Relying on headlines to make investment decisions is about as smart as investing because Bernie Madoff said it was a good idea. No, I’m not talking about “fake news” headlines, or the National Enquirer snapping the worst possible picture of a celebrity and slapping a headline over it that reads “[Celebrity] addicted to pain pills and requires satanic rituals to get out of bed each morning.” I’m talking about relying on headlines from legitimate news sources, like Bloomberg, the Financial Times, and the like, to determine financial market developments.
I’ve written on many occasions about the dangers of paying attention to headline numbers in economic releases. But that’s only one headline risk prevalent in financial markets. The other such risk — news headlines — was on full display last week as news sources from North America to Europe touted the slowing of U.S. growth. Investing based on what newsies are shouting only increases “cat food and greeting” risk. For the uninitiated, that’s the risk of you spending your retirement eating cat food and saying, “Hi, welcome to Walmart.”
U.S. growth is accelerating. You don’t have to take my word for it: the data and the markets are backing my play.
Since I’ve put major news sources on blast to start this week’s commentary, it’s only fair that I drill down and show their mistake. Here are some headlines that surfaced after the initial estimate of Q4 GDP was released on Friday:
Bloomberg - "U.S. Growth Cools on Biggest Trade Drag Since 2010"
The Wall Street Journal - "GDP Expands Tepid 1.9% on Wider Trade Deficit"
Reuters - "Weak exports curb U.S. fourth-quarter economic growth"
Financial Times - "US 2016 economic growth weakest in five years”
There are many components to the GDP calculation that are worth paying attention to, but the one that the media and Wall Street tend to focus on is the quarter-over-quarter growth rate. Unfortunately for them, the real juice is instead found in the quarterly measurement of annual growth rate, which accelerated higher for the second consecutive quarter to +1.9%, up from Q3’s growth rate of 1.7%. This is the highest annual growth rate of the last four quarters, and it puts U.S. growth just below the post-Crisis average of 2.0% a year.
This growth rate may be “tepid,” but, by the most important measure, U.S. growth did not “curb” or “cool.” Similarly, the U.S. is not experiencing “the weakest growth in five years,” because GDP growth was in fact below 1.9% for the better part of 2013 and 2014.
Regular readers know I focus on the present, and the present data from January shows the trend is continuing. Service sector data accelerated higher for the first time in three months, and is now sitting at the highest level since November 2015. Likewise, the manufacturing data accelerated for the fourth consecutive month and is now sitting at the highest level in 18 months. We’ll be getting more clarification on the consumer side of the U.S. equation in the coming weeks, but at this point all aspects of the economy have been steadily improving since last summer.
But it’s not just lagging data telling us that U.S. growth is improving. The financial markets are most sensitive to U.S. growth, and they are confirming in real-time what the lagged economic data is telling us.
My firm monitors hundreds of markets and thousands of economic data points from all over the world. We aggregate this myriad of data and evaluate it based on a unique framework that allows us to gain distinctive insights into financial market developments.
Several years ago, we developed a pair of indicators that have proven valuable in anticipating and confirming the trajectory of U.S. economic growth. One of the indices is built from markets that perform well when U.S. growth is accelerating, and the other is built to alert me when U.S. growth is slowing.
For instance, U.S. growth slowed from a peak in Q1 2015 until it hit bottom in Q2 2016. Over that time frame, my U.S. Slow Growth Index gained 24.6% and the U.S. High Growth Index grew by 8 basis points, versus a 5.3% gain for the S&P 500. That is a massive outperformance of 2452 basis points and 1930 basis points respectively over just a 15-month time period.
For the last six months of 2016, as U.S. growth was accelerating, the performance of these indices reversed course. My U.S. High Growth Index gained 13%, versus an 8.5% gain for the S&P 500 and an outright 9.2% decline for my U.S. Slow Growth Index. High Growth outperformed Slow Growth by 2220 basis points, and outperformed the S&P's monster 8.5% return by 450 basis points. This type of one-way, dramatic outperformance only occurs when U.S. growth is unambiguously improving.
But that was then, and this is now. As I mentioned earlier, the early reads of January data confirm that U.S. growth is still improving. My indices agree with what the data is telling us. Through the first 18 trading days, the U.S. High Growth index has returned +2.9%, which is 208 basis points more than the U.S. Slow Growth index and 79 basis points more than the S&P 500 year-to-date.
Keep in mind that markets and economies don’t go straight up or straight down. At some point this year, U.S. growth will begin to slow again. This doesn’t mean a recession is coming, but it does mean that certain financial markets which have lagged or outright declined will once again come back into favor, on a relative basis.
This ebb and flow in markets is why it’s critical to stay data dependent and avoid digesting news headlines as truth. If headlines include words like “tepid,” “curbs,” and “cool” when U.S. growth is improving, you can imagine what they will say when things turn for the worse.
Remember, the most important aspect of an economic data series is what occurs at the margin of the annual growth trend. Period.
Risk Is Always On
Headline risk is always on and needs to be actively managed. Luckily, this is one market risk you have complete control over.
The playbook for accelerating U.S. growth is straightforward. Favor sectors that perform well in a higher growth environment, such as financials and technology, over defensive sectors like utilities and REITs.
That said, this commentary isn’t a permission slip to run out and buy up markets that are ripping to new all-time highs day after day. U.S. equities are due for a pullback. However, no matter what the headlines read, as long as U.S. growth continues to improve, then high growth sectors will outperform their slower growth cousins.
Stay data dependent, process driven, and risk conscious, my friends.