI Director Robert Mueller as a special counselor suggests much of Washington will be lawyered up and on tenderhooks for months if not years to come. Mueller, known to stand up to the powers that be, is a career prosecutor with a broad remit to go where the trail takes him. For its part, the White House is reported to be setting up a war room to push back against the media and intelligence onslaught. The US history of special counselors or prosecutors suggests that the average process tends to take just over three years. It is quite conceivable that policy paralysis will reign in Washington for the next several years; should the Democrats win the House in 2018 (increasingly feasible) the prospects for impeachment would be much less far fetched than one would have thought a month ago.

Policy inertia is worrisome for an economy that grew at under a 1% annual rate in Q1. Q2 is tracking well above 3% but any hopes for meaningful fiscal stimulus are at this point very faint indeed. Democrats are unlikely to support the Trump agenda while Republicans nervously eye the 2018 midterm elections. (See From Fluke to Fact: Is the Anti-Trump Trade Sustainable? April 2017)

An aging economic expansion, a White House & Legislative branch focused on who said what to whom when and a Fed looking to raise rates all suggest caution is in order. The risk of a Fed mistake is elevated, given record US household debt levels and an investor base that lacks experience of investing in a rising rate environment. The Fed is in a box; should it choose not to raise rates one might even see stocks sell off, worried about what the Fed knows that the market doesn’t.



Regular readers know my Tri Polar World (TPW) thesis: that regional deepening in the three main regions: Asia, Europe, and the Americas, driven by each region’s ability to: self-finance, self-produced and self-consume, represents the coming geo-economic framework. (See The Tri Polar World 2.0 – A New Global Growth Model, March 2015)

Amidst all the DC intrigue, China's President Xi hosted a One Belt, One Road (OBOR) summit that brought a large number of world leaders to Beijing to learn about the opportunities presented by the world’s largest infrastructure project. The OBOR has been criticized as uneconomic, grandiose, a Xi vanity project etc. From a Tri Polar perspective, it looks like regional leadership.

President Xi has utilized President Trump’s America First focus to press his case as a global leader first at Davos and now at the OBOR Summit. Any doubts as to what will happen at China’s upcoming Fall Party Congress should be dispelled by now.

The OBOR project together with the Asia Infrastructure Investment Bank (AIIB) represent China’s efforts to stitch Asia & Eurasia together to China’s benefit in both geo- economic and geo-political terms. The Trump Admin’s decision to walk away from the Trans-Pacific Partnership (TPP) further reinforces China’s regional leadership opportunity. Within the TPW framework, Asia has long been seen as the Proactive region; a split screen look at DC/Beijing over the past few weeks only reinforces that nomenclature. DC myopia is occurring not in a vacuum but rather in a world where others are moving forward – rapidly in some cases.



Within the TPW framework, Europe has been known as the Reactive region given its firefighting efforts of the last 5 + years. A new moniker may be in order however as signs point to a much more positive picture for the European Union. As France’s new Economy Minister, Bruno Le Maire, recently noted, Brexit offers the chance to come up with a new direction for Europe. Greater EU cohesion suggests a hard Brexit and a weak pound. (See Trump, Trade & the Markets, February 2017)

Emmanuel Macron’s election, his subsequent Cabinet choices (many of whom are German speaking) and candidates for France’s upcoming Parliamentary elections together with his interaction with German leader Angela Merkel all serve to reinforce this positive outlook. Macron is intent on reforming France and re-energizing the European Union; more importantly, he understands the former must precede the latter in order to bring Germany along.

In Germany, the clean sweep by Merkel’s CDU Party in three recent State elections makes clear she will be returned for a 4th term as Chancellor this Fall. The payoff is a joint cabinet meeting with France in July, before Germany’s elections, suggesting both confidence in the outcome and a willingness to leverage the energy Macron’s election represents. Expect a much-needed revival of Franco – German leadership to reinvigorate the European project.

Think of the M&M ( Merkel & Macron) team taking the field to push the ball of European integration down the field. The game plan will be for Macron to demonstrate fiscal control in France, which in turn would provide Merkel an opening to take on board subjects such as fiscal union, Eurobonds and faster movement to capital markets union and the digital single market. After years of playing defense, look for European politics to go on the offensive in support of deeper Union integration.

