Note Précis Sep. 3 2024: Momentum Dominance and Valuation Agnosticism To Fade.

Note Précis Sep. 3  2024: Momentum Dominance and Valuation Agnosticism To Fade. Capital Markets are likely to reprioritize their issues. Our contribution lies in curating to balance, not to pretend to be the savviest economist or the sharpest trader or political wonk. Markets are likely processing exit from momentum dominance and valuation agnosticism. In signaling room for Fed Funds rate cuts at Jackson Hole, globally more central bank convergence appears. Policy dispersion appeared in the summer of 2024. The pace of change remains to be determined. Emphasizing data dependence does still mark evolution away from mass largesse to instead, slow and steady.

Currency risk has been considered a peripheral issue but is likely to build in the transition from quantitative to data dependence by central banks. It was already seen in the so-called Yen carry trade. Markets appear still reflecting penchant for rate relief. Until risk premiums are reestablished, we expect market volatility.

Give-or-take potential 3% annual global GDP growth, domestic and global politics are of more importance than markets have so far accorded. Of impact to revenues, logistics and energy are widening wars in eastern Europe, in west Asia and increased confrontation across Asia/Pacific. Amid populace angst, from elections in democracies to authoritarian regime releases, from Asia to Europe, what has emerged are weakened governments and cohesion.

Stark policy friction appears ahead of the November 2024 U.S. election and the same later for Canada. Often, that which seems locally logical instead exposes systemic risk. Into 2008, it was lack of understanding of consequences even among central banks about credit risk, especially in real estate. In the 1950s, excess meddling  in the Middle East led to regime overthrows with decades long global systemic consequences especially for energy. In the first half of the 20^th century, parochial euphoria led to two world wars. All could have benefited from dispassionate risk assessment.

With genesis in engineering operations research, business models are extremely useful in developing parameters not exactitudes. Earlier, we learnt by building industry/company models for many industry analysts. Inadvertent model builder bias is a risk. In reality, changed consumer behavior often intervenes. We see markets as excessively focused on central banks. The current euphoria over artificial intelligence as cure requires discrimination into revenue utility –  beyond the dulling sameness in machine rote learning being marketed as unique for instance in writings.

Political turmoil has expanded into tariffs between China and the G-7, individually and collectively. Elections worldwide and events within authoritarian areas amply demonstrate popular discontent that is seated in the cost of daily life and not just the precision of the last inflation report so favored by momentum markets. These facets are understood by central banks in being data not money supply driven. Institutions like the BIS, IMF, OECD and, for the U.S., CBO have all so warned. Fiscal matters globally have an inevitability of tax increases. Its distribution is now under political jousting, including but not exclusively in the U.S.. More strife including on policy is likely irrespective of the winning political party.

The summer of 2024 showed change, irrespective of its veneer of momentum. The Federal Reserve remains a rarity in not reporting to government but instead to the legislature. In the currency markets, as dispersion in G-7 central bank policy built up so did volatility in U.S. dollar exchange rates. Saliently, stances based on a so called Yen carry trade tottered. They had structured leverage on borrowing in minuscule Japanese rates. With only a nominal 25-50 basis point rate increase, the Bank of Japan had tried to start to normality. It reminds of years ago when eastern Europe real estate purchase rose based on perceived cheap Swiss Franc financing. Currency risk has been considered a peripheral issue in this cycle. Currency and leverage risk are likely  for countries and companies in the transition from quantitative to data dependence by central banks.

Heightened volatility is likely to gush in a liquidity effect in currency a canary but also in fixed income, equities and commodities. Still nascent risk premiums are likely to expand. Into July 2024, concern built up. Then as potential for Fed Funds rate cuts developed, complacency has resurfaced in both junk bond yields close to 12 month lows and elevated equity valuation. Conceded or not, massive quantitative ease has left its mark globally on affordability and hence consumer angst.  Markets still have to work it through.

Recent revenue releases in corporate discussion pieces indicate corporate concern. Even in the luxury space, companies report changed consumer behavior. A surprise has been muted reaction so far on risk premiums across segments not just in tree top multiples in some equities, notably within Information Technology. Information Technology has a Darwinian past arguably with a half life of 18 months before sharp competition flares. More broadly, our expectation for sustainability for S&P 500 annual earnings growth lies in the 5-10% range while consensus seems having incorporated 10-15% earnings growth and valuation multiple expansion. Amid a quality and balance sheet focus, sector issues are likely supersede geographical tilts.

We would urge diversification to exit both momentum dominance and exit valuation agnosticism. We favor above bench mark cash and precious metal exposure in asset mix. With credit risk in junk and duration risk in long dated fixed income, we favor short/medium duration and quality. In equities, we expect more focus on quality of operations and delivery. It would mean valuation contraction and less momentum. For diversification, we have capped Information Technology at 25% to make room for Healthcare and select Consumer Staples. War, changed transportation logistics and global competition including tariffs favor, in the cyclicals, Industrials, Energy and Materials over Consumer Discretionary. Rather than Utilities, we see early and decisive restructuring Financials as mission critical. E.o.e.