“Lions Don’t Lose Sleep Over the Opinions of Sheep”
Some version of that mantra must maintain residence in the non-consensus psyche of a contrarian – even if it’s not said aloud.
We’ve been making and defending the late-cycle, growth-slowing call and selling rallies since July.
While commodities, currencies, EM and domestic small caps have been crashing and confirming that view for months, with the Dow and SPX now flirting with double digit drawdowns from their respective highs, our panglossian pushback stream has finally ebbed to a trickle.
Chinese traders getting multiple days off as the market trades limit down within minutes of the open is remarkable but not remarkably surprising.
The path by which being on the wrong side of the global growth curve manifests in interconnected market risk is always uncertain … the net result on prices, less so.
We’ll announce the details of our 1st major acquisition in the coming weeks but even if we never scale headcount beyond our core team from here, I won’t lose sleep.
I’d rather go to (macro alpha) war with 10 lions than a 100 sheep.
Back to the Global Macro Grind …
The capacity for information absorption is inversely related to density.
Drowning this missive with deep analytics may sound impressive and read well in the moment but a week from now most of it will be forgotten.
Instead, I’d like to focus on one salient point from our 1Q16 Macro Themes call from Tuesday (ping for the replay/details if you missed it).
We are past peak in corporate profitability.
That’s not our contention, that’s simply the data.
The peak in both SPX operating margins and aggregate corporate profits is now rearview – and with growth estimates declining, income and consumption growth slowing, capex plans falling and inventories continuing to grow at a premium to sales, the retreat in margins looks set to persist over the nearer-term.
Earnings growth and corporate profits have been negative QoQ for two consecutive quarters as of 3Q15 and should be negative YoY in back-to-back quarters once 4Q15 is reported.
Earnings recessions have preceded actual recessions in each of the last three cycles and margin contractions greater than -60-70bps have almost always coincided with economic contractions.
The ‘almost’ modifier sits as the battleground point currently.
The last time we saw a significant earnings and margin contraction without a subsequent economic recession was in 1985-86 when oil prices dropped ~60% and profitability in the energy sector cratered, dragging broader EPS growth and profitability down as well.
Superficially, that sounds very much like the current setup – although global macro dynamics and the capacity for policy to cushion a decline are decidedly different.
So, could we again avoid a recession amidst an energy/industrial-centric profit recession?
Perhaps, but that may or may not be the right question.
In the Chart of the Day below we show corporate profit growth vs forward year returns in the S&P500.
The takeaway is straightforward: While 2+ consecutive quarters of declining corporate profits haven’t always signaled recession, such occurrences have always signaled stock market crashes in the subsequent year.
Limit down with no liquidity is the lion’s den for complacently long PnL. Last refuge currency devaluations and the limiting of shareholder sales to 1% of shares outstanding within a 3-month period (the CSRC response to today’s action in China) is a sheepish, reactionary policy response to market gravity.
Complacently long of Gravity is usually the better allocation.
To borrow the poker phrase: If you look around the lion’s den and can’t tell who the sheep is ….
… It’s okay, both sheepishness and asset allocation are (reversible) choices - keep moving.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.09-2.25%
Oil (WTI) 32.06-36.88
To long bonds and long sleeps,
Christian B. Drake
U.S. Macro Analyst