A TPDEARR Article
Trans-Pacific Dynamic Equity Allocation Research Report
Just like that, we’re already rounding out the first quarter of 2024. Time flies when you’re having fun… or getting old. And as investors and nation-states look around to gather their bearings, the two major global economic poles (US and PRC) flex their positions as mightily as they can, with the differences between them being very telling of their differing economic circumstances.
In Asia, March is usually the time when the PRC holds its 两会 (lianghui), or “Two Sessions” annual plenary combining the National People’s Conference (NPC), the world’s largest legislative body, with 2,977 members in 2023, and the Chinese People’s Political Consultative Conference (CPPCC), which holds a much broader representation of China’s leading business and party interests, and whose makeup fluctuates over time according to evolving strategic national priorities. The ten-day Two Sessions will indicate, both to domestic as well as international audiences, foci and expectations for the rest of the year, giving capitalists and industry players guidance as to where capital may flow more easily, and where it may stick, shrink, grow stagnant, and be otherwise unwieldy and unprofitable. Markets will always reorient to some degree upon learning of annual Two Sessions’ guidance as the PRC is the economic pole in the region (and the primary trading partner for virtually all Asian countries) around which all other economies must navigate. Blunt though it often is, the CCP has a reputation for economic action when it projects it will do so.
As it pertains to our macroeconomic focus for this TPDEARR issue, the subtext of the background situation in the PRC is undoubtedly the economically painful slowing of overall growth, and how the state can facilitate a fiscal and monetary environment conducive to continued growth while trying to compensate for a gradually shrinking population no longer propelled by demographic inflation, nor by the deliverance of cheap labor from rural areas to major manufacturing hubs, which themselves have been dislocating and moving abroad to cheaper (wage-based) areas. As we will discuss further below, China’s reputation is currently undergoing a shift, the complexity of which is compounded by the reality of the country’s reputation as being actually an interconnected series of reputations of hierarchically nested institutions and economic mechanisms, all under the umbrella of the CCP. In the US, by contrast, and despite what may seem like cataclysmic partisan political turmoil, the macroeconomic environment is going through much less of an evolution than across the Pacific. In fact, many suspect an easing of policy rates in the US in the coming weeks or months (and also in Japan and some other trans-Pacific economies, in a rare display of semi-unified optimism) which will bolster the perception of future profitability in equity markets. And unlike all other nation-states, the sheer volume of USD held and utilized around the world, in and of itself, IS a macroeconomic backstop for the US.
Capital flows around the world are constantly being guided and influenced by macroeconomic market forces, and in this MAR.24 TPDEARR issue we probe deeper into elements of reputation, the lowering of interest rates, and human expectations to better understand the opportunities available for profiting in the intermediate term across the trans-Pacific market economies.
Reputation
As investors, we would be wise to consider reputation closely, and not just the reputational perceptions afforded to prominent individuals (i.e., billionaires, CEOs, politicians, etc.) connected to companies we are tracking. The reputations of organizations themselves, such as central banks, political parties and governments, and also those of crowds of people, can have significant implications on markets and economies. Is there math to model all this? Some would claim so… but are you absolutely convinced arithmetic operations can helpfully encapsulate intangible human behavior, like thought and perception? Let’s consider some of the features of reputation as we swing around the macroeconomic conditions of the trans-Pacific.
Governmental reputation influences all policy applications, so it’s no secret that the orientation of all federal governments is paramount in interpreting policy, which indicate central government flows of funds. In the PRC, the CCP effectively is the modern government, its reach is limitless, and institutions around the country cannot be faithfully accepted as independent from the party’s meddling. Too many examples have been made out of too many bright minds to any longer believe that opposing the party/central government is in one’s best interest, less still that it will go unpunished. Because this reputation is continually strengthened by Xi Jinping’s recurrent “crackdowns” and all manner of CCP actions, investors and institutions routinely align themselves with companies benefitting from CCP policy directives, as opposed to aligning with “mold breakers”, unless the mold that they are breaking is something the West is leading in, then by all means. That having been said, the CCP also has a reputation for tipping the scales with heavy-handed state intervention of market activity, which non-state market participants are aware of, and reflect in their risk models and analysis. The CCP doesn’t manipulate markets every day, but because they have the perception that they could do so at any moment, the reputation holds. Likewise, the CCP knows the reputation of investors (which is that they will chase gains) and calibrates its policy with investors’ capital flow responses in mind, aiming to make key sectors and industries more attractive to capital inflows. Reputation is a dialectic between parties, and the pendulum swings both ways.
