Market Edges



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In this week’s Market Edges, we get you further prepared for #Quad4 in Q4:

  • Client Talking Points: We dissect an unsurprising U.S. 3Q18 GDP revision, break down the key takeaways on recently reported income and spending data and explain what’s next after corporate profit growth just hit a 6-year high.
  • Chart of the Week: Senior Macro analyst Darius Dale details why Wall Street’s trade war narrative is a scapegoat for #TheCycle.
  • Sector Spotlight: Macro analyst Ben Ryan takes a look at the financial market performance scoreboard and explains what’s working (and not working) in 2018.
  • What the Media Missed: We provide a transcript (and replay access) to a recent webcast hosted by CEO Keith McCullough, “Quad4: The Worst Is Yet to Come.”
  • Around the World: And finally, here’s an excerpt from a recent must-read Early Look written by McCullough entitled, “The Fed vs. The Cycle.”

Happy Macro Monday! Good luck out there this week.


1. Quick Takeaways on the Revision to 3Q 2018 GDP

The revision to 3Q 2018 GDP showed no net change to the headline (3.5% Q/Q, +3.04% Y/Y) as a modest negative revision to consumption was offset by a positive revision to investment/inventories.

There were no big surprises on the revision side given the already reported (negative) revision to Retail Sales and (upward) revision to construction activity. Trade policy frontrunning (i.e. inventory and import hoarding) into impending tariff changes amplified further with the positive revision to inventories and negative revision to the Trade balance. We’ll probably see a similar but diminished version of the same in 4Q ahead of the expected increase in the tariff rate from 0% to 25%.

To dig deeper inside 3Q 2018 check out the summary table below.

2. An Update on U.S. Income & Spending Data

It was a solid start to 4Q for both income and spending against downwardly revised September estimates. Core inflation growth continues to backslide alongside slowing growth and the retreat in both reported and expected inflation.

Here’s the breakdown of the data:

  • Aggregate Private Sector Income accelerates +30bps to +4.7% Y/Y with Personal Income, Disposable Personal Income & DPI per capita all reflecting similar modest acceleration.
  • Spending = +0.4% sequentially while accelerating +10bps to +2.9% Y/Y.
  • Savings Rate = fell -10bps M/M sequentially and -40bps Y/Y  = a support to both sequential and Y/Y Consumption growth.
  • Headline PCE Inflation static at +2.0% Y/Y while Core PCE inflation slides -10bps back below target to +1.8% Y/Y (with September revised -10bps from 2% to 1.9% Y/Y)

Remember the other dynamic at play here as well is that output price growth (GDP Deflator) is running at +2.36% Y/Y and falling.  Wages are running at +3% and rising. If growth in your biggest cost item is rising faster than selling prices, in the aggregate and all else equal, that equals margins ↓.

In other words, we got unsurprisingly stable income/consumption data. If you were looking for a discrete catalyst for (higher) rates, this isn’t it.

3. Corporate Profits = Fastest Pace of Growth in 6 Years

Call it stimulus’ last stand. Corporate profits surged +10.3% Y/Y, marking the fastest pace of growth in 6 years (fastest since June 2012) as the tail end of a record acceleration in growth and tax reform coalesced to drive a crest in the growth and profit cycle.  It obviously becomes increasingly challenging from here as the confluence of slowing growth, higher (wage) input costs, annualizing of the benefits of fiscal stimulus and significantly steeper comps all conspire against peak margins and corporate profitability.



Below is a research note written by Senior Macro analyst Darius Dale:

I’ve been waiting for this most newsy of weeks for the opportunity to use data to expose consensus trade/tariff concerns for what they really are: a scapegoat for what should’ve been a proactively predictable deceleration in global growth (it was to us back in January).