The fact that Europe’s economy is posting its best growth profile in a decade will certainly help. A currency whose fair value is roughly 1.25 to the USD coupled with near 10% unemployment illustrates the significant amount of slack in Europe’s economy; an economy which remains far behind the US in terms of recovering from the 2008-9 financial crisis. Europe has real room to grow at the regional, national and corporate level.

The 2017-2020 period should be Europe’s time to shine. Europe's potential for a prolonged  recovery in economic, political and policy terms has yet to really enter the mindset of US policymakers and investors alike. It needs to.



Politics has long been a part of the EM investment process, sometimes providing opportunity, other times wreaking havoc. Today, the asset class should be well prepared to handle political volatility; certainly domestic & dedicated investors are quite experienced while non-dedicated investors, who usually exacerbate selloffs, have only recently begun to return to the space. The risk is two fold; first that record inflows reverse and secondly, that polticial volatility impedes the search for new growth policies.

Very strong year to date performance stems from strong inflows leading to a catch up trade. To perform going forward, EMs need new growth policies. The EM export to the West model expired in 2008 while the export to China model died a few years later. Subsequently, domestic demand was tapped in many countries leading one to wonder what the go forward EM growth model might be.

One option to consider is how various EMs fit into the TPW concept of regional deepening. In Asia, this could mean being a part of the OBOR effort as well as ASEAN integration. In Europe, it might suggest taking advantage of Brexit to position oneself as a low-cost service center as countries like Poland and cities like Warsaw are doing today.

In the Americas, it could mean updating NAFTA to support Mexico’s push into services. For example, Mexico’s IT service sector is growing at 15% per annum today, faster than India’s IT service sector. For Brazil, Argentina, Chile, Peru, Colombia it might suggest pushing to have NAFTA extended southward in order for it to become a true hemispheric trade agreement.

An effort to incorporate South and Central America into NAFTA would jumpstart the Americas (known as the Inactive region) and provide a much-needed economic model for these countries. Yet any such effort may be held hostage to DC’s self-inflicted wounds. The risk is rising that the Trump Admin misses this regional integration memo, sapped by the Mueller investigation and unable to think strategically about the world around it. One worries that the US and the Americas more broadly might wake up in 3-4 years to see the geostrategic map having been redrawn and not in its favor.



I have spent quite some time thinking about how to tie all these issues together and came up with the following five-point plan during some prep work for a Bloomberg TV appearance a few days ago. (BloombergTV Day Break May 22, 2017)

Trump Troubles = US policy inertia = weak US growth = questionable US Earnings = poor US equity risk reward = rest of world (ROW) outperformance.

Solid Q1 earnings have helped US equity stay afloat during the political fireworks but the big story has been the relative outperformance of the rest of the world led by EAFE up 15% and EM up 18% vs. the US up 7%. On a strategic, multi-year basis, stay overweight non-US equities with a focus on developed x US markets in Europe and Japan. The shift to non-US global equity leadership is just beginning with EAFE related ETFs in general and European ETFs in particular looking to break out of multi-year trading ranges. However, these same instruments now look quite overbought.

Consequently, Japan looks more interesting as it has lagged while the economy enjoys its best growth run in a decade, leading to stellar earnings ( Q1 + 28% y/y) at very attractive valuations. Hedged Japan ETFs in particular have underperformed suggesting that if one believes in multiple Fed rate hikes this year these instruments could present an opportunity.

Over the near term, it’s conceivable that the US might make up some of this relative underperformance. US sectors of interest include Industrials that could benefit from a new capital investment cycle together with Consumer Staples that provide a relatively low volatility way to stay invested. The traditional sell in May and go away strategy may not be very effective this year as sentiment and technicals look supportive.

Recently, much has been written about China’s efforts to delever its financial system with such efforts being blamed for commodity price selloffs and even the end of the “reflation trade”. A more benign outlook suggests this effort will impact China’s financial sector rather than the real economy which is doing well, with new economy companies in particular reporting solid results and very rapid growth rates. China ETFs with tech exposure remain of interest; China tech stocks are outperforming US big cap tech, something one would never know reading about China’s supposed impending doom.

Within fixed income, yield differentials support USTs as Bunds sell off to reflect a better EU tone while the BOJ holds the JGB market captive. Yield curve flattening suggests US investors have pulled the plug on fiscal stimulus hopes. This environment supports positions in US High Yield, preferreds and EM USD debt as the search for yield continues. The growing gap bteween market pricing of Fed rate hikes (one and done till mid 2018) and the Fed's stated path (2 more this year + 3 next) is worrisome. My bet is that the market has it more right than the Fed, as it has for years.

