It’s been 9 years since this big bull market began.
Look at any economic indicator. It tells you the same story. The U.S. economy is entering the latter stages of expansion.
The risks are mounting. And timing the flip from bullish to bearish is critical.
Hedgeye CEO Keith McCullough hosted a free webcast to discuss the three market risks he’s watching very closely. These are the three things that could crack this bull market.
"The top three things that are on my mind are the rollover in inflation expectations, our GDP forecasts being the lowest on Wall Street and the profit cycle,” McCullough says.
You don’t want to miss this webcast.
We know you’re pressed for time: Below are three key takeaways from the webcast.
1. INFLATION EXPECTATIONS ROLLING OVER
At the end of January, Wall Street consensus was overwhelming long of Oil and short of 10-year Treasuries (according to the CFTC’s futures and options positioning data). The positioning expressed a clear macro view: Investors were long inflation. In anticipation of inflation running hot and Fed hawkishness, the 10-year Treasury rose to 2.956% in February (a 4-year high).
Our call has been, and continues to be, that because of this one-sided positioning even modestly underwhelming inflation readings would cause a shake-up. "We’re talking about here is a mild rollover in inflation expectations,” McCullough explains. “But what you've got right now are Fed rate hikes expectations at their max." There’s money to be made when investor positioning is so extreme.
Case in point: The February CPI reading (reported last week) was largely flat but 10-year Treasury yields were off as much as 16 basis points last week from the February highs. Meanwhile, yield-sensitive sectors like Financials (XLF) sector fell -2.8% last week and Utilities (XLU) bounced +1.7%.
We continue to think this theme has room to run.
2. U.S. GROWTH SLOWING?
The U.S. economy has rallied for six consecutive quarters now.
The best days may be behind us.
Since the U.S. economy bottomed (on a year-over-year basis) in 2Q 2016, our GDP estimates have been consistently higher than Wall Street’s forecasts. That’s changing.
"We've been super bullish because U.S. growth was accelerating,” McCullough says. “Now we’re getting less bullish because we’re starting to model U.S. growth slowing into the back half of 2018. But you have to be right on market timing."
Our GDP estimate of 2.64% year-over-year for 1Q 2018 implies a 7th consecutive quarter of U.S. #GrowthAccelerating. That implies 1.8% on a quarter-over-quarter SAAR basis. The Hedgeye forecast is now below Wall Street consensus. Bloomberg's consensus estimate is 2.8% year-over-year, or 2.5% QoQ SAAR.
“This is probably the biggest risk and it leads to all the other risks,” McCullough explained. “Growth slowing leads to more inflation slowing. It leads to the profit cycle slowing.”
3. PROFIT CYCLE SLOWING
It’s been another great quarter for corporate America.
Aggregate S&P 500 year-over-year sales and earnings growth for the fourth quarter came in at 7.8% and 14.4% respectively. Our favorite sector, Technology, reported 22.9% earnings growth over the same period. In the third quarter, the Information Technology sector recorded earnings beat of 10.8% versus the historical average of 4%.
"It's probable that by the time you get to 3Q of 2018, you’re going to have an earnings slowdown in rate of change terms in one of the fastest growing areas of the market and the sector that we’ve liked best, Technology,” McCullough says.
Why?
Earnings growth is recorded on year-over-year basis and, simply put, last year’s numbers were so good, they’re going to be a lot tougher to beat by such a wide margin, particularly in the third quarter. The “comp” against which Technology earnings have to beat in 3Q 2018 is 23.7% year-over-year growth.
In other words, this is probably as good as it gets.
There are a lot more investing takeaways in this webcast. CLICK HERE to watch the entire 42-minute discussion.
