“You can only lose what you cling to”
-Buddha
Market participants, and humans by and large, have a pervasive tendency to describe events and expectations in binary and Boolean (true or false, definitively) terms.
The end of the cycle, the end of globalization, I’ll never find another job, I’ll never find another partner, interest-rates can only go up from here, etc ….
It’s understandable.
Professionally, if your business model is levered to clicks, opens or AUM accretion, the secret sauce remains in the artisan crafting of a S-cubed (snark, satire and sensationalism) based narrative. It’s vastly more sirenic and marketable than the converse (sober, subtle and subdued).
Imagine your “call” in December 2014 (SPX = 2088) was for equities to do precisely nothing, on net, over the subsequent 24 months (November 2016, SPX = 2088).
Correct? Yes. Marketable? Not particularly.
Life is a generally a negative reflection of our proclivity for binary absolutism.
Life is about commas – the next opportunity for success, for alpha, for love, for self-actualization. There are very few true periods.
Internalizing that reality – not putting a period where you should put a comma - is one of life’s most well-earned lessons.
Back to the Global Macro Grind …..
The macro narrative, both domestically and globally, is shifting a bit here with many established Trends flirting with potential inflection.
The inflation outlook, for example, remains a myopic focus for markets, so let’s consider that:
For most of 2017 equities and rates were positively correlated as rising yields were viewed as a reflection of an improving growth outlook.
That narrative reversed alongside (among other things) the hourly earning print in the February NFP report as accelerating inflation, the prospects of a steeper monetary policy trajectory and growing Treasury supply angst (Fed balance sheet run-down in combination with diversification away from U.S. dollar reserves and debt financed fiscal stimulus) supplanted Goldilicks as protagonist and markets transitioned to trade in directional lockstep with real rates – which, said another way, means inflation expectations became the principal driver of price action (inflation expectations driving nominal yields higher = higher real rates)
Speculative net short positioning in treasuries subsequently ramped to >2 Standard Deviations and the yield on the 10Y UST peaked at 2.95%. At the same time, coordinated, hawkish rhetoric out of the BOJ and ECB aimed at transitioning expectations towards QE cessation only perpetuated the moves in rates and volatility.
Importantly, remember, the build in consensus macro positioning and the collective Central Bank rhetorical shift was largely predicated on extrapolating rearview conditions forward – specifically, the expectation for a continuation in the harmonized global growth and inflation trend.
Shorting the 10Y at 2.95% and continued, synchronistic global growth were/are, skillfully or fortuitously, not our calls.
Against that backdrop, let’s review a selection of the latest inflation and inflation expectation data:
- U.S. Fundamentals: The February Hourly Earnings data failed to confirm the January breakout (we previewed that probability HERE) and the lack of breakout in the February CPI data proved to be fully discounted.
- U.S. Inflation Expectations (5Y5Y forward Inflation Swaps) = -14bps off the early February peak
- U.S. Inflation Expectations (10Y Breakevens) = -6bps off the early February peak
- $USD/Oil = the dollar is no longer going straight down and oil is no longer going straight up = disinflationary, at the margin
- Eurozone CPI = decelerated -20bps to +1.1% in February, marking a 3rd month of deceleration and the weakest print in over a year
- Eurozone Inflation Expectations (5Y5Y forward Inflation Swaps) = -9bps off the latest peak and making lower highs
- China PPI = decelerated -60bps to 3.7% Y/Y in February, marking a 4th month of deceleration and the lowest print in 16 months
In short, not quite a synchronized wave of global price acceleration supportive of a wholesale shift in policy. And if our #GlobalDivergences call begins to manifest more acutely with growth decelerating across some major developed market economies, disinflationary pressure will build not ebb.
Sure, a domestic political event could catalyze a move lower in the dollar and an escalation in retaliatory tariff and protectionist policy could have inflationary impacts but the primarily effects would be stagflationary in nature.
So, what to do?
