With the markets taking another drubbing last week it didn’t take long for the popular press to flying into Terror Mode. “Stocks Crushed Across the Board.” “China Worries Stoke Global Rout.” “The Market Will Crash.”
There were no fewer than 4,000 articles written on the fact that it’s the worst 2 week start to the year of the S&P 500, in history. I’m not saying that the price action across markets hasn’t been significant. However, it never ceases to amaze me how market participants wake up one day and finally decide that developments that have been building for months, all of sudden, matter.
The markets may be off to the worst start in history but the reasons for that decline are not new.
I’ve been saying for some time that the number one driver of assets in 2016 is going to be the slowing of US growth and its impact on the Fed’s policy during 2016. Don’t let headlines and gurus distract you from keeping that at the forefront of your mind. The only developments to pay attention to are the ones that inform that narrative.
Fed Rate Hike = Lipstick On A Pig
The Fed made a mistake raising rates in December, they just haven’t admitted it yet. Given the US growth trajectory and the global backdrop, there is no chance the Fed will raise rates 4 times this year. In fact, I think the probabilities are good that it will be forced to ease once again before the end of this year.
I’ve written extensively about the issues with global growth as have many others. China’s troubles have received a lot of attention as has the issue with emerging markets. These trends have not reversed and in many cases are accelerating lower.
What has gotten far less attention is the trajectory of US growth. The latest GDPNow forecast came in at 0.6%. For perspective, this tracker started tracking Q4 growth at the end of October with an initial reading of 2.5%. We’ve lost 200 basis points of growth in the last 2 months.
But this isn’t a new development. US annual GDP growth rate actually peaked in Q3 of 2014, and has decelerated for 2 straight quarters, on its way to 3. It's not just the fundamentals that back this up, the markets have been forecasting slower US growth for 6 months.
I track two different proprietary indices that help me track what markets think about future US growth, but in real-time. One of the indices is a basket of assets that perform well on a relative basis when US growth is accelerating (High Growth Index) and the other tracks assets that outperform on a relative basis when US growth is slowing (Slow Growth Index). My High Growth Index peaked back on June 24 and has fallen 15% since then. On the other hand, my Slow Growth Index has returned 2% over that same time frame.
Fundamentals have been slowing and the markets have been corroborating that story for 6 months and yet no has really been discussing it. All of the focus was about the Fed raising rates and the fact that global growth will negatively impact the US and the Fed was wrong to raise rates with that threat. I’d argue that the Fed shouldn’t have raised rates primarily because the US economy wasn’t in a position to weather the implications of a rate hike. The global growth story should have merely been further rationale for not raising.
How To Trade This Pig
From a trading perspective, start thinking about trades that you can pair together that help you to reduce risk while giving you an opportunity to capture a good return over the time the trade is on.
The Slow Growth Index performance may not seem like anything to write home about, but think about it from this perspective. The S&P 500 has fallen 12% in the last 6 months and 8% of that is in the last 2 weeks. The High Growth Index is down 11% year to date and the Slow Growth Index is up 1%. If you went long the Slow Growth Index and shorted the High Growth Index you would be up approximately 12% this year with significantly less risk exposure than simply being long or short the S&P 500.
Regarding commodities, copper, oil, natural gas all started the new year by sliding further. The assertion that lower oil prices help to boost consumer spending hasn’t been playing out. The latest retail sales numbers show that US retailers had the worst year since 2009. Consumers are saving the difference they keep at the pump, they aren’t spending it. Obviously, if the Fed shifts to an easing policy as a result of US growth continuing to slow as I expect them to, then a weakening USD and the unwinding of SHORT energy trades will have a hugely positive impact on the entire commodity complex.
The bottom line is that if you have LONG exposure, you should use all rallies to reduce your risk exposure. If you are a long-only trader, then your strategy is pretty simple. Cash is King and being long cash can prove to be as smart an investment decision as choosing to deploy that cash.
The only other two markets that make sense right now are long-dated US Treasuries and Volatility. If you are a trader who is comfortable shorting, then this market is for you. You will have ample opportunities for shorting once these markets undergo consolidation before the next leg down.
This is the playbook to keep with until we see 3 things:
1. US growth swing higher backed by a stronger US consumer and a dramatic improvement in ISM numbers.
2. Commodities to finally bottom and show constructive price action. Constructive does not mean violent, short-covering induced counter trend rallies. Constructive means that a number of commodity markets start to slowly grind higher and begin systematically taking out critical levels of resistance.
3. Economic improvement at the margins for China and a sampling of emerging markets.
Until those 3 things happen more money is going to be made on the SHORT side of markets than the LONG.