“They are who we thought they were.”
If you haven’t seen then Arizona Cardinals Head Coach Dennis Green’s ~30 second rant following a disappointing blown victory over the Chicago Bears back in 2006, do yourself a favor and watch it: http://ftw.usatoday.com/2014/10/dennis-green-rant-they-are-who-we-thought-they-were-press-conference-cardinals-video.
Lately, I’ve been feeling some moderated version of how Coach Green felt then. In short-term-performance-chasing terms, we are definitely in the process of blowing what had been a clear lead over the bulls – or at least that’s what the general tone of questions in my inbox has been implying.
In that vein, I haven’t seen our competition attempt to catch falling knives across the spectrum of economic data since the last time they claimed “global growth had bottomed” back in early-November. I’ve had a fair amount of Bull Market Marketing Material forwarded to me in recent weeks – you know, the perpetually evolving list of reasons why you should be buying stocks (especially “for the long run”) – and most of it was what I thought it would be.
Back to the Global Macro Grind…
Unlike its cousin “Bear Market Marketing” (e.g. Zerohedge) which only exists to drive advertising revenues for its proprietors, Bull Market Marketing is an important part of our industry and our economy. If your investment horizon is long enough, you will most assuredly make money being long of stocks. There is also a lot of money to be made in the marketing of said bull markets.
Not to mention, the ingenuity of U.S. capitalism has been and continues to be a perpetual source of value creation over longer time frames. The economy would be much smaller and far less efficient if institutional investors did not generally remain fully invested, which itself effectively perpetuates the capital markets machine that helps to extend and lower the cost of credit across the economy.
All that being said, there have historically been periods where it has paid to be out of the market and we continue to think this is one of those instances. If all you did was buy cycle troughs and remain fully invested until you sold the ensuing cycle peak, you’d be the best investor in world history – irrespective of how good your stock picking or credit analysis skills are. While I can assure you that anyone expecting us to perfectly thread the needle on that goal will be as disappointed as they would be learning that I – a 6’4” black guy – cannot dunk, we will continue to work tirelessly towards it nonetheless.
As alluded to at the onset of this note, I think it’s important to revisit the debate about the state of and outlook for the U.S. economy. But before we do that, let’s just pretend for a few moments that the domestic credit cycle hasn’t inflected beyond the point of no return in recession terms. According to Reuters:
“U.S. small business borrowing fell 13 percent in January to the lowest level in more than a year… a fresh sign that economic growth could weaken in the coming months.”
Let’s also pretend that we’re not smack dab in the middle of a corporate profit recession and that those have not been consistent harbingers of stock market crashes domestically. If that’s not enough, I’m even willing to accept that corporate profits “are who we thought they were” – which would require a rather dubious eschewing of several important facts:
- On a non-GAAP basis, S&P 500 EPS climbed a mere +0.4% in 2015 – which represents the slowest growth rate since 2009 (Factset).
- On a GAAP basis, S&P 500 EPS plunged -12.7% last year – which represents the sharpest decline since 2008 (S&P/Dow Jones).
- GAAP EPS in 2015 was 25% lower than the non-GAAP figure – which represents the widest spread since 2008.
- Outside of 2008, the only other times the “GAAP gap” was as wide as it was last year was in 2001 and 2002. Recall that the domestic credit and corporate profit cycles had rolled over in each of those years as well.
- Much to the chagrin of the “ex-energy” bulls, the aforementioned 2015 “GAAP gap” was broad-based. In fact, Energy only accounted for $93B (36%) of the $256B aggregate spread across S&P 500 constituents. Healthcare and Tech accounted for $53B (21%) and $42 (16%), respectively.
While we’re in the process of ignoring bad information, we might as well omit the potential for the FOMC to make another egregious policy error at its meeting in a couple of weeks.