Speaking of key sectors, as the international competition for AI and automation dominance continues on at full clip, CCP insistence on the strategic significance of said industries will ensure that domestic PRC AI firms will be pushed to the forefront with whatever funding and motivation the CCP can muster, keeping the pressure on Western firms to increase innovation and remain leaders in the field. This competitive pressure reaffirms a macroeconomic foundation for our selection of [MAR.24 TPDEARR Squad] in this quarter’s MAR.24 Squad.
In the US, political turnover swings back and forth across the red-blue spectrum every decade or so, but the reputation of the USD maintains its consistency far more, unlike any other global currency, and in particular unlike the Chinese renminbi. And when the dollar is strong, it lends that strength to American companies who use it for their business, which many investors also believe they can tap into macroeconomically by holding equity in US firms. America’s reputation for having strong capital and equity markets is self-reinforcing, with companies, households, banks and governments all contributing to the perception with their financial behaviors. The scale at which this takes place in the US is unparalleled globally, with the limited ability by which the federal government is permitted to tamper with market activity holding as a significant factor in the profit potential afforded by the system of capitalism emanating from the heart of the West. The US has a reputation for unfettered capitalism; everybody else sees that. No matter how hard some might object, and no matter how much inequality it might induce, very little can be done practically or legally to alter the capitalist mechanisms of American society. No matter what happens today, tomorrow, US markets will still be a good opportunity to make money in the long term.
In another type of reputational display, and contrary to the monolithic strength of the CCP, some East Asian and Southeast Asian (SEA) economies demonstrate a much more regular turnover of leadership, and with that, leadership styles, goals, policy platforms, and party positions. Each time a new leadership takes over, market participants, ever in search of more gains, reorient to find the most profitable positions in relation to how the domestic markets are collectively perceived to have their industry opportunities structured moving forward, which is highly subjective and never entirely accurate. Moreover, markets with institutions that are still developing in their independence, or which have little or no independence from political meddling, thereby have their reputations affected accordingly. Since economic algorithms cannot effectively include political meddling in their calculations, any type of it is undesirable, particularly when it includes major levers of governmental finance, such as corruption within a central banking or treasury apparatus. Anti-graft investigations in Malaysia, for example, have become a relatively consistent feature of economic news, and they are certainly reputationally damaging.
Macroeconomic stability comes along only whenever both domestic business is generally humming (and consumers consuming) and foreign trade relationships are beneficial, not damaging, which is largely out of the control of the vast majority of national economies, whose trading relationships are mostly shaped by the dynamics they share with the two global economic poles, the US and the PRC. Everyone is impacted by this current bi-polar global economy. Part of China’s current reputational reimagining is the shifting of its effects on other economies’ export industries. For many countries, especially virtually all of them in East and Southeast Asia, the PRC is their largest trading partner and biggest export destination; so when PRC imports shrink, connected economies find their export demand and revenues shrinking as well. The witnessing of China’s shrinking population and growth has already done serious damage to the PRC’s reputation as an endless engine of expansion. This is particularly troubling to the recent status quo in consideration of the statistical analysis in a paper published in Open Economies Review last year, which finds other Asian economies are much more susceptible to reverberating effects of macroeconomic shocks in the PRC than in the US. You can bet central bankers throughout Southeast Asia will be hoping for major growth to domestic markets and domestic buying power to offset and counteract their out-sized dependence on PRC demand growth. Attracting foreign investment inflows will be a big part of this calculus, as it has been in the doubling of the total aggregate GDP in ASEAN economies since 2009. As these economies continue to grow and establish more market independence through completing infrastructure upgrades and domestic industry expansion, their reputations will hold more and more weight on their own, and ultimately be indicative of how investors can view the safety and profitability of their capital.
