“It’s like losing a tooth everyday”
-Jacoby Drake
So, I unwittingly stumbled into my first “is the Tooth Fairy real?” conversation last night.
Daily life is replete with parental ‘splaining opportunities but next to the birds/bees exchange, the mystical beings letdown discussion requires a uniquely soft touch and is one where you definitely want to stick the reality disclosure dismount.
The answer is, of course, unequivocally yes. But not in the supernatural, conventional sense.
Here’s how I broke it down:
The Tooth Fairy, decloaked of all mysticism = free money while you sleep .. which is awesome.
And there is only one other high probability way to get free money while you sleep. (Compound) Interest.
I give you money ➡️ you give me money to hold my money ➡️ then you give me more money for the money you just gave me …. which is awesome.
So awesome, in fact, that some really smart guy (Einstein) that only traffics in profound truths called it “the eighth wonder of the world”.
And by the mystical workings of the transitive property: Tooth Fairy = (free) money while you sleep = compound interest = awesome.
Given the response (our headline quote above), the lesson was sufficiently internalized.
And that, mi macro amigos, is how you opportunistically level up financial awareness to a captive (and captivated) audience who may or may not be tall enough to ride that conceptually abstract ride while successfully matriculating up the parental belt-notch hierarchy.
Anyway, it went over pretty well and I received $20 in previously acquired actual Tooth Fairy money to put somewhere to ‘get more money every night while I sleep’ .
Back to the Global Macro Grind ……
Meanwhile, in other transitive property news:
“Tentative agreement on partial shutdown”
“Trade talks show signs of progress”
“Eurozone activity slowing” (this morning = Eurozone Industrial Production = -4.2% Y/Y)
= today = yesterday = last week = Jan = Dec …etc.
No one wants to be lonely, especially on Valentines Eve. If you feel like you’ve read those headlines before, you are certainly not alone as they could veritably characterize any hour, day and/or headline over the past few months.
If you enjoy basking in the warm, reflationary glow of relief rallies off of oversold lows but remain skeptical in your view of the sustainability of policy catalyzed, high-beta equity reflation in the face of a steady drip of Quad 4/Quad 3 data, you are also not alone.
As a reminder, and just to be clear on how we think Tourist topics and short-term dynamics play out in equity space:
The rate-of change Trend in Growth & Inflation define the investing environment. Almost everything else represents a fringe dynamic that serves to amplify or dampen the GIP-defined trend, especially if a particular growth regime/Quad environment looks set to persist for multiple quarters. The Machine, modern market structure fragilities, policy, politics and topical headlines all play a role – and are captured/considered in our Risk Management process - but they are not the defining factors.
In other words, after the dovish pivot has been actualized, the political and trade brinksmanship resolved and the associated easing of financial conditions and equity reflation to lower highs realized, what are you left with?
The Cycle.
And the Cycle – despite contentions to the contrary – is not an intractable, supernatural phenomenon, especially in its latest incarnation.
As we’ve been highlighting for months now, the profit cycle is discretely and invariably headed lower. Indeed, with 1Q19 EPS growth estimates now negative, consensus is increasingly warming to the notion of rising earnings recession risk …. an expectation that, based on my inbox flow, is progressing towards ubiquity.
Now, with over 70% of SPX constituents having reported and trends now entrenched, I wanted to do a quick pre-mortem of 4Q18 Earnings:
- Growth | Inflection Detection: With 354 companies having reported, aggregate Sales and EPS growth is tracking at +6.8% Y/Y and +14.2% Y/Y, respectively.
- Comps | A 2019 Albatross: Earnings growth has been almost cut in half from the prior quarter against a modestly harder comp. Base effects steepen dramatically from here and are effectively uncomp’able – pretty much ensuring the deceleration will be an enduring dynamic.
- Operating Momentum | From momo to no-no: Taking a 2nd derivative approach to the data, underlying operating momentum has deteriorated significantly with just 37% and 39% of companies registering sequential acceleration in sales and earnings growth, respectively. The percentage of companies reporting sequential operating margin expansion is similarly underwhelming at just 33%
- Surprise % | ‘But They Beat … sort of, technically’: Manufacturing a beat against progressively deflated estimates remains the canonical earnings management playbook so its really the magnitude of the beat that matters. At 3.3% in 4Q18, the earnings surprise percentage is the lowest since 4Q16.
- Intra-quarter Revision Trends: After 6 quarters of strong, positive intra-quarter revision trends, intra-quarter revisions in 4Q were flat at 0.09%, marking the weakest trend since 1Q16. Moreover, revisions are tracking -2.6% thus far in 1Q19.
- Fundamentals | Forecasting Futility? …. While macro has mostly monopolized performance trends, forecasting fundamentals has mattered thus far. Over 60% of companies that have beaten top and bottom line estimates have gone on to outperform the market by +5.6% over the subsequent 3 trading days. On the flip side, 60% of companies that have missed EPS estimates have gone onto underperform the market to the tune of -4.1% over the subsequent 3 days.
Interesting detail but mostly trivial.
Let me couch the top-down contextualization of all that within the context of yesterday’s NFIB Small Business Confidence data whose recent piking effectively reflects the collision between developing 2019 conditions and residual 2018 peak cycle sanguinity and serves as a convenient microcosm for developing profit cycle dynamics.
Headline Confidence fell -3.2 pts, marking a 5th month of decline off the August 2018 cycle high and the lowest level since November 2016. Forward Expectations again served as the epicenter of weakness, falling -10 pts sequentially on the back of Decembers -6pt decline as slowing growth, political gridlock, shutdown angst and asset price volatility shock conspired to drive the largest 2-month decline since the depths of the Eurozone crisis in 2012.
As it relates to the profit cycle, the two charts below offer a good juxtaposition of underlying developments while visually emergent risk.
Specifically, a late-cycle acceleration in wages alongside a progressive slowing in (global and local) growth and a fading fiscal impulse into peak earnings cycle comps, higher interest rates and residual strong dollar translation effects is not margin and profitability positive.
And the more it looks like Quad 3 (and to a lesser extent, Quad 4) is the prospective reality, the lower the probability for multiple expansion (stagflation don’t get a multiple) and the higher the probability for revision trends to trend further negative.
In the simplest terms possible, that ultimately equates to a flat to lower multiple on a lower earnings number.
As we plainly reminded readers yesterday – it’s about slopes, shifts and delta’s. You don’t need an actual recession to get paid on a growth slowing view, you just need the probability distribution to shift to more/less probable and consensus to capitulate in the same direction for that view to be tangibly reflected and ‘capture-able’ in market prices.
Immediate-term @Hedgeye Risk Range with TREND signal in brackets:
UST 10yr Yield 2.60-2.75% (bearish)
SPX 2 (bearish)
RUT 1 (bearish)
NASDAQ 7152-7445 (bearish)
Utilities (XLU) 53.73-56.24 (bullish)
REITS (VNQ) 81.15-84.81 (bullish)
Shanghai Comp 2 (bearish)
DAX 101 (bearish)
VIX 15.02-20.66 (bullish)
USD 95.00-97.17 (bullish)
Oil (WTI) 51.68-55.25 (bearish)
Gold 1 (bullish)
To Tooth Fairies, Cycle Front-running, Market Timing and other Nonfictions,
Christian B. Drake
US Macro Analyst
