Keith is on the road this week visiting with customers and prospective customers in London; no doubt he’s accumulating reps at the one thing I am personally most passionate about as it relates to being some version of a sell-side research analyst: explaining why we’re different.
One of the core tenets to our process that differentiates us from our perceived competitors across the independent research landscape is our ability to consistently extract predictive color from financial markets. Furthermore, we apply those top-down quantitative signals in a reflexive manner to our bottom-up qualitative analysis (e.g. our Growth/Inflation/Policy framework) in order to generate actionable investment ideas and themes. Our process isn’t perfect, but 6+ years of growing a business with no banking, trading or asset management fees to help “keep the lights on” would seem to suggest it’s as valuable as an input to your respective processes as we’d humbly submit it is.
Today, the preponderance of the aforementioned quantitative signals support our fundamental research view that the US economy is mired in #Quad4 – which is an economic scenario whereby the 2nd derivatives of both real GDP and headline CPI are negative. If either the anticipated delta into this quadrant is meaningful or the setup is expected to last for more than one quarter, it becomes a meaningful macroeconomic headwind to the valuation of most financial assets.
Keith’s Model Is Signaling #Quad4
For example, take Keith’s proprietary factoring of Price/Volume/Volatility data across multiple durations (i.e. TRADE, TREND and TAIL) for various asset classes and style factor exposures. If you too subscribe to the view that financial markets are leading indicators and that various periods throughout history often rhyme with the present setup, it’s easy to conclude from these signals that the market is pricing in a #Quad4 setup at the current juncture – especially in the context of our GIP Model backtest results:
TACRM Is Signaling #Quad4
If that combination of History, Math and Behavioral Psychology isn’t robust enough for you, then let’s expand this search for quantitative confirmation to our Tactical Asset Class Rotation Model (TACRM). On this measure, there are a number of indicators that suggest the market is pricing in a #Quad4 economic scenario. To highlight a few of the most noteworthy signals:
- Only 18% of the nearly 200 ETFs comprising the TACRM risk management system have Volatility-Adjusted Multi-Duration Momentum Indicator (VAMDMI) readings greater than 0x. You have to go all the way back to the week-ended June 22nd, 2012 to find a commensurately low proportion.
- TACRM is generating a “DECREASE Exposure” recommendation for every primary asset class except Cash, which is comprised simply of US dollars and volatility – two things that have historically appreciated in value when investors liquidate assets or close out carry trades in order to raise cash.
- Regarding Foreign Exchange and Commodities specifically, TACRM generated the aforementioned bearish recommendations during the weeks-ended August 29th and August 15th, respectively. The broad-based breakdowns across style factor exposures within these asset classes – and across European equities and currencies – was one of the reasons we first started to openly debate the possibly of #Quad4 back in early August.
- TACRM is generating a “DECREASE Exposure” recommendation for even the historically defensive Fixed Income & Yield Chasing primary asset class. This is due to the fact that nearly 2/3rds of the ETFs comprising this asset class have negative VAMDMI readings.
- To highlight the market’s rotation into historically defensive fixed income exposures, the Vanguard Total Int’l Bond Market ETF (BNDX), the iShares National AMT-Free Muni Bond ETF (MUB), the iShares 20+ Year Treasury Bond ETF (TLT) and the PIMCO 25+ Year Zero Coupon US Treasury Bond ETF (ZROZ) are the only ETFs within the Fixed Income & Yield Chasing primary asset class that have VAMDMI readings greater than or equal to +1x at the current juncture.
- At +0.8x apiece, the S&P 500 sector SPDRs with the two highest VAMDMI readings currently are Consumer Staples (XLP) and Healthcare (XLV); that rhymes with our GIP Model backtest results highlighted above.
- We are constantly monitoring the composition of the bottom-20 and top-20 VAMDMI readings in the broader sample of ETFs with the expectation that breakdowns and breakouts in individual markets may front-run critical inflection points in the chaotic system that is the global financial marketplace. Among the top-20 are the iShares Nasdaq Biotechnology ETF (IBB), Health Care Select Sector SPDR Fund (XLV), iShares US Pharmaceuticals ETF (IHE) and the iShares US Medical Devices ETF (IHI) at 15th, 12th, 9th and 8th, respectively. Our Healthcare Sector Head Tom Tobin was keen to remind us of the demonstrable outperformance of these sector style factors well into the summer of 2008 – just ahead of the most meaningful #Quad4 occurrence since the Great Depression. Just something to think about…
For those of you’d who’d like to learn more about TACRM and how to fully harness the power of its signals within the scope of your respective investment mandate, please review the following presentation or ping me directly (): http://docs3.hedgeye.com/macroria/TACRM_10-7-14.pdf.
