“Villainy wears many masks, and none so dangerous as the mask of virtue.”
-Washington Irving
If you have kids, you know it’s Halloween Eve. You also know you’ll have to actively risk manage the emotional fallout of the rising probability that it gets “rained out”.
For market participants, it’s worth taking a quick moment to pause and ponder the ethereal exploits of what has been a supernatural, decade long, asset inflation Carnivale.
After all, exercising the asset deflation demons such that it’s all ‘treat’, all the time is truly a phantasmal feat.
Post-GFC, the exorcism of cycle gravity has followed a recurrent ritualistic progression:
- The cycle inflects positively, organic growth improves and Goldilocks Quad 1 conditions prevail – a macro regime which, collectively, cultivates an everything performance bonanza as both equity and credit benefit.
- As the cycle crests, pressure builds and consensus slowly acquiesces to the increasingly conspicuous RoC reality. The defensive allocation rotation ensues, selling pressure in equities builds, spreads widen and growth angst slowly (then quickly) crescendo’s … until monetary policy becomes sufficiently dovish to buttress both financial conditions and market sentiment.
- Equity and rate correlations go negative as bad news = good news vis-à-vis policy accommodation … this can continue so long as it further cements easing expectations and to the extent the bad news isn’t so bad that the capacity of central banks to backstop markets and engineer reflation comes into real question.
- At some (variable) point the negative correlation begins to decay and persistently bad fundamental news re-transitions to again being bad for equities and credits …
- It’s at this point that the equity-rates correlation needs to go positive with good news being good for asset performance with equities and rising yields both reflecting an improving growth/inflation outlook…. This is pretty much where we are now.
It really is a remarkable (or demonic, depending on your view of the ultimate implications) perpetual, asset inflation machine. … if you can also front-run the major growth/inflation phase transitions and side-step the recurrent volatility clustering and reflexive, harrowing price vacuums.
We say it all the time but Macro is not about Good/Bad, it’s about Better/Worse. Going from Bad → Less Bad is good, particularly if you have a durable catalyst capable of driving Less Bad → Good:
Invariably, and regardless of which 2nd derivative growth camp we’re in at a given time we get painted with the “perma” brush. Given our Quad 4 call/position, it’s been the doom-and-gloom label in recent quarters.
To push back a bit this morning, let’s indulge in our green-shoot, so-your-saying-there’s-a-chance marginal change monitor:
- Global PMI – which remains in contraction – has now shown two months of Less Bad
- Eurozone Industrial Activity/Sentiment has reflected some fledgling stabilization, printing Less Bad in the latest October data
- ISM: The Fed Regional Surveys for October have been stable-to-better in the aggregate for October → signaling improving prospects for a Less Bad ISM print
- Durable Goods/Industrial Production: Durable Goods and Industrial Production growth both made lower cycle lows in the latest September data but …. Aug/Sept represented peak (hardest) comps and the deceleration also carried the negative distortion from GM/Auto shutdown. In other words, progressively easier base effects and the reversal of a negative amplifier may manifest as a tailwind for less bad in the Oct/Nov data.
Of course, the bearish re-joinder to the above is that:
- Most of the cyclical-industrial indicators are still in contraction, sitting at stall speed, and are still fumbling for a clear catalyst for durable, accelerating improvement.
- The hard data will continue to catch down the leading soft over the next month or so. The preponderance of which remains decidedly Quad 4. (see this morning’s 3Q19 GDP data)
- Asia, collectively, has yet to flash “less bad” on the high-frequency, fundamental front. With the domestic economy past peak and on the wrong side of fiscal stimulus/profit cycle, a durable inflection in global growth without Asia/China participation would be underwhelming, at best.
Back to the Global Macro Grind ….
Easier Comps + $USD down + the growth less bad + lagged flow through of the coordinated global dovish pivot + the geopolitical resolution (Brexit, U.S.-China Trade, Japan-Korea) + Coordinated Fiscal Stimulus + Off-sides consensus (energy/inflation) positioning = #InflationAccelerating
If you want to Occam’s razor our inflation accelerating thesis - inclusive of both tangibly developing dynamics and prospective developments that would serve as amplifiers - that expression pretty much captures it.
