“Math gives us a way of being unsure in a principled way.”
As someone who has been bestowed with the great privilege of forecasting growth, inflation and policy for ~50 economies, I live in a constant sea of uncertainty. In fact, embracing uncertainty and having the humility to react to (as opposed to stubbornly fighting) changes in trends across economic and financial market data is a differentiating hallmark of our macro research process.
Forecasting is fun. It’s also something that I’ve been doing at a reasonably high level for the better half of the past 30 years. As much as I appreciate the various challenges and rigor associated with our proprietary GIP modeling process, my primary passion for forecasting lies in talent evaluation and player projections for the sport of American football.
Last night kicked off round #1 (of seven) of the 2017 NFL Draft, which effectively is the Super Bowl for scouts like myself – both amateur and professional. Per usual, the first round was chocked full of surprises with several notable prospects being over-drafted and a few others falling well below where a consensus assessment of “fair value” might have implied they should’ve been selected.
For those of you who care, each year I put together a scouting report that contains my projections on some of the draft’s more contentious high-profile prospects. Relating this to our industry, this presentation contains my high-conviction views on the key “battleground stocks” and is a good read to the extent you appreciate either the game of football or contrarian investing (CLICK HERE to download).
My notable “wins” in recent years include Russell Wilson and Aaron Donald – two players currently enjoying eventual Hall of Fame careers and my notable “misses” include Johnny Manziel (sorry Frank!) and Cam Robinson. Much like in investing, you win some and you lose some in the world of NFL talent evaluation.
Back to the Global Macro Grind…
Today kicks off round #1 (of three) of the BEA’s estimate of U.S. GDP growth in the first quarter of 2017. Much akin to the practices of NFL Draft pundits or equity research analysts, the economist community will rush to provide their thoughts on the quarter. And much like the consensus initial assessment of the former communities, the latter will have a lot to say about nothing.
I get into this discussion all the time – most often with new clients – but what exactly does a QoQ SAAR growth rate tell us about the state of the U.S. economy? Moreover, how does a QoQ SAAR growth rate compute with fundamental trends across the companies and industries you follow?
I’ll spare you a lengthy diatribe this morning, referring you to a couple of our more detailed pieces on the subject (“Do You QoQ?” and “So Which One of You Is Right on U.S. Growth?”) and just say that the results of our GIP Model backtest are more than robust enough to support the view that, intuitively, it just makes more sense to think about the broader economy in YoY rate-of-change terms.
Going back to my initial point, we’re probably the only firm you’ll hear from today that won’t overtly focus on the headline (i.e. QoQ SAAR) growth rate of Q1 GDP. It’s not that it doesn’t matter; I enjoy a friendly game of pin-the-tail-on-the-GDP-donkey as much as any bowtie-wearing economist with multiple degrees from hallowed institutions like the one Keith and I attended in New Haven, CT. I’m just saying it won’t be our focus.
With respect to how we prefer to contextualize this morning’s GDP release:
- With the advent of yesterday’s Durable Goods, Capital Goods and Trade data for the month of MAR – all of which slowed sequentially on a YoY rate of change basis – as well as Wednesday’s negative revision to MAR Retail Sales, our final U.S. Real GDP forecast for 1Q17E is now +2.14% YoY/+1.55% QoQ SAAR. Please note that this represents negative revisions of -12bps and -48bps from last week’s update of +2.26% YoY/+2.03% QoQ SAAR.
- The aforementioned forecasts compare to +2.10% YoY/+1.40% QoQ SAAR for Bloomberg Consensus, +1.79% YoY/+0.17% QoQ SAAR for the Atlanta Fed and +2.42% YoY/+2.65% QoQ SAAR for the New York Fed.
- It’s important to note that our final forecast highlighted above still has the U.S. economy tracking in #Quad2 for 1Q17E.
- In the absence of MAR Real PCE data – which will be released Monday 5/1 – our best estimate for the GDP Deflator in Q1 is +2.5%. The model has a standard error of 50bps, so it would not be a surprise to see it come in at +3.0% QoQ SAAR. This represents tangible downside to +1.05% from our current +1.55% QoQ SAAR estimate highlighted above and implies essentially no change to 4Q16’s +2.0% YoY growth rate.
- The exact contributions to headline growth from the Trade Balance, Inventories and [implicitly] Residual Seasonality – which are far and away the three hardest factors to predict – remain elusive from a forecasting perspective. That said, however, it is likely that the drag on growth from Trade will be lower than the -182bps rate recorded in Q4, the contribution to growth from Inventories will be less than the +101bps rate recorded in Q4 and that the Atlanta Fed’s “GDPNowcast” model has once again has picked up on a considerable degree of Residual Seasonality here in Q1 (see Chart of the Day below).
In summary, I’ll leave you with the following quote from renowned philosopher W.V. Quine:
“To believe something is to believe that it is true. Therefore a reasonable person believes each of his beliefs to be true; yet experience has taught him to expect that some of his beliefs – he knows not which – will turn out to be false. A reasonable person believes, in short, that each of his beliefs is true, yet some of them are false.”
I believe our Q1 GDP forecast is accurate (we’ll find out at 8:30AM EST). Yet I also believe there is a reasonable chance it might not be and it still might not even matter (FYI, we’re a third of the way through Q2). Judging by the outperformance of the following sectors and style factors we’ve liked on the long side throughout the YTD, the market is clearly anticipating our forecasted delta into the ever-bullish #Quad1 for at least the current and upcoming quarters:
- S&P 500 Technology Index: +14.5% (vs. S&P 500 at +6.7%)
- S&P 500 Consumer Discretionary Index: +11.1% (vs. Energy at -10.1%)
- S&P 500 Growth Index: +10.1% (vs. Value at +2.9%)
We haven’t gotten everything right (e.g. Financials up only +2.1% and the DXY down -3.1% YTD) and our four-quadrant GIP tactical asset allocation process isn’t bulletproof. That said, however, with High Yield OAS -34bps tighter on the year in the face of pervasive price deflation across the energy complex, we’re feeling pretty good about being the non-consensus, data-driven U.S. growth bulls.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.17-2.37% (bullish)
SPX 2 (bullish)
EUR/USD 1.06-1.09 (bearish)
YEN 109.15-111.88 (bearish)
Oil (WTI) 47.63-50.55 (bearish)
Gold 1 (bullish)
Keep your head on a swivel,