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Takeaway: We are getting increasingly negative on the slope of domestic economic growth.

This note was originally published December 12, 2013 at 17:45 in Macro

FLASHBACK: #GrowthSlowing (Lots of Charts) - turtlecrossingroad

Yesterday, Keith and I did a full slate of meetings with funds in NYC; without violating any confidentiality by getting bogged down in the details, here are the key takeaways we were effectively pounding the table on:

  1. We still like our #EuroBulls theme (CLICK HERE to launch our @HedgeyeTV video) and continue to see opportunities on the long side of European growth equities. We continue to like the UK and GBP then Germany and EUR in that order.
  2. Based on early warning signals, we think 3Q13 is a cycle-peak in the sequential rate of US economic growth. If we were mandated to allocate capital to US equities, it would be in high yield, slow growth, low short interest and/or commodity-linked stocks, at the margins – basically a return to the 2011-12 playbook. The UST 10Y yield has probable downside to 2.5% in this scenario.
  3. A potential 1H14 macro theme we see developing is inflation-hedge/consensus yield chasing plays continuing to make higher-lows alongside US equity volatility (CLICK HERE to launch today’s @HedgeyeTV video on a potential breakout in the VIX). That list would include gold, commodities, emerging markets, TIPS and REITs. The Abenomics trade (i.e. short JPY/long Japanese equities) would make lower-highs in this scenario.
  4. Fund flows have the opportunity to buoy the US equity market well into 1Q14, though we’d expect growth data to be decidedly cooler by then if the Fed does NOT taper. We are very differentiated from consensus in that we think that a return to prudent monetary policy is the only way to promote sustainably faster rates of domestic economic growth. We don’t buy into the consensus fear-based whining about deleveraging and the perceived risk of higher rates in the housing sector.
  5. If the Fed tapers or signals imminent tapering, we’d abandon each of the aforementioned views and would be buyers of any subsequent US equity pullback. If the Fed does NOT taper (as we expect), we’d be sellers of any subsequent US equity strength.

Today, we received a great follow-up question from a very sharp client in the fixed income space: “What is the data you’re looking at to support your view that GDP growth will slow down?”

As with any inflection-based call on growth and/or inflation, we start with the market’s risk management signals – which tend to lead the reported data. The USD is decidedly broken from a quantitative perspective and long-term interest rates are making lower-highs vs. the YTD peak in both growth data and #GrowthAccelerating expectations.

FLASHBACK: #GrowthSlowing (Lots of Charts) - dale1

 

FLASHBACK: #GrowthSlowing (Lots of Charts) - UST 10Y

Moreover, both are declining on a QoQ average basis, which is historically something you’d see during periods of marginal stagflation (i.e. Quad #3 of our GIP model = Growth Slows as Inflation Accelerates).

FLASHBACK: #GrowthSlowing (Lots of Charts) - GIP Model Backtest

 

FLASHBACK: #GrowthSlowing (Lots of Charts) - Quad  1 vs. Quad  3

 

FLASHBACK: #GrowthSlowing (Lots of Charts) - USD  UST Rates and GDP

That reflexive relationship is something we’ve seen throughout the YTD:

FLASHBACK: #GrowthSlowing (Lots of Charts) - 4

As it relates to early warning signals, the ISM data appears have materially inflected here, which confirms what we’ve already seen with respect to the respective trends in consumer and business confidence.

FLASHBACK: #GrowthSlowing (Lots of Charts) - 5

 

FLASHBACK: #GrowthSlowing (Lots of Charts) - 1

 

FLASHBACK: #GrowthSlowing (Lots of Charts) - 2

 

Recall that inventories juiced the 3Q GDP print – which we’ve argued is a healthy, pro-cyclical response to increased business confidence. Well, now said business confidence has inflected to the downside here in 4Q and we anticipate inventories will follow suit when 4Q13 GDP is reported.

FLASHBACK: #GrowthSlowing (Lots of Charts) - 3

Again, our call for an inflection in growth is in the very early innings so you won’t see it in the broad swath reported data just yet – much like you didn’t see a ton of data to support our #GrowthStabilizing and #GrowthAccelerating calls at the start of the year.

FLASHBACK: #GrowthSlowing (Lots of Charts) - US QoQ

I’m guessing to the naked ear we sound about as crazy as we sounded roughly one year ago when we were pounding the table on long side of US equities and on the short side of anti-growth assets (e.g. gold, EMs, commodities, etc.) as the biggest US growth bulls on the street. For now, that’s a position we feel comfortable taking in the absence of a change of heart at the Fed.

Please feel free to email us with any follow-up questions or if you’d like us to forward you the analyses supporting the conclusions laid out at the start of this note.

Have a wonderful evening,

DD

Darius Dale

Associate: Macro Team