“There is a way of being wrong which is also sometimes necessarily right.” -Edward Abbey
While my focus this week has been on timing the entry of both Long-term Treasury (TLT) and Bond Proxy (XLU) positions, something not so funny happened on the way to the “shorting Tech on valuation” forum. US Tech (XLK) just closed at yet another all-time high.
Yep. Tech (XLK) was up another +0.6% yesterday to +14.7% YTD. What did the valuation experts get wrong? That’s pretty straight forward – both the top-down unprecedented #acceleration in US GDP growth and the epic bottom-up #acceleration in Tech EPS growth.
That’s right. Being wrong for the right reasons is a tremendous learning experience for all of us in this profession. That’s the only way to not be wrong the next time. We live. We study. We learn, and we grow.
Back to the Global Macro Grind…
Just to put some numbers on what US Growth #Accelerating and Tech Bears had wrong:
- US GDP Growth has #accelerated (y/y) for an unprecedented 8 quarters in a row (prior record was 7 in the early 1990s)
- US Tech Earnings Growth has #accelerated to +45.6% year-over-year so far in the Q2 of 2018 Earnings Season
Anyone who has studied market history within the lens of the rates of change in GROWTH and INFLATION knows that when GROWTH is #accelerating, “expensive” growth exposures get more expensive until that causal growth factor slows.
Again, there isn’t a bear on Wall St. who prefaced their short FAANG or short NASDAQ ideas by telling you 8 quarters ago that “I realize headline GDP is going to have a +3% in front of it for 4 of the last 5 quarters and EPS growth is going to go from negative to +40-50%.”
Having been a bottom-up stock picker and aggressive short seller in the hedge fund community before starting Hedgeye, I learned a long time ago that if you don’t do macro as a component of your short selling #process, macro will eventually do you.
Back to the data dependence of it all, here’s your Q2 Earnings Season update:
- 116 of the SP500’s companies have reported aggregate year-over-year EPS growth of +24.4%
- 22 of the NASDAQ 100 companies have reported aggregate year-over-year EPS growth of +48.5%!
- 263 of the Russell 2000 companies have reported aggregate year-over-year EPS growth of +41.1%!
When you write about rates of change, the words should mean something. If “epic bottom-up #acceleration” in EPS growth doesn’t define what Mr. Market has been discounting for the last year, I don’t know what does.
Really epically huge, indeed.
So is it finally all “priced in”? Oh boy. The answer to that question doesn’t start with “valuation.” Markets don’t stop going up on valuation. Again, the answer starts with momentum in the rates of change in both top-down and bottom-up fundamental factors.
In rate of change terms, here are some things to consider that should be new for growth exposures in Q3:
- Q2 is the last “easy” comparison (using a 2 year look back) for US Tech Earnings Growth
- Q3 should be the 1st quarter in the last 9 where US GDP growth won’t #accelerate year-over-year and sequentially
- Q3 and Q4 are quarters where we still have #ChinaSlowing, #EuropeSlowing, and #EMSlowing
Interestingly, as global and cyclical growth continues to slow from their respective cycle peaks, what happens to US Growth as it continues to #accelerate is that it earns a higher and higher relative return.
That’s why the last 2 US stock market tops in my career (2000 and 2007) were characterized by narrowing breadth. On a very short-term memory basis, one way to think about this is the post-print divergence between Netflix (NFLX) and Google (GOOGL).
It’s not about what the “stock is up YTD.” It’s all about what the stock and/or factor exposure does on both an absolute and relative basis from here. God help any all-time high chart if the company’s growth slows and margins compress.
As for me, I’m not hyperventilating about when to “short Tech.” I have plenty of short ideas (China, Europe, EM, Financials, Industrials, etc.) that have already started to work for the right reasons. So why would I short sector and factor exposures that don’t yet have those?
What if the rates of change in both US GDP and Tech EPS growth start to slow in both the aggregate and from a single stock “idea” perspective? Oh, I will love that on the short side. Won’t you? Timing that right obviously matters.
On another important note about US Equity Sector Styles and long/short positioning, yesterday I sold Energy (XLE) in Real-Time Alerts and bought Utilities (XLU).
I’m moving the Bond Proxies (Utes and REITS) to #1 and #2 on the long side and staying with Financials (XLF) and Industrials (XLI) as #1 and #2 on the short side. Still bullish on Tech, but not as bullish as we were from Q4 of 2016. Stay data dependent, my friends.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:
UST 10yr Yield 2.78-2.97% (bearish)
SPX 2 (bullish)
RUT 1 (bullish)
NASDAQ 7 (bullish)
Utilities (XLU) 51.60—52.91 (bullish)
REITS (VNQ) 80.07-83.00 (bullish)
Industrials (XLI) 72.67-75.01 (bearish)
VIX 11.78-14.56 (bearish)
USD 93.90-95.25 (bullish)
EUR/USD 1.15-1.17 (bearish)
GOOGL 1 (bullish)
NFLX 339-382 (neutral)
Best of luck out there today,
KM
Keith R. McCullough
Chief Executive Officer
