Growth = The Initiator

“It starts with a basic shape called the initiator.”

-Benoit Mandelbrot

If you want to build a fractal, you can evolve your process and get cracking on that this morning. In its most basic construction all you need are three things: an initiator, a generator, and a rule.

As everyone who works with me knows, one of my favorite initiators is a triangle. An equilateral triangle is the basic initiator for a fractal pattern called a Sierpinski Gasket. It’s named after a 20^th century Polish mathematician by the name of Waclaw Sierpinski.

That’s right. Instead of whining about Trump or “valuation” this morning, start winning with some 3-factor modeling. From a price, volume, and volatility perspective, the US Equity market continues to signal a fractal pattern we call Quad1.

Back to the Global Macro Grind …

One of the most basic initiators for a stock market is real growth. If real growth is accelerating, it generates a series of asset allocation, sub-sector exposure, and style factor rules inasmuch as growth slowing does.

On Friday we got an initial read on what was Q1 of 2017’s real GDP growth:

1. Initial Q1 GDP (subject to revisions) was +1.90% year-over-year
2. That was -24 basis points below Hedgeye’s forecast of +2.14%
3. The GDP Deflator (proxy for inflation) came in at its highest level since Q1 of 2012 = 2.3%

Since GDP effectively bottomed at +1.3% year-over-year growth in Q2 of 2016, the Q416 and Q117 GDP reports of +1.9-2.0% real GDP growth confirmed the TRENDING (multiple quarters) acceleration markets have been pricing in.

While it wasn’t a blowout GDP report, it wasn’t expected to be by either The Growth Bulls (us), consensus growth bears, or the bond market. Post the Q1 data-driven rate hike, bond yields have corrected inasmuch as the “reflation” trade has.

Alongside easing base-effect comparisons, Reflation’s Rollover (Q2 Macro Theme @Hedgeye) is one of the major reasons why Q217 GDP (i.e. the quarter we’re currently in as opposed to coming from) is going to accelerate on a real basis.

That’s what our process and model are signaling as the highest probability position to take. How about US Equity markets?

1. Nasdaq led the growth accelerating charge (again), closing up another +2.3% last week = +12.3% YTD
2. Russell 2000 registered another all-time closing high of 1419, then backed off to close the week +1.5% = +3.2% YTD
3. SP500 added another +1.5% week-over-week, closing just inside her all-time high of 2395 = +6.5% YTD
4. Tech (XLK) was +2.3% week-over-week to +12.4% YTD
5. Consumer Discretionary (XLY) was up another +2.1% week-over-week to +10.6% YTD
6. Utilities (XLU) were -0.1% week-over-week to +6.4% YTD
7. REITS (MSCI Index) dropped -2.7% week-over-week to 0.0% YTD

Sure, maybe both Hedgeye and Mr. Market are dead-wrong on their real US #GrowthAccelerating theme for Q2 of 2017… but we’d rather remain on the right side of the market’s trending score. If growth was slowing, Utes and REITS would be crushing it.

What’s actually getting crushed is the “reflation” side of this macro market TREND. Check out these weekly moves in “reflation” expectations within the context of 6 month returns:

1. CRB Commodities Index down (again) -0.1% last week and -4.0% in the last 6 months
2. Oil (WTI) down (again) -0.9% last week and -4.9% in the last 6 months
3. Sugar -2.3% last week remains in crash mode, -23.1% in the last 6 months
4. Rice down hard, -6.3% last week and -13.1% in the last 6 months
5. Cocoa remained in crash mode, -0.5% last week and -29.9% in the last 6 months
6. Nickel deflated another -0.4% last week and is -11.4% in the last 6 months

Rice, Cocoa, and Sugar? Are you kidding me Keith? Why can’t we go back to reading something on Zero Edge about “consumer spending being the weakest in 3 years”?

Real Consumption (reported real, remember, minus the highest Deflator since Q1  of 2012) only slowed sequentially (q/q, not a TREND) from +3.1% year-over-year in Q416 to +2.8% in Q117 and is poised to accelerate (again) with inflation slowing in Q2.

If you’ve been underweight “reflation” and long real growth, congrats. In stark contrast to the aforementioned 6 month returns for all sorts of inflation expectations, the Nasdaq and Russell are +16.5% and +17.9%, respectively.

You can slice and dice the trending (6 month) returns of SP500 Style Factors and you’ll see the same things:

1. High Beta was up another +1.5% last week = +18.3% in the last 6 months
2. Low-Yield was +1.9% last week = +13.5% in the last 6 months
3. Top 25% EPS Growers were up another +1.3% last week = +14.3% in the last 6 months

*Mean performance of Top Quartile vs. Bottom Quartile, SP500 companies

That’s probably why the Low Beta, Yield Chasing, and Slower For Longer portfolio looks a lot like the consensus that GDP of +1.9-2.0% is about as good as it’s going to get in 2017 (i.e. wrong).

Get the basic shape of real growth’s sine curve right and you’ll get a lot of other things right.

Our immediate-term Global Macro Risk Ranges (intermediate-term TREND views in brackets) are now:

UST 10yr Yield 2.17-2.37% (bullish)

SPX 2 (bullish)
RUT 1 (bullish)

NASDAQ 5 (bullish)

XOP 34.23-36.56 (bearish)

RMZ 1143-1172 (bearish)

VIX 9.91-12.58 (bearish)
USD 98.25-100.51 (bullish)
EUR/USD 1.06-1.09 (bearish)
Oil (WTI) 47.69-50.97 (bearish)

Best of luck out there this week,

KM

Keith R. McCullough
Chief Executive Officer