Profiting from Populism, Central Banking, & The Splintering Global Economy (w/ Jay Pelosky)

JAY PELOSKY: It’s wonderful to be back here
at Real Vision and to talk about the tribe tripolar world. I had a great interview a year, year and a
half ago, with Grant Williams. And so happy to come back and update the audience
on what’s happening in the tripolar world framework. So as a quick review, the tripolar world really
stands for a thesis which argues that regional deepening and regional integration in the
three main regions of Europe, Asia, and the Americas can drive the global economy forward. And it’s an outgrowth of my frustration really,
for the policy mix that was developed over the course of the years following the great
financial crisis, when policy really was central bank driven, and monetary policy specific. Which worked out well for the financial markets,
but didn’t help Main Street in the real economy particularly very much. And so as a result– one of the results is
that we’ve seen this rise of populism, both in the developed and the emerging economies,
which we now have to deal with. So as a reminder, the tripolar world regional
integration is driven by three new and mutually reinforcing factors. The first is each region’s growing ability
to self finance. So if you think about the development for
example, of the Chinese capital markets, or South American pension system, or the European
corporate bond market, all those are examples of each region’s growing ability to self finance. The second driver is each region’s growing
ability to self produce. Think about advanced manufacturing, robotics,
3D printing. All these things are allowing production to
be centered closer to the consumer. And so the third driver is exactly that–
each region’s growing ability to self consume. Driven really, by the rise of urbanization,
service sector economy, and of course, ecommerce. So as we see it at TPW Investment Management,
globalization as it was discussed and described in the 1990s and early 2000s is no longer
viable. Certainly not at the ballot box, whether it’s
in the United States, or Europe. Really, anywhere in the world. And secondly, economic nationalism really
doesn’t work in our global economy. So we believe that the tripolar world is a
kind of interim step or a step in between the two between full globalization and economic
nationalism. There’s space for regional deepening and regional
integration to drive the global economy forward. And from an investment perspective, we believe
that it offers our clients and ourselves a differentiated view, a different way of viewing
the markets, the economics, politics. Which therefore, should allow us to generate
alpha over time by identifying things and looking at things through somewhat of a different
lens. So the tripolar world framework is really
something that I’ve been developing over the last half dozen or so years. Really, wrote my first piece on it back in
2012, 2013. And so it’s constantly been evolving. And some of the really early opportunities
in terms of an investment opportunity as viewed through the tripolar world framework was with
the Brexit situation in Europe. When Brexit happened, everyone was very bearish
on the euro and on Europe. In fact, it turned out to be a great opportunity,
because it really forced Europe to start to think about how does it integrate more deeply. And then with President Trump’s election,
you had NAFTA and the threats to break up NAFTA. And if you remember, the Mexican peso went
from 18 to 22. Tremendous opportunity to buy the peso because
if you had that regional deepening perspective, you realized there was no way we were going
to move to break apart all those regional supply chains that had been developed over
the last 20 years. And lo and behold, here we are with a new
NAFTA, the USMCA– US, Mexico, Canada Agreement, which effectively is the same agreement with
some minor touches. The one change that is significant and was
buried in the fine print is that any of the three parties who want to enter into a trade
agreement with a non, market economy has to let the other two know. So no prizes as to who the nonmarket economy
is in the situation. Obviously China. So as we think about the tripolar the world
today, we’re really focused on two separate themes. The first is what we call the three Ts for
trade, tech, and turbans. And the second is what we see as the American
divergence shifting to rest of the world convergence. And we’ll talk about that in a minute. But first, the three Ts. So when we think about trade in the conflict
between the US and kind of the rest of the world, at least initially, now kind of settling
in to be a US-China focus, there were two things that stood out to us. The first was that President Trump clearly
wants to bring some of those supply chains closer to home and within the United States. And to us, that’s really on an open door,
because if you think about the second driver to the tripolar world, it’s each region’s
growing ability to self produce. And so that is, in fact, happening. It’s called reshoring. It’s been going on for some time. But the president is trying to drive that
process more aggressively. The second thing that stands out in terms
of the trade is it’s really directed against China. And this has become clearer over the last
