This note was originally published at 8am on January 27, 2015 for Hedgeye subscribers.
“Each thing is of like form from everlasting and comes round again in its cycle.”
Until you’ve survived a few cycles in this business, you haven’t really lived. Cycles come in many styles and durations. Sometimes they’re cyclical. Sometimes they’re secular. Most of the time, you can front-run them – in rate of change terms.
Yes, the ole rate of change. As in the thing that helps you analyze time/speed – accelerations vs. decelerations. No, it’s not what most traditionally-trained-linear-economists use. That’s why what you read here every morning is different.
What is not different this time is that there will be an economic cycle. While central planners will try their damndest to “smooth” and “stabilize” it… in the end, the gravitational force of the cycle will prevail.
Back to the Global Macro Grind…
It’s a lot easier to make bold statements like that about the economic cycle when:
A) The cycle is already slowing
B) The Bond Market is already pricing it in
“So”, while our call on global #GrowthSlowing + #Deflation isn’t yet consensus on the sell side, the buy-siders (and self directed individuals) who are set up for it are the ones who are getting paid.
To review the #process of measuring markets and economies in rate of change terms, I always try to contextualize the rate of change in indicators as either EARLY-cycle, or LATE.
For the purpose of this morning’s discussion, I’ll focus on a USA trifecta of LATE-cycle macro factors slowing. Oh, and by the way, they started slowing in the following order (not all at once):
- INFLATION (classic late-cycle) has undergone a full phase transition to #deflation in the last 6-8 months
- JOBS (as late-cycle as late-cycle gets) peaked in the back half of 2014, and Jobless Claims are breaking out now
- EARNINGS (yes, they are cyclical) peaked, in rate of change terms, when pricing and FX impact did (2014)
That last one (EARNINGS) is going to drive the people who are pitching “SP500 isn’t expensive” (if you use peak sales growth and margins to derive SPX earnings) right batty. The rate of change slowing in cyclical data generally does.
With US Earnings Season underway, here are some early highlights (with ~20% of SPX constituents having reported – see Chart of The Day for color coded rate of change breakdown):
- From an operating momentum perspective this is about as ugly as it’s been in recent memory
- Only 33% of companies are registering sequential acceleration in sales growth thus far
- Only 40% registering sequential margin expansion, and 50% seeing sequential acceleration in EPS growth
Now if all you do is look at absolutes vs. Old Wall “expectations”, I lost you at rate of change. But, since most of you reading this pay for it, I’m highly confident that you get it. Calculus was a 12th grade pre-req to the Early Look.
For your stock picking friends who don’t do macro math and don’t get rate of change, ask them the following questions:
- If a company’s growth rate is about to slow, will the stock go up or down until the slow-down is priced in?
- What if a company’s margins are about to compress from an all-time peak?
Seriously. It’s not rocket science. You just have to doggedly track the second derivatives and #grind.
You also have to do the required #history reading to respect that #Deflation hasn’t been a sustained reality for nearly a decade now. If you expand your analytical horizons to past cycles, you’ll find ones like the 1927-1933 #Deflation (i.e. the ugly kind) and the more beautiful ones like 1983-1989 (even though America had to go through the ugly to get there).
Delaying the ugly (btw, Dalio coined the “ugly vs the beautiful deleveraging”, not me) via some cochamamy central plan only postpones the inevitable. Draghi and Yellen know that. They’ve been trying to delay the mismatch between falling demand and inflated prices with the illusion of growth (Policies to Inflate via currency devaluation), for what, 6 years?
Thankfully, not everyone shares our view of holding both large cash and long-dated Treasury positions (see Asset Allocation Model) so that we can buy the riskier things we like when they really deflate. Our current strategy doesn’t hold us hostage to an inevitable late-cycle slowdown, and makes us a nice, low-volatility absolute return, while we wait…
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 1.75-1.84%
Oil (WTI) 44.03-46.85
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer