Mindfulness

If you read the title of today’s commentary and your finger is hovering over the delete button, it’s probably because you believe that there can’t possibly be a profitable link between sitting silently, paying attention only to your breath, while listening to John Tesh and financial market mastery. 

Ah, my friends, you would be mistaken. Remove your shoes, step into my ashram and I will prove to you that one of the most important edges you can develop as an investor is the practice of mindfulness, John Tesh music optional.
Mindfulness is the practice of bringing one’s attention to the internal and external experiences occurring in the present moment. As it pertains to financial markets, I define mindfulness as the ongoing practice of developing a better understanding of what’s happening right now. 

But why is this an edge?  

Because most investors, retail and institutional alike, spend the majority of their time doing one of two things. First, they look backwards at data that is months old and as relevant as a Beta tape in a streaming video era. 

Second, they look so far forward using Wall Street forecasts they’d be better off calling Miss Cleo. I’ll break down, break apart and utterly dismantle the absurdity that are Wall Street forecasts in another commentary, but for today, let’s focus on why driving while looking in the rearview mirror is a recipe for investment disaster.

Lame Government Numbers

You’ve probably seen a number of media stories in the last week about the “advanced estimate” for US Q1 GDP Data. I don’t know about you, but when I see the word “advanced” I think of being in front of something or being first, like concert tickets. 
Advanced ticket sales for the concert 6 months from now start at 10am this Saturday. And starting at 9:55am, you start hitting your refresh button feverishly so you can get the best seats, IN ADVANCE. 

How lame would it be if the advanced ticket sales this Saturday at 10am were for a concert that happened 2 months ago? But that’s exactly what happens when the government sells you tickets to the GDP estimate concert. 

They tell you in early May what they think occurred 2-4 months ago. Not only is this lame, it’s a complete waste of your time. Using Q1 data to make investment decisions in May is like watching “Leave It To Beaver” to understand the dynamics of American families in 2016. 

The Value of Now

I don’t want you trying to watch a Beta tape when you can get Netflix on your smart phone. I want you to be mindful. Everyone sees what happens every day but how many people make an effort to understand what those everyday events say about the investment climate and how we should position ourselves? Not many. A critical edge can be gained by figuring out what’s happening around us and then using that insight to inform our trades.

What if I told you that you didn’t need to be one of the guys in “The Big Short” to see the Financial Crisis coming and to profit from it?  You certainly weren’t going to see the Crisis coming by looking backwards 3 months. All you had to be was mindful of what was happening, as it was happening.

Don’t believe me? Let’s walk through the critical events leading up to the peak of the S&P 500 on October 11, 2007.

March 2006: Housing stocks and REITS peak.
June 2007: Bear Sterns closes two hedge funds who invest solely in subprime mortgages and are forced to dump assets, which causes issues at Merrill Lynch, JPMorgan, Citigroup and Goldman Sachs.
July 2007: Bear Sterns tells investors in the funds that they will get little or no money back from the two funds after the banks refuse to help bail them out.
August 2007: The Fed cuts rates 0.5% and warns that the credit crunch could be a risk to economic growth.
September 2007: The Fed cuts rates again, just 1 month after the initial rate cut.
October 2007: UBS, one of the world’s top flight banks announces $3.4B loss from sub- prime-related investments and the CEO steps down.
October 2007: Merrill Lynch announces $7.9B loss and the CEO resigns.
October 2007: Citigroup announces $3.1B loss. Two weeks later they announce another $5.9B loss. Within 6 months, Citigroup announces a total of $40B in losses.

All of these events occurred BEFORE the market peaked. Even at the end of September 2008, a year after the S&P peaked, it was just 15% off the highs from October 2007.  The big capitulation occurred during the final 3 months of 2008 and the beginning of 2009. There were ample events that signaled we were in uniquely tumultuous times. And you had almost 18 months to position yourself to profit from the huge drawdown that occurred. 

Now, let’s use this same mindfulness to get our hands around what’s happening right now on May 9. Rather than using 3-month old data to make investment decisions today, I prefer to use a tried and true one-two punch that helps me to be mindful. The first punch is current quarter economic data, no older than 4 weeks, followed by the second punch, which is real-time market data. 

First Punch

So far the handful of data from April isn’t encouraging for those wishing for a Q2 rebound in US economic activity. The data points: Manufacturing PMI, Consumer Confidence Index, Chicago PMI, Richmond Fed and Dallas Fed Manufacturing Index, all fell from last month. The one bright spot is the service sector, which accelerated slightly from the numbers in March. 

The one area of the economy that everyone seems to be leaning on for a Q2 rebound is the labor market. There are two problems with this perspective. First, all of the major labor market indicators for April, which were reported just last week, deteriorated from their March reports. Second, the labor market has looked from good-to-great for the last 3 quarters, all the while US growth fell off a cliff. 

With all that said, it’s early still in the quarter and we don’t have a ton of data to evaluate. More to follow.

Second Punch

Now for what the market is telling us in real-time. I’ve developed a number of proprietary indicators that better help me assess the current conditions in financial markets. Two of these indicators make a regular appearance here in this commentary because they are so damn accurate at discerning the trajectory of US economic growth in real time. 

One such indicator I monitor on a weekly basis is my US Slow Growth Index and another is my US High Growth index. As the names would imply, the Slow Growth index is comprised of markets that perform well when US growth is slowing, as it has been for 3 straight quarters. In contrast, the High Growth index, is comprised of markets that tend to perform well when US growth is accelerating higher. 

Luckily for regular readers of TWR, you didn’t have to wait until early May and the “advanced estimate” of Q1 GDP to know that US growth slowed. Throughout the first quarter, I discussed what the relevant data points were saying about US growth and what these 2 real time indicators of growth were telling me. 

The Slow Growth index was up 11.6% during Q1, while the High Growth index declined 10 basis points. With this kind of disparity in performance, even a Wall Street analyst could tell that the probability for an economic slowdown from Q4 2015 to Q1 2016 was pretty darn good. In fact, during the 13 weeks of Q1, the Slow Growth index outperformed in 10 of those weeks, or 75% of the time. 

Not to mention that the fund flows into the Slow Growth assets were historically high, while the High Growth assets saw net outflows. The signal from markets was crystal clear, US growth was slowing.

We are currently 5 weeks into Q2 and these indicators are painting a similar picture. So far this quarter, the Slow Growth index is up 1.4%, while the High Growth index has declined 3 basis points. 

In addition, the fund flows are continuing to lean in the direction of Slow Growth assets. Keep in mind, this is just a snapshot in time and as more Q2 data is unveiled and markets move, all of this is subject to change. 

However, right now, the slow growth playbook remains the way to trade the market. This means being LONG US Treasuries, utilities and cash. Yes, cash is an investment position. The playbook also calls for being SHORT sectors like technology, financials and consumer discretionary. If being SHORT isn’t an option, then STAYING AWAY ENTIRELY is the way to play these growth oriented sectors.

The next time you read a headline that says “Critical Data Point from What Might As Well Be 10 years ago because of its relevancy today and how it impacts your portfolio” close the web browser. You will never get those 5 minutes of your life back. Be mindful. Put on some John Tesh, focus on your breathing, and then pick up the latest copy of The Whaley Report.