Two thousand years ago, Marcus Aurelius dropped some profound thoughts: “Think of the life you have lived until now as over and, as a dead man, see what’s left as a bonus and live it according to Nature. Love the hand that fate deals you and play it as your own, for what could be more fitting?”
On the surface, this quote may seem a bit heavy for financial market commentary and appear to have absolutely no connection to financial markets. But take a closer look and you’ll see embedded in Aurelius’ words the two key principles needed to be a consistently successful investor.
First, “Think of the life you have lived until now as over” means you must focus on better understanding what’s happening right now. The past is past; let’s think afresh about what will work best now. In contrast, most investors anchor themselves to what’s already happened in financial markets, and make today’s decisions by extrapolating past events into the future.
Second, “Love the hand that fate deals you and play it as your own …” means you must trade the market you have, and not the market you want. In contrast, most investors make decisions based on their perspective of what markets should be doing rather than what markets are doing.
Right now, investors are ignoring the immortal words of Aurelius, and in so doing are informing my newest Macro Theme for the U.S.
The Life You Have Lived
U.S. growth has been accelerating for the better part of two years. The global economy has also been cooking with kerosene since Q3 2016. However, this globally synchronized growth scenario is beginning to unravel.
I’ve recently discussed growth slowing in both China and the eurozone, and now I’m beginning to see chinks in the U.S. economic armor. Though not widespread, there have been several key economic data sets downshifting from acceleration to slowing.
On the consumer side of the growth equation, retail sales have been slowing for four months and total vehicle sales for six months. We’ve also started to see multiple aspects of the housing market topping out.
Looking at the broader economy, the Markit U.S. Composite PMI, which measures both manufacturing and service activity, has been slowing since October. The composite reading has been weighed down primarily by the service sector, as manufacturing activity continues to improve here in 2018. The persistence of manufacturing activity is confirmed by recent industrial production growth, which has now accelerated in four of the last five months.
Despite the divergence between two sides of the economy, I see a Rampage-style headwind for U.S. manufacturing in the months ahead, with central bank policy playing the role of George and oil playing Lizzie.
The Fed has been joined by the People’s Bank of China, the Bank of England, the Hong Kong Monetary Authority and the Bank of Korea in bellying up to the central bank tightening bar. Though it takes time for these policy shifts to be felt in the economy, they will certainly drive the cost of investment higher, which hits the manufacturing sector squarely between the eyes.
The crude angle on manufacturing is pretty straightforward. Crude oil is up 50% in the last nine months, and elevated oil prices impact the entire U.S. economy, but most of all manufacturing.
This commentary is not a warning shot; the risk of a U.S. recession is the size of a flea right now. However, what matters most in financial markets occurs at the margin. Right now, economic and financial market data is beginning to shift at the margin, and very few people are discussing it.
Love the Hand That Fate Deals You
One of the common mistakes investors make is to isolate their evaluation of economic data from financial market developments. The real power lies in aligning these two evaluations because you begin to see the dance that exists between the underlying economy and financial markets.
Many times, financial markets will give you a nod, in real time, as to where the economy is headed. Our research clients are familiar with two real-time indices I developed, which help me clarify the most likely direction for U.S. growth.
The U.S. High Growth Index is composed of U.S.-based assets that perform well when U.S. growth is accelerating. The other index, the U.S. Slow Growth Index, is composed of U.S.-based assets that perform well when U.S. growth is slowing.
Since July 2016, my High Growth Index has outperformed my Slow Growth Index in 17 of the last 21 months, and never in consecutive months. However, over the last four weeks, these indices are confirming that a Fundamental Gravity shift may be underway.
For the first time in two years, the Slow Growth Index has outperformed High Growth for four consecutive weeks. If Slow Growth continues this outperformance for another few weeks, it’ll outperform High Growth in back-to-back months for the first time since February 2016.
Do you know what the best-performing sector of the U.S. equity market was over the last month? Utilities. Do you know what the best-performing U.S. equity sector is when growth slows? You guessed it, utilities. And while utilities posted a 1.9% gain, the other eight S&P sectors lost between 4% and 9% (the S&P 500 is down 5.3% since December 31.
Now, one month does not make a trend, and you certainly don’t make decisions based on what two indices are telling you to the exclusion of everything else.
However, when you couple the recent trend shifts in U.S. economic data with the confirming shifts in financial markets over the last month, it should raise your antennae.
If U.S. growth is beginning to slow, then utilities, REITs and consumer staples will outperform relative to other U.S. equity sectors. Further, we should see Treasuries (all along the curve) perform well, and gold should be able to break through $1,488.
On the bearish side of the playbook, the worst-performing sectors will be technology and industrials. I think the downside in tech could be particularly ugly given the massive run-up over the last few years.
The Bottom Line
Investors will rationalize one or two months of slowing economic data or growth-related asset class underperformance as one-off events. Generally, market participants don’t change their perspective until they’ve been clubbed over the head with enough contrary economic data or their portfolio screams “uncle.”
Am I early? Probably; I usually am. I like to get to the party a little early, stake out the best vantage point, and get acclimatized to my surroundings before things get into full swing. This philosophy means I spend some time standing alone and looking awkward. However, awkwardness and solitude are rewarded because being early gives me two distinct advantages.
First, I’m able to survey the best spot to position myself for maximum social interaction, where people are naturally likely to gravitate. I position myself in the markets most likely to outperform before other investors even arrive.
Second, I’m able to chat up the bartender, Steve, while he sets up the bar. My first-name-basis rapport guarantees my bourbon pours are a little heavier than my fellow partygoer. You might say my evening has a better reward-to-risk set-up than that of investors who will arrive fashionably late.
China is slowing, the eurozone is slowing; how long do you think it will take before the U.S. domino falls? Perhaps it's already been knocked over. The global growth-slowing party has already started. Where are you?