several weeks. And to us, it suggests actually, an interesting
driver to Asian integration. So the typical perspective is oh, the US is
challenging China’s capacity to export to the United States, and we want to shrink that
trade deficit with China. The way that tripolar world thinks about it,
when you look at the prism or the framework of the tripolar world, is that we’re actually
driving Asian integration by forcing China to do several things. First, we’re telling them that they shouldn’t
rely on the US export market. Second, we’re telling them that they shouldn’t
rely on us semiconductors and technology and things of that nature. So what are we hearing from China? Now we hear about China’s need for self-reliance. We hear about production shifting from China
to other parts of Asia, driving that Asian integration that is a central thesis of the
tripolar world. So when we look at the trade fight in all
the headlines that are written about trade, we think about it than the construct of deepening
Asian integration, and really ceding Asia almost to China. And when we think about the strategic implications
of that, it’s quite concerning because when you look at global growth forecasts for the
next 20 or 30 years, the vast majority of global growth is expected to come in Asia. So by the US stepping away from TPP, forcing
China to become more self-reliant, driving the dispersion of production and capital away
from China to India and the Southeast Asian nations, all of that is driving Asian integration,
and making it a more challenging situation for the United States. So that’s trade. The second focus on our three Ts is tech. And here, tech is really fascinating. Because technology, first of all, from a market
perspective has been the principal driver to the US outperformance this year in 2018. It’s been basically the US outperforming everything
else, and that outperformance driven by technology. But over the last several months, technology
has really started to suffer and to flag as a performer. And I think in our view, the tech space is
sniffing out the fact that tech is most exposed to this trade conflict. And here’s why. Tech has basically been valued as a global
opportunity, right? Global– it can benefit from supply chains
all around the world in terms of reduction, for example, of smartphones. Pieces come from all over the world, they’re
assembled in China, they’re shipped all over the world. The demand is global. Smartphone demand in India, smartphone demand
in Southeast Asia, smartphone demand in China– all of that is underpinning the valuation
of tech stocks. But what we have today is actually a splintering
of the technology space. And you have such tech luminaries as Eric
Schmidt, former chairman of Google, saying that in the next decade, he expects there
to be two internets– one driven by China, one controlled by the United States. And there’s even a new term for it called
Splinternet, which is kind of interesting. I hadn’t heard of that until quite recently. But I think that is a real factor for investors
to consider. If we are, in fact, going to kind of a regional
tech universe, where technology has a US kind of space to it, an Asian China-specific space
to it, and then a European space to it– and Europe is very important here because Europe
is really the regulator. Much as in both in trade and technology, Europe
is very important because it’s the swing player between China and the United States. And so Europe actually has quite an interesting
opportunity to kind of play one off the other. But in the trade space, it’s Europe ruling
through the WTO. In the tech space, it’s Europe ruling through
privacy matters. So you have tech, which has been valued as
a global play, now having to be looked at, I think, much more as a regional play, and
subject to very different supply chain constraints and very different demand profiles. And I think this is going to play out over
the next coming years, and it’s something investors really need to start to think about
deeply. And again, the tripolar world gives us an
advantage in how we view these because we can see it through that regional integration
process. And then third, the third T is turbans. And I don’t mean turbines as in energy and
power. Turbans as in kind of the honorific headwear
that different Ayatollahs wear for example, in Iran. And what I’m really driving at here is sanctions,
and the US sanctioning different parties trying to limit them to participate in the world
economy. And the potential blowback to the United States
of that policy decision. And it really struck me a few weeks ago when
the meeting UN here in New York, when we had Europe, China, Russia and Iran all working
together to develop an alternative payment system to avoid US sanctions on Iran, keeping
Iran in the nuclear agreement. And basically set up a different financial
system, a financial structure. Now many people would say that’s kind of ridiculous,
and it’s never going to happen. And it probably isn’t going to happen in the
near-term. But I think it’s important for investors to
really contemplate a couple of things. One is that the US is among the world’s largest
debtors. Two, the US in the next couple of years is
going to have a trillion dollar deficits. And three, we need foreign buyers to purchase
that debt. Otherwise, we have to make it more appealing
