RECESSION AHEAD? FUGGEDABOUTIT!...2019/02/05 · RECESSION AHEAD? FUGGEDABOUTIT! February 4, 2019 EXECUTIVE SUMMARY Recently, a number of prominent investors and analysts, including

Cam Hui, CFA | [email protected] Page 1

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Quantitative & Strategy

RECESSION AHEAD? FUGGEDABOUTIT!

February 4, 2019

EXECUTIVE SUMMARY

Recently, a number of prominent investors and analysts, including Jeff Gundlach, David

Rosenberg and Ed Yardeni, have warned about an ominous recession signal from the latest

Conference Board’s consumer confidence print.

Bespoke’s Paul Hickey observed that the spread between the Conference Board’s present

situation and expectation components of the consumer confidence indices are flashing

recessionary signals. In the past, whenever this spread has exceeded 50, recessions aren’t far

behind. It is now 82.3. Ouch!

Fuggedaboutit! The American economy isn’t going into recession. Call us bullish, but with

a caveat.

We believe the U.S. economy is unlikely to enter a recession based on long leading indicators,

barring a full-blown trade war. However, investors should expect a growth scare going into

Q2. In light of the powerful short-term price momentum in stock prices, timing the

inflection point between rebounding optimism and a growth scare will be a tricky task.

We remain cautiously bullish on equities. However, should the growth scare become the

dominant narrative in the coming days and weeks, it could become the trigger for a re-test

of the December lows. If that were to occur, investors should look through the “you won’t

want to buy” fears to step up and load up on equities.

Cam Hui, CFA [email protected]

Table of Contents

Confident About A Slowdown? .............. 2

A False Signal ...................................... 3

The Consumer Revival ........................... 5

Prepare for the Growth Scare ................. 8

Waiting for the “You Won’t Want to Buy”

Moment ................................................ 10

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February 4, 2019


Confident About A Slowdown?

Recently, a number of prominent investors and analysts, including Jeff Gundlach, David

Rosenberg and Ed Yardeni, have warned about an ominous recession signal from the latest

Conference Board’s consumer confidence print.

Ed Yardeni’s analysis of the present situation to expectations spread was especially ominous for equity investors.

Exhibit 1: Present Situation to Expectation Spread and Bear Markets

Source: Yardeni Research, Inc.

Fuggedaboutit! The American economy isn’t going into recession. Call us bullish, but with a caveat.



February 4, 2019


A False Signal

To be sure, there are numerous signs that confidence indices of all stripes are rolling over, starting with the University of Michigan consumer confidence index.

Exhibit 2: Consumer Confidence Is Falling

Source: dshort.com

NFIB small business confidence is coming off its highs.



February 4, 2019


Exhibit 3: NFIB Small Business Optimism Coming Off Its Highs

Source: dshort.com

However, Renaissance Macro pointed out the recession probability signal based on present

conditions to expectations spread recession indicator is at 100%, but it has been elevated since

mid-2014. This is not a reliable and actionable indicator.

Exhibit 4: Not an Actionable Signal

Source: Renaissance Macro Research


https://twitter.com/RenMacLLC/status/1090633061262413826


February 4, 2019


The Consumer Revival

If you are worried about the American consumer, then ask yourself why real retail sales are

continuing to make new highs? Past recessions have usually been preceded by a peak in real

retail sales.

Exhibit 5: No Signs of a Peak in Real Retail Sales

Source: FRED, Federal Reserve Bank of St. Louis

Over on Wall Street, the relative performance of consumer discretionary stocks has been rising.

Most notably, the turnaround even as stock prices plunged in December and continued as the

market rallied.



February 4, 2019


Exhibit 6: Consumer Discretionary Stocks Are Outperforming

Source: Stockcharts

In addition, the housing sector, which is the ultimate form of cyclical consumer durable, is

showing signs of a turnaround. November new home sales surged and handily beat Street

expectations last week. In addition, the relative performance of homebuilding stocks have

begun to turn up as long rates have fallen. Similar the pattern of consumer discretionary stocks,

this group’s relative uptrend occurred ahead of the stock market sell-off last December.



February 4, 2019


Exhibit 7: A Relative Bottom in Homebuilders

Source: Stockcharts

Do these charts look the market signals of a weak consumer to you?



February 4, 2019


Prepare for the Growth Scare

This doesn’t mean that equity investors should entirely shrug off downside risk and the bulls

won’t have clear path up to all-time highs. Prepare for some volatility as there may be a growth

scare ahead.

We are indebted to the work of New Deal democrat, who has been monitoring high-frequency

economic data and categorizing them into coincident, short leading and long leading indicators.

This framework is highly useful for understanding the growth outlook in different time frames.

