Editor's Note: Below is a particularly prescient Macro research note written by Hedgeye Senior Macro analyst Darius Dale and sent to institutional subscribers. It was published on July 20, 2015. The S&P 500 had just hit an all-time high and Dale laid out our bearish view on U.S. equities.
Well timed. The market ultimately tumbled -12% in August after that note was published. Dale's thinking is instructive for investors still wondering what is happening in the more recent stock selloff. We were and still are bearish.
After nearly two months under water, the benchmark S&P 500 has finally made a new all-time high. While optically impressive, there are a myriad of quantitative signals underneath the hood that do not support chasing the market here.
Immediate-term TRADE Duration Risk: The SPX is at the top end of its immediate-term risk range of 2,091-2,130.
With nearly 2% downside, 0% upside and the VIX nearing the low end of our 11.29-14.59 immediate-term risk range, investors would do well to book gains in U.S. equities here (i.e. reduce gross and/or tighten net exposures). As Keith highlighted on today’s Macro Show, if 2,091 breaks, there’s no support to 2,035.
Intermediate-term TREND Duration Risk: Our Tactical Asset Class Rotation Model (TACRM) is now generating a “DECREASE Exposure” signal for U.S. equities. Currently, TACRM is generating a commensurate bearish signal for each of the six primary asset classes tracked by the model (slide 6).
Sell everything? As predicted in our previous refresh, the recent bullish-to-bearish reversals in Emerging Market Equities, Foreign Exchange and Commodities were, in fact, a harbinger for similar breakdowns across the Domestic and International Equities asset classes. Our recent decision to add SPY to the short side of our thematic investment conclusions confirm how we are thinking about this risk in real time. At the bare minimum, it implies investors would do well to reduce their gross exposure and/or tighten up their net exposure to global asset markets.
CLICK HERE to learn more about TACRM, what these signals imply and how best to incorporate them into your investment process.
Long-term TAIL Duration Risk: Market breadth is broadly deteriorating and in dangerous territory.
One of the conventional “isms” of stock market analysis is that benchmark indices tend to peak very late into the economic cycle – well after broad-based signs of deterioration have emerged at the single-stock level.
In the face of a #LateCycle slowdown, benchmark indices are able to continue higher due to the fact that investors increasingly crowd into large-caps and/or stocks that have idiosyncratic growth opportunities that are less tethered to the [deteriorating] economic cycle, at the margins. Ultimately the cycle always prevails (see: 2000-2002 or 2007-2009), but positive absolute returns can be sourced from an increasingly narrow group of stocks and/or style factors well into the start of any given bear market.
Source: Bloomberg L.P.
Source: Bloomberg L.P.
There’s a number of ways to measure market breadth on a trending basis (e.g. % of stocks making new highs, % of stocks correcting, % of stocks crashing, etc.), but for the sake of simplicity we track the percentage of stocks below their respective 50-day and 200-day moving averages in the Russell 3000 Index – which, at covering about 98% of the investable public equity market, makes it the broadest measure of the U.S. stock market.
On this measure, broad U.S. equity market breadth is as poor as it has been at any local peak since 10/9/07 – the previous cycle’s all-time high closing price for the SPX – surpassing the deterioration we saw at the 5/21/15 high, which was very much on par with the 7/19/07 local peak.
October 9th, 2007:
May 21st, 2015:
July 19th, 2007:
While not useful as a timing indicator, the aforementioned deterioration does imply the duration and scope for prospective returns are substantially worse than many investors may assume given consensus expectations for the length and strength of the current economic cycle, which we can loosely infer from consensus expectations for U.S. monetary policy.
Checking back in with TACRM, we are seeing market leadership increasingly concentrated amongst the exact style factors we’d expect to outperform in the latter innings of an economic and market cycle: large-caps (defensive safety and dividends), healthcare (increased consumption and the ability to maintain pricing power during economic downturns) and growth (many biotech and new tech companies don’t have earnings to speak of, therefore investors don’t have to worry about earnings misses derailing the momentum of the respective charts).
All told, we hope you find these quantitative signals helpful with respect to your individual investment mandate. As always, feel free to email us with questions.
Best of luck out there,