Tactical (1-3m)

Cyclical (6-12m)

Structural (2-3y+)

Portfolio Positioning

Equity

Tactically Neutral: Tactical Outlook Model turned bullish (link), but flows are stretched and valuation headwinds remain; risk-on can be better expressed via small caps optionality. Defensive sectors are priced for “soft-landing”, stand to outperform in recession.

Relative Value: Long homebuilders (cum. flow), (analog), (VWAP), (link), long defensives (utilities, staples, healthcare) (link), short US semis, long China tech (link)

Cyclically Bearish: S&P 500 forward EPS estimates have been rising through the year, already pricing in a soft landing, leaving room for downside surprises (link). The medium-term volatility cycle is biased upwards (link). Outside of US large caps, valuations already look pretty attractive (link). Our Godot's Recession thesis is playing out now with labor costs pressuring profit margins (link). VP US recession signal remains active (link).

Relative Value Regions: China vs US recession divergence + out-of-sync policy & excess liquidity cycles, favors China. “Sell hubris, buy humiliation”.

Relative Value Sectors: Exposure to rising labor costs & interest expenses varies by sector. Lower forward EPS guidance (excluding AI/tech) in 2023 are reminder of the importance of sector selection heading into 2024.

Least exposed: drugs/grocery stores, energy, basic resources.

Most exposed: consumer products & services, machinery, food & bev, construction & materials (link)

Covid resulted in the mother of all bullwhip effects that is still causing distortions today. We highlight long and shorts tied to this theme (link).

Structurally Bullish: Age of Scarcity means reversal of cheap credit, cheap labor and cheap commodities. Equities to weather era of higher inflation better than bonds (link).

Relative Value Regions: Capital cycle points to EM (LatAm in particular) outperformance vs US (link). Japan is capital-scarce.

Relative Value Sectors: Capital cycle favors: homebuilders, tobacco, energy, tankers and telcos.

Avoid: banks, software, biotech and entertainment (link).

Our revised roadmap after 2Q23 (Godot's Recession) focuses on labor strength (labor fighting to restore real income levels) eating into profit margins, eventually forcing corporate lay-offs once the margin erosion becomes too painful. Our US recession signal also remains ACTIVE.

We utilize our single stock selection framework to express our overweight defensives view / maneuver extreme dispersion of single stock valuations (link), . Leading indicators continue to behave in line with the start of historical recessions: maintain spare bullets to add risk on further stress (i.e. overweight cash).

Our 3-step roadmap to get aggressive on equities includes: 1) policymaker panic (i.e. Fed easing), 2) selling capitulation signals (not there yet), 3) recession signal off, leading indicators turn up.

Core equity allocations focus on capital-scarce areas: energy, homebuilders, tobacco, tankers, telcos, China, Latam.

Nasdaq/AI price action has echoes of the dot com bubble: avoid taking big bets either way on AI/Nasdaq.

Fixed Income

Tactically Neutral to Bullish: Tactical Outlook Model now long (yield lower) after LPPL climax (link). IG, EM (USD), Govt tactical models all bullish (link) (link) (link)

Relative Value: Long Agency MBS trading near par (link), Long TIPS (link), Long Canada front-end (link), receive BRL (link).

Cyclically Bullish (yields lower): Risks that would driver term premium higher likely priced in (link). Active VP US recession signal suggests yield plunge comes once US labor coincident data cracks. US cyclical inflation LEIs have rolled over. Our Fed easing model is now active, indicating today's economic backdrop is historically associated with rate cuts (link).

Relative Value: Bullish duration, specifically via convexity / Agency MBS (link) (link) . Bullish TIPS (real yields) (link) (link) (link), Bullish Brazil sov debt (link).

Structurally Bearish (yields higher): The Age of Scarcity means reversal of cheap credit, cheap labor and cheap commodities. Higher inflation + yield capping (financial repression analogy to Fed-Treasury Accord period).

Demographic trends (more “capital consumers” (young, old) vs less “capital providers” (middle-age) mean higher yields are needed to clear the market for capital (savings) (link).