The transfer of political risk from Europe to the US together with Fed uncertainty is likely to keep the USD rangebound. In the commodity space, precious metals remain of interest given that environment. Should the Fed not raise rates next month gold and silver should benefit.


From Fluke to Fact: Is the Anti Trump Trade Sustainable?

Financial markets offer endless capacity to surprise. This is especially true when one adds politics and policy to the basic issues of economics and markets. Monetary policy has dominated market thinking since 2009; politics took over in 2016. One of 2017’s biggest surprises to date has to be that the markets Pres. Trump bashed the hardest in his campaign have performed the best, including Europe, China, Mexico and EM in general.

The question today is whether this is just a fluke, an oversold bounce that should be sold or something more sustainable, a fact on the ground that should be bought and built upon. High beta outperformance in a rising US equity market is not that unusual; being able to sustain that outperformance when the US is flat to down is more demanding.

If sustained, it could signal the beginning of a lengthy period of non-US market outperformance, something few are positioned for and a prize worth getting right. US equity over the past five years is up 70% vs. ex US equity up 9%. The US bull market is 8 years old and 2% off its all time high. We may well be due for a turn.

Lets utilize our Global Risk Nexus framework to ascertain the likely course of action based on the interplay between economics, politics, policy and markets. Given how the clock is running out on Pres. Trump’s First 100 days it makes sense to start with the US. We can then incorporate the rest of the world with a focus on European politics, given the French election, together with some thoughts on Asian ship sailing & saber rattling. We can wrap up with a stab at answering the title question and some asset allocation thoughts.


The Trump Administration’s first 100 days end on April 28th, the very same day a possible Government shutdown might begin as the US Govt.’s funding bill also expires on the 28th.  Coming off a two week Easter break, Congress will have less than a week to avert a shutdown while the White House, desperate for a W, seeks to re open the healthcare debate… its mad scramble time in DC.

Far from the winning the President promised on the campaign trail the First 100 days tally to date is close to a policy zero as one headline put it. The political score is better as the President spent much of his first month in office focused on fulfilling campaign promises via executive order.

However the failure to repeal and replace ObamaCare has had numerous implications including: a gaping hole in the White House to do list, bruised feelings within the Republican Party, a sense of rejeueventation amongst Democrats and and an all round reminder that the so called “Trump Trade” was actually a Republican party sweep trade.  The post election rally thinking was quite simple: Republican control of the White House, Senate and House of Representatives meant that the DC policy logjam would be broken.

The repeal and replace debacle has made clear however that the Republican Party has yet to fully switch from being an opposition party to being a governing party (only a small number of Republican legislators were in office when Republicans last controlled the Govt.) while an inexperienced (in the ways of Washington) White House & Cabinet has yet to figure out how to run the machine. As a result, the policy timeline assumed by those eager buyers of US equity back in Nov – Dec 2016 should be tossed out the window.

The health care debacle, record low Presidential approval ratings and the Senate’s use of the so called nuclear option to confirm Supreme Court Judge Gorsuch has resulted in a White House with limited political capital and a Democratic opposition loath to work across the aisle. Tighter than expected special House elections stir early Republican forebodings about next year’s midterms. The first 100 days of a President’s term is usually when key policy themes get enunciated and acted upon on the legislative front; the Trump Administration’s record to date does not bode well for the future.

The path to future policy success is also being undermined by an Administration whose team remains woefully incomplete. President Trump is far, far behind his predecessors in terms of nominations for the roughly 500 Federal Govt jobs that require Senate approval. Note we are discussing nominations, not approvals – in other words this is a self-inflicted wound rather than opposition party obstructionism.

The President seems intent on running the Presidency much as he ran his company, namely in very lean, classic NYC family real estate fashion. Of course the Federal Govt is a very different beast.  As such one starts to wonder what the first year of the current administration will generate in terms of policy.

Fiscal policy is already being pushed back into 2018 at best as Treasury Sec Mnuchin takes the temperature of Congress. The longer it takes the more limited tax reform will be as House members will be loath to engage in root and branch reform in an election year (Fall 2018 midterms). Very little is heard of the President’s trillion-dollar infrastructure program.  Big time fiscal stimulus seems off the table.