Consider yesterday’s Home Builder Confidence data for March as it offered a nice case study in dealing with increasing market cross-currents.
Here’s how we contextualized the parallel dissonance currently being experienced by Builders:
Parallel dissonance represents the capacity to manage competing and conflicting views in your mind at the same time while not being left decisionally impotent by information toxicity.
It’s also the purgatorial cerebral chamber in which builders have been forced to take up residence of late.
Let’s start with rates as Builders have been forced to mentally balance and reconcile two opposing realities with respect to interest rates:
- On the one hand is the forced (re)acknowledgement that interest rate sensitive sectors are, in fact, interest rate sensitive and housing related equities rarely (never) perform well during periods of expedited interest rate increases.
- On the other hand, as we’ve now observed in multiple instances post GFC, rates rising remains the catalyst for rates falling as too high/too fast begets increasing equity angst and renewed concern about the growth/inflation outlook .... all of which, ultimately, feed-back negatively on yields.
As it relates to sector fundamentals:
- On the one hand, accelerating GDP, continued labor market tightening, rising after-tax incomes, incremental credit box expansion, cycle high consumer confidence readings and all-time lows in existing market inventory (which perpetuates the “if you build it they will come dynamic” for new construction) all remain positive for underlying demand
- On the other hand, labor shortages remain an ongoing source of industry angst, lot supply issues may be getting more acute, material costs are accelerating and the prospects for additional input cost pressure via further tariff and trade-war mongering have become a more tangible concern.
As a builder, what do you do with that convoluted constellation of cross-currents?
Practically, you probably don’t do much of anything (Sentiment was down -1 pt in March) and issue some canned, generic commentary precisely like that included in the March HMI press release.
Parallel Dissonance, of course, increasingly characterizes prevailing macro conditions more broadly. In addition to the inflation dynamics highlighted above, recall some of the higher-level macro dynamics domestically:
- Earnings Season: Earnings season in now rearview and profit cycle comps get increasingly harder
- 1Q GDP: We are now below the street on 1Q18 GDP
- Comps: Base effects across the following get decidedly more difficult through 2H18: GDP, Corporate Profits, Productivity, Consumer Confidence, Business Confidence, Savings Rate (& consumption growth by extension), Industrial Production, Durable Goods Orders, Capital Goods Orders, Retail Sales.
- Timing: But at the same time the current data remains ‘good’ and the data associated with the above won’t begin being reported until mid-late April, at the earliest.
The broader point is that sometimes watching and waiting is what you do …. just because we’re self-tasked with delivering high frequency tactical commentary everyday doesn’t mean there’s a rash of moves to make at every time and every price.
Measuring and mapping (the data) isn’t necessarily synonymous with ‘doing stuff’, particularly around prospective inflection points or phase transitions.
Permanence is not a defining characteristic of macro cycles. No periods, only comma’s.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:
UST 10yr Yield 2.79-2.91% (bullish)
SPX 2 (bullish)
RUT 1 (bullish)
NASDAQ 7 (bullish)
Biotech (IBB) 109-116 (bullish)
Energy (XLE) 66.00-68.78 (bearish)
REITS (RMZ) 1021-1065 (bearish)
Nikkei 201 (bearish)
DAX 12011-12485 (bearish)
VIX 14.32-20.31 (bullish)
USD 89.40-90.33 (neutral)
EUR/USD 1.22-1.24 (neutral)
YEN 105.33-107.17 (bullish)
GBP/USD 1.37-1.40 (bullish)
Oil (WTI) 59.73-62.98 (bullish)
Nat Gas 2.61-2.86 (bearish)
Gold 1 (bullish)
Copper 3.07-3.18 (bearish)
AAPL 173.99-182.29 (bullish)
AMZN 1 (bullish)
FB 178-188 (bullish)
GOOGL 1086-1183 (bullish)
NFLX 296-331 (bullish)
TSLA 316-347 (bearish)
Have a great weekend,
Christian B. Drake
US Macro Analyst
