“Priming the Pump …. Have you heard that expression? … I came up with it [that expression] a couple of days ago and I thought it was good.”
-President Trump, Interview with The Economist (5/11/17)
Deep Analysis tends to precede Deep Pockets.
Cutesy & cogent, eh? …. Especially if you get paid to analyze stuff!
But maybe the direction of causality actually flows the other way with the proclivity for deep pockets to fund deep analysis operating in a positive, inequality-building feedback loop.
Or maybe since there’s only a small degree of separation between anyone and some “accidental millionaire” it's just a completely spurious statement.
Or perhaps information toxicity terminally plagues deep analysis and it's a structurally simple process applied rigorously & repeatedly that drives consistent returns.
Maybe it's some teeming conditionally dependent cauldron of all of the above. It’s hard to know, especially early on a Friday morning.
I do know that the hereto Teflon Don(ald) actually said the headline quote above.
I’ll leave it to you to decide whether or not it represents another example of organized, idiot savant’ish chaos messaging tactics and what it implies about the deep pockets-cerebral fortitude relationship.
I also know there's not enough alpha cloth for every investor to be cut from it. So let’s attempt to prove our macro mettle and try to simplify some this weeks complexity.
Back to the Global Macro Grind…
Our #ReflationsRollover call wasn’t accidental. But it wasn’t hyper sophisticated either.
It was primarily, and simply, base effect driven as we comped against the worst growth figures of the Industrial Recession.
Now, with Commodities flagging, Energy and Materials underperforming, Manufacturing PMI’s slowing, Import Prices decelerating and Inflation Swaps and Breakevens all cresting and rolling off early year peaks, that Rollover has clearly manifest.
Has it been fully discounted?
If you missed yesterday’s Early Look, it was a good one.
We were simultaneously bullish and bearish. That wasn’t accidental nor was it conceptually complex. It was simply duration sensitivity.
From a Risk Management perspective, in the immediate term, the VIX was oversold and SPX, $USD, 10Y Yields, Tech and Consumer Discretionary were all overbought and we had actually shifted the RTA portfolio to net short.
In other words, yes, our pro-growth and disinflationary outlooks were largely priced in on an immediate term basis. So we sold some.
But our expectation for growth to improve and inflation to decelerate over the intermediate-term remains unchanged. So we’ll look to buy back those exposures on pullbacks.
Simple.
To make this tangible, consider Gold, as it’s been a particularly tractable example over the last month.
The macro factor flow impacting gold generally runs like this:
Nominal Yields ↑ + Inflation Expectations ↓ => real yields ↑ => Gold ↓
The simple intuition is that with inflation expectations falling and real yields rising the risk of currency devaluation is declining (as is the need to hedge against it) and the opportunity cost of not holding dollars is rising (as the real return on dollar assets is improving, on the margin).
If improving growth prospects predominate to support nominal yields while Reflation’s Rollover continues to dent inflation expectations then real yields will continue to rise and gold will remain under pressure.
And since we’re discussing the intermediate-term, allow me make some simple medium-to-longer-term predictions:
- Volatility will go up.
- Credit spreads - high yield in particular - will widen.
- If the Fed keeps hiking, commodities keep falling and China keeps slowing/tightening, EM outperformance will roll over.
- As the expansion crests and wage inflationary pressure builds, capital will cede share (of national income) to labor and profitability will see incremental pressure.
If you own your investment duration and can get leverage to those exposures without much carrying cost then, mi amigo, your pump is primed for favorably leverage to positive asymmetry.
In the nearer-term, however, Quad 1 (Growth Accelerating while Inflation Decelerates) carries some specific implications.
Historically, accelerating growth has served to constrain the upside in volatility and the downside in demand for corporate credit.
In short, multi-year tights in spreads, multi-year lows in Fx and Treasury volatility and decade lows in equity volatility are certainly notable asymmetries and those will all reverse … but a sustained, bearish breakout only really becomes the baseline expectation when the slope of growth turns negative - recall what happened when #Volatility’sAsymmetry (3Q14 Macro Theme) reversed as growth slowed from 1Q15-2Q16.
Lastly, I wanted to quickly touch on credit trends and, in particular, the 2Q17 Senior Loan Officer Survey that was released earlier in the week.
Recall, trends as of the 1Q survey were not growth positive as Banks had tightened standards for C&I loans for a 6th consecutive quarter, tightened CRE standards for a 7th consecutive quarter, tightened auto loan standards for a 3rd straight quarter and tightened standards for credit cards for the 1st time in over 6 years.
Credit trends are typically reflexive and self-reinforcing and that magnitude and duration of credit tightening is generally only observed during or preceding recessions.
However, we also floated the following:
“... a credible argument could be made that, in this instance, Credit trends are, at least in part, a lagged reflection of “this time was different” dynamics (industrial recession, capex recession, earning/profit recession without an “official recession”) – all of which are now demonstrating fledgling, positive inflections which may, again, subsequently flow through to credit trends on a lag.”
Or, more simply:
“Would you ramp investment or capex demand if growth is slowing, profit growth is negative and your confidence in the present and forward outlook is declining? Similarly, would you ramp credit extension in that environment?”
It was meant as a rhetorical question and implied the converse should also hold.
That is, with Industrial Production, Durable Goods, Capital Goods and Corporate Profits all now accelerating, SPX earning growth having its best quarter since 2011 at +15.5% YoY in 1Q17 and Aggregate Private Sector Income Growth accelerating to a 6-qtr high in the 1st quarter, will that show up in credit trends on some short but variable lag?
The answer, at least according to the 2Q Survey, is a conditional yes:
- On net, 2.8% of banks eased C&I lending standards for large and medium firms; 2Q17 is the first such instance in the last seven quarters.
- Lending Standards eased across all 7 categories of residential home loans.
- A net 7.8% of banks eased standards on Credit Cards
- On the bearish side: banks tightened auto loan standards for a 4th consecutive quarter, tightened standards across CRE loans for an 8th consecutive quarter and demand across most loan categories was lower sequentially
So, on balance, the credit box is expanding.
Do we need some additional clarity on fiscal and tax policy to support a notable pickup in demand on the corporate side? Yes, probably.
Is the slowdown in consumer loan demand concerning?
That’s more equivocal.
The slowdown in auto lending and demand has been pretty well advertised and “peak auto’s” is typically a mid’ish cycle phenomenon so the deceleration there isn’t acutely concerning.
On the Housing side, Mortgage Purchase Application volume is currently running at an 85-month high so consumers may, in effect, be trading lower-ticket discretionary consumption for high-ticket durables consumption.
Moreover, if income growth is accelerating the need to tap credit is diminished, on the margin.
As can be seen in the Chart of the Day below, as it stands currently, the acceleration in income growth is more than offsetting the deceleration in revolving credit growth and has served to buttress total household consumption capacity. Income growth and household consumption capacity are both at 6-qtr highs and should remain near current levels in 2Q as well.
Have a great weekend,
Christian B. Drake
U.S. Macro analyst
