Jay Pelosky is co-founder and CIO of TPW Investment Management. He is responsible for management of all TPWIM’s global asset allocation and portfolio strategy, leads the research activities of the investment team, and produces numerous written market and research commentaries. ETF.com recently spoke with Pelosky about his latest views on the financial markets and his top ETF picks.
ETF.com: What is TPW’s investment philosophy, and what part do you play in it?
Jay Pelosky: TPW Investment Management is a global multi-asset, 100% ETF-based investment solutions provider. We provide solutions through our own portfolios, of which we have three: our flagship global multi-asset portfolio, our global macro income portfolio and our global macro equity portfolio.
We also do custom portfolio construction through a partnership we have with SMArtX. We’re happy to work with clients in whatever way works best with them. I serve as chief investment officer and lead our monthly investment process, which has three steps.
The first step is the framework we use to think about the world, which is our Tri Polar World framework. TPW stands for Tri Polar World, and is the thesis that I’ve been developing over the past decade or so. It argues that the integration of each of the three main regions of the world—the Americas, Europe and Asia—will drive the global economy going forward.
Then we have a second phase, which we call the global risk nexus (GRN) scoring system. That looks at economics, politics, policy and markets in each of the three main regions and globally. We think about this on a six- to 12-month forward basis, and it really serves to help us generate our investment themes. One of the themes is the idea of lower-for-longer global growth, and how that can lead to higher-for-longer global stock prices.
The third step in our process is ETF selection and portfolio construction. Over the last number of years, ETFs have expanded dramatically in terms of the ability to drill down not only into individual countries and individual sectors, but also factors, fixed income and now ESG. They’re also becoming cheaper every day.
For us, as portfolio managers, constructing portfolios out of ETFs is really attractive, and something that we embrace on a monthly basis with our portfolio process.
ETF.com: Financial markets had a great year in 2019. Stocks went up, bonds went up, commodities went up. Do you think that’s something that can repeat this year?
Pelosky: You’re absolutely right; 2019 was a year where virtually all assets appreciated. We don’t expect that to be the case in 2020. You’re going to have to be much more selective this year.
Our view is that we’re not going into a recession; we’re going to have reflation. We’re working off of what we call our “big four cycles”: global easing, a global growth bottom, a U.S.-China trade truce and rising inflation.
In January, over 80% of countries reported a composite PMI over 50, which is expansion territory. That’s in large part driven by the fact that much of the developed world has been running at almost full employment. OECD unemployment, for example, is at a 50-year low and wage gains are above inflation. In that environment, it’s very difficult to get a recession.
Our expectation is for a lower-for-longer global growth path, which is constructive for risk assets. Lower for longer means you’re not going to have a recession; it’s low growth, it’s not no growth.
At the same time, you’re not going to have overheated growth, which would lead to central banks having to come in and raise rates. That’s what typically kills economic expansions, bull markets and stocks.
Most central banks have also made it very clear that they’re going to let inflation run high. That’s constructive for risk assets like equities, but it’s negative for fixed income, especially long-duration fixed income.
ETF.com: I assume, given your bullish outlook for stocks, you don’t see the coronavirus as derailing the global economy?
Pelosky: That’s correct. While it’s obviously a big issue for folks who’ve been affected by it, from an equity and risk market perspective, the coronavirus has actually been healthy because it’s caused everybody to take a step back.
If you remember, three weeks ago, the concern was that markets were getting overheated. The S&P 500 hadn’t had a 1% pullback in 70 sessions; all the sentiment indicators were all flashing red, etc. Now we’ve had all those things come off the boil, which is healthy.
We weigh the virus risk against some of the other factors we’ve mentioned, and the other factors win out. The economic data coming through has been consistently strong, with the exception of some factory of production data out of Germany.
There’s plenty of liquidity around, which supports financial assets. Then you have earnings coming in better than expected, both in the U.S. and in Europe. All those things have inoculated equities against the virus.
In fact, we’ve been looking at the virus as an opportunity. A couple of weeks ago, just as the virus was starting to manifest itself in the markets, we decided to add to commodities and reduce our long-duration exposure.
Commodities had been aggressively sold. The relative strength index in the Invesco Optimum Yield Diversified Commodity Strategy No K-1 ETF (PDBC) was under 20. When the RSI gets to such low levels, you’ll typically do great if you can just hold on for a few months.
ETF.com: It’s interesting that everything that worked last year—technology, growth, momentum, etc.—is working again this year. Are those areas going to keep working, or would you focus on the more depressed areas of the market?
