The global bull is set to continue, but a new chapter may have started yesterday.

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thomas look

Jerome Powell did not pull the night down on Wall Street

Jerome Powell refrained from doing it again. What? Pulling the night down on the Wall Street bull. Unlike in 2022, his Jackson Hole speech did not trigger a sharp sell-off. Two years ago, he indicated that tough times, pain, and a few rate hikes may lie ahead. This year, he confirmed that the inflation mission has been accomplished.

From now on, employment will become the more critical part of the dual FED mandate. The FED chair emphasized that the FED would stay data-dependent (not single data point-dependent). But he did not hedge and made the regime change crystal clear.

The FED has now moved from a restrictive policy stance to a (much) loser one and from a hiking cycle to a declining cycle. Central banks worldwide have embarked on a globally synchronized easing cycle, supplying the markets with more liquidity than in the months before. My preferred scenario is 8 consecutive rate cuts of a quarter point each during each of the next eight meetings.

Never fight the FED. Never fight the FED when the Fed is in synch with its brothers, sisters, and cousins from around the developed world. And never fight when liquidity is plentiful. Unless there is clear evidence that we are heading towards a recession, and this evidence has not been there so far, a soft landing is my preferred scenario.

The situation for the global stock markets has become much more positive since yesterday. Why? The global central banks will probably avoid policy mistakes (too late at the pivot point) triggering credit crises that have caused or exacerbated recessions in past times.

Jerome Powell likes to reproduce the soft landing from 1995 and 1996, which gave way to a vast Internet bull. The "I may become Arthur Burns II if I am not tough on inflation" fear has melted away and been replaced by the fear of being "too late again."

What is ahead?

Wall Street was amused. So was the Crypto space. Real Estate and Financials were the leading sectors. The R2K outperformed all other indices. Next week, we will see whether the JP lowering rates bull has legs.

Nvidia's earnings on August 28 may be the catalyst to move the market up or down. Hardlanders will not give up that easily. The "inflation is sticky" camp has also not thrown in the towel. And the Federal Open Mouth Committee members are always good for some disturbances.

The mainstream long-term investment thesis on Wall Street is similar to this. This is the Blackrock one (Wei Li post on LinkedIn).

1/ Expansionary fiscal spending and more transition-related spending could push up the real neutral rate.

2/ Structural constraints such as labor shortage could push up long-run inflation.

3/ Offsetting upward pressures, trend GROWTH is likely a bit weaker than pre-pandemic.

The result would be below-average growth, much higher government debt, higher inflation than during the pre-Covid era, and persistently higher interest rates.

I think this view is flawed as the central banks would do everything they can in a low growth scenario to lower rates as much as possible, even tolerating some level of inflation.

As higher debt is a global phenomenon (Europe, the US, Japan, etc.) and nothing specific to the US, investors (bond vigilantes) would need to accept this fact. They may complain, but there is virtually no alternative in the fixed-income sector.

If growth stays below the trend for quite some time (say between 1 and 2 percent), we will even see a return to the low rates of the ZIRP era. For rates to stay higher for long in such a deficient growth environment, something external would need to prevent the central banks from lowering rates. For the US, this could be a low demand from bond buyers at meager rates.

As a share of federal revenues, federal interest payments in the US are projected to rise to 20.3 percent by 2025, exceeding the previous high of 18.4 percent set in 1991. CBO projects that interest costs in 2024 will total $892 billion — a jump of 36 percent from the previous year and following increases of 35 and 38 percent in each of the two years before that.

Some of the developed, mature, aging, and tired countries of the Western world would not be able to pay higher rates for their sovereign debt in an extended low-growth/recessionary environment with less tax income for a longer period of time without facing severe structural problems.

They would have to adopt more drastic measures such as inflating some debt away, repudiating some of the public debt, a kind of haircut (see the Cyprus example during the GFC), or a measure similar to the German Lastenausgleich (after WW II).

In its October 2013 Fiscal Monitor Report, titled “Taxing Times,” the IMF already proposed a ‘one-off capital tax’ of 10% as a possible option for reducing the high sovereign debts in the eurozone countries.