Transitions are processes, not points, and if you view the Inflation Accelerating expectation against the push-pull and chop associated with the larger green-shoot←→ bearish re-joinder backdrop above, it shouldn’t be difficult to understand why we’re tightly risk managing our energy/inflation accelerating exposures.
It also shouldn’t be difficult to understand why we’ve begun to pivot in that direction. If Quad 2/Quad 3 remains somewhat of an open question over the nearer-term, the default portfolio solution is redundancy … simply be long of whatever works in both Quads.
But selectively - being lazy long during phase transitions isn’t a defensible strategy.
Moving on …
Yields are inextricably bound up in all the shifting growth/inflation expectations described above and Housing, at present, is tightly tethered to rates dynamics.
I comprehensively contextualized the favorable, near-term fundamental setup for Housing last week (HERE) but since most of what we got yesterday on the domestic macro front was housing-centric, here’s the incremental:
“U.S. Home Prices decline for the first time in a year in August”
That was the Bloomberg headline following yesterday’s Case-Shiller Home Price data. While facially correct, it falsely contextualizes the underling dynamics across a number of dimensions.
- Home prices trends are a lagged reflection of supply-demand conditions in the housing market. Sellers change price setting behavior on a lag to demand trends and those price changes are reflected in official HPI data on a further lag. Remember, yesterday’s Case-Shiller data was for August … and the index itself is calculated using a 3-month rolling average covering the June-August period. Take a moment to internalize how lagging that is.
- Most of what we’ve seen in term of decelerating price growth in 2019 is a reflection of the twin rate shocks and growth related volume slowdown that occurred in 2018 and into 1Q19.
- Those effects have been slowing moving out of the reported HPI data with the pace of price deceleration moderating in recent months.
- Indeed, at the National level, HPI actually accelerated on a year-over-year basis for the first time in 17-months in August. A reality antithetical to the sentiment captured in the headline newsflow.
Meanwhile, Pending Home Sales rose +1.5% sequentially, accelerating to a 46-month RoC high at +3.96% Y/Y. On an NSA basis, signed contract volume was +6.3% Y/Y, good for a 50-month RoC high.
And comps only get easier the next three months. In other words, further rate-of-change solidity across housing volume measures is pretty much baked through year-end.
What’s less baked at this point (after massive outperformance and rebased sentiment) is the markets inclination to look past another quarter+ of fundamental strength to a more discrete entre into Quad 2/Quad 3 domestically (and the associated inflationary/rate impacts).
The latest backup in rates represents an attempt at discounting that probability.
However, as we’ve now observed in multiple instances post GFC, rates rising remains a primary catalyst for rates falling as too high/too fast begets increasing equity angst and renewed concern about the growth/inflation outlook .... all of which, ultimately, feed-back negatively on yields.
As it stands, we still like housing. We like it less than we did a year ago, but it’s difficult to build a convicted short case based on an expectation for accelerating growth, particularly when the divergence and growth spread between housing and pretty much everything else is widening, not contracting.
We’ll get there, but not yet.
If all of the above ‘feels’ like an oppressive mix of convoluted cross-currents, that’s because it is. Convolution characterizes inflection periods, pretty much by definition.
And we don’t promise clean 100% certainty, 100% of the time.
We do promise transparent, thoughtful analysis, and a risk management process to help traverse the chop and exorcise you’re inner macro tourist.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND signals in brackets) are now:
UST 10yr Yield 1.66-1.86% (bearish)
UST 2yr Yield 1.52-1.68% (bearish)
SPX 2 (bullish)
NASDAQ 8027-8346 (bullish)
Utilities (XLU) 62.89-65.04 (bullish)
REITS (VNQ) 93.03-95.98 (bullish)
Energy (XLE) 56.77-60.48 (bullish)
USD 96.84-98.02 (bullish)
Oil (WTI) 52.70-57.42 (bullish)
Nat Gas 2.20-2.68 (bullish)
Gold 1 (bullish)
Best of luck out there today,
Christian B. Drake
Macro Analyst
