The Half Penny Place

Asset Allocation Update

The Half Penny Place

April 2024. by PM

Executive Summary

  • Markets are beginning to price in a higher probability of a growth re-acceleration;
  • In doing so, our Regime readings have moved towards REFLATION, requiring tactical shifts;
  • Inflation readings are bottoming out, the ‘last mile’ to the Fed’s 2% target seems problematic;
  • Precious Metals begin to shine – entering the next stage of the new bull market;
  • Chinese stimulus will invigorate Shanghai listed stocks, and industrial metals to boot;
  • Japan’s great re-awakening threatens repatriation of vast global savings; a global upswing would likely not leave renewable’s equities behind.

  • Introduction

    April finally saw markets wave a white flag of sorts, and recognise that the ‘benign conditions’ beginning last October must be called into question. A surge in bond yields as consumers refuse to stand down, and geo-political tensions rattled risk assets and put a bid into the US Dollar and commodities. With it, it has brought a transition in our macro regime from Goldilocks to Reflation, which has been quietly simmering below the surface for some weeks now.

    Investors have finally had to place more weight on the potential for a global growth reacceleration, and the consequent asset allocation implications that brings. The benign ‘priced for perfection’, soft landing narrative has potentially been toppled, but that’s not to suggest that any correction is anything other than a buying opportunity – or a window to reposition for further equity upside but in different spots perhaps

    Figure 1: Market Regime Summary

    Quad Regime

    Global Regime : REFLATION

    Global Macro Risk Matrix: REFLATION, which is a risk-on regime, in which investors are generally rewarded for having riskier rather than defensive assets, as economies are accelerating.

    Key portfolio construction considerations in REFLATION:

    Risk Assets > Defensive Assets,
    High Beta > Low Beta,
    Cyclicals > Defensives,
    Growth > Value,
    SMID Caps > Large Caps,
    International > US,
    EM > DM,
    Corporate Bonds > Governments
    Industrial > Energy > Agricultural
    FX > Gold > USD.



    In fact, in having downplayed sticky inflationary data, many central banks, including Jerome Powell, as the US Federal Reserve Chair, continue to be more dovish on interest rate prospects than the data would warrant. Liquidity notably is beginning to stall, as the QE programs continue to be unwound and perhaps in an deliberate attempt to quash any further inflationary uprising before the election, our measures are beginning to show a tightening of financial conditions, which will ultimately act as a handbrake during the summer months on financial markets.


    Leading indicators, having stubbornly pointed to a limited probabilities of a recession for months, are ultimately being validated. (When put to strict proof we anticipate that the narrative pendulum will ultimately swing to a point in which economic momentum is fully priced in, and with it, any prospect of interest rates fully priced out, before the economic slowdown begins in earnest – but that is possibly a post summer story). Private sector balance sheets (read: the European and US consumer) and artificial intelligence productivity gains, continue to support robust consumer spending and capex, also underpinned by ongoing fiscal infrastructure programs.


    The last mile of ‘disinflation’ as always going to be the most troublesome, and increasingly we discuss a ‘sticky inflation’ theme. We believe we now live in a world whereby 3% inflation is the new ‘2% inflation’ of central banker’s policy mandate, and we are unlikely to see much by way of sustained progress towards the 2% target.

    Central bankers’ rhetoric will ultimately pivot and gradually introduce that idea, but not before they abandon the benefits seen in lower pricing from supply side interruptions healing, and the deceleration in wage growth that has largely been achieved without a significant uptick in unemployment numbers.

    The more prosaic view, is that enduring increases in trend inflation are not attributable to supply chain shocks, rather firm aggregate demand given the very accommodate fiscal policy governments are running. That’s to say material spending programs as yet have any corollary in higher taxes or reduced state benefits. Energy prices can be seen as supply side shocks, witness the OPEC oil embargo in 1973-75, which induced a recession and energy led inflation. Ultimately, that subsided as crude began to flow once more. That doesn’t describe our current macro-economic environment.

    Figure 2: Treasuries, Inflation and Policy

    The above chart shows decades of interest rate history, relative to changes in the level of interest rates. The current environment we face is one with more than a passing resemblance to those conditions in the 1960’s, those of the underlying trend in inflation being higher. As the last of the components of the inflation framework, (being housing services), begin to bottom, one of the most pressing concerns markets will face is whether inflation can plateau at these levels, or begins to climb once more. Should the inflationary touchpaper light once more, long term government bonds will suffer. As we stand, there is no need to buy long term government bonds when shorter duration, such as 2 years’, offer comparable if not higher yields without the volatility.

    Asset Allocation Views

    Asset Class Short-Term View Long Term View
    DM Equities Sentiment remains bullish, technical in limbo really after lurch lower. Valuations are elevated, with risks being balanced as the equity risk premium falls. We still favour DM ex-US on relative value over a longer view. In the immediate term US valuations remain elevated, cycle signals are mixed and monetary headwinds remain.
    EM Equities Potentially bottoming and turn generally across commodity markets, as technicals look positive Structural drivers remain: global capex, energy transition story, supply tailwinds
    Property Poor performer generally in late cycle markets, sentiment though extreme now on the downside. Significant reset in valuations , although yet to register as ‘cheap’. Leverage still high, and post pandemic demand still uncertain.
    Corp. Credit Priced for perfection, as risk on sentiment pushes spreads to all time lows. Little margin for error. Expensive on valuation grounds, as policy tightens, data soft, better entry points await.
    Govt Bonds Attractive valuations, yet definitive ‘bottom’ still to be seen as inflation data becomes sticky. Perhaps next year, in a traditional slow down, bonds will yet prove their value, whilst real yields better still low historically.
    Cash Continues to offer superior risk free yield relative to bonds and stocks, capital preservation tool too. In nominal terms, cash rates elevated, rising in real terms as inflation falls.
    US Dollar Short term yield differentials reducing, yet sticky data could support ranging action for the foreseeable. We lean bearish on a medium term basis, as stretched valuations play out.


    Japan is one of the largest pools of savings in the world. It’s role as a structural exporter of capital, (that’s to say providing savings/investments to the rest of the world), is almost unparalleled and certainly underappreciated. All told, to the nearest billion or so, it holds over 2trn USD of bonds – half of that number details US bonds and a good soaking in the EU too, with over 400bn. Starved of attractive yields domestically, Japanese investors for decades, both retail and institutional, have sought more enticing returns available of fixed income assets abroad – understandably whilst the land of the Rising Sun was mired in a negative interest rate policy. This has been the standard setting in Japan as policy makers have sought to generate an inflationary pulse in the economy for decades.

    To do so, they have maintained negative interest rates. However, with 30 year Japanese Government bonds yielding circa 1.75%, there comes a tipping point when Japanese investors begin to consider domestic options. So far the Japanese Central Bank have done a marvellous job of transitioning out of a negative interest rate policy without any major ‘bumps in the road’. However, genuine structural improvements in corporate earnings and an export machine that is at full tilt, will ultimately be realised in a repatriation of investments, which could be tectonic. The smallness of the moment will likely understate the magnitude of the meaning, as US bonds in particular lose one of their mainstay supporters.

    Figure 3: Currency breakdown of Japanese foreign Bond Holdings

    Whilst the reflationary environment compels us to lean into late cycle assets – commodities, cyclical equity sectors including materials and miners, we are hesitant to press our bets in the energy sectors at this point.

    A strong rally driven by geo-political concerns is understandable, but the energy mix this year remains balanced – this is not 2022, and we’re inclined to express the regime change in other commodities directly such as natural gas, and agricultural plays thereafter. That said, the enduring AI theme grows new tentacles, as the reality dawns that AI can account for an increase of 2-3% of new energy consumption, when the expected energy demand for data centred is brought into the calculus. Ever since the Shale revolution though, the elasticity of crude oil supply, that’s to say the energy industry’s ability to respond to price rises in quickly increased supply, can cap rallies quickly.


    A shift in market regime has asset allocation implications. The Chinese have determined enough air has been left out of the property balloon and have begun to provide stimulus which, by our lights, has initiated a new bull market in Shanghai, having washed out over ten years’ of gains. Moreover, generally, over the longer term we believe emerging markets, traditionally seen as higher risk propositions, offer more compelling opportunities than developed markets. As yet, the US tech train steams on, underpinned by blowout earnings by NVIDIA. Only twelve months’ ago, it reported quarterly sales in the order of 9bn USD, which blew the barn doors off. Only a year later, and this quarter’s were 22bn USD.

    In perhaps another indication, the time is opportune to rebalance exposures, the ‘renewables’ sector is offering compelling valuations. After an almost -70% drawdown following the bursting of the 2020/21 bubble, renewable energy stocks are plain cheap.

    Figure 4: Relative performance of renewables versus traditional Oil and Gas stocks

    Perhaps reflecting growing scepticism of the energy transition in many quarters, renewable energy equities have reset significantly relative to their fossil fuel brethren. The drop in carbon prices has reached levels where the German government has put in print before it would ‘back up the truck’, that’s to say be a ready buyer of carbon at such prices. From a purely contrarian perspective, many of the solar and wind companies, having previously traded sympathetically to other tech names, have adopted the half penny place. As a cyclical asset, if the world reflates somewhat in the coming weeks, asset allocators might do well to build exposure to a discarded sector, that was this time last year one of the Darling Buds of May.

    Information is based on our current understanding of taxation legislation and regulations. Any levels and bases of, and reliefs from, taxation are subject to change. Tax treatment is based on individual circumstances and may be subject to change in the future. Although endeavours have been made to provide accurate and timely information, we cannot guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No individual or company should act upon such information without receiving appropriate professional advice after a thorough review of their particular situation. We cannot accept responsibility for any loss as a result of acts or omissions.


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