Far from the fiscal-monetary joint venture one might have expected to boost the economy we have gotten monetary tightening and no fiscal boost. The Federal Reserve has raised rates three times while Q1 GDP is expected to come in well under 1%, a combination that has led to murmurs about the old three steps and a stumble Fed rule. The Fed has gotten out ahead of the White House and perhaps a bit over its skis as well.

Weak economic data, especially on the retail front coupled with a growing sense that inflation (driven more by oil fumes than sustained price increases) may have already peaked has led currency and fixed income markets to reprice the “reflation trade”. Bonds have rallied sharply while the USD has softened. Stocks are left as the one main financial instrument that remains in thrall to the idea of a stronger US economy, better earnings and higher stock prices.

The financial sector is a key one to observe as we move to midyear. A post election rally leader, financial stocks reaction to Q1 earnings over the past week has been both disappointing and illuminating. Experienced investors know to watch the reaction to news as well as the news itself; bank stock reaction to earnings news is worrisome.

Earnings were good, even with easy comps given how lousy Q1 2016 was. Yet bank stocks sold off leaving the financial sector ETF (XLF) roughly flat for the year though still up over 15% since the election. Up 15% plus in 5 months suggests one of the challenges for US equities going forward; the market is extended and fully priced.

Bank stock weakness may be reflecting a few issues: slowing overall loan growth and rising bad debts in the auto finance space; a flattening yield curve as the 2/10 yr. UST curve has flattened from 135 bp wide to 100bp which calls into question the potential for banks to profit from curve steepening and finally the idea that banks would benefit from Trump deregulation efforts (recall the campaign promise to kill Dodd – Frank).

Yet, suddenly bank deregulation talk been replaced by talk of re regulation in the form of a 21st Century Glass – Steagall Act no less. This calls into question the operating environment for the big banks and financial companies that make up the XLF and is likely to represent a serious overhang for the sector.

Absent financial sector leadership it’s hard to see the broad US equity market do well given the bank rally rationale is effectively the America First thesis. Another market segment to watch along the same lines is the small cap space which took off like a rocket right after the election on hopes of growth, tax reform & deregulation but has since marked time. If banks and small caps struggle, it’s hard to see the broad US market perform very well.


Notwithstanding all the ink spilled on the “Trump Trade” the place to be in 2017 has been outside the US, in Europe, Asia and Latin America. Global ex US equity is up about 7.5% ytd versus the S&P up roughly 5%. Only Japan has struggled and even it is up roughly 4% in USD terms given yen strength.  Emerging Markets, of which so many were so fearful, is up 11% ytd.

The world economy is in the midst of a gentle upswing, an upswing that should help the rest of the world perhaps more than it helps the US. Central Banks in Europe and Japan are unlikely to begin pulling back on their monetary accommodation, unlike the US where the Fed is well on its way to try and normalize financial conditions. Emerging markets should be beneficiaries of this global environment, free from worries about excessive dollar strength or a strong US equity market that sucks capital in from the rest of the world.


Europe is front and center given its electoral calendar in general and this weekend’s French elections in particular. Given the two round nature of French elections the final outcome wont be known till early May but investors, who shunned European equity last year (record outflows) seem quite sanguine with recent equity inflows the best in over a year, the Euro solid as a rock and sovereign rates quite stable.

Should France fail to elect either National Front leader Le Pen or Communist Party stalwart Melenchon, the outlook for European financial assets would seem quite bright. Election concerns center around an expected low turnout and a high number of undecided, both of which were hallmarks of Brexit/Trump upsets. On the plus side the latest polls suggest En Marche! leader Macron is pulling away from Le Pen whose support peaked a month ago, suggesting a final run off between the two. Should le Pen and Melenchon make the run off the market reaction will be ugly.

Beyond the French election things seem to be getting better in Europe. Economic activity is better than in the US with private sector activity at six-year highs. Inflation seems a bit more entrenched (a good thing), the Euro is reasonably valued (and supported by record current account surpluses) and rates have room to rise. Unlike the Federal Reserve, the ECB has no plans to unwind its monetary stimulus and there is no sense of more onerous bank regulation.

I continue to feel Brexit and Trumpian rhetoric will serve to unite Europe and bring it closer together. (See Trump, Trade & the Markets, Feb. 2017) Being forced to contemplate a future without the UK and perhaps without the US standing shoulder to shoulder will tend to have that effect. Amidst all the negative press, public support for the Euro is at all time highs and Macron among others in Europe are now campaigning in full-throated support for the EU.

