Macro Update: Pulling Forward

For the second week in a row our macro assessment, via our proprietary index, shows net improvement. The PWA Macro Index gaining 2.14 points, to -6.12:

While we had an equal number of positive and negative needle-movers (2 each), the positives saw greater net improvement (one moving two spots) than did the negatives.

The positives...

Personal Income rising to a 6.2% year-on-year rate:

Durable Goods Orders Ex-Transportation Equipment moving to a positive 1.68% year-on-year:

The negatives...

Chicago Fed National Activity Index declining for the third straight month:

Sector/SP500 ratios (Defensive sectors, staples and utilities outperforming. All cyclical sectors, save for financials and materials, underperforming): 

Putting today's macro conditions in perspective demands that we consider the source, or the force, influencing the data:

Personal Income: Rising year-over-year when a record number of folks remain unemployed can only mean one thing, huge government transfer payments. Sustainability going forward is of course the question...

Durable Goods Orders: Sales of stuff that equips the home has risen amid what we'll call, for the moment, the stay-at-home economy. The services component in the latest spending data is, on the other hand, declining. Question being, how much of the recent activity is a pulling forward of purchases that would've otherwise occurred over the months and years to come? Answer: A lot! Next question, what will the numbers look like as things get back to some semblance of normalcy? Answer: They likely drop, a lot!

Chicago Fed National Activity Index: Tracks 85 "coincident indicators" to get a feel for at-the-moment general conditions. It falling back to earth says the stimulus bump is receding notably. Of course there's another round of stimulus coming... Question will be; if folks see it as the last round, will they spend as much, or will they sock it away?

Sector/SP500 Ratios: Our score declining suggests that traders may be starting to think that the party's over. Or perhaps it's just a bit of profit-taking....

Bottom line: Commonsense, not to mention history, demands that we approach the latest net improvement in the data with a healthy dose of skepticism. Recognizing full-well that more stimulus is a given, and a covid vaccine a virtual given in the not too distant future.

As former Fed governor William Bullard declared earlier this week:

"...the stimulus provided by lower interest rates inevitably wears off. Cutting interest rates boosts the economy by bringing future activity into the present: Easy money encourages people to buy houses and appliances now rather than later. But when the future arrives, that activity is missing."

I'd, again, add "...the stimulus provided by lower interest rates and record government transfer payments, and any other form of public-sector intervention for that matter.... pulls activity into the present."

All that said, we remain flexible and open to all possibilities... I.e., we're simply assessing probabilities, which is an ongoing, everyday process...

Other inputs to our index worth sharing...

Overall consumer spending, while waning in rate of change terms, continues its upward trend:

High-frequency retail sales data (the pace), on the other hand, continue to roll over (jibes with the Chicago Fed Index):

Jobless claims, while still epochally high, continue to trend lower:

Rail and intermodal traffic still on the rise:

Caterpillar global sales growth lower (by 20%) for the 10th consecutive month:

Baltic Dry Index (cost of shipping raw materials across the world's oceans) rolling over:

Well, we can't end a report on current macro conditions without mentioning Q3's amazing 33.1% annualized (quarter-on-quarter) rebound in GDP. 

Indeed, that's impressive! Although we were bouncing (with mega assistance) from an epoch plunge, and we remain somewhat short of year ago levels... but still!

In terms of where the growth came from; of course, per the above, personal consumption, with those durable goods purchases, was the largest contributor. There was also a good amount spent by companies on capital equipment (unambiguously positive). Home construction was also an add, as was companies restocking their inventories. Foreign trade and, ironically, government spending (just wait till next year [read infrastructure]) both were drags.

Bottom line, there's much to play out in the weeks and months to come. As for next week... well... next week will be interesting...

Finally, I feel compelled to include herein my close to this week's main message, as I want to make clear that while conditions are anything but ideal, there'll nevertheless be true opportunities to exploit going forward:

I'll leave you with a couple snippets from our "firm-wide trading log." As you'll note, in our view, even though the foreseeable future looks anything but bright from our present vantage point, there will absolutely be opportunities to exploit, as well as risks to manage:

Note: Feel free to shoot me an email if you'd like translations of any unfamiliar terms...

10/16/2020 HEDGING ACTIVITY 
We added what amounts to a third of the number of current put hedge contracts in 11/13 3000-strike spx puts (or xsp equivalents). This firms up the hedge a bit (has lost some potency given OTM-ness and theta) in case of an immediately-bearish election outcome… We also bought 12/31 4000-strike calls (“) to provide some upside on bullish election and/or positive vaccine news. On average the addition amounted to a cost less than 0.20% of each client’s portfolio.

10/22/2020 (amended 10/26) POTENTIAL ALLOCATION TWEAKS
Europe is a mess with regard to covid; adding notable stress to an already severely stressed economy, and its markets reflect it. A vaccine and effective therapies will no doubt offer hope to equity investors, plus a positive Brexit outcome (which I expect) will help as well. Asia, on the other hand, is having a better go of it on covid, and, if we can believe China’s numbers (we should be skeptical) in particular (although South Korea is also showing promise), economic conditions are better as well.

Question being, which area of the developed world offers the best prospects going forward? While Europe is working off a lower base, in terms of equity price action in 2020, Asia has a somewhat better overall setup right here. Considering reducing our FEZ exposure and picking up a bit more VPL with the proceeds... Will look at country ETFs in the region as well.

Also, emerging market equities are interesting right here. Our general thesis says that the dollar will trend lower for the foreseeable future, in which case emerging market equities are an obvious play. Considering upping exposure there as well, taking from the cash allocation. 

In terms of U.S. sectors, energy remains severely off of its pre-covid high. A pickup in activity and/or inflation will likely see the sectors' equities higher. Valuation is relatively compelling… Considering upping the target allocation at the margin (a great deal of macro risk remains in the system, however), question being, do we go all xle or do we include an individual position, such as Schlumberger?

Commodities are also an obvious play relative to our thesis, one that we’ll likely increase in the months to come. In the very near-term, however, I expect a potentially dollar-driven pullback that would offer up a better entry for adding exposure. In that event we’d reduce our cash exposure to gain it.

With regard to potential adjustments (the above just scratching the surface [I've previously mentioned our intent to exploit infrastructure opportunities next year, for example]), each is unique in and of itself. Cutting European equity exposure, for example, demands that we cover all conceivable angles. I.e., the ECB (European Central Bank) meets tomorrow, and, as I mentioned in the note, a Brexit trade deal is pending, and there's likely a vaccine in our near future. Bullish outcomes here could see a period of global outperformance for this severely beaten down region of the world. Thus, any near-term adjustment we make will likely be modest. Longer-term, however, we may find ourselves owning notably more Asia and less Europe... 

Bottom line: Global markets are dynamic, and, therefore, so is our analysis. Intimacy with global macro conditions, painstaking diligence, open-mindedness, humility and proper risk management are all essential to doing it right over the long-term.

Have a nice weekend!

Marty