ABC's of Tech In #Quad4

“We're talking about words like pendeloque, erysipelas, odylic, auslaut, and aiguillette.”
-Neil Howe 

Per Hedgeye Demography Jedi, Neil Howe, the age-old purpose of the annual National Spelling Bee is to test the spelling skills of 7^th and 8^th graders against the nearly half a million words contained in Webster's Third International Dictionary…

Over the last twenty years, as Millennial and now Homelander birth cohorts have entered this narrow age bracket, the skill level of the contestants has obviously been rising.

Now, apparently, the kids have won and Webster's has lost. The judges simply ran out of difficult words. The kids knew them all. If their parents run money, I wonder if they can spell out what happens to Tech and Energy in Quad 4?

Back to the Global Macro Grind…

After another nasty day for Tech (XLK -1.8%) and Communications (XLC -3.1%) stocks, you won’t hear much about the Quad 4 fundamentals of demand slowing into rising inventories. Nope, blame anything but The Cycle.

As a refresher on something bottom-up investors can spell-out easier than top-down Quad 4:

1. 492 of the SP500’s companies have reported aggregate year-over-year EPS growth of +1.52%
2. 66 of 68 Tech companies have reported an aggregate year-over-year EPS DECLINE of -6.12%

That’s right, since printing #PeakCycle year-over-year earnings growth of +32.1% in Q2 of 2018:

1. Tech has seen its earnings growth rate cut from 32.1% to 5.8% when the US economy hit Quad 4 in Q418
2. And is about to see a double-digit DECLINE in year-over-year EARNINGS in Q2 of 2019 against the +32.1%

I guess that’s what happens when “Secular Growers” see The Cycle slow for the 1^st time in 3 years. They remind you that they, like everything else that matures economically, are cyclical.

No worries though. If and when the Fed cuts rates and we head back into Quad 3, you can buy Organic Growth as a Factor Exposure (from a lower price). At least that’s what our back-test says. That said, the companies still have to deliver growth.

Has your money manager, Tech analyst, etc. baked down -5-8% aggregate SP500 EPS growth into their model? If you could legally know that’s a high probability scenario, would you make any risk management moves ahead of that?

What’s Mr. Market thinking about this Quad 4 Profit Cycle Risk?

1. NASDAQ is down -10.2% since the market started pricing in a Quad 4 Scare in MAY 2019
2. Tech (XLK) was down -8.7% in May and down another -1.8% yesterday = Bearish TREND @Hedgeye
3. Both Amazon (AMZN) and Facebook (FB) broke bad to Bearish @Hedgeye TREND yesterday
4. Apple (AAPL), Google (GOOGL), and Netflix (NFLX) were already signaling Bearish @Hedgeye TREND
5. Tesla (TSLA) remains Bearish @Hedgeye TREND and the poster-child of a story stock with epic leverage

Not to be confused with Webster’s definition of leverage: “the ratio of a company’s loan capital (debt) to the value of its common stock (equity)”, epic leverage is what Elon Musk has after selling cool cars for 80-90 cents on the dollar.

Yeah, it was cool and secular and awesome and huge…

But really, it’s also pro-cyclical. Do you know what inexperienced companies (even if they are “Secular Growers”) do, pro-cyclically, to their balance sheets if they’ve never had to live through a down earnings cycle?

As a percentage of High Yield and Junk, what Sector just hit a new cycle high at around 16% of total?

A: Tech

I’m thinking that question might have broken the 8-way tie at the National Spelling Bee. Right, that wouldn’t be “fair” to ask the children to think about something they couldn’t study rote-style.

Over to Wikipedia instead of Webster’s: “Rote learning is a memorization technique based on repetition. The idea is that one will be able to quickly recall the meaning of the material the more it repeats it.”

“So”… you know, on the Old Wall many like to repeat things like:

1. “If there’s no recession coming, you buy credit and equity”
2. “Earnings were better than expected this quarter”
3. “Credit quality is different this time – it’s not like 2016”

Again, totally cool and secular and awesome things to say… but as anyone who made money through the 2000-2002 period like I did knows:

1. You don’t have to have a “recession” to lose ½ your money in “stocks” if earnings go negative year-over-year
2. Ex-Tech, earnings were “better than expected” in both Q1 of 2001 and Q1 of 2019 – then, way worse in Q201
3. The last pro-cyclical Credit chase was in Energy/Industrials – this one is in Tech/Comms (like in 2000)

Admittedly (from Neil’s quote) I had to look up what erysipelas means. Maybe our 7^th graders should teach our money managing parents what an “acute, sometimes recurrent disease caused by infection” is…

The ABC’s of Quad 4 say that NEGATIVE year-over-year EARNINGS infect Credit Spreads, 100% of the time.

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

UST 10yr Yield 2.05-2.36% (bearish)
SPX 2 (bearish)
RUT 1 (bearish)
NASDAQ 7 (bearish)
VIX 14.23-20.81 (bullish)
USD 96.87-98.11 (bullish)
Oil (WTI) 51.79-58.03 (bearish)
Gold 1 (bullish)
AAPL 171.05-186.25 (bearish)
AMZN 1 (bearish)
FB 161-180 (bearish)
GOOGL 1019-1153 (bearish)
NFLX 330-353 (bearish)
TSLA 172-206 (bearish)

Best of luck out there today,
KM

Keith R. McCullough
Chief Executive Officer