It’s worth considering whether Europe might not be entering some very good years as political risk fades, growth recovers, efforts to deepen integration bear fruit and political risk shifts elsewhere. A quite contrarian point of view but one well worth considering.


The Trump Admin’s unprecedented ability to shift points of view has been on vivid display in regards to Asia. From promising to label China a currency manipulator to then saying the USD was too strong and from recommending that the US stay away from the North Korean issue to threatening to send a mighty Armanda, Asia has been front and center of the Trump Admin efforts to recalibrate.

Yet, the Trump – Xi summit accomplished little on the surface and time will tell if more was achieved, especially in the context of North Korea. In the case of Asia writ large, President Trump’s decision to pull out of Trans Pacific Partnership (TPP) talks would seem to give China the green light to lead Asian integration. While Japan, South Korea and India will all seek to have a say in how Asia is put together it seems clear from this armchair that China has the inside edge.

Japan is growing above potential while signs of reflation take hold with even core CPI showing year over year gains. Trade gains suggest Japan is enjoying its usual position as a global growth winner with export volumes running in high single digits. Unemployment is at record lows and like the ECB, the BOJ has no plans to end its monetary support of the economy.

In the Americas the economic opportunity and strategic imperative of building deeper relations between the NAFTA countries and South – Central America awaits US leadership. Mexico has been one of the world’s best stock markets in Q1 while auto production soars and domestic demand grows. Mexico’s ability to jump start domestic consumption would be a real shift in its growth profile and one that would hedge against US trade risk. The country is already looking to Brazil and Argentina in regards to food imports, an example of how the US does not hold all the cards in these potential trade disputes.


I think there is a very good chance that US equity will underperform the rest of the world in 2017. Absent a sharp fall in US stocks the developed markets of Europe and Japan have room to run on earnings growth, valuation and ownership grounds. EM equity, where allocations have surged to 5-year highs, is more case-by-case in my point of view. It is too early to say we are off to a multi year period of US equity underperformance but I am leaning in that direction. Tactically underweighting US equity makes sense while preparing the long-term strategic underweight case.

The US equity market is priced not for the status quo ante but rather a US economy boosted onto a higher growth path by what I have termed a “fiscal – monetary policy joint venture” that supports a mid teens earnings rebound and a Shiller CAPE PE of 30x. Failure to implement policy that helps the US reach that new growth path implies a downward repricing to rebalance the equity market for an economy & earnings that grow more in line with the past few years. At the moment US equity is being supported by a robust Q1 earnings season… what comes next remains to be seen

Europe, on the other hand, is growing faster than the US, with earnings growth running roughly double that of the US and valuations that in Shiller Cape terms are roughly 50% that of the US. Double the earnings growth for half the price – now that’s a statement an investor can get behind!

Of course there is the political risk, but it is not a surprise; if anything it runs the risks of being overanalyzed to death. That not to say a negative surprise cannot happen but rather that many have decided to stay out until there is more clarity and once that clarity is there, especially if there is no political upset (represented by a Le Pen – Melenchon runoff), then higher prices and perhaps significantly higher prices will prevail.

I continue to like Europe in three ways; broadly from the regional context, country specific where Spain is my preferred option as a housing recovery (one of the world’s best real estate markets in 2016 with much the same expected this year) should help the banks which in turn make up a good slice of the index and sectorally, with EU banks being one of my Top 5 Trades for 2017. (See 2017 Outlook: America First? Dec. 2016)

Japan may represent the most interesting opportunity at the moment. The stock market has been weak, notwithstanding earnings expectations in the mid teens coupled with rising revisions as the domestic economy does better than expected, the global economy picks up and the BOJ continues to hold rates down. The Abe Govt continues to push labor and productivity reforms, which if implemented should be quite constructive.  Should concerns over Europe and North Korea abate, one could expect to see a weaker yen and hence hedged equity remains the preferred vehicle here.

Broad emerging markets have done better than expected and may also be on the cusp of a longer-term rebound. If so, it could be the markets segment that helps lock in US underperformance in the years ahead and thus bears careful watching. Specific country selection is warranted today; one can consider countries such as Mexico (another top 5 trade) and China where better growth, some inflation and the continued need for domestic investment opportunities suggest that a stock market down close to 50% from its recent high is well worth a look.

On the fixed income side interest remains in financial preferreds and high yield in the US as well as EM USD debt. The search for yield continues; unlike in the equity space the best opportunities reside in the US or in USD. Gold remains favored in the commodity space; recent weakness in industrial metals suggest that the low growth, low rate world may yet remain.


