by Jurrien Timmer, Director of Global Macro, Fidelity Investments
Spontaneous friendships in Tokyo
It’s week two of my three week roadshow through the Asia Pacific region, and my current leg is a generous 6 day stay in Tokyo. This city and its people and culture never disappoints, and this time is no exception.
As structured and formal as the business meetings are (including the ritual of bowing and exchanging business cards), the weekend took a decidedly more spontaneous direction. My wife and I hired a tour guide through our hotel, and we ended up inviting him to dinner last night. Not having made any reservations, and with the restaurant from the famous “Kill Bill” scene booked, I picked a random sushi restaurant. The three of us showed up and found it to be a tiny place on the second floor of a side street. No sign, just a staircase followed by the traditional cloth curtain. The place only had 5 seats and we were the only customers that evening. The result was an incredible Omakase meal prepared by our “private” chef Tomomichi. During dinner the inevitable topic of Karaoke came up, and after the meal the chef himself took us up another flight of stairs to an equally tiny karaoke bar. There we met the owner Seiji, who along with our chef and guide Yuki took to the mic to sing Japanese songs. My adventurous and extroverted wife quickly followed (Abba’s “Dancing Queen”), and after that the mic inevitably landed in my hands. The point of this story is that spontaneous magic and friendships can happen even in the most unexpected foreign places. We made three wonderful friends in a single night and it happened with zero planning or expectation.
As for my business meetings, the main topic was the AI boom and how to simultaneously participate in it and protect from it. A dualistic quandary if ever there was one. Other highlights were Kevin Warsh’s first FOMC meeting and another supposed peace deal with Iran, as well as questions about Japan’s own future.
The week in brief
Premature victory?
Another supposed deal to reopen the Strait of Hormuz was announced, taking WTI oil down to $77 and the 12m forward contract to $70. With inventories down to critical levels, it’s imperative that the oil starts moving soon. We’ll see if it actually happens.
The markets have taken the approach all along that this conflict would mimic the 1990 Gulf War, which ended almost as quickly as it began. That has not turned out to be the case at all, but that hasn’t prevented bullish investors from looking past the supply chain bottleneck in the Strait.
The news of an MOU calling for a 60 day period for negotiations caused TIPS break-evens to plummet back down to the low 2’s. Breakevens never followed the BCOM Spot index higher, which has been puzzling to me.
As for the AI trade, it was alive and well last week even though the broad indices mostly treaded water. Note below the S&P 500 ex-AI in green. The rally of the past 12-18 months has been mostly AI.
Rates around the world remain in a bear market (likely a structural one), and both the ECB and BoJ tightened last week. The Fed model remains a left tail risk for equities, in my view.
US bonds remain eerily quiet, almost suspiciously so. I still think that inflation is underpriced and that nominals are too low in the US. But real rates are generous at +2% and provide some cushion.
The US earnings “clock” continues to advance in the sweet spot quadrant (9 pm – midnight), boosted by favorable financial conditions. Today looks quite a bit like 2021 and even 2017/2018.
As long as earnings revisions continue to tick up and rates stay well-behaved, this bull market has the potential to advance higher. The S&P 500 index has continued to trade in a range of roughly 20-24x (forward).
As for the secular trend, one thing I have been pressing on clients is to harvest the beta while we can, while appreciating how plentiful it has been and that it’s not going to last forever. The secular wave has been alive and well but getting on in age. Per the chart below, for the S&P 500 the 10-year price CAGR is 13.7% and the income (dividends and buybacks) is 3.9%. That means that the “share” of income of the total return is only 25%.
That’s in line with past mature secular bull markets. I don’t think we are at the end yet, but between this statistic, the new equity supply boom, and the cannibalization of buybacks from CAPEX, for me it seems like we are getting closer to the final innings.
As I mentioned earlier, investors want to both participate in the AI boom and protect themselves from it. For me, that latter goal is best executed via the income part of the price-income spectrum. Fortunately, the global stage is a more level playing field with payouts growing competitively around the world, and in some places at lower multiples. So, there is income to be harvested around the glove, as well as capital gains.
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