The FED's Playbook: Don't Fight It Unless You Have a Plan!

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Don't fight the FED unless

Chinese stocks experienced a significant surge of more than 6% from the lows of 18 September, propelled by a series of easing measures implemented by the People's Bank of China (PBOC). The central bank's actions included reducing bank reserve requirements, cutting interest rates, and offering leverage to brokers for stock purchases. While these measures have been met with enthusiasm in the markets, using government funds to support stock prices raises questions about the underlying economic conditions.

The timing of these actions is strategically aligned with the Federal Reserve's recent 50 basis point rate cut. This move by the Fed has provided the Chinese government with increased flexibility to ease its monetary policy without risking significant currency depreciation.

Global Implications

The effects of China's stimulus are not confined to its domestic markets:

Currency Impact: The offshore yuan reached a 16-month high against the dollar, reflecting increased confidence in the Chinese economy.

Global Central Banks: Other central banks may follow suit, potentially leading to a wave of monetary easing globally.

Stock Market Performance: Global stock indices are already touching new record highs, with the MSCI world stocks index reaching a fresh peak.

Market Reactions

• The blue-chip CSI300 and Shanghai Composite indexes surged by more than 6%.
• Hong Kong's Hang Seng Index jumped more than 5% to a four-month high.
• European markets responded positively, with the pan-European STOXX 600 index rising 0.6%.

The global financial landscape appears poised for a period of increased monetary stimulus, even as stock markets reach unprecedented heights..

While these measures have provided an immediate boost to market sentiment, their long-term effectiveness in addressing underlying economic challenges remains to be seen.

US, Eurozone, and Southeast Asia - three different trajectories, three different opportunities

The economic trajectories of Southeast Asia (excluding Japan and China), the Eurozone, and the United States have been diverging in 2024 and are expected to continue on different paths in 2025. This divergence is characterized by varying growth rates, inflation trends, and policy responses across these regions.

Southeast Asia

Southeast Asia is poised for robust economic growth in 2024 and 2025, outpacing many other regions globally.

Growth Outlook:

• The region is forecast to grow by 4.6% in 2024 and 4.7% in 2025, up from 4.1% in 2023.
• This growth is driven by strong domestic demand, a continued recovery in tourism, and improving export prospects.

Key Drivers:

• Private consumption remains a significant growth engine, supported by stable prices and increasing tourism-related activities.
• Infrastructure spending in major economies is boosting investment demand.
• Manufacturing and exports are showing signs of recovery, particularly in electronics and semiconductors.

Country-Specific Trends:

• Indonesia is expected to maintain 5.0% growth in both 2024 and 2025.
• Vietnam, the Philippines, and Malaysia are projected to see growth rates between 4.5% and 6.2% in 2024-2025.
• Thailand's growth is forecasted at 2.6% in 2024 and 3.0% in 2025, supported by a turnaround in merchandise exports and tourism.

Eurozone

The Eurozone is experiencing a challenging economic environment, with slow growth and diminishing inflation concerns.

Growth Outlook:

• Economic growth in the Eurozone is expected to be modest compared to Southeast Asia and the US.
• Soft business activity reports have raised expectations for more rate cuts by the European Central Bank.

Challenges:

• The region faces headwinds from the lingering effects of the energy crisis.
• Manufacturing weakness and sluggish consumer spending are weighing on economic performance.

Germany - the sick man narrative is back

There are growing concerns about the German economy potentially facing a recession in 2025, with particular emphasis on challenges in the automotive industry.

Automotive Industry Challenges

1. Electric Vehicle Transition: German automakers need help to compete in the electric vehicle market, particularly against Chinese manufacturers.
2. Job Cuts: Major companies like Volkswagen are considering substantial job cuts and potential plant closures due to declining competitiveness and the need for cost savings.
3. Production Shifts: A trend of relocating production to lower-cost countries impacts domestic manufacturing.

Economic Indicators

Several economic indicators are pointing towards potential recession risks:

1. GDP Growth: The latest forecasts suggest meager growth in 2024 (0.1%), with only a modest improvement in 2025 (1.0-1.1%). However, these projections are being revised downwards.
2. Industrial Production: Manufacturing output has declined, with some energy-intensive sectors showing particular weakness.
3. Export Challenges: German exports face headwinds due to global economic slowdowns and increased competition.