Here’s How Trump Can Win At Trade...Embrace the Tri Polar World

As President Trump contemplates a new trade order, one that puts America first, he may be surprised to find he is pushing on an open door. From both a top down geo- economic level as well as bottoms up corporate level, 21st Century trade is in urgent need of a new vision.

One vision the President may wish to consider is what I have termed the Tri Polar World (TPW) global growth model. This model argues that regional deepening in the three main regions of the Americas, Asia and Europe could become the world’s next growth catalyst.

Globalization as we know it is dead in the water while policies of economic nationalism risk trade conflict across the globe.  Given a fragile global economy coupled with a broad and massive debt overhang, trade conflict is arguably the last thing the world needs. Regional deepening on the other hand has the potential to harness the tailwinds of technology & consumer demand to drive the global economy forward.

Similar to most new orders the TPW arises out of the ashes of its predecessor, the Washington Consensus, itself a victim of the Great Financial Crisis (GFC) of 2008. One reason for the world’s current growth malaise is that the GFC upended not only the US debt financed consumption model but also Europe’s vendor financing model and the emerging market’s export to the West model.

Thus globalization has been in retreat since 2008, as the financial sector, the tip of the globalization spear, was rolled back while global trade growth rates became so anemic as to fall below already unsatisfactory global GDP growth rates. At the corporate level, outdated concepts such as outsourcing and offshoring have been replaced by onshoring and supply chain reshaping to service the last mile. 

Today, each main region has the potential to deepen its integration & thus stimulate growth via three new and mutually reinforcing factors: the ability to self finance through growing wealth pools and deeper capital markets; the ability to self produce through the rise of advanced manufacturing, automation and robotics (albeit with worrisome job implications) and the capacity to self consume through urbanization, the service economy and the relentless rise of e commerce.

Each region has approached this new world differently, providing an opening for Presidential leadership. Asia, led by China, has been the proactive region, as demonstrated by the creation of the Asia Infrastructure Investment Bank, China’s launch of its One Belt, One Road project (designed to reposition and repurpose China’s infrastructure capacity), and most recently the opportunity to develop pan Asian trade pacts aided by President Trump’s decision to withdraw the US from the Trans Pacific Partnership (TPP).

Europe, beset by a series of rolling financial, economic and political crises, has been the reactive region, focused on trying to keep its union intact. It’s an open question as to whether the combination of Brexit and President Trump will reenergize the European project or cause its demise. Ongoing projects such as the Capital Markets Union and Digital Single Market suggest opportunity; multiple elections this year pose risk.


That leaves the Americas or the inactive region. The Americas, which arguably introduced the concept of regional deepening with the North American Free Trade Agreement (NAFTA), has failed to make any progress since.

President Trump, in upcoming talks with his fellow NAFTA leaders, has a tremendous opportunity to lead with this new trade vision and not only update NAFTA but extend it further southward, bringing into the regional fold South and Central America. Focusing southward as opposed to across the Atlantic or the Pacific would deepen economic relations with 20 + countries and roughly 500 million people whose political systems are more open to closer engagement with the US than at any point in the past several decades.

Such a vision would leverage NAFTA rather than eliminate it, demonstrate a strategic vision beyond the art of the deal and lead the way to a new cycle of US, regional and global growth. Technology is bringing the world closer together, replacing the 1980s-1990s cheap labor & global supply chain focus with that of 21st Century customer fulfillment, last mile logistics and regional integration. President Trump has a unique opportunity to Go Big AND Go Home. He should seize it.

Trump, Trade & the Markets

President Trump’s first weeks in office have certainly been busy. The challenge for financial markets is that very little of that business has been about moving the economy forward. Arguably much of what has been floated or discussed could be negative for the global economy, especially around the trade issue, which provides promise and peril for both President Trump and the markets.

President Trump’s early focus on action by executive order has resulted in something akin to a continuation of his campaign. It is a clear-cut case of making good on his campaign pledges to the extent possible by executive order alone (many will be litigated in the courts or reshaped in the legislative process). Clearly though his political “base” is pleased to see action being taken on campaign promises.

So good politics, at least good “base” politics but what about the costs of such an approach? Well the costs are not insignificant. They include the elimination of the traditional Presidential honeymoon where the first 100 days are meant to be about not only setting the policy stage but also exploring ways to work with the other side, the members of the losing party. There has been very little of this in the Trump administration from the Inauguration onward.

