Last week was a slow week, devoid of any significant macro developments. So, I thought it might be a good time to discuss the differences between the lagging data that is reported around the world on a weekly basis and the real-time information that markets deliver us throughout the day.
A common theme since I began writing this weekly commentary has been juxtaposing the 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's coming down the pike with regards to fundamental developments. Following I'll explore how I put all this current and historical information to work in positioning ourselves for the future.
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, 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 peaked at new all-time high on July 17.
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, 2013 you 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 out performance 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 markets have demonstrated an ability to front run changes in US growth in the past but what about this year?
Here are the GDP reports (rearview) since Q4 2014:
Q4 2014 = +2.7%
Q1 2015 = +2.4%
Q2 2015 (estimated) = +2.9%
Here is what markets (windshield) have been telling us since the beginning of the year through last Friday’s close:
First quarter 2015
US Slow Growth Index = +1.9%
US High Growth Index = +3.1%
US Equities (SPY)= +0.49%
Second Quarter 2015
US Slow Growth Index = -6.7%
US High Growth Index = +0.75%
US Equities (SPY)= +0.49%
Third Quarter 2015 (through July 24)
US Slow Growth Index = +0.29%
US High Growth Index = +0.75%
US Equities (SPY)= +0.97%
US Slow Growth Index = -4.7%
US High Growth Index = +4.7%
US Equities (SPY)= +1.96%
So far this year, High Growth assets have been outperforming Slow Growth assets and the broader US equity market over every time frame.
And as you can see, the lagging GDP reports have confirmed what the markets were telling us in real time, that US growth is accelerating. Even the early Q3 market data is showing that the market is giving a slight nod towards expecting US Growth to continue to accelerate higher from Q2’s expected 2.9% annual growth rate.
Obviously the key to this is to monitor this data in real-time as lagging fundamental data is reported to investors. If you have a solid process in place to help you understand what the markets are telling you then the next significant move for any of these markets will tell us a lot more about the future of US growth than any three month old set of data could ever hope to.