What is the most important thing investors should be watching right now?
This new conversation between two astute Macro minds— Jurrien Timmer, Director of Global Macro at Fidelity and Darius Dale, Senior Macro analyst at Hedgeye—cuts straight to the heart of that critical question.
Here’s a key takeaway from Jurrien during their discussion:
“The numbers out of the global economy are bad and still getting worse.
What you want is for the data to be bad, and get less bad. That's when you get into that early cycle, second derivative starting to improve while the level is still going down.
We're not there yet. This is still falling knife type territory.”
We transcribed key excerpts from this conversation between Darius and Jurrien below.
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Darius Dale: Good morning everyone. This is Darius Dale, Senior Macro Analyst on the Hedgeye Macro team. Welcome you to our third Hedgeye Investing Summit. We appreciate you joining us this morning.
I'm joined by our first guest, Jurrien Timmer. He's the Director of Global Macro in the Global Asset Allocation division at Fidelity Investments. His primary role is to support the asset allocation process of Fidelity's multi-asset class solutions group. He obviously does this by analyzing market trends and economic data. Jurrien co-managed the Global Strategies Fund from 2007 to 2014. We appreciate you joining us.
Jurrien Timmer: Thank you, Darius.
Dale: I always enjoy discussions with you. You're very specific in your market views. And you've been very specific about calling this a bear market. So walk me through that logic, and then, how you think about the next 12 months as it relates to potential upside.
Timmer: Well, just to clarify, my base case is that this has been a bear market. Everyone seems to be anticipating the next bear market. Everyone seems to be looking for that recession. I think there are a lot of brain cells being spent in our industry calling that next bear market after a quintupling of the S&P over the last 10 years.
My point is why are we looking for the next bear market if essentially we've already had one?
The fourth quarter of last year the S&P was down 20% for all of a New York minute, right? But the Shanghai Composite, Emerging Markets and a lot of other parts of the world were down more than 20%. China was down -30%. The MSCI All Country World Index was down 23%.
If you look at valuation, the PE ratio on the S&P peaked at 19.5 in January 2018. It bottomed at 13.7 right after Christmas in 2018. That's about a 28% haircut, I believe. PEs around the world are down about 25% to 30%. In the U.S., we're back to 17 or about a 50% retracing. But in most of the rest of the world, the PEs are still down there. You look at the CRB Raw Index, that's at the lows.
Another way of looking at it, as a former technical analyst, I've been looking at charts for 35 years. One of the things that I've learned is you look at the market, not in isolation, whether it's up or down, but you look at it relative to its long-term trend line.
The value proposition of investing in equities is that you get 10-11% return over the long haul, against 15 volatility. That's the price you pay. The return is that you have to stomach churning volatility from time to time. Usually the market is a pendulum swinging up and down, ahead of the trend or behind the trend.
What we've seen since 2009, which was the last major bear market bottom, is that we've had three runs where the market runs very strongly at a slope greater than the trend line of 10-11% and then it stalls and sits there and does nothing for months and months. So 2011 was a period like that, 2015-2016 and now 2018-2019.
For the last 21 months, the market has done absolutely nothing. The MSCI All Country World is literally unchanged from 21 months ago. That's in total return terms. The S&P is up 5% from 21 months ago. But against what should have been a 20-plus percent move over that almost two-year period. You could call that a bear market or at least a holding pattern or a consolidation.
So between the 20% drawdown, the almost two years behind trend, the sharp valuation haircut, I think I could easily make the case that we have seen a bear market now. Whether it will continue or whether we've seen the end of it is the big question. You have to consider that we have sort of a skinny deal on trade and the Fed is now going to cut, presumably again either in October or December and now doing $60 billion in QE that they call not QE. Has this holding pattern ended and are we about to run again?
Dale: I think that's the most important question we should be asking ourselves as investors because clearly, we've seen a massive performance divergence between more cyclically-oriented sectors and style factors and those that are traditionally labeled “defensive.”
If you look at Low Beta, Minimum Volatility securities in the U.S. equity market, they're up over 20% on a year over year basis. Whereas something like the High Beta ETF (SPHB) is up only 1%. So you’ve seen this bifurcation across the equity markets manifest itself through multiple sectors and the deviations and divergences within those. You can make the case today that does support the fact that we've seen sort of this rolling bear market as you’ve determined.