Kicking off the first 100 days with the obligatory repeal of Obama care and the naming of a Supreme Court nominee suggests playing to the base may take precedence over building up the economy. These issues almost ensure a long, drawn out and divisive legislative period, even before one brings into the mix tax reform, the budget deficit, fiscal stimulus, trade or infrastructure.

Yet financial markets have responded positively to date, seemingly unflustered by all the political volatility. How long can this continue is one of the big questions for investors to consider, as is the capacity for the Trump administration to move from politics to policy. Such a shift requires a fully fleshed out team, a strategy and a process to develop, shepherd and implement legislation, none of which is readily apparent.

So far patience has been a virtue; EM equity, thought to be squarely in the cross hairs of a protectionist, strong dollar US policy mix, leads global equities up 6% year to date.  Ten year UST yields, thought to be at risk to bond vigilante attack, are hovering around 2.40%, down sharply from post election highs while the USD itself is off close to 4% from its recent high. Markets would seem to be fading the Trump jobs promise.

Economic policy needs to be brought forward fairly soon however. Equities have risen post election not on the media created “Trump trade” but on the expectation that a Govt controlled by one party, namely the Republicans, would be able to get things done.  This meant in particular bringing fiscal policy to bear alongside monetary policy to boost the economy and create jobs. Failure to do so would suggest a fully valued stock market with forecast 2017 EPS growth of 15% is well ahead of itself, especially considering 2016 EPS growth is likely to come in around 5%. US equities are not priced for status quo ante but something much better.


There is no question (at least not from this armchair) that global trade policy needs refreshing. With finance (the tip of the globalization spear) in pullback mode since 2009 and global trade growth below that of (subpar) global GDP growth President Trump may find himself pushing on an open (trade) door. 

Regular readers know I have a dog in this fight, namely my Tri Polar World (TPW) global growth model which argues that the three main regions: Asia, Europe and the Americas can catalyze global growth by regional deepening. This regional integration is driven by three new and mutually reinforcing factors: each region’s ability to self finance through growing wealth pools, self produce through advanced manufacturing and self consume through urbanization and the rise of e commerce. (See Tri Polar World 2.0, published March 2015)

In each of the three main regions this perspective puts one at odds with current consensus. Currently, consensus thinking seems to hold that the US has all the cards in (possible) trade disputes with Mexico, Europe and China. There is a case to be made, however, that in fact the opposite is true, particularly for investors. Lets explore each region in turn beginning with the Americas where President Trump has made a point of questioning the future of NAFTA, the North American Free Trade Agreement.


Clearly there is room to update and enhance NAFTA. Both Mexico and Canada have signaled they are open to such an exercise. President Trump could lead an effort to not only enhance NAFTA but expand it further southward to include South and Central America. Laying out a vision of the Americas within a Tri Polar World would demonstrate presidential leadership, offer a way forward for the global economy and enhance regional deepening at a time when South America is more open to such an idea than at any point in the past several decades.

Eliminating NAFTA makes no sense at all given how intertwined the various regional supply chains have become over the past twenty years. Political integration within North Americas has stalled but corporate supply chain integration has expanded dramatically. As noted in my 2017 Outlook (See America First?, published December 2016) the idea that the US can go it alone is as outmoded as the idea that the way forward is to extend supply chains 3,000 miles. The future of globalization is regional integration.

There are growing signs that corporates recognize the need to consolidate and shrink supply chains. The corporate agenda has shifted from outsourcing in the 1990s to reshoring over the past half decade to a growing focus on reshaping supply chains. Today's corporate challenge is to satisfy a consumer who expects to see something they fancy, order it off their phone and have it delivered by the end of the day. Satisfying that demand mitigates against the global supply chain and instead supports a thesis of regional supply chain integration. President Trump is an accelerator of such corporate strategy.


Conventional wisdom towards Europe suggests all is lost and it’s only a matter of time before the EU disintegrates. I disagree and believe that the combination of Brexit and Trumpian rhetoric could lead the EU to greater integration. Think of what occurs when one stares into the abyss and contemplates a future never expected; it concentrates the mind. Europe, in staring into a non US abyss, could conclude that what it has is worth fighting for. In other words, rather than simply giving in to the forces of disintegration, Europe could well embrace what it has and seek deeper regional integration.

