Fundamental Gravity

03/21/2016 10:00 am EST

Focus: ETFs

Landon Whaley

Editor, Gravitational Edge

Landon Whaley sees three primary factors, which he believes ultimately determines the prices and trends of various asset classes. Using this approach, the editor of The Whaley Report, also highlights ETFs that benefit from these underlying forces.

Steve Halpern:  Our guest today is Landon Whaley, editor of The Whaley Report.  How are you doing today, Landon?

Landon Whaley:  I’m doing real well, Steven.  Thank you for having me.

Steve Halpern:  Well, thank you for taking the time.  Underlying your investment strategy is the fundamental notion that different economic environments favor different asset classes.  Could you explain how you undertake this analysis?

Landon Whaley:  Absolutely.  I believe that beyond the short-term fluctuations in markets, there are only three factors that influence asset prices: Expectations for economic growth, expectations for future rates of inflation, and finally how central banks respond to those expectations.  

I call this the fundamental gravity, so at any point in time, an asset’s fundamental gravity is either bullishly lifting it higher or bearishly pulling it down.  

I tracked this fundamental gravity for 35 economies around the world to better understand which asset classes are primed for outperformance and also which asset classes are likely to underperform.  

My team and I have done an extensive amount of research in this area and have come to realize than an economy can be in one of four environments and that the performance of assets varies widely within each of those four environments.  

The reason this understanding is so important is because as Paul Tudor Jones once said, “The world is simply a flow chart of capital.”  Having traded markets for almost 20 years, I can tell you there’s no truer statement.  

The world money is constantly looking for the best returns.  Understanding the fundamental gravity of an economy gives you an edge because it allows you to anticipate the assets that will receive inflows of capital, and the assets most likely to see outflows.

Steve Halpern:  In a way, you’re not really looking at the waves, but you’re looking at whether or not, within any market, the tide itself is rising or falling.

Landon Whaley:  Well, we use the tide as the underpinning for everything we do, but we do certainly pay attention to the waves as a way of positioning ourselves when the time is appropriate.

Steve Halpern:  Now, you recently published an intriguing review of slow-growth assets versus high-growth assets.  Could you explain what that means and what that pertains to the current market environment?

Landon Whaley:   Absolutely.  Well, that sort of ties in with our last comment about waves.  In addition to the fundamental gravity for each economy, I also track a number of proprietary indicators that are designed to give me a real-time signal as to when markets are presenting an opportunity to trade profitably.  

You mentioned two of those indicators that I use to monitor US markets.  The US slow-growth index is made up of assets that outperform when US growth is slowing and, on the flipside, the high-growth index is made up of assets that typically outperform US economic growth is accelerating higher.  

Those real-time indicators signaled to me last October that I should position myself for slower growth because markets were starting to align with the fundamental gravity, which had shifted to a bearish stance a couple of months before that.  

Let me talk quickly about the year-to-date performance of the equity markets so that the audience can better appreciate why being able to align yourself with the fundamental gravity is so valuable.  So far this year, the S&P is down about 0.5%.  Our high-growth index is down 2.6%.  

At the same time, slow-growth index is up 9%, so assets that thrive in a slower growth environment have significantly outperformed both the grower US market and their high-growth counterparts.  

This is the type of performance advantage we’re able to gain by first understanding the fundamental gravity of the tide, and then trading assets that outperform in that type of environment when the waves tell us to do so.

Steve Halpern:   Because of the lagging nature of economic data, you also emphasized that this information you assess must really be considered within the context of what the market is saying you can do in real time.  Can you explain this?

Landon Whaley:   As I said earlier, everything I do is built from understanding the tide or the fundamental gravity of an asset class; but as a trader, I must listen to what the market’s telling me on a daily basis.  Keep in mind that day-to-day, markets are not fundamental analysts, but rather they’re just barometers of investor sentiment.  

Fundamental data is always lagging anywhere from one to three months, but markets tell me five days a week in real-time what people are thinking about the future.  By thoughtfully combining the lagging fundamental data with what markets are telling me in real-time, I can spot where there are opportunities within a given market.  

The real opportunities come when there’s a shift in the fundamental gravity that has yet to be accepted by the markets and I see an inflection point in the waves of that market that tell me it’s time to act.  This is exactly what happened last year in the US, which I just discussed.  

In August, I saw a bearish shift in the financial gravity for the US, and a couple of months later in October, I received the real-time signal from our slow-growth index that it was time to act.  

As a result, I’ve been trading on the profitable side of the US market for the last five months and was able to not only sidestep, but profit from the volatility that occurred in January and early February.

Steve Halpern:  Now as you’ve explained your view currently as an investor should be defensibly positioned, but you’ve also suggested that a way to do that is to do long treasuries and gold.  Could you walk us through some of the specific ETF recommendations that are suited to this environment?

Landon Whaley:  Of course.  Today, more than ever, investors need to understand how potential central banking decisions impact their portfolios.  In that context, I love gold and US Treasuries right now for the simple fact that I believe they are relatively immune to central bank actions.  

For example, we have the Fed’s March announcement this week.  The number one question on everybody’s mind is will they raise or won’t they?  I like to find trades that have a high probability of working no matter what a central bank decides to do.  Albeit, those trades are difficult to find, right now gold and treasuries fit that mold.

 Let’s take gold for example, which you can trade using the Gold Trust SPDR (GLD).  Gold historically performs extremely well when rates are falling or remain low.  

The fact that central banks are going to negative rates at an unprecedented pace provides a perfect environment for gold to prosper.  No matter what the Fed decide to do this week; gold will continue to perform well because the rest of the world is still aggressively trading.  

I see a similar set-up with long-dated US Treasuries which you can trade using iShares Barclays 20+ Year Treasury Bond (TLT).  US Treasuries are being driven higher by slower global growth.  No matter what the Fed does this week, global growth will still be slowing, and that’s going to trump any action taken by the Feds.  

Just look at the performance of TLT since the Fed hiked in December.  It was the first rate hike in 10 years and TLT has responded by rallying 7% higher.  TLT is going to continue to perform well with or without a rate hike.

Steve Halpern:  You’ve also suggested some relatively defensive positions within the stock market, and you pointed to the utility sector and consumer staples.  What’s the outlook in these areas and are there any particular ETFs that our listeners could consider?

Landon Whaley:  Absolutely.  The US is still in a slow-growth environment, and so I favor these two sectors specifically because they will continue to outperform, in my opinion, their higher-flying counterparts.  I’d buy utilities via the Utilities SPDR (XLU), which recently broke the new all-time high and is trading around $48 a share.  

You can buy XLU on a pullback as low as $45 and depending on where you enter the trade, you can set a risk price as low as $44 a share.  I would use $44 a share as the line in the sand.  If XLU closes below that price, then the US economy will be picking up steam and utilities are going to be set to underperform.  

As for the Consumer Staples Select Sector SPDR (XLP), it broke the new all-time high just a couple of weeks ago and has been grinding higher ever since.  

It’s currently trading just above $52 a share.  You can buy XLP on a pullback to as low as $50, and depending on where you enter the trade, set a risk price around $49 a share and use that as your line in the sand.

Steve Halpern:  Again, our guest is Landon Whaley of The Whaley Report. Thank you for your time today; it was a fascinating discussion.

Landon Whaley:  It was my pleasure, Steven.  Thank you.

By Landon Whaley, Editor of The Whaley Report

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