Do you think the transition either to the downside or to the upside is a function of monetary policy, the trade truce or just better economic data?
Timmer: I think it's probably a combination of all of the above. Obviously, trade pressures have changed corporate behavior. We're seeing that in the earnings numbers. Obviously Q3 earnings season is really going to kick into high gear. We are seeing that companies are being cautious. Of course, the companies will always blame whatever is the headline of the day.
Everything is being blamed on trade.
The Fed's response is obviously important. If you look at the ISM or the PMI globally, they've been declining for over a year. The ISM has been falling for 13 months from 62 to now 48. So you could argue that on the industrial manufacturing trade side, the global economy is in recession already, like it was in 2016 and like it was in 1998.
When you look at forward returns at different ISM prints below 50, the bigger your forward returns become. Just because cyclically, if you bought them somewhere in the 40 it's just the math, right? Your 12 months forward hit ratio starts going up.
The problem is that left tail does not get any less painful, even though the hit ratio goes up. So the cost of being wrong – even if you're batting average is 75% -- is catastrophic. And I think we're kind of in that falling knife scenario where at a 48 reading on ISM shows history starts getting on your side. But you may have to endure three or six or nine more months of pain before you're right. That’s kind of the point about where we're at.
Dale: As you know, our industry has become increasingly short-term as it relates to performance pressures. Professional investors don't really have six to nine months to be wrong.
To your point, we've been decelerating broadly from a global perspective all the way going back to the end of 2017. It's been almost two years of persistent deceleration. Clearly, manufacturing is in recession across all these major economies. The hard data is going to continue to catch down to the soft data and we've yet to see a sustained inflection in the soft data. But effectively what you're saying is that we're getting to these levels where it just makes sense to bet on a cyclical recovery. Is that fair? Getting to this next 12-month upside, does that require a recovery in this global economy?
Timmer: Yes. We're seeing what you're seeing. The numbers out of the global economy are bad and still getting worse. What you want is for the data to be bad and get less bad. That's when you get into that early cycle, second derivative starting to improve while the level is still going down. We're not there yet. This is still falling knife type territory.
What I'm saying is that you're getting closer to that “V” and from an asset allocation perspective. Let's say you were underweight risk six months ago. I don't know that I want to be underweight risk today. I may not want to be overweight risk, but it's closer to “V” shaped recovery that you start to rebalance into. Maybe you take a little off the table on the long duration side or on the bond proxy side.
But having said that actually I think those trades have to do with where we are in the cycle. I think there's also a large demographic component. Obviously your Demographer Neil Howe has written a lot about that. The world is seeing a tidal wave of aging populations in the U.S., Japan, China and Europe. I don't know that we've ever seen anything like it in terms of the size. That is impacting the global decline in yields and financial repression by central banks and flight to quality.
So I wonder how much of it is just the demographics of people solving for yield rather than for growth because they're just in that phase of the life cycle.
It's the same with Utilities and REITs. Look at the leadership in the U.S. equity markets. It's been the secular growers and the bond proxies leading. Now what do they have in common? They both generate yields. The bond proxies are stable, actual cash yield and the secular growers are more of a buyback type of yield. It's not direct, but they have yield in common. And I think that is a long-term driver that may very well continue to dominate performance even though we will have cyclical ebbs and flows.
Dale: One of the assets that obviously really benefits in a falling yield environment is gold. What are your views on gold?
Timmer: Gold has become a bond proxy. We've all seen the chart of the negative yielding debt overlaid against the price of gold. They're perfectly correlated. Gold is a play on real rates, probably more than anything else. If you look at the TIPs yield it’s a very strong inverse correlation over the last 10 years or so.
I'm convinced that over the next 10 years as this demographic tsunami sweeps around the most of the world I think yields will stay low. When you combine demographics with debt, that’s the two headed monster.
We're at $15 trillion in negative yielding debt. Warren Buffett always liked to dis gold because it doesn’t have a yield. In a negative yielding world, a zero yield is a high yielding asset all of a sudden. So yes, I like gold from that perspective.