Unfortunately for Macro Tourists, the global economy and the financial markets that underpin it tend to abide by the laws of Complexity Theory – Occam’s Razor be damned. If you don’t have a repeatable process to measure and map the many grains of sand that strike such a complex system each day, it’s highly likely that you’re going to be consistently excellent at Macro Risk Management, across cycles. And I say that with the utmost humility; as someone who doesn’t spend any time modeling companies, I shouldn’t expect to be a good stock picker or lender either…

Going back to the data, we are keen to note that of the six major aggregate high-frequency growth categories we universally track in our Global Macro Risk Monitor (i.e. consumption growth, consumer confidence, manufacturing growth, business confidence, export growth and PMIs) only export growth is broadly trending higher across both G20 and Emerging Market economies. Across all economies, the percentile of the latest figure has a mean of 59% within their respective trailing 10Y samples, suggestive of above-trend growth – which is more than I can say for each of the other aggregates, save for the confidence metrics.

Consensus “Trade War” bears will point to inventory pre-ordering ahead of tariff implementation in hopes to redirect the discussion to something decidedly less tangible like the so-called “capital investment overhang”. OK, let us humor that narrative as well. Why in the world would the threat of unraveling global supply chains cause a deceleration in CapEx growth domestically – particularly given that a large focus of Trump’s economic policy is to promote the revival domestic manufacturing economy?

That’s easy: it hasn’t – management teams be damned; CEOs want to hit their bonus targets too (RE: scapegoat). When you study the growth rate of New Orders for Core Capital Goods, you quickly arrive at the conclusion that steepening comparative base effects accounted for 107% of the deceleration in business investment from the SEP ’17 peak of 13.29% YoY to the latest rate of 3.41% YoY (OCT). That actually implies business investment is actually ever-so-slightly higher than it likely would be absent a positive impetus (i.e. tax reform).

All told, I trust that you do not interpret this latest version of our war against Macro Tourism as an attack on anyone’s process. Rather, we hope you take it as a reminder that you can make and save your clients a lot of money by simply making yourself more aware of these trivial cyclical realities via bean counting the data.


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It’s been a rough start to the fourth quarter for investors still positioned for U.S. #GrowthAccelerating. After the U.S. economy accelerated for 9 straight quarters (from the 3Q16 low of 1.3% to 3Q18’s 3%), our call continues to be that U.S. growth will slow through at least 1Q 2019.

U.S. #GrowthSlowing is already being discounted by Mr. Market. The pockets of outperformance (and underperformance) largely fits the playbook of our Growth, Inflation, Policy model. (Click here to watch a brief video about our four quadrant GIP model and the the investing implications.)

What’s working? Style factors like Low Volatility, Dividend Yield.

What’s not working? Sectors like Technology and style factors like Momentum.

Below is a note written by Macro analyst Ben Ryan with analysis of 2018 performance data:

In the QTD “Low-Vol, Yield” has won out which is an important and new shift. Mapping bucketed style factor strategies to sector returns is straightforward so far this quarter: Investors elected for certainty, tangibility & lower volatility into Q4 in place of the future uncertainty embedded in growth and TAM stories that were winning exposures for so long. Breaking the top 3000 U.S. stocks into single factor Long-Short portfolios and observing performance is a great way to observe this handoff from “optimistic uncertainty” to “tangibility”. We show the largest performance divergences both QTD & YTD in the chart below.

With the #Cyclical Peaks section of our Q4 Themes deck, we showed the increasing crossover of Tech stocks in growth and momentum strategies. We’ve heard plenty of speculation that many quant strategies are saturated which led to the violent October volatility and selling in tech stocks. We do hypothesize that this is a market-structure risk, but there is also evidence that rules-based, systematic strategies haven’t been the incremental seller yet.

Here’s what we mean. Many popular factor portfolio constructions looking to capture the “momentum” premium are focused on 6-12 month price momentum. Only recently have Tech exposures lost momentum. Remember that strategies don’t rebalance daily. It’s often a quarterly or semi-annual exercise. As you see on slide 20 (3rd slide below), the info tech weightings in momentum portfolios has changed very little since the start of the quarter. Rules-based rebalancing as the incremental seller probably hasn’t had an impact yet (if it will which is a major debate in the investing community right now).



After having been bullish on U.S. growth and stocks for the better part of the last two years, our Macro team made a big pivot in late September.

