A common theme since I began writing this weekly commentary has been juxtaposingthe weekly data dump that occurs in global economies with what the financial markets are telling me in real-time. Markets will routinely tell us, in advance, what is coming down the pike with regards to fundamental developments. For instance, take US GDP growth from 2012 through 2013. US GDP growth rates were as follows:
Q3 2012 = +2.8%
Q4 2012 = +0.1%
Q1 2013 = +1.1%
Q2 2013 = +2.5%
Q3 2013 = +4.1%
Q4 2013 = +2.4%
So, in hindsight, we saw GDP growth declined at the end of 2012, bottomed in the fourth quarter and then accelerated sequentially from Q4 2012 until Q3 2013. If we had only known that US growth was going to accelerate like that beforehand we could have positioned ourselves for optimal returns.
We know that fundamental data is never real-time. So, what were markets telling us about US growth in real time? I have referred to my US Slow Growth and US High Growth indices in past issues of The Whaley Report.
The US Slow Growth index is made up of securities that have historically perform well when US growth is slowing and the High Growth index contains securities that perform well when US growth is accelerating, like in 2013.
My US Slow Growth index topped on October 4, 2012 and continued to decline until bottoming on December 19, 2013. My High Growth index bottomed on June 4, 2012 and recently peaked at a new all-time high 3 weeks ago on March 7.
A third market which is a great proxy for US Growth is the yield on 10-year Treasuries. This market bottomed on July 24, 2012 and peaked on December 31, 2013. Yes, I’m aware that market tops and bottoms can only be identified in hindsight.
So, I generally wait for a market that has potentially topped to make a lower high before calling a top and vice versa for a market that might have bottomed, I wait for that market to make a higher low.
If we use these parameters to assess our three growth indicators, here is what we get. The US Slow Growth index made a lower high on November 26, 2012. The US High Growth index made a higher low on November 16, 2012. And finally, US Interest Rates made a higher low on September 4, 2012.
If you waited for all three indices to confirm that the US was headed for higher growth rates you could have reallocated accordingly anytime after November 27, 2012. That’s a full 6 weeks before Q4 2012 GDP would have been reported in January 2013 and that’s a full 5 months before Q1 2013 GDP would be reported in April.
Let’s assume that you took the month of December off for the holidays and on January 2, 2013you reallocate your account for higher US growth because all three indicators are still in their respective up (High Growth and rates) or down (Slow Growth) trends.
And let’s also assume that you're going to hold that allocation until all three indicators break those trends. US interest rates broke its uptrend on January 22, 2014 and US High Growth Index broke its uptrend on February 3, 2014.
The US Slow Growth index broke its downtrend and started to head higher on January 28, 2014. Is it any wonder that all three indicators broke their trends within 10 days of each other right around the time we started to receive Q4 2013 data?
But the real question is, how would interpreting what the markets were signaling months in advance of the data help you to take advantage of the trend? From the closing price on January 2, 2013 through the closing price on February 3, 2014, the Slow Growth index was down 11%, the High Growth index was up 25% and the SPY was up 22%.
I know that 3% of outperformance doesn’t sound like much, but compound that over a couple of years and it starts to become meaningful.
What would it have been worth in performance to have avoided the securities in the slow growth index? Or better yet, understanding in December of 2012 that the market was pricing in higher US growth, you shorted securities that perform poorly in that environment?
Even if the Slow Growth index had put up positive performance in 2013, you’re risk adjusted return would have been phenomenal. We now know that US growth slowed in the Q4 2013 but what about Q1 2014 and beyond? Here is what markets have been telling us since the beginning of the year through last Friday’s close:
US Slow Growth Index = +8.7%
US High Growth Index = +1.7%
US Interest Rates ($TNX) = -9.1%
US Equities (SPY)= +1.2%
So far this year, Slow Growth has outperformed High Growth and the SPY by 700 basis points. Obviously the key to this is to monitor this data in real-time as lagging fundamental data is reported to investors. All of these particular markets have been range bound since late February. The next significant move for any of these markets will tell us a lot more about the future of US growth than Yellen could ever hope to.