Diary of a Financier

Bull v. Bear: The economic deceleration is real this time

In Economics on Fri 17 Apr 2015 at 14:09

A combination of California port closures and record snowfalls in the Northeast have conspired to drag on 2015q1 economic data.  Recall that both matters were formidable headwinds a year ago as well, with 2014q1 GDP @ -2.1% saar.

A couple notes in regards to that comparison, which is an important gauge of 2015’s economic health:

  1. 2014q1 established an easy base for yoy comps
  2. 2014q1 featured nationwide weather disruptions, whereas 2015q1’s have been isolated to the Northeast
  3. Most importantly, 2015 lacks the snapback that 2014 yielded at this time as evidence of pent-up demand

Last year, I vocally highlighted the accelerating recovery as evidenced by economic data (in March & June), which was subsequently vindicated by GDP spikes in both Q2 @ +4.6% saar and ultimately FY14 @ +2.4%.  I cannot make the same case again this year — at least not quantitatively.

Lets compare data from 2014 to 2015 for the same dates (week 14/April):

2014 2015
Railtraffic +3.1% unch ytd
Retail sales (core) +2.6% +0.3% yoy
Durable goods (core orders) +2.3% -0.7% ytd
Manufacturing PMI (ISM) 53.7 51.5
Services PMI (ISM) 53.1 56.5
Inflation (core CPI) +2.4% +1.8% ttm

Economic growth in 2015 is underwhelming, objectively lacking the snap-back that it exhibited in 2014.  Headline data (as opposed to core) make the yoy divergence look even worse — mostly attributable to this year’s collapse in energy prices.

Expectations are important here, and the Street has slowly come-around to acknowledge the weaker quarter with forecast Q1 GDP consensus now down from a high of +2.8% to +1.2%.  However, only a minority have issued Q2 forecast warnings, as almost everyone expects a recovery driven by pent-up demand (Q2 consensus > +3.0%) — a reflexive reaction, based upon faith, that’s colored by the recency effect of 2014’s comeback.  Interestingly, consensus was bearish last year at this time.

~~~~

That is not the whole story, however, as far as capital markets are concerned.  The stock market is a multifactor discounting machine, so I have to consider all of the major factors involved:

Economy ():
See above

Credit (+):
With the exception of exuberant margin debt, both corporate & household balance sheets are materially deleveraged and are now actually releveraging off of multi-decade lows, with credit still amply available.

Fundamentals (PUSH):
In the US, 5-years’ worth of weaker dollar tailwinds have reversed overnight — now presenting headwinds.  Consequently, Street consensus is undergoing its annual downward revision cycle, taking SPX FY15 EPS down from a high of over $128 to $120.5 today.
With the bar now set low, USD’s rally overbought, and $XLY among the most heavily slashed growth forecasts*, the risk here is to the upside.

Valuation (+):
Almost every valuation metric suggests $SPX has reached fair value, and historically SPX enjoys +28% additional return after reaching fair value.
In addition, inter-asset class relative valuations still recommend equities over bonds (SPX 5.9% earnings yield vs. 4.5% Baa bond yield).
That said, relative valuations and sentiment are more attractive in International risk markets.

Sentiment (+):
Fund manager sentiment & allocations are at neutral levels.
Retail investor allocations & sentiment are also average, with a swelling neutral cohort in the latter indicative of healthy uncertainty.

Trend/Technicals ():
Risk market trends are undeniably bullish.
However, chart technicals are bearish, with broad US markets like $IWV in a daily ST H&S top within a larger diamond top formation and 2x bear divergence.
In addition, the arrival of May brings strong seasonal headwinds.

In aggregate, these indicators produce a pretty neutral signal (net +1).  We’ve already reduced our allocation from overweight risk to equal-weight (currently net 61/33/6 vs 60/40 benchmark allocation, 0.77 vs 0.76 beta, 0.88 vs 0.71 sigma).

Were nothing to change by month-end, my plan is to reduce risk exposures even more, due to seasonality and the underwhelming economic climate.  Nevertheless, the risk is to the upside…

~~~~

First, the US economy’s last chance to re-accelerate arrives in May/June, at which time we’d expect the effective tax cut from lower energy prices to manifest itself in consumption data* (a 6-month lag historically).

As a rule, I’m approaching the Fed’s rate hike with indifference. After all, the Fed has waited all these years to raise policy rates from ZIRP so as to do so in the least-disruptive way — haunted by the double-dip experience in the Great Depression.  That said, the Fed itself is the second major variable in this decidedly neutral analysis: an upside risk (for equities) that deferring a rate hike in June catalyzes a revaluing of the severely overbought $DXY and severely oversold $EUR.

We’re back to the “bad is good” environment, because weak economic data provokes Fed dovishness provokes USD devaluation provokes upward earnings revisions provokes multiple expansion.

–Romeo

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  1. […] in H2 5. Government spending seasonality: -0.6pp drag on GDP in Q1 + Q4 historically [Previously: The economic deceleration is for real this year] […]

  2. […] since we should be seeing a faster snap-back as evidence of pent-up demand; this report clinches my thesis that we won’t see that Q2 recovery in 2015: – Weekly traffic: -2.8pp @ -1.6% yoy – Growth […]

  3. […] we should be seeing a faster snap-back as evidence of pent-up demand; this report reaffirms my thesis that we won’t see that Q2 recovery in 2015: – Weekly traffic: +1.8pp @ +0.2% yoy – Growth […]

  4. […] worse since we should be seeing a snap-back as evidence of pent-up demand; this report reaffirms my thesis that we won’t see that Q2 recovery in 2015: – Weekly traffic: -2.5pp @ -2.3% yoy – Growth […]

  5. […] I’ve noted, weak economic data has persisted in Q2.  In a sea of bad reports, only the recent spike in […]

  6. […] enough to sway a Fed that seems committed to raising rates in September regardless. [Previously: The economic deceleration is real this time, “I’m approaching the Fed’s rate hike with indifference. After all, the Fed has waited all […]

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