This note was originally published
at 8am on March 19, 2012.
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“It is neither wealth nor splendor, but tranquility and occupation, that gives happiness.”
The first time I made the Inflation Slows Growth call (Q1 of 2008), I was a little stressed out. I was just starting a new company. I had everything to lose. Plenty of people were shooting against me.
The second time (Q1 of 2011), I had a much larger research team working alongside me and our confidence was high that consensus was way too bullish. People started to believe in our process.
This time (Q1 of 2012), from a fundamental Growth and Inflation perspective, very few factors in our risk management model suggest it’s going to be different. Growth continues to slow, globally, as inflation accelerates.
Back to the Global Macro Grind…
While the calculus associated with how inflation slows real (inflation adjusted) growth is trivial, consensus calculations addressing this very basic real-world relationship are not.
Let’s look Credit Suisse’s latest “Reasons To Be Positive On Equities”:
- “Bond yields could rise further – this might help equities”
- “The Macro environment is supportive – Economic momentum indicators suggest global and US growth is still well above consensus”
- “The dovishness of central banks and the synchronized QE as the end game”
I’ll stop with their first 3 reasons as the next 6 have to do with the run-of-the-mill bull market thesis that has had people run right over if they bought Equities at the end of Q1 2008 or Q1 2011 (‘the world is awash with liquidity… stocks are cheap… blah, blah, blah’).
First, in addressing reasons 1-3 in order, I always start debates with my analysts with questions:
- Does the thesis change if bond yields don’t rise further?
- What’s consensus GDP; what’s your outside of consensus forecast; and what track record do you have in making these GDP calls?
- What’s different this time about central bank easing that won’t perpetuate inflation and, in turn, slow growth?
So, if you are meeting with Credit Suisse or JP Morgan’s Tom Lee in the coming weeks, see if they can answer those 3 questions.
Facts about reasons 1-3:
- Bond Yields rising to their YTD highs in Q1 of 2011 were not a buy signal for stocks – they were a huge head-fake
- US GDP growth slowed hard in the face of $120 (Brent) oil in Q1/Q2 2011 to 0.36% and 1.34%, respectively
- On the margin, the only central bank of the 3 majors that can cut rates to 0% from here is the ECB
Furthermore, our risk management models suggest that reasons 1-3 need to be contextualized:
- 10-year US Treasury Yield TRADE, TREND, and TAIL lines are 2.12%, 2.03%, and 2.47%, respectively
- Our “low” and “high” scenarios for US GDP growth in Q1 and Q2 of 2012 are 0.9% and 1.7% (y/y), respectively
- The Sovereign Surprise of 2012 could be Japan, resorting to BOJ money printing, which would be US Dollar bullish (hawkish)
In other words, making a call that everyone is going to dog pile into Equities after this compressed smack-down move in Treasury Bonds is not one that is backed by anything that’s actually been happening in the world since 2008.
In theory, it makes sense. And in actuality, since Equity “fund flows” and volumes are dead, that’s what the Equity market needs (rotation out of bonds into stocks). But, to be clear, what people need in this business and what’s going to occur, can be two very different things.
Because an equity fund manager needs to chase performance or a pension fund needs to target a rate of return, doesn’t mean anything at all really. Markets do not care about what any of us need.
No matter what your successes or failures for 2012 YTD, what you need to get right from here are the slopes of Growth and Inflation. How does accelerating inflation infect growth? What pace of Deflating The Inflation could foster sustainable US Consumption Growth?
My Tranquil Occupation isn’t perma bull or perma bear – it’s perma process. In order to answer all of the aforementioned questions, you need a process that has proven to be both accurate and repeatable.
What would get me on board with some of Credit Suisse’s thoughts on US Equities:
- US Dollar Index breakout into the mid-80s (versus $79.81 this morning)
- US Treasury Yields (10-year) breaking out > 2.47% and holding there
- US Federal Reserve? Get them out of the way
My scenario is at least consistent. The Credit Suisse report wants you to believe that both bond yields and growth expectations can break-out to the upside while maintaining “synchronized QE” from central banks. By definition, all 3 of those things can’t happen at the same time. Unless, of course, the Fed is as conflicted and compromised as the world is beginning to believe it is.
My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, US Treasury 10-year Yields, and the SP500 are now $1636-1679, $124.69-127.49, $79.55-79.93, 2.12-2.38%, and 1377-1409, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer