Unyielding Resolve

“We had to go ahead and discover everything ourselves.”

-Orville Wright


That’s the quote David McCullough opens with in one of the most inspiring chapters of The Wright Brothers – Chapter 4, Unyielding Resolve. “The pall of discouragement disappeared in a matter of days, replaced with a surge of characteristic resolve.” (pg 65)


Now that we have the latest super #LateCycle US jobs report out of the way, I’ve got it out of my system that the Fed is actually going to raise rates into this slow-down. That’s obviously a big problem for many asset classes. But the Fed only cares about the SP500.


At 1.88% year-over-year growth in Non-Farm Payrolls (with a standard error of 90,000 on the # itself so it will be revised), November was the slowest rate of change jobs report of the year. This US Labor Cycle peaked in Q1 with 2.34% NFP growth in February 2015.


Back to the Global Macro Grind


We’ve always measured macro markets (and their implied opportunities and risks) in rate of change terms. The Establishment not doing it that way had them miss both Global #Deflation and #GrowthSlowing in 2015.


Unyielding Resolve - deflation


Their missing it on the latest of late cycle indicators (employment) doesn’t matter to us inasmuch as most of the non-employment data doesn’t seem to concern them. Please don’t look at ISM or PMI data for details.


If all you did was think like a Fed Head and stare at the SPY last week, nothing happened – the SP500 was down then up, closing 0.1% week-over-week. Hooray. If you’re just a US Equities person and you dug 1-level (Sector Styles) deeper, here’s what else you saw:


  1. Tech (XLK) +1.5% on the week to +7.8% YTD
  2. Industrials (XLK) -1.0% on the week to -3.6% YTD
  3. Energy (XLE) -4.5% on the week to -18.3% YTD


So, if you “back out Energy” and MLP stocks (Alerian MLP Index down another -11.0% on the week, taking its 2015 crash to -37.7% YTD) … oh, and back out producer price #Deflation (Industrials) and bought big cap Tech charts that have gone parabolic, all good.


I think I’ve pointed this out weekly in 2015, but it’s worth repeating this morning – during a Global #GrowthSlowing phase, “cheap” cyclical and industrial equities get cheaper, and the expensive growth that you can find gets more expensive.


That happened in Q3/Q4 of 2007 (late cycle) and it’s happening right now. So I hope you’ve discovered what US Equity market Style Factors you should continue to avoid as the economic cycle slows and the credit cycle peaks and rolls:


  1. LEVERAGE: High Debt (EV/EBITDA) Stocks were down another -1.0% last week and are -9.9% YTD
  2. BETA: High Beta Stocks were down another -1.1% last week and are -7.3% YTD
  3. SIZE: Small Cap Stocks were down another -1.5% last week and are -12.0% YTD


And you might notice that while the Russell 2000 was down -1.6% last week (-1.8% YTD), it’s down less than the Style Factor exposure I am looking at within the SP500 as that’s a measure of the mean performance of the Top Quintile vs. Bottom Quintile of SP500 companies.


Regardless, you get the point – what’s worked during #Deflation and GDP slowing in 2015 is:


  1. Good Balance Sheets: Low Debt = +3.6% YTD
  2. Quality: Low Beta and Low Short Interest +1.7% and +3.0% YTD, respectively
  3. Organic Sales Growth: Top 25% Sales Growers in the SP500 = +7.3% YTD


That’s why that +7.8% YTD performance for the XLK (Tech) is so close to the Organic Sales Growth Style Factor (hint: they are largely the same stocks). And it’s also why the illusion of growth (levered companies like Kinder Morgan, KMI, and Valeant, VRX) crashed.


If you go all big picture on your colleagues and look at his non-linear yet interconnected world of growth and inflation expectations in cross-asset class terms, here’s what else you’d have noticed last week:


  1. Commodities (CRB Index) were unable to bounce on a Down USD week and remain in crash mode -20.3% YTD
  2. Oil (WTI) continued to crash, closing down another -3.8% last week at -33.1% YTD
  3. Natural Gas deflation of -1.4% on the week took its YTD below that of crude oil at -38.2% YTD
  4. Cattle prices deflated another -3.5% week-over-week to -16.2% YTD
  5. Namibia’s stock market dropped another -6.2% on the week to -18.4% YTD


Seriously – who the heck cares about Namibia? Probably as many Federal Reserve people who care about cattle ranchers in Nebraska or pig farmers in Iowa (Lean Hog prices have crashed -35% YTD). So let’s just call all of these “no-price-stability” things transitory.


Reality is that for companies with heavy foreign currency, commodity, and/or emerging market exposure, 2015 was not good. The MSCI Emerging Markets index (ex-Namibia) was -0.9% last week and is -14.3% YTD.


And then of course you have the Credit Market Signal within the long-term US Treasury Yield signal. This is only the 4th time “high yield” credit has generated a negative annual return going all the way back to 1994. So I say we start talking ex-Energy, ex-Credit now too.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.19-2.33%

SPX 2057-2112
RUT 1165--1191
EUR/USD 1.05-1.09
Oil (WTI) 39.28-41.91

Nat Gas 2.10-2.25

Gold 1049-1089
Copper 1.99-2.09


Best of luck out there this week,



Keith R. McCullough
Chief Executive Officer


Unyielding Resolve - 12.07.15 EL chart

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