On that note, Fed funds futures currently peg the probability of a hike at only 8%; we’d be willing to bet that the probability of the FOMC opting to further “normalize policy” in 12 days is actually in excess of the +10.1% rally off the February 11th intra-day lows in the SPY.
We know the bull thesis for stocks and high-yield credit is ever-changing, but common sense would seem to suggest bulls can’t have their cake and eat it too. At this stage in the cycle, asset price inflation has direct policy consequences…
There. We’ve reset the macro debate to purely high-frequency economic data terms. With respect to the data, it’s been a fair fight between bulls and bears in recent weeks. On balance, domestic economic data has continued to surprise to the downside (per the Bloomberg U.S. Economic Surprise Index), but it has done so at the slowest rate since February ’15, breaking out above its ~8 month-long holding pattern in the process.
Aiding the aforementioned breakout were very solid Retail Sales, Real PCE and Durable Goods reports for the month of January, as well as the ISM Manufacturing PMI’s sequential uptick to 49.5 in February. As we discussed in section III of our 2/26 note titled, “We’re Wrong On U.S. Growth (Well, Kind Of)”, these data points, among others, nudged up our predictive tracking algorithm’s estimate for Real GDP growth in 1Q16 to +2.0% YoY and +1.0% QoQ SAAR.
To the extent those estimates – which are well below the Street, including the Atlanta Fed – hold firm, we are looking at a very marginal delta into the hawkish #Quad2 (i.e. growth and inflation accelerating concomitantly) for the first quarter of 2016. Recall that we had previously been tracking in the stagflationary #Quad3 (i.e. growth slowing as inflation accelerates).
More importantly, in recent weeks asset markets have been pricing in the material change in implied performance between these two GIP Model quadrants (i.e. expectations shifting from #Quad3 to #Quad2):
- Equities: The SPX has historically appreciated +1.1% on average per quarter with a 77% positive hit rate in #Quad2 vs. -0.2% with a positive hit rate of 48% in #Quad3 [INSERT massive short squeeze HERE]. REITS, Tech, Industrials and Healthcare have historically led the way in #Quad2 vs. Utes and REITS in #Quad3.
- Fixed Income: The performance of factor exposures in #Quad2 is almost the complete opposite of that in #Quad3. Specifically, yields and spreads tighten across the corporate credit spectrum in #Quad2 vs. widening across the board in #Quad3. The opposite is true for Treasury bond yields. The 10Y Treasury yield has backed up +17bps since its February 11th YTD low while the Bloomberg HY Index has rallied +5.4% over that same time frame.
- Commodities: The performance divergence in Gold between the two quadrants is not immaterial. Specifically, Gold has historically returned +1.6% on average per quarter in #Quad2 vs. only +0.6% in #Quad3. Gold is up +9.4% MoM.
- Currencies: The most important performance divergence between the two quadrants is that of the U.S. Dollar Index. Specifically, the DXY has historically returned +0.4% on average per quarter with a 62% positive hit rate in #Quad2 vs. only +0.1% with a 48% positive hit rate in #Quad3. The DXY is up +2.1% since its February 11th YTD low.
Even assuming recent signals from “the market” are right about #Quad2 here in 1Q16, we still think it’s important to pound the table on the undeniable fact that growth continues to slow on a trending basis across every major category of high-frequency economic data, as highlighted by the Chart of the Day and below. This keeps our #USRecession theme firmly intact; see the “transitory” GDP growth accelerations of 2Q00 and 2Q08 for more details.
And by the way, it turns out “the market” actually does agree with our assessment of the data – the bond market that is. The U.S. Treasury 10s-2s spread has actually compressed -4bps over the past three weeks and by -14bps over the past month. At 100bps wide, it’s the narrowest it’s been since late-2007.
We all know what happened after that.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 1.66-1.87% (bearish)
SPX 1 (bearish)
DXY 96.58-98.72 (bullish)
Oil (WTI) 29.25-35.46 (bearish)
Gold 1 (bullish)