In a recent webcast, Hedgeye CEO Keith McCullough discussed our U.S. #GrowthSlowing call. McCullough warned investors about “Quad 4” and the havoc it will continue to inflict on portfolios.

In addition, McCullough welcomed on two of our veteran analysts, Howard Penney (Restaurants/Consumer Staples) and Brian McGough (Retail) to discuss the investing implications in their respective sectors.

Below is an excerpt transcribed from this special investing webcast. (Click here to watch the entire 53-minute webcast.)

*  *  *  *

Keith McCullough: I’m going to get right into it, get right into the process and outline what Quad 4 is. If we show you slide five on the process component of the deck, you can see that all we really care about is measuring and mapping the rates of change of the economy.

We do subscribe to nonlinearity. We do subscribe to math. We don’t do the Old Wall stuff that didn’t signal getting out of any of these things at the end of September—it was on September 27th.

We care about whether we see accelerations or decelerations, or whether things are getting better or worse, not whether things are qualitatively good or bad, expensive or cheap.

Next slide. It may look a little busy, but again, when you’re doing math, you do have to get a little bit busy. I mean, it surely beats staring at a 50-day moving monkey. This is our four-quadrant map. So what I’m showing you here are two things, growth and inflation on the x and y axis in rate of change terms. As you can see, all the quarters up until this quarter—nine quarters in a row—the US economy was in what we call Quad 1 or Quad 2.

McCullough: Quad 1 and Quad 2 are where you have growth accelerating. Quad 2 of course is when you have growth and inflation accelerating. Interest rates are going up, the Fed is going, hawkish. Does it sound familiar? It should, it was our call for two and a half years.

Now, Q4 is Quad 4. So you see back down there in the bottom left corner, you have both growth and inflation slowing at the same time. Again, that’s in rate of change terms.

If you want to look at a bar chart of this, which is a lot easier to look at, for those of you who are new to our process, just the time series of this is on slide 13. This is GDP.

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McCullough: I think that most things macro at this juncture, if you haven’t seen our work, have to do with awareness. If you missed the move, then you were probably at least unaware of a lot of things. We want to make you aware.

So, the bottom of year over year GDP growth was of course in Q2 of 2016. I say, ‘of course,’ because anyone who subscribes to the rate of change process should know that. You should not risk manage markets unless you know that. You shouldn’t know the 200-day moving monkey, and not know where GDP bottomed.

Moreover, you should know that it has accelerated for nine straight quarters. So, what we’re saying is from the 1.3%, which is the low on that chart, to the current forecast that we haven’t, again, it’s more like a “nowcast.” We’re using a predictive tracking algorithm, or a modern day mathematical tool, to drop in there with a 2.77% number. The green bar is lower than Wall Street’s red bar. The way that Wall Street will read this is as a big GDP miss, which is on the next slide. We can show you our current nowcast for US GDP growth, the number that Wall Street stares at, is going to collapse to 1.22%.

This is fully loaded with every economic data point that’s been reported, that has back-tested as relevant in our model. As you can see Wall Street is well ahead of us.

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McCullough: Actually, this is the first time in the last five quarters that we’ve been below Wall Street. We used to be well ahead of Wall Street. That was of course before you saw the 4.2% and the 3.5%. So that’s the only half of the story. The other half of course is inflation peaking and rolling.

Inflation peaked in the second and the third quarter of 2018, July was that number, July was 2.9% on a year-over-year basis, which ended up with this quarterly average as you can see there of 2.7% and 2.6% respectively in Q2 of 2018. You’re following the black bars there. And most importantly, you’re not following a black bear kind of sort of your following black bear and you don’t want to be eaten by that black bear, which is inflation expectations as it falls to our current nowcast for Q4 to see inflation fall from the cycle peak to 2.37%. And then as you can see in the blue bars that follow that, we’re well below Wall Street.