Pelosky: We’d definitely favor value versus growth. If you look at what’s leading in the equity space year to date, it’s technology, and particularly, the very high growth part of technology. If you look at what’s leading in fixed income, it’s long duration, like the iShares 20+ Year Treasury Bond ETF (TLT).
We see those two things as being in bubbles that are linked. The rally in fixed income is allowing people to assign a higher valuation to the growth stocks in the tech space, while at the same time, retarding flows into the cyclicals and the value stocks.
Cyclicals and value stocks start to work once growth becomes apparent and interest rates rise. That’s what was starting to happen in Q4, but it got reversed these last couple of weeks because of the virus.
Looking ahead, we’re focused on a peak in the virus in terms of new cases, and we’re focused on the factories in China reopening. We expect that to happen in the next couple of weeks.
As the factories restart and the production cycle gets going again, there’ll probably be a pretty big inventory rebuild. At that point, you’ll have the growth concerns fade. The growth pickup will lead to interest rates going higher; tech and growth stocks coming down; and financials and other parts of the cyclical-value space going up. All the stuff that was starting to work in Q4 will work again.
ETF.com: What’s your take on international stocks in 2020?
Pelosky: Within equities, we favor the non-U.S. over the U.S. markets. Within the non-U.S., we favor the developed over emerging.
We like Europe and Japan, and we’re particularly keen on European financials, as well as small caps. We have a position in the iShares MSCI Europe Financials ETF (EUFN). If we’re correct that Europe should have a modest growth recovery in 2020, the region’s bonds should probably yield closer to plus five or 10 basis points, as opposed to minus 40. That should be very constructive for the banks.
The iShares MSCI Europe Small-Cap ETF (IEUS) is the European small cap position that we have, which, again, should benefit from a recovery and better growth profile within Europe as a whole.
For Japan exposure, we’re using the iShares MSCI Japan ETF (EWJ). One of the things that people haven’t really been paying too much attention to is the fact that Japan is undergoing a significant governance revolution, giving much more attention to shareholder returns. There’s a big increase in stock buybacks, dividends and things of that nature.
Japan is known for having tremendous amounts of cash on company balance sheets just sitting there. That’s starting to be unlocked.
In the emerging market space, we have a barbell strategy. We like China. We’ve held it throughout the coronavirus situation and haven’t touched our weightings there. We’re overweight the country through the iShares MSCI China ETF (MCHI).
We also like some of the smaller Asian markets, like Taiwan and South Korea, which allow us to play the semiconductor cycle and the 5G demand cycle.
We have positions in Latin America, particularly in Brazil. Brazil has been a disappointment; it’s down almost 10% year to date, mostly because of currency weakness. The currency has been weak, in large part because the government has been cutting rates to reduce the real rate. Currently, real rates in Brazil are at generational lows, which ultimately should be good for the stock market.
We are quite keen on the e-commerce and internet opportunities within emerging markets. We like the Emerging Markets Internet & Ecommerce ETF (EMQQ), which offers you exposure to all the major e-commerce emerging market companies in one instrument.
If you think about it, with the virus forcing a lot of people to be quarantined and reducing face-to-face activity, that increases the demand for e-commerce. That’s actually been quite constructive for these internet companies, and as a result, they outperformed the underlying emerging market exposure.
In terms of value over growth and cyclicals over defensives, we own the iShares Core S&P U.S. Value ETF (IUSV) and the iShares Edge MSCI Intl Value Factor ETF (IVLU).
On the cyclical side, our biggest exposure in the U.S. is through the Financial Select Sector SPDR Fund (XLF). The fund is currently trading right around $31/share. That’s a resistance point that goes all the way back to 2007. If rates head back up, as we expect they will, XLF could break through that level pretty convincingly.
Other ETFs we own are the VanEck Vectors Semiconductor ETF (SMH), the Industrial Select Sector SPDR Fund (XLI) and the iShares Transportation Average ETF (IYT), all on the basis of an economic pickup.
ETF.com: You’ve talked about interest rates rebounding and duration being dangerous. Does that mean you’d recommend investors keep the duration of their fixed income portfolios on the lower end?
Pelosky: Yes, absolutely correct. We think rates are headed back up, but not that dramatically. For example, the 10-year Treasury yield will go somewhere between 2% and 2.5%, but not back to 4% or 5%, because there’s just not going to be that much inflation.
Still, we prefer short duration over long. We also prefer credit over sovereign. We have a pretty big position in the iShares iBoxx USD High Yield Corporate Bond ETF (HYG).
We also like things like preferreds. We have a large position in the Global X U.S. Preferred ETF (PFFD), which gives you very low volatility and a very nice yield. Finally, we like emerging market dollar debt through the iShares JP Morgan USD Emerging Markets Bond ETF (EMB).
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