Macro Playbook Update: Pricing to Perfection

Takeaway: Domestic capital markets continue to perfectly price in our forecasted GIP Model quadrant for 1Q16 (i.e. #Quad3 stagflation).

Earlier this evening, we received the following question from a very thoughtful [and successful] investor in response to our deep dive on Q4 2015 and full-year 2016 GDP

"What are the sectors that outperform and underperform in quad three? Quad four?"

Given it's obvious relevance and our interest in continuing to broadly own the U.S. capital markets debate, we thought we'd share our response with a broader audience:

"Hi John,

Thanks for reaching out; hope all is well, good sir.

In #Quad3, the sectors that have historically performed best are Utilities, REITS and Tech – in order from best to least best:

Macro Playbook Update: Pricing to Perfection - Utilities

Macro Playbook Update: Pricing to Perfection - FTSE NAREIT Index

Macro Playbook Update: Pricing to Perfection - Information Technology

The sectors that have historically performed most poorly in #Quad3 are Materials, Financials and Consumer Discretionary – in order from worst to least worst:

Macro Playbook Update: Pricing to Perfection -  Quad3 Materials

Macro Playbook Update: Pricing to Perfection -  Quad3 Financials

Macro Playbook Update: Pricing to Perfection -  Quad3 Consumer Discretionary

In #Quad4, the sectors that have historically performed best are Healthcare, Consumer Staples and Consumer Discretionary – in order from best to least best:

Macro Playbook Update: Pricing to Perfection - Health Care

Macro Playbook Update: Pricing to Perfection - Consumer Staples

Macro Playbook Update: Pricing to Perfection - Consumer Discretionary

The sectors that have historically performed most poorly in #Quad4 are Energy, Financials and Materials – in order from worst to least worst:

Macro Playbook Update: Pricing to Perfection - Energy

Macro Playbook Update: Pricing to Perfection - Financials

Macro Playbook Update: Pricing to Perfection - Materials

The table below details the breadth of our factor exposure backtest data according to the respective GIP model quadrant:

Macro Playbook Update: Pricing to Perfection - GIP Model Backtest Weighted

With 2016’s first month of PnL officially in the books, we are keen to highlight how domestic capital markets continue to perfectly price in ongoing #Quad3 stagflation.

Macro Playbook Update: Pricing to Perfection - UNITED STATES

Within the equity market specifically, Utilities, REITS and Tech are all outperforming the broader market by an equally weighted average of 424bps. Meanwhile, Materials, Financials and Consumer Discretionary are each underperforming the broader market by an equally weighted average of 327bps. The delta between our [only] preferred equity sector on the long side (i.e. Utilities) and our most preferred equity sector on the short side (i.e. Financials) is a whopping 1380bps. That is a ton of alpha without having to take on any market risk.

Macro Playbook Update: Pricing to Perfection - 1

Within fixed income specifically, our call to aggressively high grade bond portfolios is paying off as well. Our favorite long idea in the space (i.e. 30Y Treasury Bonds) is outperforming our favorite short idea (i.e. High Yield Credit) by 1049bps YTD already. Muni Bonds are delivering solid absolute and relative performance as well.

Macro Playbook Update: Pricing to Perfection - 2

Macro Playbook Update: Pricing to Perfection - Barclays Aggregate YTW
Macro Playbook Update: Pricing to Perfection - Barclays Aggregate OAS

Macro Playbook Update: Pricing to Perfection - Barclays High Yield YTW

Macro Playbook Update: Pricing to Perfection - Barclays High Yield OAS

All told, accurately forecasting directional trends in top-down growth and inflation readings continues to deliver a substantial degree of alpha for investors who are appropriately positioned for our forecasted quadrant outcomes. More importantly, we expect this #Quad3 divergence trade to continue for the next month or two. By mid-to-late March, however, the market may have begun to price in the economy’s inevitable shift back to #Quad4.

Will Healthcare and Consumer stocks be as defensive as they have historically been in #Quad4 during the next iteration (2Q16)? Per the hyperlinked research below, the fundamentals would suggest the answer to that question is a resounding “NO”. That said, however, the confluence of time and price will ultimately reveal the truth as it always does.

Hope this helps; let me know if I can expound upon or add anything. See you in a couple of weeks!"

Enjoy your respective weekends,

DD

Darius Dale

Director