Living in the US, I can’t speak to how other countries view the US equity markets but I can tell you that domestically, the US equity market is the center of the financial universe and receives the majority of all types of media coverage from CNBC to bloggers. Being a global macro guy this drives me crazy because while the US equity markets are important, they don’t exist in a vacuum, nor do they drive the majority of asset prices.
Considering the coverage that US equities gets here in the States I’m constantly amazed at how many people seem to be caught off guard by any type of downside volatility in US equity markets.
The only people that seem to see this type of volatility coming are the same ammo-and-canned-food crowd that I mentioned last week. Speaking of which, how perfect was the timing of last week’s commentary on headlines? Here are some of the headlines from last week:
“Panic Grips Global Markets”
“What’s Next After the Biggest Bloodbath in 2015”
“7 Charts Showing the Market Panic”
“Did China Just Give the Fed a Big Sucker Punch?”
My favorite is the use of the word “Bloodbath,” really? The S&P 500 (SPY) is now off just 3% for the year, does that really count as a “bloodbath?”
So while SPY has given back its 2015 gains, not much else has occurred, yet. Before I get accused of being Jim Cramer and staunchly defending US equities and believing that every dip should be bought, let me state clearly that I’m neither a bull or a bear, I’m agnostic in that respect. I don’t really care if markets go up or go down.
I’m not saying that last week’s decline doesn’t have some significance or couldn’t be the beginning of something more dramatic. I just think it’s a waste of time to forecast whether this is the beginning of the end.
Stick to your process.
If your framework is solid, then it works whether markets are going up or down. Your process will tell you what markets to be involved in and which side of that market provides the best risk to reward characteristics.
While most investors are focused on whether now is the time to buy US equities or not, I would encourage you to focus on what’s happening at the margins of financial markets. Markets will tell you all you need to know if you learn to listen to them.
The last time I did a drill down on US markets was in the July 27 issue of TWR. Here is what I said at the time as it relates to how investors were positioning themselves:
“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..”
The key part of that quote is “…the key to this is to monitor this data in real time…” So, in addition to the latest Q3 GDP estimates being revised down to less than 1.5%, what, if anything has changed over the last month ? There are several significant developments here in the US.
US Growth Expectations
The most significant development is a shift in the positioning of investors. The playbook of being LONG High Growth US assets and either SHORT or NEUTRAL on Slow Growth US assets, which worked until the end of July, has stopped working. Since my last update, the Slow US Growth market index has outperformed both the broader US equity markets (SPY) as well as my High US Growth market index.
The Slow Growth Index is up 4.6%, while the High Growth Index is down 5.6% and the S&P 500 (SPY) is down 5.3%. That is an astounding 1000 basis point divergence in performance over just 4 weeks and it says that investors are solidly positioned in the slow growth camp for the end of the year. I can also tell you that from a quantitative perspective, the Slow Growth Index looks poised to explode higher while both the High Growth Index and the SPY have been damaged over the last month and look suspect.
The other significant development is the direction of the US dollar. As of the July 27 issue of TWR, the USD was trading near the top end of its 6-month trading range, looked poised to break-out of that range.
The US dollar attempted that breakout 8 days later and has since fallen 3.5%, closing this past Friday back at $94.84. As a reminder, the main driver of the USD’s rally was the divergence in growth outlooks for the US versus the Eurozone and Japan had capital flowing into the US.
Since there hasn’t been a dramatic change in the fundamentals of either the Eurozone or Japan over the last three weeks, I have to believe that the recent weakness in the USD is related to investors re-evaluating the true growth prospects of the US. Few people are talking about the USD because a 3.5% decline after a huge run-up isn’t news worthy, especially if there is no real technical damage, which is the case currently.
US Yield Complex
The US Treasury market remains confused as to the future of US interest rates. The latest Fed minutes showed that there is still debate as to whether the US economy is strong enough to withstand higher rates.
All 3 sections of the US yield curve are indicating different directions for Fed policy. The short-end of the curve is convinced that an interest rate hike is imminent, the middle part of the curve is undecided and the long end is signaling no rate hike and a possible recession.
It’s worth pointing out that the Fed meeting reflected in last week’s minutes occurred before the Chinese Yuan devaluation and the latest sell-off in crude oil prices. Those two developments could have as much impact on the Fed’s rate hike decision as anything occurring in the US economy.
Up markets or down markets, it doesn’t matter. Stick to your process. When everyone else is talking about panic and bloodbaths, keep your wits about you. Continue to evaluate markets in the exact same way whether the VIX, a commonly used indicator of stock market volatility, is trading at $15 and all appears calm, or its trading at $40 and the media is telling you the sky is falling.
In both cases, the reality is far from the commentary. This is why it’s important to focus on what’s occurring at the margin, because few others are paying attention and by the time you hear about it on CNBC, its too late to provide you with an edge.