Recession Risks for 2025

While official forecasts haven't explicitly predicted a recession for 2025, several factors are increasing this risk:

1. Structural Issues: Germany is grappling with cyclical and structural economic problems, including the transition to green energy and digital technologies.
2. Global Economic Factors: Weak demand from key markets like China and ongoing geopolitical tensions impact Germany's export-oriented economy.
3. Automotive Sector Woes: Given its significance, the automotive industry's struggles could have ripple effects throughout the economy.
4. Investment Decline: A noticeable decrease in Germany's domestic and foreign investment could further slow economic growth.

While a recession in 2025 isn't a certainty, combining these factors has led to increased pessimism among economists and business leaders.

1. The Ifo Institute lowered its growth forecasts in its Autumn 2024 outlook: For 2024, growth was revised to 0% (from 0.4% in the summer forecast). For 2025, growth was revised to 0.9% (from 1.5% in the summer forecast). The Ifo Institute describes the German economy as "stuck in crisis," citing both cyclical and structural factors negatively impacting growth.
2. The German Council of Economic Experts (GCEE) forecasts meager growth:0.2% for 20240.9% for 2025
3. KfW Research predicts slightly higher but still modest growth:0.3% for 20241.2% for 2025
4. The European Commission forecasts 0.1% growth for 2024 and 1.0% for 2025.

United States

The US economy is showing resilience but faces a complex economic landscape in 2024 and 2025.

Growth Outlook:

• The US economy continues to demonstrate strength, with the S&P 500 and Dow Jones Industrial Average reaching new closing peaks.

Monetary Policy:

• The Federal Reserve has initiated its easing cycle with a 50 basis point cut, signaling a shift towards a more accommodative policy.
• Markets are pricing in 76 basis points of easing for 2024, though some analysts believe this may be overestimating the Fed's capacity to ease policy.

Labor Market:

• The strength of the US jobs market remains a key factor in shaping economic expectations and policy decisions.

Divergence Factors

1. Growth Rates: Southeast Asia is expected to outpace both the Eurozone and the US in terms of GDP growth.
2. Inflation Dynamics: While inflation is easing in Southeast Asia, it remains a concern in the US, influencing monetary policy decisions.
3. Monetary Policy: The US has begun easing, Southeast Asian central banks are maintaining a cautious stance, while the ECB may need to consider further easing to support growth.
4. Economic Drivers: Southeast Asia benefits from strong domestic demand and recovering exports, while the Eurozone struggles with manufacturing weakness, and the US shows resilience despite tighter monetary conditions.
5. External Factors: Southeast Asia's growth is partly driven by "China + 1" supply chain shifts, while the Eurozone and US face different geopolitical and trade challenges.

Charting the Course: Three Economic Paths for the U.S. in 2025

Looking toward 2025, the U.S. economy stands at a crossroads with three potential trajectories. The consensus among economists and market analysts points to a soft landing—a scenario where economic growth slows to a sustainable pace, curbing inflation without triggering a recession.

Two minority perspectives present alternative futures: one envisions a reacceleration of growth mainly fueled by a manufacturing boom, while the other anticipates a looming recession driven by various economic headwinds.

Consensus Scenario: Soft Landing

Economic Overview: Gradual cooling of the economy leads to stable growth.

Key Drivers: Effective monetary policy, controlled inflation, and steady employment rates.

Implications on the Stock Market:

U.S. Stock Market in General: Expected to maintain steady bullish performance, with substantial gains as investor confidence remains solid amid a balanced economic environment.

Small and Mid-Cap Tech Stocks: This scenario could be highly bullish for small and mid-cap tech companies, especially high-growth, but currently slightly profitable/unprofitable. Firms adhering to the Rule of 40—where their revenue growth rate plus profit margin equals or exceeds 40%—may attract significant investor interest. As interest rates decline, capital costs decrease, leading to an expansion of valuation multiples. Investors may be willing to pay more for future earnings, boosting stock prices of companies with strong growth prospects.

Mag-7 Stocks: The leading tech giants—Microsoft, Apple, Alphabet (Google), Amazon, Nvidia, Tesla, and Meta Platforms (Facebook)—may continue to perform well but might not see the explosive growth of smaller tech firms. Their extensive market capitalizations and established positions could lead to steady but more modest gains. However, declining interest rates and stable economic conditions may still support strong performance, especially if these companies continue to innovate and expand into new markets.

