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October 4, 2024

Money Printing Goes Global (Again)

The United States and China may be locked into a great power competition that will define the 21st century, but their central banks are now swimming in the same direction.

Monetary policy around the world has pivoted in the direction of greater liquidity—with an extra assist from Saudi Arabia, which now intends to increase oil production by year end.

Low oil prices are disinflationary and give the U.S. and China more room to stimulate. Investors across asset classes are unsurprisingly happy.

Despite a number of looming risks, investors can protect themselves, while benefiting from all of this stimulus, by focusing on stocks that are based on durable cash flow streams, scarce real assets, and structural growth opportunities.  

With inflation rates subsiding for the moment and clear signs of weakness in labor markets emerging, the Federal Reserve has executed a sharp policy reversal.

Jerome Powell and company cut rates 50 basis points on September 18, a supersized move historically associated with financial crises. The Fed also signaled its capacity to do much more if current trends persist. Markets responded favorably.

Powell’s counterparts in Beijing no doubt took notice. The Chinese stock market has been a disaster for several years, while China appears increasingly at risk of failing to achieve its 5% economic growth target.

On September 24, less than a week after the Fed moved, the People’s Bank of China announced a wide range of monetary stimulus measures. The stock market in China soared.

The MSCI China ETF (MCHI) returned 22% in September, although Chinese stocks still remain way below their highest levels of three years ago.

Many western fund managers, who had abandoned all hope for China, scrambled to establish positions in what had become a very statistically cheap (low multiple) stock market.

A number of U.S. stocks with significant exposure to China also benefited from the news of aggressive stimulus. These include industrial metal plays like Inflation Protection Model Portfolio holding Freeport-McMoRan (FCX), which we profiled here in March.

Shares of FCX advanced 13% in September as copper prices rallied in anticipation of a recovery in the Chinese real estate sector, which is among the primary targets of the stimulus measures.

Liquidity and global turmoil

As the U.S. and China stimulate, tensions flare around the world. The combination of easy money and geopolitical instability has boosted the gold price. Gold touched another all-time high this week. Gold has advanced some 29% year to date.

Oil prices have also been volatile and likewise influenced by international tensions and political maneuvering, especially in the Middle East. In the past few months, oil has moved down in response to signs of economic weakness in the U.S. and China as well as indications by Saudi Arabia that they intend to increase production.

During the recently concluded third quarter of 2024, gold advanced 13%. Meanwhile, oil prices declined some 16%, pressuring many energy stocks.

Gold versus Oil - Q3 2024

In the first few days of October, however, we are witnessing a bit of a spike in oil prices, as Israel and Iran square off. Gold is also benefiting from this uptick in geopolitical uncertainty.

On September 11, Saudi Arabia’s massive state-owned energy company Aramco announced a major commercial partnership with China, following a visit to the Kingdom by Premier Li Qiang, China’s second highest ranking official.

Saudi Arabia and China have become increasingly intertwined, politically and economically. Saudi delegations now participate in BRICS conferences, while China has become Saudi Arabia’s most important customer and a major investor.

Through production increases, Saudi Arabia is effectively accommodating Chinese stimulus efforts, which may be intentional. If oil prices remain subdued because supply expands, China can inject liquidity into its economy with less risk of inflation. The Saudis have a natural commercial interest in helping the Chinese economy regain its footing.

Falling rates prop up stocks and bonds

Both stocks and bonds advanced in the third quarter, as interest rates came down. In the U.S., tech stocks took a back seat to the broader market for a change, based on the perception that cyclical companies (as opposed to structural growers) will benefit more from lower rates.

The S&P 500 Index ended the quarter up 6%, versus 2% for the tech-heavy Nasdaq Composite Index. Falling interest rates also propped up long-term bonds. Long-term Treasuries, as indicated by the performance of the iShares 20+ Year Treasury ETF (TLT), rallied approximately 8%.

Stocks versus Bonds - Q3 2024

Model Portfolio positioning

Approximately 90% of our 76research Model Portfolio holdings delivered positive returns in the third quarter of 2024. The only material downside came from two energy sector holdings. However, the vast majority of these declines have already been erased with the bounce in oil prices thus far in October.

Our holdings have benefited generally from the positive momentum in markets as well as company-specific catalysts, such as earnings results.

For the quarter ending 9/30/2024, the median total return of our Model Portfolio positions was 10.8%. This performance compares favorably with the 5.9% total return of the S&P 500 Index.

Performance for the top 50th percentile of holdings across the three Model Portfolios ranged from 11% to 25% during the quarter.

Outlook

Federal Reserve rate cuts, China stimulus and disinflationary Saudi oil production increases present a favorable scenario for investors in stocks and other risk assets.

On the other hand, international conflicts represent an always unpredictable risk factor, as does the outcome of the U.S. election. We are also mindful of the possibility, signaled by weak jobs data, that U.S. economic growth is rapidly decelerating.

Across our Model Portfolios, we continue to emphasize durable business models from diverse industries that are underpinned by structural long-term trends. Such stocks should benefit from declining interest rates from an earnings and valuation perspective, while their cash flows are relatively shielded from macroeconomic volatility.

Within our Inflation Protection portfolio in particular, we continue to emphasize gold-related investments. We view gold as a beneficiary of global stimulus efforts, a paradigm shift away from dollar-based fixed income assets and, as we have seen quite recently, a valuable portfolio diversifier in times of geopolitical stress on markets.

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