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“I just need to survive the summer and then we’re off to the races.”
-Boston PM 

Yesterday was the second (of three) days meeting with institutional clients in Boston, MA. I think the primary reason Keith and I love marketing in Boston so much is that the sheer breadth of world views here is unparalleled. 

Only here can we do five meetings in one day with five different teams on five different floors of the same asset management firm and leave the building with five unique perspectives on how the markets and the economy are likely to unfold over the next 6-9 months – which just so happens to be our sweet spot with respect to “making calls” (something Keith discussed in yesterday’s Early Look).

That’s not to suggest markets like New York, Chicago, California, or Texas are riddled with pervasive groupthink. Au contraire, the types of fund managers that would even subscribe to our data-driven, ruthlessly process-oriented approach in the first place tend to have rigorously researched Macro opinions in their own right. 

The thing that’s more unique about Boston than anywhere else, however, is the relative lack of turnover – both in our client base and with respect to who’s actually sitting in the analyst/PM seats on their side of the table. Generally speaking, you get to know why a portfolio manager in Boston believes what she believes here more so than anywhere else. The mutual familiarity helps to deepen our discussions. 

Back to the Global Macro Grind… 

One discussion topic that didn’t require any familiarity at all was the fact that our US GIP Model analysis shows 2Q19E slashing deeply into #Quad3 followed by a whipsaw back to the Maginot line between Quads 3 and 4 for 3Q19E. Said simply, everyone wants to know what the risk of returning to deflationary conditions is and after the carnage of #Quad4 in Q4, I don’t blame them. 

Let’s play a round of market trivia. What do the following dates have in common? 

  • May 22nd, 2001
  • May 19th, 2008
  • May 2nd, 2011
  • May 20th, 2015 

If you answered… 

a) The US equity market rallied to a complacent local-high that day which wouldn’t be reclaimed until at least the next year;
b) The US economy was on the precipice of a downturn in corporate profits; or
c) I just saved a lot of money on my car insurance by switching to Geico

... you would’ve been correct in at least two of those three cases. I barely knew how to operate a motor vehicle in 2001. 

  • S&P 500 Earnings growth peaked at +22.9% YoY in 3Q00, troughed at -18.2% YoY one year later, and didn’t inflect back to positive until 2Q02. This earnings recession spanned a total of four quarters and that May 22nd, 2001 peak wasn’t eclipsed until May of 2006.            
  • S&P 500 Earnings growth peaked at +7.7% YoY in 4Q07, troughed at -47.3% YoY one year later, and didn’t inflect back to positive until 4Q09. This earnings recession spanned a total of seven quarters and that May 19th, 2008 peak wasn’t eclipsed until September of 2012.
  • S&P 500 Earnings growth peaked at +24.6% in 4Q10, troughed at -0.5% in 2Q12, and didn’t inflect back to positive until 4Q12. This earnings recession spanned a total of two quarters and that May 2nd, 2011 peak wasn’t eclipsed until February of 2012.
  • S&P 500 Earnings growth peaked at +10.6% in 2Q14, troughed at -8.0% in 1Q16, an didn’t inflect back to positive until 3Q16. This earnings recession spanned a total of five quarters and that May 20th, 2015 peak wasn’t eclipsed until July of 2016. 

The SPX peaked on May 1st, 2019. S&P 500 earnings growth peaked at +24.5% YoY in 2Q18 and is currently tracking at +1.4% YoY with 459 companies having reported Q1 earnings. Up +24.2% YoY in 3Q18 is no slouch of a comp either. 

That was a literary tactic I like to use called inception. I didn’t have to make a case that the latest May peak would resemble all the others in that it wouldn’t resume making new highs in short order due to a pending earnings recession. You more than likely started to assume that by yourself.

Here are three very important calendar catalysts that are suggestive of why it could be, however: 

  1. With the advent of yesterday’s Jobless Claims and APR Money Supply data, our nowcast for US Real GDP growth in 2Q19E nudged up marginally to 2.56% YoY/1.55% QoQ SAAR. A headline growth rate of 1.6% (the BEA likes to use round, sometimes questionable numbers) would mark the slowest print of the Trump administration and you have to go all the way back to the throes of 1Q16 to find a lower figure. That data is scheduled to be released on July 26th. Also being released in July is the first batch of Q2 earnings, which we anticipate will be the first of two consecutive quarters of DOWN YoY S&P 500 EPS growth.
  2. On August 13th the BLS will release JUL CPI data. That print is highly likely to be lower than both the JUN data and the Q2 average, which will heighten fears around a resumption into #Quad4 in 3Q19E. Recall that our GIP Model has the US economy very narrowly tracking in #Quad3 next quarter. Inflation is likely to accelerate materially from there until FEB ’20, but that won’t stop Mr. Market from battle-testing “at-risk” #Quad3 exposures in the heat of the moment. As an aside, many investors are going to blame #Quad4 trading days from now until then on what looks to be a ratcheting up trade war just like many blamed first-global-then-US-#Quad4-conditions on the trade war last year, but they could’ve just proactively prepared for the carnage when we said to do so in January and September 2018 for international and domestic exposures, respectively. FWIW, we don’t have a line into Donald Trump’s thought (or lack thereof) process.
  3. In the context of the former two catalysts, we think the implied probability of a September rate cut is likely to near double from the 54.3 % it’s priced at today

All told, we are of the view that investors should proactively prepare for a pickup in volatility across “at-risk” #Quad3 exposures over the next few months. 

We are also of the view that investors should use any such weakness to BTFD, hand-over-fist, in such exposures ahead of the Fed and its monetary policy cabal cooing like doves in Jackson Hole come late-August. Survive the summer. 

Our immediate-term Global Macro Risk Ranges are now: 

UST 10yr Yield 2.34-2.48% (bearish)
UST 2yr Yield 2.13-2.28% (bearish)
SPX 2 (neutral)
RUT 1 (bearish)
NASDAQ 7 (bullish)
Energy (XLE) 63.00-65.29 (bullish)
Shanghai Comp 2 (bearish)
VIX 14.02-22.45 (bullish)
USD 96.80-97.99 (bullish)
Oil (WTI) 60.78-63.86 (bullish)
Gold 1 (bullish)
Copper 2.70-2.83 (bearish) 

Keep your head on a swivel,

DD

Darius Dale
Managing Director

Sell in May and Buy the Looming #Quad4 Scare - At Risk  Quad3 Exposures