Emerging Markets
Markets continue to be tossed to and fro by central-bank policy, and risks of higher commodity prices. These are due to fiscal stimulus and exogenous weather and war-related risk, which could send food and energy prices higher this winter. We remain long gold outright, energy and metals producers via the XOP, XME and PICK ETFs, direct commodity exposure via the COMT ETF, and futures exposure to backwardation in copper (long 4Q23 copper futures vs. short 4Q24 copper futures).
The recovery of China’s industrial profits is set to disappoint in 2H 2023. Corporate profits are more sensitive to changes in prices than volumes. Given producers’ selling prices will keep deflating through 2023, industrial profits will only stabilize at a very depressed level even with a mild improvement in volume. A disappointing recovery in industrial profits entails more downward risks for A-share prices in absolute terms. Chinese 10-year bond yields are set to drop to a record low.
The world economy is likely already in recession, defined as world growth dipping to sub-2 percent. So far, the world recession has been China-led, but in the coming months it will change to being developed economy-led. Hence, while metals and industrial commodities may get some brief respite, high yield credit and stocks will underperform government bonds. New tactical recommendations are to overweight French luxury goods versus US tech, and to overweight USD/COP.
We build a four-stage business cycle framework based on economic growth and capacity utilization, and then analyze historical returns for most major asset allocation decisions for each stage. Given that we are in the early recession stage (negative growth coupled and an overheated economy), our framework recommends a defensive positioning across all asset classes.
In Section I, we reiterate why a soft economic landing remains improbable in the US. Some reasonable estimates of the level of excess savings point to their depletion in a year’s time, but other estimates indicate a much earlier end point. We interpret this evidence, as well as other indicators, as pointing to an earlier rather than later US recession if the current stance of monetary policy is maintained or tightened further. In Section II, we provide an update on the US housing market. We acknowledge that permanent site residential structures investment may begin to contribute positively to US real GDP growth if the recent pickup in housing starts is sustained. But the recent housing market data is symptomatic of a negative housing supply shock that is far more consistent with the “no landing” economic scenario than the “soft landing” scenario that stocks are betting on. We continue to recommend that investors position their portfolios conservatively.