His latest update has pointed to persistent readings of short-term weakness, but a long-term

(one-year) strength indicating low recession risk.

The long-term forecast and the nowcast are slightly to the positive side, while the short term forecast is slightly

negative for the fourth week in a row. Some of this is due to the government shutdown, so we will have to

wait several more weeks to see is the changes are real.

The signs of short-term weakness into mid-2019 could be mistaken by analysts as the basis for

a possible recession. Cue the growth scare going into Q2. Troy Bombardia also observed that

the ECRI Weekly Leading Indicator has been consistently negative, which is another worrisome

sign.

Exhibit 8: Weakness in ECRI Weekly Leading Index = Possible Growth Scare

Source: Troy Bombardia

Another warning sign for equity investors is the continuing downgrade in forward 12-month

EPS estimates. To be sure, stock prices have held up well during a Q4 earnings season whose

beat rates are roughly in line with long-term averages, but how long can stock prices defy the

gravity of negative fundamental momentum?


https://seekingalpha.com/article/4237542-weekly-high-frequency-indicators-3-timeframes-close-neutral


February 4, 2019


Exhibit 9: Falling Forward 12-month EPS = Negative Fundamental Momentum

Source: FactSet Research Systems

The chart below depicts quarterly actual and estimated earnings. If New Deal democrat is right

about economic weakness in Q2, then equity investors should be prepared for either downward

revisions in Q2 EPS estimates, or downside reporting surprises.

Exhibit 10: Prepare For Q2 Weakness

Source: FactSet Research Systems



February 4, 2019


Waiting for the “You Won’t Want to Buy” Moment

For now, the current newsflow of a dovish Fed and a likely U.S.-China trade deal is tilting

sentiment and price momentum bullishly.

Exhibit 11: U.S.-China Trade Agreement Ahead?

Source: Twitter

However, we are concerned that the late December bottom seemed too easy. II sentiment has

normalized, and % bears spiked only briefly above % bulls. These readings are inconsistent

with past durable intermediate term bottoms.



February 4, 2019


Exhibit 12: Sentiment Returns to Complacency

Source: Investors Intelligence

Another worrisome sign evident during this rebound rally is the lack of apparent leadership.

The relative performance of NASDAQ and small caps are not showing signs of sustainable

leadership. If this rally were to carry itself further, what’s going to lead the way?



February 4, 2019


Exhibit 13: Where Is the Market Cap Leadership?

Source: Stockcharts

There is a trader’s adage on Wall Street that when it’s time to buy, you won’t want to. There

are too many investors and traders who are too eager to buy the dip.

It is difficult to see how the market could fall without some bearish catalysts. We have to wait

for the “you won’t want to buy moment”, which may occur when the market hits the growth

scare speed bump in the coming weeks.

In conclusion, the U.S. economy is unlikely to enter a recession based on long leading

indicators, barring a full-blown trade war. However, investors should expect a growth scare

going into Q2. In light of the powerful short-term price momentum in stock prices, timing the

inflection point between rebounding optimism and a growth scare will be a tricky task.

We remain cautiously bullish on equities. However, should the growth scare become the

dominant narrative in the coming days and weeks, it could become the trigger for a re-test of

the December lows. If that were to occur, investors should look through the “you won’t want

to buy” fears to step up and load up on equities.



February 4, 2019


Disclaimer

I, Cam Hui, certify that the views expressed in this commentary accurately reflect my personal views about the subject company (ies). I am

confident in my investment analysis skills, and I may buy or already own shares in those companies under discussion. I prepare and edit

every report published under my name. I depend on my colleagues for constructive criticism on my research methods and conclusions but

final responsibility is my own.

I also certify that I have not and will not be receiving direct or indirect compensation from the subject company(ies) in exchange for publishing

this commentary.

This investment analysis excludes any target price, and is not a recommendation to buy or sell a stock. It is intended to provide a means for

the author to share his experience and perspective exclusively for the benefit of the clients of Pennock Idea Hub (PIH). My articles may

contain statements and projections that are forward-looking in nature, and therefore subject to numerous risks, uncertainties, and

assumptions. The author does not assume any liability whatsoever for any direct or consequential loss arising from or relating to any use of

the information contained in this note.

This information contained in this commentary has been compiled from sources believed to be reliable but no representation or warranty,

express or implied, is made by the author or any other person as to its fairness, accuracy, completeness or correctness.

This article does not constitute an offer or solicitation in any jurisdiction.

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RECESSION AHEAD? FUGGEDABOUTIT!...2019/02/05 · RECESSION AHEAD? FUGGEDABOUTIT! February 4, 2019 EXECUTIVE SUMMARY Recently, a number of prominent investors and analysts, including