Europe’s corporate structure also seems ahead of its political class. There are reports on almost a daily basis of media companies seeking to build out “pan European” brands and structures while fintech companies seek to obliterate domestic boundaries. The Internet of Things (IoT) could prove to be Europe’s tech Renaissance. Should Europe be able to implement the Digital Single Market or the Capital Market Union the repricing to be had would be wild!

This perspective suggests markets are PAST peak EU and Euro bearishness. Yes there are important upcoming elections in France, Holland and Germany and yes the Fillon affair has thrown French politics into a tizzy & bond spreads have widened as a result. However, there is also the reality of better growth than the US, the lowest unemployment rate since the crisis, easier & growing credit, a cheap currency, manufacturing PMIs at a 6 year high & continued ECB monetary accommodation to consider.


President Trump’s decision to pull the US out of the Trans Pacific Partnership (TPP) would seem to clear the way for China to lead Asian regional integration. One can expect China to try and further stitch up the region via trade pacts following in the footsteps of its One Belt & Suspenders regional infrastructure push.

However, there also seems to be a growing risk of a trade fight between China and the US with most commentators feeling as if the US holds the trump cards (no pun intended). Given that China is one of the biggest creditors to the US, one wonders why this point of view is so widely held. Perhaps it’s the old cliché about if one owes the bank a $100 its one’s problem but if one owes the bank a million dollars it’s the bank’s problem, just writ large to national scale.

China however is unlikely to make the same strategic mistake it made in 2008-9 when instead of blaming the West and the Great Financial Crisis (GFC) for its need to rebalance its economy, it doubled down on stimulus with the result that today it has a significant (and very well known) debt problem.

Instead it would seem quite possible that should the US label China a currency manipulator that China could use this pressure to first, blame the US for the need to reset its growth profile, second, let its currency float to a much lower level, say 8 to the dollar and third, decide to sell a chunk of its UST position.  The combined effects of which would likely include a stronger USD and higher US rates leading to a weaker US stock market and softening US economy. 

The idea that the US holds all the cards in potential trade conflicts with its erstwhile partners is an area where the gap between reality and fiction seems to be at its widest.


What does all this mean for one’s investment portfolio? It suggests that the better risk adjusted opportunities lie outside the US, especially in the equity space. Dollar strength is overdone, especially against the Euro while EM equity is at risk to policy movement in the US.

The best area of opportunity remains the Developed Markets (DM) ex US, namely in Europe and Japan. Global growth is picking up, led by the DM economies. European banks remain very much of interest given faster economic growth, expanding credit and loan growth and rising rates. The sector remains cheap, underowned and underappreciated. More broadly, Europe’s Q4 earnings season has been the best in several years and earnings revisions are moving higher.  EU equity funds had record outflows last year; 2017 could see the reverse. Yes, political risk exists in Europe as it does elsewhere but it seems in the price, absent a Le Pen victory in France. Pullbacks should be bought.

Japan remains of interest given the view that 2017 will bring the return of inflation. Corporate restructuring, improved governance, rising EPS forecasts and the potential for a weaker yen are all supportive, especially on a currency-hedged basis.

In the EM space, Mexico remains a preferred option with an attractive risk reward profile. The very solid response by both the peso and equities to President Pena Nieto’s decision to cancel his meeting with President Trump suggests an awful lot is priced in. In fact the peso is trading stronger than the immediate post election price.

Chinese equities are worth a look as well. Stability is the focus in the run up to the Fall Party Congress while a growing crackdown on capital flight suggests that money will stay in country. Given the property run up and commodity price boom of the past 18 months or so, equities, still 50% or so off the 2015 high, would seem to be of interest. A trade conflict with the US that included devaluation as a choice could send Chinese stocks soaring.

Beyond trade, the 2017 outlook noted above outlined three possible policy paths for the US: Full Bore Trump, Unmoored Trump and a narrow policy path to success. Full Bore Trump which implies aggressive fiscal stimulus and Buy American infrastructure efforts that would spark inflation & the return of the bond vigilantes seems increasingly unlikely. Odds of an Unmoored Trump path, where the first 100 days passes with limited activity on the economic front leading to markets recalibrating their economic and earnings growth expectations, seems like a rising possibility. The narrow policy path to success, which implies a well-developed process to guide legislation and drive its implementation, seems less likely today than a month ago. All of which suggests the gap between political volatility and stock market volatility is likely to be closed at some point. Stay focused my friends!