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8/6/2019 Will Equities Stay Resilient as the Economy Slows?
http://slidepdf.com/reader/full/will-equities-stay-resilient-as-the-economy-slows 1/[email protected] Fundamental and technical analysis, but mostly judgment 1
MosaicGlobalPerspectivesFundamen ta l and Techn i ca l Ana l y s i s , bu t Mos t l y J udgmen t
M o s a i c M a r k e t R e s e a r c h , L L C
K e v i n A . L e n o x , C F A
W e b s i t e : M o s a i c m a r k e t r e s e a r c h . c o m
E m a i l : K l e n o x @ M o s a i c m a r k e t r e s e a r c h . c o m
WillEquitiesStayResilientastheEconomySlows?
Althoughthecurrentsoftpatchineconomicgrowthiswidelyexpectedtobetransitory,ourmostimportantmetricsformonitoringfinancialconditionsandleadingindicatorssuggestthattheequitymarketsarevulnerable.EventhoughtheS&P500justsetapost-recoveryhighlastFriday,there’sbeenapronouncedflight-to-qualitythemeoverthepastfourtofiveweacrossmultipleassetclassesthattypicallyprecedeanegativereturnenvironmentforequities.OurassessmentisthatthecurrentsynchronizedweaknessinU.S.andglobalgrowthwillprovetobesomewhatmoreprotractedthancurrentconsensestimates.However,globalinterbanklendingandswapspreadsarenotyetreflectinganincreaseinsystemicstresswithinfinancialsystem.Atthispoint,theweightoftheevidenceisprovidingaclearsignaltoreduceportfoliorisklevels.Wehave
highlevelofconvictionthatportfoliosshouldbetacticallyunderweightinequities,especiallysmallcap,andhighyield.
WefindthattheISMManufacturingandISMServicesPMIscanoffervaluableinsightregardingthecurrentstageofthebusinesscycle.ThemoreeconomicallysensitiveISMManufacturingPMIhasremainedabove50for20consecutivemontandnearhistoricallypeaklevelsover60forthefourthstraightmonth.AccordingtoarecentstudybyRBCCapitalMarketstheS&P500hasrallied21.1percentintheyearleadinguptotheISMreaching60,andonly6.5percentoverthesubsequ12-monthperiod.Whilethere’snothingmagicalaboutreadingsover60thatshouldpromptinvestorstoimmediatelygetdefensive,itdoesmeanthatinvestorsneedtobekeenlyawarethattherisk/returnprofileislessattractiveatthispointofthcycle.Forexample,thesharpdeclineinboththeJPMorganGlobalServicesPMIandtheU.S.ISMServicesneworderscomponenthasbeenconsistentwithpriorperiodsofslowereconomicgrowththatpersistsforseveralmonths.OurpremisethattheISMbusinesscycleindicatoriscurrentlyintheso-calledpeak-to-50stage.Thisisveryconsistentwiththerotationawayfromcyclicalstockstomoredefensivestockswithabove-averagedividendyields.
Investorshadbegunrotatingfromeconomicallysensitivecyclicalstockstomoredefensiveandhigherdividendyieldingequitiesinmid-February,butthemomentumhasacceleratedoverthepastfiveweeks.Despitestrongfirstquarterearningresults,particularlycyclicals,investorsareclearlypositioningforamorechallengingeconomicenvironment.WefinditnoteworthythatwhileGDPestimatesarebeingratcheteddownfor2011and2012,S&P500earningsaremostlybeingrevisedhigherduetothestronger-than-expectedfirstquarterresults.Equitiesarepoisedtofaceadditionalsellingpressurwhenearningsforsubsequentquartersarerevisedtoaccountfortheweakeningeconomiclandscape.
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Da t e : 5 / 0 9 / 2 0 1
S o u r c e : U . S . B E A , I n s t i t u t e f o r S u p p l y M a n a g e m e n t
8/6/2019 Will Equities Stay Resilient as the Economy Slows?
http://slidepdf.com/reader/full/will-equities-stay-resilient-as-the-economy-slows 2/[email protected] Fundamental and technical analysis, but mostly judgment 2
ThecreditmarketshavehistoricallybeenareliableleadingindicatorofimportantinflectionpointsintheS&P500.Inparticular,wemonitorseveraldifferentgaugesofOASandCDScreditspreadsbetweenhighyieldandinvestmentgradecorporatebonds.Inaggregate,thesespreadshavecontinuedtowidensincemid-February,andthere’sadistinctflight-to-qualitytrendthatshouldmakeequityinvestorstakenote.
Thebull-flatteningtrendofthe2s10scurveisaconfirming,butoftendelayedindicatoroffutureeconomicweakness.Interestingly,the10-yeargovernmentbondyieldshavefallenforalloftheG-7countriesoverthepastfourweeks.Theweaknessinthebankingindustryappearstobeaconfirmingsignalthatthecurvewillcontinuetoflatten.Also,theGermanBundcurveisinabear-flatteningpatternthatpointstowardagrowingthreatofstagflationintheEurozone.
Thepriceofcopperpeakedinmid-February,andclosedthisweekbelowthe200-daymovingaverage.Weviewcopperaskeygaugeofglobalgrowthtrends,andithasbeenaconspicuouslaggardastheS&P500reachedapost-recoveryhighlaFriday.Ourbasketofcopperproducingstockshavebeenunderperformingtheprimaryglobalequityindicesoverthepastweeks,whilethemajorstockmarketindicesforcommodityproducingcountriessuchasAustralia,Brazil,CanadaandRushaveallfollowedaverysimilarpatternduringthissameperiod.Inourview,thisdataisconsistentwithamoreprotractedperiodofglobalgrowththatwilllikelyresultinfurtherdownwardrevisionstoglobalGDPestimates.
Thesteeplossesthisweekinbothcommoditiesandequitieshelpedtriggerinvestorstoreducetheirexposuretomorerisk
currenciesliketheAussie.Inaddition,therewasahugespeculativepositionintheEurobasedontheexpectationofhigheinterestratedifferentials.Intheeventofanunexpectedsurgeofriskaversion,adisorderlyunwindingofthecrowdeddollafundedcarrytradewouldcreateaddedsellingpressureforrisk-orientedassetclasses.
Althoughthebalanceofrisksaretiltedtothedownside,ourindicatorsareportrayinganorderlyadjustmenttoalower-thanconsensustrajectoryofeconomicgrowth.Thestrongdegreeofcorrelationamongleadingindicatorsandcross-marketanalysisprovidesahighdegreeofconfidencethatinvestorsshouldbetacticallyunderweightinequitiesandhighyieldboSmallcapstocksappearparticularlyvulnerablebasedonthecurrentstageofthebusinesscycle,valuationanddeterioratibreadth.
S l o w i n g E c o n o m y , C o n t i n u e d
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