Volatility of Profits vs. GDP

“Profits are more volatile than GDP.”
-Howard Marks 

Thanks to the legendary Howard Marks for reminding us of that basic fact. The Old Wall in all its glory has done a horrendous job forecasting the relationship between #slowing GDP and Corporate Profits since the beginning of time. 

While Marks doesn’t have a refined #process to nowcast GDP with the precision that we have here @Hedgeye, he really hasn’t needed that to beat markets over the years. That’s because he’s a buyer of “distressed” markets. 

In ROC (rate of change) speak, markets aren’t distressed (stocks crashing and credit spreads widening) until it’s very obvious that both GDP and Corporate Profits are #slowing at an #accelerating rate. 

Back to the Global Macro Grind… 

I got into a good back and forth tilt with a hedge fund manager in Connecticut yesterday about the US Profit Cycle. His view was that “all” of 2018’s accelerations in US GROWTH, INFLATION, and PROFITS were due to Tax Reform. 

Ultimately, I was trying to make the point that I didn’t care if it was Trump’s Tax Reform, the biggest PBOC stimulus in the history of China, or unicorns morphing into real pets with apps on Greenwich Avenue… 

The ROC (rate of change) #acceleration was what it was… 

And that’s why staying long Quad 2 exposures (Long Growth and Short Treasuries, Gold, Bond Proxies) worked for the 2.5 years into the “valuation” (and Trump) bears capitulating in September of 2018. 

Now, all of that – and I mean all 3 things that matter most in our ROC model – is #slowing: 

1. Our GDP nowcast for Q1 of 2019 is currently ticking at +1.22% headline vs. +2.56% in Q4 (and +3.4% in Q318)
2. Headline INFLATION (CPI) has #slowed from #PeakCycle in JUL18 of +2.9% to +1.5% in FEB of 2019
3. SP500 PROFITS #slowed from #PeakCycle of +24.5% y/y in Q2/Q3 of 2018 to +12.3% y/y in Q418 

That’s right, for you fans of The ROC, the GROWTH rate of PROFITS got cut in HALF. Yeah, I’m going all caps on you now, lol… and stocks crashed as both that and Q119 SP500 PROFIT guidance dropped to NEGATIVE -3% y/y GROWTH. 

Oh, no no no Keith, ‘my super stock picks only collapsed in Q4 because the Fed was tightening.’ 

As Marks reminds us about The Cycle (in Mastering The Market Cycle), “the ups and downs of the economy absolutely are very important in determining the rise and fall of corporate profits.” (pg 75) 

If GDP, inflation, and profits didn’t slow (never mind cutting both the growth rate of INFLATION and PROFITS in HALF from their respective cycle peaks), why did the Fed go dovish? And why are Utilities (XLU) making all-time highs, daily? 

Oh, right Keith, ‘nice call on Utilities… but they’re too expensive here.’ 

How many hedge fund PMs in CT, NY, and MA have had Treasuries, JGBs, and Utilities as their Top 3 gross LONG positions since The Cycle peaked in September of 2018? You should allocate those that did lots of capital. 

Rather than getting into the general over-supply of under-performance in the hedge fund community (due to the lack of a data dependent and globally interconnected macro #process), let’s focus on what’s likely to happen next: 

1. The Fed issued 2 rounds of cowbell within 3 weeks and stocks have reflated from their crashed out DEC lows
2. Stocks, especially those that love Quad 3 Cowbell, have ramped and squeezed whoever shorted in DEC/JAN
3. The GDP and PROFIT cycle data still has to be reported again in APR/MAY 

Oh, Keith, ‘but isn’t it all priced in?... why do I keep losing money not being short stocks before they go down (8 of 9 days in March)… and then getting squeezed after shorting them after they went down?’ (SPX up for the last 3 days) 

As anyone who has successfully traded through every economic and profit cycle peak (making money at both the turn and ultimately on the down moves) knows, you have to risk manage an obvious situation as it becomes more obvious. 

Buy/Cover (at the low-end of the @Hedgeye Risk Range) low, and Sell/Short (at the top-end of the range) higher. 

Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND signals in brackets) are now: 

UST 10yr Yield 2.56-2.68% (bearish)
SPX 2 (neutral)
RUT 1 (bearish)
NASDAQ 7 (bullish)
Utilities (XLU) 56.50-58.78 (bullish)
REITS (VNQ) 83.35-86.01 (bullish)
Housing (ITB) 33.99-35.52 (bullish)
Energy (XLE) 63.83-67.21 (bullish)
VIX 12.65-17.61 (bullish)
USD 96.00-97.75 (bullish)
Oil (WTI) 55.34-58.97 (bullish)
Gold 1 (bullish)
Copper 2.87-2.95 (neutral) 

Best of luck out there today,

KM

Keith R. McCullough
Chief Executive Officer