Minority View 1: Reacceleration of Growth Sparked by Manufacturing

Economic Overview: A resurgence in manufacturing ignites robust economic growth.

Key Drivers: Technological innovation, reshoring of industries, increased global and domestic demand.

Implications on the Stock Market:

U.S. Stock Market in General: Likely to see solid gains, particularly in industrial and manufacturing stocks, which could drive broader market indices upward.

Hypergrowth Tech Stocks: Potential mixed outcomes. Tech companies supporting manufacturing—such as those in automation, artificial intelligence, and the Internet of Things—may benefit substantially. However, there could be a rotation of investment away from other high-growth tech areas toward manufacturing and industrial sectors.

Mag-7 Stocks: Companies like Nvidia and Tesla, which are deeply involved in manufacturing advancements, AI, and electric vehicles, could see substantial gains. Nvidia's role in providing GPUs for AI and Tesla's leadership in EVs and manufacturing technologies position them well in this scenario. Other Mag-7 companies may experience only moderate growth adapting to or capitalizing on the manufacturing boom through their products and services.

Minority View 2: Recession

Economic Overview: Economic indicators point downward, leading to a contraction.

Key Drivers: High debt levels, geopolitical tensions, market corrections.

Implications on the Stock Market:

U.S. Stock Market in General: Anticipated downturn with increased volatility. Broad market declines are likely as earnings shrink and investor sentiment turns cautious.

Hypergrowth Tech Stocks: May face sharper declines. Often priced on future growth expectations, these stocks could see very significant devaluations as investors flee to safer assets.

Mag-7 Stocks: The Mag-7 may experience significant volatility. Despite their strong fundamentals, these stocks have high valuations that can be sensitive to economic downturns. Investors might rotate from tech giants into more defensive sectors like utilities or consumer staples. However, their robust cash reserves and market dominance could help them weather the storm better than smaller competitors, potentially positioning them for strong rebounds post-recession.

Knowledge Corner

As of mid-September 2024, the S&P 500 forward earnings estimate shows continued strength. The forward estimate for earnings per share (EPS) has risen to $66.81, up from $64.03 in the previous quarter.

This represents a 4.34% quarter-over-quarter increase and a 15.58% year-over-year rise from the prior year's estimate of $57.80.

Additionally, the forward 4-quarter estimate is now at $260.60, continuing its upward trajectory for the fourth consecutive week, signaling optimism about earnings growth for 2024. The forward P/E ratio is currently at 20.75x, which is slightly elevated.

FOMC vs. R-star. "More members are now open to a rising R*, increasing the chance that the current easing campaign will end much earlier than pricing now implies."

The hypergrowth portfolio

The portfolio has performed very nicely since its start on 1 July 2024. It is up more than 10 percent and rose this week.

Samsara is up nearly 50 %, followed by MakeMyTrip, Zeta Global, and Crowdstrike, which are up more than 25 %. Nvidia and Microsoft are the positions that are slightly in the red.

I expect a return to the year's winners during my expected year-end rally. That said, I am prepared to buy the dip from the list of stocks I published last week.

I specifically like AI stocks that have moved considerably lower since summer and whose long-term stories are fully intact. On my shopping list are:

Semis: Nvidia, AMD, Taiwan Semi, Synopsys

AI beneficiaries: Vertiv, Microsoft, Oracle

AI and AI applications: ServiceNow, Apple

Housing/Real Estate/Credit: Zillow, Toll Brothers, Upstart, Redfin

Investment Managers: KKR, Apollo

Emerging Markets: MMYT, NU Holdings, Sea Limited,

Special AI Situations: Tempus AI, Zeta Global, Samsara

Crypto: Microstrategy,

Cloud: Datadog, Cloudflare, Monday.com

Consumer: Sprout Farmers Market, Walmart

Health Care: Vertex, Gilead, Eli Lilly

I started adding from the list buying initial positions in AMD, Taiwan Semi, Vertiv, and Sprout Farmers Market last week. I intend to add Nvidia; I plan to add from the industrial and industrial metals sectors (e.g., Copper).

Why? Copper vs. gold. "Historically, as shown in the chart below, key turning points in base metals began with a significant rise in gold prices. Copper prices are likely gearing for another significant catch-up move, in my opinion."

I also like the chart of the S&P GSCI Industrial Metals Index ($SGY). It looks bullish to me.

The TLT ETF, on the other hand, looks toppy to me. I see little upside from current levels.