to them. And how do we do that? Well, we either have to make the interest
rate higher or the dollar cheaper. And neither of those are particularly in the
mindset of investors at the moment. And certainly in the US equity market. If we’ve just seen the last few weeks, higher
interest rates are not conducive to equity market appreciation. So I think when we can when we look at the
tripolar world, what we see is that a lot of the current activities, be it trade, be
it tech, be it US economic sanctions and financial sanctions, are all accelerating the development
of the tripolar world. It’s accelerating Asian integration by forcing
China to be more self-reliant and to distribute low cost and low production value material
to Southeast Asia. It’s driving technology into separate components. And we haven’t even talked the coming fight
over AI, which is going to be very much a China-US fight. And the people who way better than I suggest
that whoever controls and dominates the AI space is going to have a very significant
leg up. And then you have all the issues surrounding
the supply side of, are there Chinese spies putting little pieces of equipment on production
on motherboards, which then go into the US system, and they can spy on us. All you have to do is think about that for
five minutes and you realize that a global supply chain in technology, which has really
underpinned the pricing of the hardware, is going to have to change. And then that demand. We’re not really allowing Chinese companies
to do more in the tech space in the United States. Is it going to be any surprise when in the
next few years, it’s quite likely that US tech companies, already limited in China,
will become even more so. And then finally, the financial sanctions
we think are very, very big issue. The US is going to require a lot of buying
capacity to buy the trillion dollar– or the debt to fund a trillion budget deficit on
an ongoing basis. To suggest to foreign buyers that, you know
what, you shouldn’t really want to participate in our financial system, you shouldn’t want
to have dollar based commodities, is it any surprise that China is now trying to develop
yuan denominated oil contracts and other contracts or commodities? So as we look at the world, we think the US
is setting up for some potential problems with its policy mix, which drives that regional
integration, the process that underpins the tribe polar world. And we believe we’ll have opportunities that
we potentially will see before others, given how we approach the tripolar world. So as we think about the world going forward,
one of the key themes that we’re looking at is this idea of the sustainability of US divergence
from the rest of the world. And we’re doing this through not only the
tripolar world framework of regional integration, but also, using our next level down analysis,
which we call the Global Risk Nexus Scoring System or the GRN. And the global risk Nexus scoring system allows
us to score to actually rank each region in the world in four separate factors– economics,
politics, policy, and markets. And we see this is really allowing us to quickly
identify areas of disagreement within the team, areas of opportunity that we perhaps
haven’t thought about, how different our views shift and shape over time. So we actually go back and look in history,
how did we value America’s trade policy for example, over the last year. How has that evolved. How do we view European economics, for example,
over the last year. And each one of those four has subcategories
that we also score on a monthly basis. Our process is primarily a monthly portfolio
asset allocation process. So as we look at the world today, what we’ve
noticed is that we are, in our view, just passing through peak divergence between the
US and the rest of the world. And let’s go through each one of those four
to identify how we’re moving– in how we see that particular process moving. So in economics, if you think about the US
in Q2, 4% plus GDP growth. If you look at the rest of the world, China
decelerating, Japan still not growing particularly rapidly, and Europe being quite disappointing
in its growth. So that divergence between US growth and the
rest of the world growth was quite significant. We believe going forward, that divergence
is going to narrow. And so for example, if you look at 2019 consensus
GDP forecasts, by Q4 of 2019, the US is only forecast to grow 2%. So we’re talking about 4% plus in Q2 of ’18
to 2% growth in Q4 ’19. So that is converging closer to the rest of
the world. So that’s economics. The second is politics. Politics has clearly been an issue, particularly
in Europe, when we think about the European integration, the European poll. Politics has bedeviled the European financial
markets, whether it’s from Brexit all the way through to German coalition problems,
to Spain, Catalan, the separation from Spain. To Italy, to Turkey. It’s just been one thing after the other. And the US for all of its kind of political
intrigue within the White House and between Congress and the White House, really hasn’t
had any effect on US assets, as obviously is clear, because the US has done so well. I think that’s in process of changing as well. When you look at President Trump’s recent
comments about the Fed, we think that that really started– that spooked the market a