1969-70 analogy to today (i.e. an inflationary recession) showed that Fed cuts only happen when hard data gets very bad (bond upside comes later into the recession)(link).

We like core allocation to TIPS, as real yields are still mispriced in the current environment (link). US real yields have surged above post-GFC highs (link).

We are cyclically bullish duration (term premium risk priced in, govt. cap on real yields), specifically via agency MBS and TIPS. However, structurally, duration upside is limited in a high inflation recession, so need to aggressively rotate out of bonds after recession hits due to the coming “Age of Scarcity”.

Next move in the curve will be (bull) steepening, however still very negative carry on steepeners. We defer to VP Fed easing model for timing on steepeners / receivers (model currently active).

In EM, stick with Brazil sovereign debt as easing cycle gets priced in/underway.

FX

Tactically Bullish: USD Tactical Outlook Model is now bearish (link)

Relative Value: Long EURCHF via options (link), Short NZDUSD (link), Buy the dip in USDTHB (link), Short EURNOK via put spreads (link), buy any dips in AUDUSD (link)

Cyclically Bullish on USD: Our refreshed cyclical / structural FX framework points to a bullish USD outlook (link).

Relative Value: The BoJ will need to abandon Yield Curve Control (YCC) completely to get out of its impossible trinity problem.

Relative Value: Capital cycle & re-shoring trends + capex / commodity supercycle = bullish Latam (in particular MXN).

Still waiting for EM bottom-fishing signposts to buy crisis currencies (e.g. ZAR, TRY) (link).

Our refreshed cyclical / structural FX framework points to a bullish USD outlook (link).

Carry trades continue to work well as the rate differential to funding currencies (JPY, CNH) remains historically large, offering a large margin of error.

Commodities

Tactically Neutral: Tactical Outlook model neutral signal, more demand headwinds (link). Gold tactical long after breaking key $2000/oz resistance (link)

Relative Value: Long goldminers (link), long industrial commodities (RoW de-syncing vs US) (link)

Cyclically Neutral: Global recession and China bottoming (but not yet reflating) means cyclical growth headwinds are still there. Supply indicators have adjusted sufficiently to suggest the supercycle intermission is almost over for our favored energy and copper markets (link).

Relative Value: Cyclically gold performs best when real yields peak into recession and the end of hiking cycles (link). Industrial commodities are biased higher, given the rest of the world has already gone through their recessions, while the US is yet to break; the diffusion of our various country LEIs and the inputs are all turning up (link)

Structurally Bullish: Age of Scarcity means reversal of cheap credit, cheap labor and cheap commodities. Commodity supercycle in tact.

Relative Value: Gold, oil, copper, natural gas etc. are all structural real asset winners in the Age of Scarcity.

Commodity supercycle intermission almost over as cyclical LEIs are getting closer to bottoming. Long-term supply indicators are increasingly aligned for a bullish structural setup in energy and copper.

Credit

Tactically Neutral: Tactical signal bullish on IG (link) and high yield (link). Credit data remains clearly recessionary (link).

Cyclically Bearish: Credit spreads remain complacent, pricing in a soft landing as investors reach for yield.

Relative Value: Leveraged loans to software are particularly vulnerable in the upcoming recession. Beyond direct shorts, shorting BKLN and bad BDCs are proxies, where in exchange for very negative carry, you get effectively capped downside.

Relative Value: Linked to Age of Scarcity, we think duration will underperform in the next cycle with higher inflation (IG vulnerable). Select HY credit linked to capital-scarce industries should perform well (e.g. energy, telcos).

Private credit is the key area of credit risk/contagion today that could trigger spread blowouts across the spectrum.

IG over HY over Leveraged Loans.

We are particularly worried about recovery rates in this cycle being lower than the historical 70% given covenant-lite, sponsor-led issuance into the post-Covid once-in-a-generation liquidity boom.

“The worst loans are made in the best of times.”

ADVERSE SELECTION remains a problem inherent with companies that issued leveraged loans (especially in hot areas like tech). Companies that cannot borrow at a fixed rate must opt for loan-only structures.

Asset Allocation