“The sharp deterioration of the public finances in many countries has revived interest in a “capital levy”— a one-off tax on private wealth—as an exceptional measure to restore debt sustainability. The appeal is that such a tax, if it is implemented before avoidance is possible and there is a belief that it will never be repeated, does not distort behavior (and may be seen by some as fair). … The conditions for success are strong, but also need to be weighed against the risks of the alternatives, which include repudiating public debt or inflating it away. … The tax rates needed to bring down public debt to precrisis levels, moreover, are sizable: reducing debt ratios to end-2007 levels would require (for a sample of 15 euro area countries) a tax rate of about 10 percent on households with positive net wealth. (page 49)”

The post-WW II situation as a comparison

I like to compare today's situation with the 1940s and 1950s (the idea is from Jurien Timmer from Fidelity). After World War II, the global economic picture was as distorted as it was after Covid. The result was rising inflation after the war for some time (for a couple of reasons, among them supply chain issues) and a stock market sell-off from 1946 until 1948.

Here are the yearly price changes (excluding dividends) of the S&P 500 from 1945 to 1948:

1945: 30.72%

1946: -11.87%

1947: 0.00%

1948: -0.65%

The distortion period after WW II was from 1946 until 1948. Things normalized quickly and gave way to the 1950s bull market. The annual price changes in the SP 500 from 1949 until 1959 were above average.

1949: 10.26%

1950: 21.78%

1951: 16.46%

1952: 11.78%

1953: -6.62%

1954: 45.02%

1955: 26.40%

1956: 2.62%

1957: -14.31%

1958: 38.06%

1959: 8.48%

I expect a similar outcome to happen now. Why? There are some notable parallels between the post-World War II period of 1946-1948 and recent supply chain disruptions and inflation:

1. Rapid inflation: In 1947, inflation jumped to over 20% in the United States. This was one of the six periods since World War II where inflation (as measured by CPI) was 5% or higher.
2. Supply shortages: The post-war inflationary episode was partly caused by supply shortages, the elimination of price controls, and pent-up demand.
3. Disrupted supply chains: World War II significantly disrupted the global economy and supply chains and took time to recover in the immediate post-war years.
4. Pent-up consumer demand: There was a surge in consumer demand after the war as spending that had been suppressed during wartime was released.
5. Transitory nature: The inflationary pressures of this period were transitory. Economic forecasters at the time rightfully expected low or even negative inflation (except for the spike in inflation due to the Korean War period) for the following years.
6. Quick decline: The post-WWII inflationary period suggests that inflation could quickly decline once supply chains are fully online and pent-up demand levels off

And the 1995 soft landing?

There are also similarities to the period from 1995 until 2000 to today, particularly regarding the advent of the internet then and AI/GenAI now:

1. Technological revolution: 1995-2000: The internet was becoming mainstream, changing how information was accessed and utilized. Today: AI, particularly generative AI, is seen as a transformative technology with wide-ranging implications across industries.
2. Market sentiment: Both periods are characterized by strong bullish sentiment, with investors excited about the potential of new technologies. Bank of America analysts suggest that current market sentiment is closer to 1995 than the peak of the dot-com bubble in 1999-2000.
3. Focus on specific sectors: 1995-2000: Internet and tech stocks were the primary beneficiaries. Today: AI-related stocks, particularly in the semiconductor and Mag-7 sectors, are seeing significant gains.
4. Productivity expectations: Both eras are associated with expectations of significant productivity gains from the new technologies. Goldman Sachs forecasts widespread AI adoption could boost productivity growth by 1.5% and add $7 trillion to the global economy.
5. Market leadership: Both periods feature relatively narrow market leadership, with a few tech-focused companies driving significant market gains.
6. Valuation concerns: In both eras, there are debates about whether stock valuations, particularly in the tech sector, are justified by fundamentals or represent a potential bubble.
7. Investor behavior: Both periods see increased retail investor participation in the stock market, driven by excitement about new technologies.
8. Economic backdrop: Both eras feature relatively strong economic conditions, low unemployment, and discussions about potential interest rate cuts by the Federal Reserve.

However, there are also some key differences:

1. Market maturity: Today's tech giants are more established and profitable than many speculative internet companies in the late 1990s.
2. The breadth of impact: AI is expected to have a broader impact across industries than the internet in its early days.
3. Global context: The current era features a more complex geopolitical landscape and concerns about deglobalization.
4. Regulatory environment: There's more awareness and discussion about potential regulation of new technologies today compared to the 1990s.

While there are striking similarities between the two periods, particularly regarding technological excitement and market sentiment, the current AI boom is occurring in a more mature and complex market environment compared to the internet boom of the late 1990s.

The state of global stock markets

I expect the global stock markets to be higher than today at the end of the year. I am still unsure about the seasonally weak period until October, but as I will show in the chart at the bottom of the post, trying to time the market has never been a good idea for long-term investors.

While the bull channel trend formed in autumn 2023 did break, the long-term upward channel in place since autumn 2022 was not validated and kept moving higher.