little bit. And while we have no expectations that the
Fed will remain anything but independent, that kind of talk, again, from a very large
debtor, is not conducive to market stability. So we think that political kind of Teflon
nature of the US is going to converge with the rest of the world. And the other side of it is that the European
political risk would have to seem to be pretty fully in the price of assets, be it equities
or the euro, for example. So that’s economics, that’s politics. If we think about policy, and focus on the
central banks for a minute, we have the Fed tightening, tightening, tightening, raising
rates now eight, nine times in a row. And the ECB for example, and BOJ doing absolutely
nothing. And as we go forward, we’re of the view that
the Fed is likely to pause here over the next couple of quarters. While we do expect the ECB to end its QE at
the end of the year, as has been suggested for some time, and look to raise rates in
2019. So that divergence is also narrowing. So we’ve got we’re going from a period of
kind of US exceptionalism, US divergence from the rest of the world to convergence. And then fourth, and finally, and most importantly,
obviously, since we’re investors, is the markets. And here, it’s really fascinating– at least
to me. Because you’ve had a situation where the US
has been kind of turbo charged on its economy from fiscal stimulus. And that turbo charging has also turbo charged
earnings. So you have a situation where US earnings
growth in 2018 more than double the non-US developed markets average, for example. And that earnings growth in the US has been
led primarily by technology. So here we are right now in the middle of
Q3 earnings season. People very focused not only on the Q3 earnings,
because that’s backward looking– markets are forward looking. Very much focused on Q4. And more importantly in Q4 2019. And so if you look into 2019, two things really
stand out on the earnings front, which I think, and we think at TPWIM is very, very important
for investors to consider. The first is that technology goes from being
in an above average earnings grower in 2018 to a market level earnings grower in 2019. So tech earnings, which have been way ahead
of the market, are going to basically coincide with the S&P, OK? That’s one. Very important factor since tech has been
the leading sector year to date for the US equity market. The second, even more important from an asset
allocation perspective, thinking globally, thinking about the three regions, Europe,
Asia, and the Americas, is that US earnings growth is going to converge with the rest
of the world earnings growth. So if you look at 2019 forecasts, Europe is
forecast to grow earnings roughly 10%, Japan 8%, and the US 10% or 11%. So all of a sudden, you have a situation where
those drivers, which have led to that US outperformance over the course of 2018, are all starting
to converge with the rest of the world. And that, to us, really suggests that investors
need to consider a different kind of playbook as we go into late 2018 and into 2019. It’s really fascinating. We finished up talking about that– American
divergence, converging with the rest of the world. And it’s actually apparent in performance
of markets. So if you look for example, year to date,
the US is outperforming the acwi ex US markets by 1,500 basis points. It’s a massive gap. Ahistorical in its size. Not a usual performance. The last three months, that gap has shrunk
to 600 basis points. And over the last one month, it’s 100 basis
points. So that convergence of all the things we talked
about has also happened in terms of equity market performance. And I think investors have to be careful not
to be kind of– not seduced because, that’s the wrong word– but frightened away from
non-US assets because of all the headlines. So the headlines will tell you, oh my god,
you just want to stay away from everything outside the US. The markets are telling you that actually,
the price to be paid in terms of underperformance for holding non US assets is shrinking. And therefore, potentially, going to go the
other way. The other thing that’s really of interest
to us– and I like to look at performance. I like to not try to tell the market what
to do, because that’s very frustrating. But to let the market tell me what’s going
on. And when I look at the performance of different
assets– because as you know, we’re a multi asset ETF based investment management company–
when I look at across assets over the last several months, several things pop out at
me that are interesting. The first is that emerging market debt is
outperforming. So for all the talk of the last six months
about Brazil, and Turkey, and Indonesia, and India, and Argentina, emerging market debt,
both local currency and dollar denominated, is trying to find a bottom. And that makes sense because they were the
first in. And it’s typical– the first and sometimes
can be the first out. So that’s something to pay attention to. Within the emerging markets space, our positioning
is much more in the debt side than on the equity. In large part because we’re not really sure
what that 2019 equity earnings profile was going to look like given all the macro uncertainty. So that’s one. The second is that gold has outperformed after
