“There is a thin line between being a hero and being a memory”
-Optimus Prime
You know how after the 1st scene of the latest Transformers movie you realized you’d never get those 20 minutes back and spent the subsequent 129 minutes lamenting the magnitude of Michael Bay’s mailing-it-in’ness? Why even make the movie?
Well, with the bond market closed, U.S. equity volume down -20%, zero domestic eco data, Japan closed, Canada closed and Italy hoping Columbus might get lost again and manage to somehow discover some positive 2nd derivative growth data, that was pretty much yesterday’s forgettable reality for ticking red & green number enthusiasts. Should the market really even be open?
POTUS was, of course, over-engaged in some now requisite superfluous activity, Erdogan stepped further down the dictatorial rabbit hole and Catalan risk headlines were quick to fill the headline void left by the dearth in hard macro data.
But as every good macro-tician knows, if you stay ready you never have to get ready so…
Back to the Global Macro Grind…
I’m a not so closeted reductionist, as regular readers are aware. Intuitive simplicity distilled from complexity has a not so sneaking tendency to work – in investment space - more often than not.
And nothing provides the mental latitude for big picture thinking like low volume, low volatility days with no tangible fundamental catalysts.
One Factor To Rule Them All …
Consider the deep simplicity in the chart below. It’s a setup slide in our 4Q17 Macro Themes presentation and shows the 10-quarter trend in GDP Growth (Y/Y).
GDP Growth slowed progressively for 5-quarters from +3.8% in 1Q15 to +1.2% in 2Q16. Growth then inflected off that 2Q16 low and progressively accelerated to +2.2% over the subsequent 4 quarters.
What should be simple, intuitive and surprising to no one is that #SlowGrowth Quad 3&4 exposures outperformed materially during the first period while #GrowthAccelerating Quad 1&2 exposures outperformed significantly during the 2nd period.
Is it that simple?
Sine curve optimized allocations … Get the Trending slope of growth right and get most of the big macro sector and style factor allocations right with everything else sitting as trivial but occasionally sirenic noise.
That is, indeed, most of it and it’s even most-er when the growth curve, globally, looks similar. Such simple truthiness and “insight” probably doesn’t get you paid 2 & 20. Correctly and recurrently forecasting and front-running it might.
Anyway, the growth discussion naturally leads to a consideration of the burgeoning set of factors underpinning increasing investor angst around market imbalances.
To name a few:
- U.S. investment Grade spreads
- U.S. High Yield spreads
- U.S. IG CDS
- U.S. (& broader DM) Equity Volatility
- U.S. Equity Valuation (pick your measure)
- EU IG and HY Spreads
- EM Hard Currency Debt
- Geopolitical risk and policy uncertainty
Those market price realities – all of which are at cycle or all-time highs/tights - sit as negatively asymmetric risks at current levels.
But that’s been broadly true for a while now. When do they really start to matter?
The short answer is that they start to matter when that growth chart stops trending up and to the right.
Take the multi-quarter deterioration in the subprime auto and credit card space as it sits as a tractable example, in microcosm.
The emergent rise in delinquencies and charge-offs is notable and certainly worth monitoring but the risk doesn’t really propagate until the labor market rolls. As it stands, labor conditions continue to tighten and initial claims continue to put in their trough.
The risk is real and will manifest more acutely but you have to pocket that eventuality and come back to it when separations start to inflect higher.
This brings us to the outlook for growth and it is, admittedly, less ‘clean’ than it’s been in recent quarters.
To be clear, our current forecast continues to call for further acceleration but we’re likely to see less congruous improvement, particularly from an earnings growth and corporate profitability perspective.
Taking a multi-duration approach, it looks something like this:
Profit Cycle/Intermediate-term: In the Chart of the Day below the rate-of-change gravity embedded in the comps is evident. The easiest comps are now rearview as we move past trough comparisons from the industrial and profit recession and we’re likely to see further sequential deceleration in year-over-year earnings growth. Comp dynamics are similar across both corporate profitability and productivity in the aggregate.
Growth Accelerating, Profits Accelerating, Productivity Accelerating is a strong bullish trinity and one that is now likely to get less good from a rate-of-change perspective.
Immediate-Term: Hurricane related supply constraints helped juice the Headline ISM Manufacturing and ISM Services readings to 161-month and 146-month highs, respectively. While the headline benefited from the positive distortion, the internals in both reports were broadly positive with New Orders improving sequentially and printing >60. That New Orders improvement accords with the preponderance of Regional Fed Surveys for September which reported the same, signaling continued strength in activity nearer-term.
The weather related distortion will also provide a conspicuous benefit to Friday’s Retail Sales report for September. Harvey related replacement demand helped drive unit auto sales +15.2% M/M and +4.65% Y/Y. Autos represent ~20% of Total Retail Sales and Autos + Gas Station Sales (recall, Retail Sales are reported nominally so energy/gas price inflation boosts reported spending) are ~30% of total.
In other words, expect more reflationary and growth accelerating data domestically this week, at least.
I’ll leave it there this morning and let Albert close it out ….
“If you can’t explain it simply, you don’t understand it well enough” (Albert Einstein)
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:
UST 10yr Yield 2.25-2.40% (bullish)
SPX 2 (bullish)
RUT 1 (bullish)
NASDAQ 6 (bullish)
VIX 9.05-10.88 (bearish)
Christian B. Drake
U.S. Macro Analyst
