Little Things

“The number of really distinct mathematical concepts and tools at our disposal is surprisingly small.”

-Benoit Mandelbrot (aka The Brot)

As any great athlete, analyst, and/or portfolio manager knows, doing a lot of the little things right adds up. Taking short-cuts, lacking discipline, and being inflexible does too (not in a good way).

While the number of really distinct modeling principles associated with our process is relatively small (Calculus, Bayesian Inference, etc.), the multiple factors we have to consider across multiple durations is considerably larger.

That’s why I’m such a big fan of The Brot. The mother of all encompassing concepts is fractal geometry. It knows no bounds. It abhors the consensus path of linearity and it embraces the uncertainty of our ever-changing ecosystem. I love that.

Back to the Global Macro Grind…

One of the most basic mathematical concepts embedded in calculus is the rate-of-change. One of the biggest factors considered by “bottom-up” analysts and portfolio managers alike is the rate of change during Earnings Season.

Since my sector analysts can help us measure and map the rates of change at the individual company level, I simply let them do their job as I consider the #ProfitCycle from a “top-down” perspective.

Not to be confused with the lows of last year’s US profit #Recession (when the rate of change of US corporate profits was negative, on a year-over-year basis, for multiple quarters in a row depending on the sector):

1. 283 of 500 S&P 500 companies have reported POSITIVE year-over-year sales and earnings growth
2. Aggregate SALES growth is currently tracking at +4.3% year-over-year
3. Aggregate EPS growth is currently tracking at +5.9% year-over-year

And, from both a sales and earnings perspective, these are the highest aggregate growth rates we’ve seen during Earnings Season. Sales and earnings have been accelerating, weekly, as we move past the half way point of the reporting period.

Digging into the Sector Styles:

1. Basic Materials – 16 of 25 companies have reported aggregate SALES and EARNINGS growth of +6.1% and +7.6%
2. Technology – 43 of 66 companies have reported aggregate SALES and EARNINGS growth of +7.0% and +9.3%
3. Financials – 52 of 63 companies have reported aggregate SALES and EARNINGS growth of +5.1% and 10.6%

All 3 of these sectors fit our Quad2 (growth and inflation accelerating) asset allocation for Q4 of 2016.

All 3 of these sectors have been beating the SP500 since the election. I’m still a buyer of all 3 of these sectors (XLB, XLK, and XLF) on pullbacks to the low-end of my immediate-term risk range because all 3 sectors continue to signal bullish TREND.

Looking ahead at the “earnings compares” (year-over-year EPS comparisons) for all 3 of these sectors:

1. Basic Materials registered -16% and -9% y/y EPS growth in Q1 and Q2 of last year
2. Technology registered -7% and -3% y/y EPS growth in Q1 and Q2 of last year
3. Financials registered -14% and -7% y/y EPS growth in Q1 and Q2 of last year

That’s right. You remember now. At this time last year, there were plenty of reasons for stocks and their respective sectors to be in crash mode. That’s generally what happens when earnings go negative!

Then…

1. The Fed had to pivot hard, to dovish, devaluing the Dollar in 1H of 2016
2. Bond Yields put in their all-time lows (Q2 of 2016)
3. And the beginning of a bottoming process began

So, you might want to send this note to the “valuation” experts who have been shorting Higher Beta US Equity exposures for the last 3 months… and remind them there’s a not-as-smart guy saying that:

A) When the rate of change in sales and earnings is accelerating, you tend to get multiple expansion

B) When the rate of change in sales and earnings is decelerating, you tend to get multiple compression

And since valuation isn’t a catalyst (phase transitions in rates of change are), you don’t really have a catalyst until maybe Q3.

That’s when the sales and earnings acceleration might slow. But we’ll have to see about that. That’s where our buddy Bayes comes in. He’s big time on having an open mind to all the little things embedded in the rate of change data.

Our immediate-term Global Macro Risk Ranges are now:

UST 10yr Yield 2.40-2.55%

SPX 2

NASDAQ 5

VIX 10.12-12.54
USD 99.25-101.20
EUR/USD 1.05-1.08
Oil (WTI) 52.23-54.31

Gold 1183-1236

Best of luck out there today,

KM

Keith R. McCullough
Chief Executive Officer