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McCullough: So again, if you think about being long, the long bond or long, long term Treasuries or short term for that matter, that nowcast again on slide 15 would give you an outlook that is not consensus. But if it becomes reality, which we would consider the high probability situation, that inflation falls back towards 2%, that will give the Fed plenty of opportunity to go dovish.

And as the Fed debates going dovish, bond yields start to fall once they’ve actually gone dovish, bond yields may have bottomed, we’ll have to see about that. But in the meantime, we want to be long, long term Treasuries. We want to be long of course, bond proxies which include Utilities, Consumer Staples, etc.

Slide 28 can show you the regime of data as it’s been reported on a look back on a go forward basis.

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McCullough: So even if you are not mathematically inclined, and we would highly suggest that you become mathematically inclined, because again, you have to have an informed opinion that is based on actual numbers, not a feeling about markets or where you’d like them to be.

Don’t forget a lot of people on TV, old wall TV that is paid to promote their own compensation schemes and that is largely having to do with a rosy outlook, which of course we don’t have currently. Q4, as you can see on a color-coded basis, goes from bright green to a series of yellows and yellow is not as good as green inasmuch as going from red to orange to green was very bullish in rate of change terms.

Now we’re going to go from bright green to yellow. Okay? Yellow, yellow, yellow.

Now if you look at this on a global basis, God forbid you’re actually measuring and mapping the rest of the world as opposed to just jumping from macro tourists headline to headline every morning. When’s Trump going to meet with Xi? What are the Italians saying? Yeah, it’s much more important to know what quadrant each of these countries are in.

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McCullough: China and Italy in particular have been disasters this year. Our model called that on this, on this. Again, a lot of numbers. I don’t use a lot of words here other than the ones coming out of my mouth, but you can see Quad1s and Quad2s, those are green because they’re good. Yellow lights are not as good and red lights are very bad.

So as you can see, these are the top 20 countries in the world by GDP. They went into Quad 4 unanimously, the mean and the mode of that did in Q1 of 2018. That’s when we went bearish on China are, had already gone bullish on Europe and went bearish on Emerging Markets in particular.

And as you can see, Quad 4 in Q4 is a global matter with the US joining it for the first quarter after nine greens in a row.

Alright, slide 66 two more slides. What do you do when margins are at peak? Do you buy the stock market? If you bought the stock market at any of those three tops, at least the last two, you would have been body-bagged don’t get body-bagged. Okay? We don’t want that to happen to you, your family or any of your net wealth.

Again, we’re at the currently the third dot in the last 20 years where you could buy a stock because “it looks cheap” to a broker or a pundit that is calling it cheap on peak earnings. So when they’re calling a cheap, they’re using the wrong “e”.

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McCullough: So if I tell you something looks cheap at 15 times earnings, it doesn’t mean anything if the “e” is wrong. Okay? So what we’re predicting here is, again, through dollar strength our call remains bullish on the dollar and rising wages. We’re going to continue to see some margin compression from the cycle peak. So inasmuch as we have growth slowing, and we have inflation slowing, we have margins compressing.

Margins compressing is actually as dangerous as anything out there.

And guess what they have to do with? The two causal factors that are growth and inflation slowing. They give you deleverage on your P&L if you’re one of these people out there that have made your own money by running your own companies. You know exactly what we’re talking about. Of course, many of the people that you listened to on old wall TV, have never run a company or a P&L.

Last slide, slide 70. From a factor exposure perspective, this is going to get you into the learning mode. And again, it’s not just what sectors and what asset classes you’re long or what currency—we want you to be long dollars and not long bitcoin. Not a bad call this year, right? Not a bad call indeed.

But again, from an asset allocation level, then we get into the sectors that we like because I pointed out here on the left side Consumer Staples is a good place to be, inasmuch as I said utilities is. But then on the right side where not to be—momentum stocks. This is when you go into the fourth quadrant. This back tests against economic realities. Don’t forget, that’s why we made the call.

Being long momentum, high beta, tech, growth, the Russell growth, that is not where you want to be.