The short-term downward trend formed since the end of July has broken to the upside and is confirmed by a weekly ATH close in the Dow Jones Global index!

In my opinion, the bull has at least one more substantial leg to go before we may see a recession in the US in 2025 and a more prolonged correction.

The rise of Southeast Asia

Lower global rates have historically been very good for emerging markets - unless accompanied by severe recessions. I particularly like Southeast Asia and the middle-class build-up in India and the ASEAN countries (plus Vietnam).

A good example is Malaysia. The local stock market has already performed nicely in the past months.

I will continue underinvesting in Europe in my global ETF-based asset allocation and overweight positions in Asia and the US.

Bottomline - Positioning for 2024 and 2025

Despite potentially favorable tailwinds, I do not see any all-clear signs for emerging markets. I prefer to stay selective - country-wise and ETF-wise.

I sold the cash position on Friday and bought two ETFs during the week. Position one is the GX FTSE Southeast Asia ETF (ASEA), and position two is the India Consumer Egshares ETF (INCO).

GX FTSE Southeast Asia ETF (ASEA)

The Global X FTSE Southeast Asia ETF seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of the FTSE/ASEAN 40 Index.

The ETF tracks the FTSE/ASEAN 40 Index, which consists of the 40 largest and most liquid companies from five ASEAN countries: Singapore, Malaysia, Indonesia, Thailand, and the Philippines. The top 5 holdings are (latest available information):

1. DBS Group Holdings Ltd (11.81%)
2. Oversea-Chinese Banking Corp Ltd (8.28%)
3. PT Bank Central Asia Tbk (7.91%)
4. United Overseas Bank Ltd (6.12%)
5. PT Bank Rakyat Indonesia (4.87%)

Country Allocation (latest available information):

1. Singapore: 38.8%
2. Indonesia: 22.6%
3. Thailand: 18.6%
4. Malaysia: 16.3%
5. Philippines: 3.7%

Sector Weights:

1. Financial Services is the dominant sector in the ETF. The top 5 holdings are all financial institutions, and they account for close to 40 % of the fund's assets.
2. Other sectors represented in the fund include Communication Services, Consumer Defensive, Energy, Industrial, Real Estate, and Utilities.

Lower global rates, accelerating growth, and the build-up of the middle class should do well for the financial sector in the ASEAN countries.

India Consumer Egshares ETF (INCO)

The Columbia India Consumer ETF seeks investment results that correspond (before fees and expenses) to the price and yield performance of the Indxx India Consumer Index.

1. Description: The Indxx India Consumer Index is a maximum 30-stock free-float adjusted market capitalization-weighted index designed to measure the market performance of companies in the consumer sector of India.
2. Composition: The index consists of common stocks listed on India's National Stock Exchange and Bombay Stock Exchange.
3. Focus: It specifically targets companies in the consumer industry in India.
4. Methodology: Free-float adjusted market capitalization-weighted, Maximum of 30 stocks defined by Indxx's proprietary methodology
5. ETF Details (for INCO, which tracks this index): Invests at least 80% of its net assets in Indian consumer companies included in the index. It aims to be substantially invested with at least 95% of its net assets in these securities. Classified as non-diversified
6. Sector Focus: The index and related ETF provide exposure to companies involved in the consumer sector in India, which may include both consumer discretionary and consumer staples businesses.

Strengthening the consumer is the prime goal of the Modi government. I expect the positive performance of the ETF to continue.

The Global ETF Portfolio

The ETF portfolio performed nicely in the past week—the value appreciated by about 2 percent. I am applying a long-only strategy with a covered call writing strategy overlay.

The China ETF was the only ETF in the red. Bitcoin, US homebuilders, and Russel Midcap were the best performers.

I prefer staying fully invested and hedging via selling calls or other strategies using derivatives instead of trying to time the market.

Why? The chart below shows the devastating effects of missing the market?s best days. It uses the SP 500 as an example.

The Devastating Effect of Missing the Market's Best Days

The 25-year period between August 1999 and July 2024 consisted of roughly 6,200 trading days. Being uninvested for the best ten days of that stretch would have significantly diminished long-term total returns.

Using an all-stock S&P 500 portfolio as an example, moving to cash for each of the ten best days in those 25 years would have resulted in an annualized total return of 3.31 points lower versus simply remaining invested in the market.

In terms of dollar amounts, a $100,000 portfolio that missed the ten best days since August 1999 would be worth less than half of one that remained fully invested through July 2024. Notably, missing the best 40 or more days in the last 25 years has resulted in a negative return.