Our internal GDP tracking algorithm indicates U.S. economic growth is accelerating and inflation is slowing down. Historically, that's been the best time to own domestic equities. That's why on any stock market pullback we are enouraging investors to buy.
Save your skepticism, hear us out.
Q1 is Done: A Brief Review
It's now the second quarter of 2017. The S&P 500 has obviously had an impressive run year-to-date.
Here's the sector breakdown:
- S&P 500: +5.5%
- Technology (XLK): +10.2%
- Consumer Discretionary (XLY): +8.1%
- Health Care (XLK): +7.9%
- Utilities (XLU): +5.6%
- Consumer Staples (XLP): +5.6%
- Materials (XLB): +5.5%
- Industrials (XLI): +4.6%
- Financials (XLF): +2.1%
- Energy (XLE): -7.2%
From a sector performance perspective, Tech and Consumer Discretionary leading the pack is exactly what you'd expect to see as the U.S. economy heats up.
Even more drastic is the trend in High Beta versus Low Beta stocks.
High beta stocks are the companies most tethered to swings in the broader stock market. In other words, the highest beta stocks jump or fall more than the S&P 500, as the stock market moves higher or lower. Conversely, Low beta stocks are less correlated to the direction of the broader market.
This matters today because high beta stocks typically outperform, historically, when the U.S. economy is growing. Over the last six months, that's exactly what has occurred. High beta stock are up 13.6% over that period versus 4% for Low beta.
Unsurprisingly, this breakout in high beta stocks also corresponded with the bottoming out of the U.S. economy.
U.S. GDP fell for five straight quarters from Q1 of 2015 when U.S. GDP was +3.3% year-over-year to Q2 of 2016 at +1.3% year-over-year. Then U.S. economic activity picked up in the third quarter. As the data came rolling in for the quarter, around October, high beta stocks really took off.
We expect the U.S. economy to continue to accelerate just as inflation slows down. Case in point, Hedgeye CEO Keith McCullough breaks down last week’s commodity moves within the context of their 6 month returns in today's Early Look:
- CRB Index (19 Commodities) was +1.3% last week but is actually down -0.2% in the last 6 months
- Oil (WTI) reflated an impressive +5.5% last week but is also down -1.1% in the last 6 months
- Gold was dead flat at 0.0% last week and has been terrible, down -5.7% in the last 6 months
We say commodity prices have peaked, expect them to start falling once again.
Why the recent peak in inflation?
As you can see in our Chart of the Day below, the nineteen commodities within the CRB Index fell off a cliff last year. That's why we said inflation, or reflation, would accelerate, particularly in the first quarter of 2017, on a year-over-year basis as commodities lapped last year's bombed-out levels.
U.S. consumer price inflation hit five year highs recently.
In other words, the peak may be in.
Note: As inflation rolls over that's additive to U.S. GDP. "As most of you know, as reflation slows, what they call the GDP “Deflator” falls… and REAL GDP accelerates in kind," McCullough writes this morning.
The U.S. economy is accelerating and inflation is slowing down.
Here's a bit of advice on how to play this set-up. The Nasdaq hit an all-time high on Thursday. As we wrote Friday, it's time to book gains, then wait and watch for a pullback. We'd suggest investors buy any pullback as U.S. heats up, particularly into the second, third and fourth quarter of 2017.