Lowering Rates
According to a recent publication in the Federal Reserve of Kansas City‘s Economic Review, analysis of inflation conditions has revealed that within high-inflation environments, such as the one the US is currently in, the economy reacts slower and with more volatility to changes in monetary policy. If the US Fed, in careful consideration of the implications associated with maintaining its reputation, is projecting that it’s unlikely to quickly and dramatically lower rates over the coming 12-18 months, we can’t help but beg a particular question: Even if we do believe that the Fed is going to slow-roll broad rate reductions over the coming years, is that actually the right choice? There are more than a few threads to pull here, so what are we waiting for!?
To begin, perhaps the simplest way of expressing what “lowering rates” actually does in an economy is that it makes the cost of money cheaper. When a business or firm wants some cash, “lower rates” means that it costs less to access that money now and pay it back later. Cheaper money has obvious impacts on the human psyche, with a broad concern being that risky behavior will increase as the actual costs of doing so are, quite literally, less. With cheaper access to money, spending goes up across the board. Businesses hire, expand, and make capital investments. Consumers do what consumers do: spend. But, if consumers have already been spending, and are either unable or unwilling to dip into savings as indicated by credit levels at an historic high $5T, are people actually going to even further increase their debt spending if/when rates are lowered? Furthermore, how much does it matter how significant the rate lowering actually is in terms of its impact on spending behaviors?
I’ll just come right out and say it: Everyone is fearful of a recession, and yet, perhaps that’s exactly what we need to clear the runway for the next few decades. There. Fed Chair Paul Volcker did it in the ’70s-’80s with his Volcker disinflation; and sure, it caused two recessions, but look at what it did for American industry and technological superiority over the following three decades! Yes, there was economic pain for many, but it did a great job of “wiping the slate clean”, as it were, and setting the stage for the “healthy” business (and monetary) environment leading up to the ’08 recession. I know, I know, the recession was caused by excessively risky behaviors, largely on the part of large financial players who “should’ve” known better, “So how healthy was it really?” the detractors introject. Well, it was healthy enough to support risky behavior; that’s exactly my point. The kind of risks that were taken (and ignored) by traders and institutions alike were the kind only possible within a financial environment that is bursting with capital flows, not anemic and devoid of the currency lifeblood required to come off as “healthy” and actually fund the risky behaviors themselves.
And let us not forget about the effects of the Levers and Pulleys that are the mechanisms of an economy itself. Let’s say rates are lowered a little bit after the next FOMC meeting, perhaps a quarter of a point. How will that pull on the level of unemployment? How would such employment shifts differ depending on geographic placement and regional differences in price-consciousness? How will a slightly lower interest rate lever investment flows for those on the fence about allocating funds one way or another? And perhaps more importantly, how much different would such effects be if the rate were lowered more dramatically, like a full point and a half!?
Critically important as these issues are to a functioning economy, let’s not bog ourselves down with trying to find quantitative solutions to such unanswerable questions; the fact remains that the passage of time finds all economic situations to be unique, and thus no historical event or precedent will ever perfectly presage or describe future events. And though no statistical analysis will be able to precisely pinpoint the eventualities of billions of individual (irrational) human behaviors, the lowering of rates at all will stoke optimism in the perception of possible business growth opportunities, which will be reflected in increased buying behaviors of public equity, and growth in equity markets more broadly. And with that, we realize again that central banks everywhere, and always, are playing a guessing game. Argh! If only humans were rational agents! Macroeconomics is supposed to be mathematical! Where are the equations we can solve to determine outcomes!?
…I do NOT digress. There is no getting around it.
Humans are weird, and managing “the weird aspects of the weird” is, somehow, strangely, an important function of financial authorities in modern society. Next section.
The Psycho-Mathematical ‘Management’ of Human Expectations
Humans, not rational automatons, we are all, every one of us. Our internal mental environments are an ineffable swirl of irrationalities from which some rational thoughts and behaviors are drawn and expressed, but certainly not exclusively. All humans, nonetheless, express subjective and unique irrationalities, bespoke to their individual histories, which no known mathematics can define and express. So, if humans can’t be expressed by math, why do “we” use math to express economic reality, of which humans are the most important part?
