“People remember the recent past better than the distant past. We predict by extrapolation”
-Bruce Greenwald
“Bird-in-Hand” arguments for analyzing a business probably get less and less attention the longer that broad-based economic growth accelerates.
If you’re on the right side of the “surprise factor” on growth, you can ride the wave of consensus re-rating toward steeper projected growth trajectories. Worry about getting the “E”, “EBIT”, etc. correct.
That’s our view anyway which is why the first slide in the #CyclicalPeaks section of our Q4 Macro themes presentation that we rolled out last Thursday shows the tight fit between sales/margins/earnings growth for corporates relative to what has been 8 consecutive quarters of real economic growth accelerating.
Steeper projected trajectories on growth of course mean that the pull-forward impact, should expectations about the future change, is typically going to be more violent… More volatile.
Greenwald goes on to write that “valuations vary significantly if the underlying assumptions are off by only small amounts”.
Back to the Global Macro Grind…
The visual referenced above is also the Chart of the Day where we show that the second derivative in GDP tracks the second derivative in sales, earnings, and margins nicely:
- US GDP growth bottomed in Q2 of 2016 at +1.3% YY, and has accelerated for 8 consecutive quarters to +2.9% YY in Q2 of 2018. As you know, the probable scenario in Q3 is that this streak will be extended to 9 quarters.
- Sales and earnings growth for S&P 500 constituents tracks this sine curve nicely with the steepest growth rates solidified in Q2 of 2018 at +9.4% on the top-line and +25.3% on the bottom line. Operating margins have also expanded to a place where they typically face headwinds.
- And you know the story from here…. On most metrics there has been no forward multiple expansion since growth bottomed in Q2 of 2016 as equities have rallied.
Getting in front of a potential change in this growth trajectory for us (getting the “E” right in other words) is driven by comps, base effects, and the observed extrapolation of trends by consensus.
Our answer to the pushback that “growth data is still running at peak rates and earnings for Q3 will likely show the same which is a catalyst for the next few months” is that:
- Yes, that view is at least partially embedded in bottom line growth rate expectations for the S&P 500 which are expected to accelerate to 37% YY in Q3.
- The intra-quarter timing of when the market gets new information on economic growth and corporate profits probably hasn’t changed.
Embedded in any long-term view that we show clients on real growth driving asset class and sector/style-factor returns is the fact that the market trades ahead of the “QUAD” positioning that is solidified post-quarter.
The market is the first to care about the growth-driven “bird-in-hand” arguments which is why isolating QUAD4 with style factor exposures (i.e. long Low-Vol, Yield, Quality metrics associated with low-growth but less volatile businesses) is much more powerful than picking sectors.
Historical Quad 4 Returns:
- S&P 500 Low-Beta Min Vol: +1.8%
- S&P 500 Div. Aristocrats: +1.6%
- S&P 500 Healthcare (best sector performer): +0.5%
- S&P 500 Information Technology Index (worst sector performer): -3.6%
- S&P 500 High-Beta Index: -3.8%
- S&P 500 Momentum Index: -4.8%
The thing about momentum of course is that it owns growth after growth has accelerated economically and outperformed in markets for an extended period of time. We walked through some of the over-arching risks associated with “growth” and “momentum” style factor rotation in the #CyclicalPeaks section of our Q4 Macro Themes last week, so please reach out to discuss further.
What we do know for sure is that the market hasn’t liked domestic growth accelerating exposure one bit to start Q4. The Russell 2000 Index had another ugly day yesterday with the “growth” index leading to the downside. The Russell 2000 Growth ETF (IWO) was -1.5% and is -5.3% m/m off the all-time lows in both realized and forward-looking volatility for the Russell 2000 Index just a month ago (yes, we’re believers this too was driven by domestic growth accelerating).
We’re not saying we nailed it after two market days because we don’t manage money. We just hope to help clients that do with an alternative way of thinking. The point we wanted to make was just that growth is always “running hot” before it rolls and the timing of that river card for judging historical winners & losers over a long period of time probably hasn’t changed much.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:
UST 10yr Yield 2.95-3.10% (neutral)
SPX 2 (bullish)
RUT 1 (bearish)
NASDAQ 7 (bullish)
Utilities (XLU) 51.30-53.69 (bullish)
REITS (VNQ) 78.70-82.04 (bullish)
Industrials (XLI) 77.67-80.04 (neutral)
Shanghai Comp 2 (bearish)
Nikkei 237 (bullish)
DAX 12115-12495 (bearish)
VIX 11.39-14.21 (neutral)
USD 93.60-95.75 (bullish)
Good Luck Out There Today,
Ben Ryan
Macro Analyst
