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Key Takeaways:

  1. Domestic economic growth continues to both accelerate and surprise both economist consensus and investor consensus to the upside in the process.
  2. We, however, have been anticipating these outcomes for nearly a year now and our models continue to project upside through at least 1Q18E.
  3. We reiterate our bullish bias on U.S. equity and credit beta, as well as our preference for growth over value and consumption/services exposure in lieu of cyclicals. 

It’s great to be a U.S. Growth Bull. As a millennial in his early 30’s it’s easy to miss the days when Ringling Bros., Barnum and Bailey wasn’t headline news, but I press on instead. There’s something about the opportunity that American Capitalism provides that gets me excited to wake up every day and compete.

Q3 GDP: Closest to the Pin (Again) and Why Bears Need Gin - American Flag with Eagle

Speaking of competition, this is the 2nd and 3rd straight quarter we’ve been closer to the pin than Bloomberg Consensus and the Atlanta Fed, respectively, with respect to forecasting headline real GDP growth, which came in at +3.0% QoQ SAAR for 3Q17. Recall that we were anticipating growth to come in at +3.26% vs. +2.60% for the former and +2.52% for the latter.

While I genuinely could care less about the Macro Tourism embedded in playing pin-the-tail-on-the-headline-GDP-donkey four times a year, it’s nice to know that our proprietary forecasting methods and associated tools are effective. It feels good to challenge the establishment economics community with unique perspectives (e.g. GIP Model, forecasting via Bayesian Inference, etc.) and earn a seat at the table. Football and hockey players need to eat too (especially us offensive linemen)…

Moving along, the 2nd straight 3-handle on the headline real GDP growth rate represented a sequential acceleration of +10bps on the YoY growth rate to +2.3% YoY (a mere 3bps shy of our estimate) and confirmed our #Quad2 forecast for 3Q17. Our initial volley for 4Q17E represents a mere +6bps acceleration +2.36% YoY, which translates to a deceleration on the headline figure to +2.15% QoQ SAAR.

Q3 GDP: Closest to the Pin (Again) and Why Bears Need Gin - U.S. Real GDP Estimates YoY

Q3 GDP: Closest to the Pin (Again) and Why Bears Need Gin - U.S. Real GDP Estimates QoQ SAAR

Q3 GDP: Closest to the Pin (Again) and Why Bears Need Gin - U.S. GIP Model

Q3 GDP: Closest to the Pin (Again) and Why Bears Need Gin - GDP Summary Table

The Animal Spirits in me feel like that number is a bit low relative to the ongoing recovery in corporate profits and how that will likely feed into an increased demand for capital expenditures here in Q4, but, thankfully, how I feel is not an input in our dynamically-reweighted 30-factor predictive tracking algorithm for U.S. GDP. If said indicators were to materially accelerate throughout Q4, our model will pick up on that. In an era where Data Science will be increasingly relied upon to drive returns, I think that’s a nice alternative to having “boots on the ground”. The economy is, in fact, humming where I live in Gramercy, however…

Base effects for CPI steepen markedly here in Q4 and again in 1Q18E and that progression is the sole reason we are currently well below economist consensus with respect to headline inflation over the next few quarters. Our real-time inflation tracker picked up on the acceleration recorded in the previous quarter and now that model is once again pointing to a rollover in reflation – at least in reported terms – much like it did from the February peak (though by a considerably reduced degree).

Q3 GDP: Closest to the Pin (Again) and Why Bears Need Gin - U.S. Headline CPI Estimates YoY

Q3 GDP: Closest to the Pin (Again) and Why Bears Need Gin - CPI Base Effects

Q3 GDP: Closest to the Pin (Again) and Why Bears Need Gin - INFLATION MODEL

With our #1 preferred factor exposure in the U.S. equity market for nearly a year now (i.e. the NASDAQ 100/QQQ ETF) up nearly +3% today to +28% YTD on yet another upside surprise in domestic economic growth, this note might sound like somewhat of a victory lap. It isn’t; we realize such buffoonery is not helpful for investors managing the daily stresses associated with a PnL. What is helpful, however, is reminding investors of the quantitative risk management setup heading into today’s print:

  1. Front month implied volatility was trading at a +115% and +138% premium to trailing 30-day realized volatility in the NDX and QQQ’s, respectively. Those figures represented 1Y Z-Scores of +3.0 and +3.6, respectively.
  2. Heading into the week, speculative net length within the futures and options markets for NADAQ e-minis was a lowly +30,930 contracts. That represented a decline of -75,053 contracts over the past six months, as well as a 1Y Z-Score of -1.52.
  3. The confluence of these signals suggested to us that buy side consensus was [relatively] bearishly positioned on the factor exposure we’ve felt was the best way to play a domestic economic recovery all year long. Largely citing valuation concerns, the preponderance of investors have been fighting the aforementioned gains the bulk of the way up – at least in the context of how we quantify sentiment using these (among many others) proprietary indicators from the derivatives markets.

Q3 GDP: Closest to the Pin (Again) and Why Bears Need Gin - S P 500 TTM PE vs. ISM Manufacturing

Q3 GDP: Closest to the Pin (Again) and Why Bears Need Gin - Tech Valuation

What is also helpful is reminding investors of the fundamental catalysts perpetuating those stellar returns:

  1. Growth as a style factor does extremely well when growth is accelerating (go figure).
  2. The domestic economic cycle has legs – at least through the first half of 2H18E and likely well beyond – irrespective of tax reform.
  3. Tax reform is an explicitly bullish catalyst for the growth style factor considering that large-cap Tech accounts for the lion’s share of offshore retained earnings.

Q3 GDP: Closest to the Pin (Again) and Why Bears Need Gin - Russell 1000 Growth GIP

Q3 GDP: Closest to the Pin (Again) and Why Bears Need Gin - Tech GIP

Click HERE, HERE and HERE to download presentations jam-packed with proprietary analysis that support the aforementioned claims (132 slides in total).

All told, domestic economic growth continues to both accelerate and surprise both economist consensus and investor consensus to the upside in the process. We, however, have been anticipating these outcomes for nearly a year now and our models continue to project upside through at least 1Q18E. We reiterate our bullish bias on U.S. equity and credit beta, as well as our preference for growth over value and consumption/services exposure in lieu of cyclicals.

Enjoy your respective weekends,

DD

Darius Dale

Managing Director