It’s really easy, with the ever-expanding universe of information sources, to miss the forest for the trees.
It's easy to feel like you need to make a change in your portfolio every time you hear market pundits talk about each data point as if it’s the most critical data point in the history of earth.
The problem with that strategy is that you would change your portfolio 9 times a day. Oh, and every data point issued by the government is not, in fact, the most critical data point in the history of earth. Last week is proof.
The S&P 500 exchange-traded fund (ETF) SPY, which mirrors the returns of the S&P 500, declined 1.40% last week. Despite the decline, there was no real technical damage done as it continues to trade in the same range that it has been trading in since busting to a new all time high back in the middle of August.
If you hadn’t watched the market action you would have assumed (incorrectly) that it was a pretty ho-hum week in the US Equity markets.
However, what that cumulative return for the week doesn’t tell you is:
1. SPY declined 3 days last week on above-average volume (high conviction) and rallied 2 days on below-average volume (low conviction)
2. SPY had its worst day since April on Thursday and the 161 basis point decline occurred on volume in excess of 150MM shares traded. Why is this significant? Because SPY has only traded over 150MM shares on 24 other occasions this year, that’s 13% of all trading days. And 75% of the other 150MM+ trading days were also down days.
All of this activity was driven by a mixed bag of data reports, Chinese rumors and Draghi comments. It would be extremely easy among all of the blog posts, Tweets and CNBC talking heads to forget the core purpose for the equity markets, to discount future growth expectations.
It’s all about growth baby, the rest is just small talk. Short-term price movements are based on crowd psychology and technical factors. But the farther out from today you go, the more markets move towards their underlying fundamentals.
For equity markets, this means they move towards the expected growth of the underlying economy they represent. Period.
So is the US growing or slowing? I’ll be the first to admit that we’ve been getting some mixed signals out of the markets over the last couple of weeks, which might have led me to jump on the long US yields and short US bonds bandwagon a bit prematurely.
How Growth Works
Let’s look at what the type of US growth different segments of the capital markets are telling us to expect. Investors began the year by positioning themselves for slower US growth.
This positioning continued well into Q3 as my “Slow US Growth” market index consistently and handily outperformed both the broader US equity markets as well as my “High US Growth” market index. This relative and absolute outperformance continued until 1 month ago.
During the month of September, the positioning in certain asset classes have begun to shift. While all three indices have declined since the beginning of September, slow growth assets have underperformed high growth assets by 130 basis points and the broader US equity market by 316 basis points.
This is a big shift from the first 8 months of the year when slow growth assets outperformed high growth assets by 1000 basis points and the broader US equity market by 500 basis points.
So, while investors' conclusions and markets jumped all over the place last week, I didn’t see a lot in the data to get worked up about. In addition, markets are continuing to jockey back and forth without any real clear direction. Slow growth assets, once again, outperformed high growth assets by 175 bps and the SPY by 120 bps.
My takeaway from last week is that markets are still questioning how to be positioned for the final 3 months of 2014.
The Data and The Margins
As always, data is only useful when it's put in the context of the broader markets. The strongest periods of economic growth for the US have always been accompanied by the trifecta of strong equity markets, a strong US dollar and rising/elevated interest rates.
So far this year that trifecta is mixed: S&P 500 (SPY) 8.7%, US Dollar (UUP) 5.9% and US yields have declined 16.2%. But as usual, these top line performance numbers don’t tell the whole story.
The SPY’s returns came from April to July. SPY was flat for the first four months of the year and although its had some dramatic moves, as of Friday’s close, its essentially unchanged since July 24.
The US dollar’s strength has been entirely since July 23, after being flat for the first 7 month of the year. The dollar’s rise has been nothing short of meteoric, with a couple of short consolidation periods along the way, culminating with Friday’s close above a 5.5 year downtrend line that began on March 6, 2009 and hasn’t been tested since June 2010, over 4 years ago. A 1-day close a trend does not make.
I typically like to see 3 consecutive closes above (below) a critical price level. But when anything occurs that hasn’t occurred for 4-6 years, I take notice.
As for US yields, there are still well off their New Year’s Eve highs, but have gained 8.5% just in the last month and within the last two weeks have been challenging critical overhead levels. I wasn’t surprised to see weakness in USY yields this year.
As I pointed out in the December 12 report, each of the last two times that the Fed has ended a QE program, rates have spiked initially and then declined over the intermediate term. That's exactly what we saw once tapering was announced in mid December.
So, it’s a little bit of a mixed bag right now in the US. The equity market is trying to find its identity after a clear identity for the first 8 months of the year. Slow and High growth are battling week in and week out for supremacy.
The US dollar is making an epic move, while US yields are bouncing nicely off the lows but having trouble closing above key price levels which would certainly usher in a regime shift to higher yields and lower bond prices.
During times like this where there are potential regime shifts all over the place, it's important to pick your spots even more cautiously than you do normally and trade with smaller size than you would normally.
The beauty for us is that it doesn’t matter if the US enjoys high growth or if economic growth slows from here because we will continue to focus on the critical economic and market indicators so that we can position ourselves to take advantage of the opportunities that present themselves, regardless of what's happening.