The Median Consumer Is Signaling Recession
Lastly, one of the things we don’t do that many of competitors anchor on is survey work. This is because:
- Our six-person Macro Team is flat-out better at forecasting the 2nd derivate of both growth and inflation than most corporate executives.
- Consensus among both corporate executives and the fundamental analyst community is almost always dead wrong at critical inflection points (e.g. early-2000, late-2007 and early-2009).
- Quite often, surveys tend to be an incestuous process that would generate a Circular Reference warning in the most basic of spreadsheets. For example: “Banker A” tells “CFO B” that 2015 growth will 3-plus percent; “CFO B” orders 3-plus percent worth of inventory from “Supplier C”; “Supplier C” tells “Banker D” that its order book is “off the charts”; “Banker D” relays that information to “Economist E”, who then updates his 2015 GDP growth forecast to 3-plus percent. #Magical.
That being said, we will happily cherry pick survey data that supports our fundamental conclusions when the preponderance of high-frequency economic data is not yet supportive of our forecasts as it is currently.
Given that so few investors actually analyze macroeconomic data in a repeatable and robust manner, we constantly find ourselves having to debate what we think are moot points regarding lagging indicators such as continued strength in the labor market and the 2Q14 GDP print.
So in light of that, we thought we’d use the following PwC survey data to highlight the ongoing “early cycle slowdown” Keith has being writing about all year:
- The projected average household expenditure during the upcoming holiday season of $684 is down -6.9% YoY.
- 84% of US households plan to spend the same amount as last year or less.
- 72% of US households believe the economic environment is the same or worse than it was last year.
- 67% of US households are in what PwC labels as the “Survivalist” bucket, which means they earn less than $50k annually and have budgets that are constrained by the rising cost of living. The proportion of US households that fall into this cash flow constrained category is up +200bps YoY and up +400bps from 2012.
- 84% of shoppers cite price as the primary factor for choosing a particular retailer, up from 74% in 2013.
All told, at least 2/3rds of the country thinks we’re already in or heading into what may ultimately turn out to be a recession or, at best, a recession scare. This conclusion is very much in line with our work on the median consumer as part of our #ConsumerSlowing theme.
If you’re buying risk assets at these valuations and spreads, you better have some darn good edge on why the 1/3rd will prevent that from occurring. Refer to our #Bubbles theme for a detailed discussion of the still-egregious mispricing of many financial assets.
Investment Conclusion: Continue Rotating Out Of #Quad4 Losers and Into #Quad4 Winners
We obviously understand that most investment mandates will prevent you from raising what we perceive to be adequate levels of cash or from tilting defensively enough to weather such volatility. In light of that, we’ve created a daily product – The Hedgeye Macro Playbook – to help you better incorporate our research conclusions into the scope of your respective strategy. Be on the lookout for that 1-page summary every weekday prior to the market open.
Beyond that, we’ve put together the following list of US equity subsectors that have historically fared really well (i.e. quarterly performance in the ~90th percentile and above) or really poorly (i.e. quarterly performance in the ~10th percentile and below) in #Quad4:
- Tires & Rubber
- Automotive Retail (only 6 historical occurrences)
- Drug Retail
- General Merchandise Stores
- Home Improvement
- Agricultural Products
- Specialized Finance (only 8 historical occurrences)
- Real Estate Services (only 4 historical occurrences)
- Health Care Facilities
- Managed Health Care
- Industrial Gasses
- Specialty Chemicals
- Metal & Glass Containers
- Consumer Electronics
- Specialized Consumer Services (only 6 historical occurrences)
- Coal & Consumable Fuel (only 4 historical occurrences)
- Other Diversified Financial Services (only 8 historical occurrences)
- Diversified REITS (only 5 historical occurrences)
- Industrial REITS (only 5 historical occurrences)
- Office REITS (only 5 historical occurrences)
- Residential REITS (only 5 historical occurrences)
- Retail REITS (only 5 historical occurrences)
- Health Care Technology (only 5 historical occurrences)
- Research & Consulting Services (only 4 historical occurrences)
- Electronic Equipment & Instruments
NOTE: If any of the aforementioned GICS Level 4 industries have recorded at least 10 quarters in #Quad4, we did not include the number of historical occurrences in parenthesis; most had 14.
Best of luck out there,
Associate: Macro Team