So if you’re scared because somebody had you in that, you should be more than scared. You should be very afraid at this point. Because you are only going to wear more losses. Okay? You can hope and pray for an Italian or Trump or Xi or whoever you want and that might give you a good day like it is today. But again, it’s only a good day from a very, very bad place in your portfolio.

Rule number one in risk management: Don’t lose money when everybody else is. Our subscribers have not. That’s what we’re trying to help you join them here in the coming months. And as Darius pointed out, guess what, we’re still in Quad 4 in Q1 of 2019. And it’s still not yet the end of November. Okay?

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Below is an excerpt from a recent Early Look written by CEO Keith McCullough with post-Fed minutes release analysis:

CLIENT: “So my Old Wall brokers called and told me to buy stocks (again) yesterday because the Fed going dovish for all the reasons why I shouldn’t have been bullish for the last 2 months is the catalyst.”

RISK MANAGER: “Interesting, what stocks did they tell you to buy?”

CLIENT: “Oh, Tech stocks, Energy stocks – and some Industrials too… because we have Trump/Xi this weekend.”

RISK MANAGER: “Oh, ok. Do you know what those stocks do when the Fed goes dovish in Quad 4?”

CLIENT: “No, can you remind me?”

Sure. As opposed to making brokered, banked, and un-back-tested “calls” like those, our independent research and risk management #process is designed to help you make patient decisions when your competition is panicking.

I don’t want to spend too much time reviewing what should be obvious this morning to anyone writing down what’s actually happening after another 1-day panicking-of-the-new-narrative-seeking-bulls, but here’s a quick recap:

  1. After US stocks had another bounce to lower-highs on decelerating volume, Chinese stocks dropped -1.3%
  2. After a small correction from its Quad 4 in Q4 highs, the US Dollar has resumed its ascent
  3. A disastrous #Quad4 Deflation of Oil continues (WTI down -35% since OCT)
  4. Both short and long-term Treasury Yields are hitting fresh Quad 4 in Q4 lows
  5. And the Quad 4 in Q4 economic data continues to roll in…

CLIENT: “Oh, right. The data. Please tell me more about the data.”

RISK MANAGER: “No problem, here you go – Darius Dale has been preparing for this part of the season, for the entire season.”

“Hey fellow Data Dependent’s, thanks for checking in.

Regarding Powell’s comments, diligent study of the last 3 economic cycles reveals the Fed ending its tightening cycle was indeed a panacea 2/3rds of the time (i.e. in the late 80’s and in the mid-2000’s). The other 1/3 of the time matters too:

A) When I layer on the context of actual economic activity via our historical GIP Model regime data, I see that the US economy was in a favorable Quadrant for risk assets 60% of the time from the cessation of tightening to the eventual ending of those two cycles: in Quads 2-3-1-4-2 in the five quarters from FEB ’89 through 1Q190 and in Quads 4-1-3-2-1 in the five quarters from JUN ’06 though 3Q07.

B) Then when I look at the Fed pausing in MAY of 2000 – i.e. the one time ending rate hikes didn’t matter to the stock market – that was in the context of the US economy being in Quads 2-3-4-4 in the four quarters ended 1Q01. The purpose of this note is to alert investors to the fact that the aforementioned path is much more akin to our current dour outlook of Quads 4-4-3-3 in the four quarters ended 3Q19E.

All told, as I wrote in my 11/27 note, investors would be remiss to analyze and act upon Fed policy pivots in a vacuum. The GDPCPI, and corporate Profit Cycles matter most and Powell’s less-hawkish comments today have little to no bearing on our forecasts for either.”

CLIENT: “Wow, thanks – I haven’t read that anywhere else.”

Of course you haven’t. That’s the point. The Old Wall didn’t make the Quad 4 in Q4 call back on SEP 27th… because they don’t even know what the damn quads are! Whereas everything we do and say depends on back-testing it against our own process.

They may hate me and hate that I moved to Long Treasuries, Short Junk (instead of buying every draw-down in Tech Stocks) when they were mostly all talking up the “risks of rates breaking out to the upside” for the last 2-3 months…

But economic gravity does not hate. It just doesn’t care.