Behavioral economics, a relatively new addition to the conversation, does a much better job of representing humans as irrational economic agents than conventional economic orthodoxy, though still, and self-admittedly, imperfectly. Psychoanalysis of the behaviors of key decision makers of funds is just as likely to provide profitable insight about market moves as is mathematics, as at least in the case of archetypal studies, irrationalities are an instrument intrinsic to the understanding and forecasting of events; all activity is equally valid criteria for analysis, not just the arithmetically friendly stuff. And on that token, when the central bank is trying to decide if now is a good time to lower rates, and by how much, are they more closely considering what the economic models detail about a certain selection of quantifiable statistics, or are they trying to anticipate and counter-manage investor sentiment and possible reactions to announcements, based upon whether and how much they align with whatever metric(s) selected for consideration, all of which are unique to individual participants?
In the end, as former US Secretary of the Treasury Tim Geithner likes to put it, “Plan beats no plan.” Bankers, as well as institutional funds and investors, ultimately usually end up basing their analytical conclusions on whatever most closely aligns with the subset of math they’ve selected for measurement and use. Whether they actually put those conclusions into practical action is another matter, influenced much more heavily by psychology. Furthermore, whether or not it’s desirable to use mathematical analysis as the foundation for behavior and policy is itself debatable, but its nonetheless the “body of evidence” that most financial decision makers believe is available to them. One can only use what one has access to. And even on top of all that, the individual subjectivity inherent in psychology makes any conclusions drawn from it basically inadmissible in other situations. And yet! What is the goal of the Chairman of the Fed, Jay Powell, when he makes an announcement about a lowering of interest rates? Is it to deliver the information flat out? Or is it to deliver the information, but only in such a way as to ensure that the act of delivering the information (as well as the linguistic packaging of the information) doesn’t provoke an adverse response from market participants whose expectations have been poorly anticipated and managed, which can have catastrophic economic consequences. This. Is. Reality. Macroeconomic policy, action, and stability, are all highly dependent on the resultant interplay between mathematical planning and human psychological responses.
Institutions and central banks which operate independently, and deftly, can walk this tightrope between rational and irrational processes, at least for awhile. As we take up positions in new equity assets this quarter, we have to accept that we cannot predict investor sentiment nor very well interest rates around our targeted exit range in 12-18 months. We can, though, weight more heavily those companies who benefit from multiple tailwinds, making the lessening or loss of any one of them less detrimental to the overall trajectory of growth. Currency strength, expanding and diversifying import/export relationships, infrastructure expansion, and taming interest rates are all macroeconomic tailwind factors we incorporate into our selection of TPDEARR Squad assets. But we cannot forget that what makes equity assets rise in value is not the series of macroeconomic quantifications that can be laid out in support of a desired result, but rather the perception of the future success of a company among market participants who believe they can also profit and so buy the asset, thereby raising its price. What raises an equity asset’s price is the belief of the possibility to share in the future profitability, not anything that is practically transacted within the company whose ownership the equity represents.
And finally, as always, even in depressed macroeconomic conditions, there are always winners among the pack. Underestimate not the crafty capitalist; there is always another way to make money.
Additional Notes
The volume of consumer spending in the US has reached unprecedented levels, and calls attention to the debt servicing industry that provides the financial infrastructure. While some commercial debt firms are struggling because of their exposure to empty real estate that’s been vacated due to shifts to remote work, other firms are thriving and chomping at the bit looking at all this consumer debt. The macroeconomic combination in the the US of a strengthening economy, lowering inflation, steady currency value, potential lowering of interest rates, and growth in the jobs market has manifested in an absolutely ungodly amount of consumer spending (which itself appears to be propelled by a strong public sentiment of an even greater appetite for spending yet unrealized,) and undergirds our support for both [MAR.24 Squad Asset #2] and [MAR.24 Squad Asset #5].
tkscm, limited 