being a pretty miserable asset to hold for quite some time. And that suggests two things– well, it suggests
one thing, which is that there’s real fear starting to bubble, which is a good sign. I think contrary indicator, right? Contrarian indicator– people were afraid
that’s good, because that means positioning is probably a lot cleaner across assets than
it has been. But I also wonder if gold is not sniffing
out a Fed pause, right? Because when rates go up, that’s bad for gold,
because it doesn’t yield anything. And all of a sudden, cash, now yielding 2%
in the United States– typically, you would think gold would be going down. And it has underperformed. But over the last several months, gold has
been a significant outperformer, and gold miners in particular. So I think that’s something to really start
to contemplate as well. And then the third and probably most important
is that US high yield has outperformed. And this is definitely something that most
people would not expect. And high yield has been one of the most hated
assets all year. No one can understand how it’s performing
well. The spread over treasuries is so narrow, et
cetera, et cetera. But to me, what that suggests is that recession
risk in the United States is not very high. Because credit typically leads you that situation. When credit starts to deteriorate, that’s
when you typically get a sense that recession could be coming. And the fact that US high yield has done quite
well and outperformed on a relative basis is suggesting to us at least, that recession
risk in the United States is not that significant. Which then in turn suggests that the kind
of equity market volatility we’re experiencing currently is more of a correction than the
prelude to a collapse or a crash ala 2008. So that suggests that investors probably shouldn’t
be shaken out. But in our view, the opportunity lies in the
non-US markets, particularly developed non-US equity markets, Japan and Europe. The opportunity in emerging markets is more
on the fixed income side than the equity side. And the opportunity in the fixed income space
is more on the credit side than on the sovereign side. And I think if investors can think about those
different prospects, can contemplate a world where trade, technology, US sanctions, all
the things that are in the headlines, are driving us to a world of regional deepening,
regional integration, a tripolar world between the Americas, Asia, and Europe, then you can
start to think about, how do I position a portfolio that allows me to take those opportunities
that are existing in these different regions. And I think one last thing I’d say is that
on the technology side, China tech has corrected almost three times more than US tech, but
has a much faster growth profile. And so China, it’s interesting. Lot of negative press about China. We talked about it earlier about the trade
and the sanctions. We see it as a benefit to China on the medium
term. And longer term, we’re actually forcing China
to become stronger by isolating them as we’re trying to do. And I think technology-wise, if you think
about China tech, really being able to control all the China, and most likely, all of Southeast
Asia as well, because there really are no tech competitors in Southeast Asia, then you
can start to think about, wow, that’s an asset that’s down 30% year to date. And maybe, actually, if we’re thinking about
technology, and we’re thinking about a USMCA world, we might want to think about technology
in China. TPW Investment Management is a relatively
new investment management company. We began earlier this year. And really, we offer global, multi asset,
liquid, and low cost ETF based portfolio solutions for both individual and institutional investors. At the moment, we have a product suite of
three different portfolio solutions. The first is our flagship global macro multi
asset portfolio, which has an eight year track record. The second is a global macro income portfolio,
which is fixed income focused, but we add in things like MLPs, and equity dividend plays,
and preferred’s into that mix, so it’s not your straight Barclays ag fixed income vehicle. And the third is a global macro equity product
solution, which looks at equities all around the world. All ETF based. And we use macro and global macro in each
of our product names, because we really want to take back that term global macro. Because it’s kind of been used as a way to
describe a particular strategy, which is global macro hedge fund. But if you actually look into the literature,
global macro means focusing in strategizing across national and international thematic
ideas. And that’s really what we think we do at TPW
Investment management. And so our focus really, is to leverage that
tripolar world framework, which is unique to us. Its original thinking. And that’s one of the things that we like
to think we offer, is we are original independent thinkers in the markets. And that’s my background with a lot of experience
on the sell side at Morgan Stanley. So we have that mentality of coming up with
our own ideas. So we want to leverage the tripolar world
framework, leverage our global risk Nexus Scoring System to create differentiated frameworks
and perspectives which allow us to add alpha for our clients.

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