If the U.S. economy is as excellent as everyone on Wall Street says, why are the best defensive sectors outperforming the S&Ps, asks Landon Whaley.
The 2020 decade is off to an auspicious start. Nothing describes the current investing environment better than Tesla (TSLA). The stock is on a SpaceX rocket ship to Mars. It now has a larger market cap than 490 companies in the S&P 500 but can’t get admitted to the index because the company hasn’t yet posted profits for four straight quarters! Similarly, the S&P 500 is setting new all-time highs despite the fact operating profits have flatlined for five consecutive years, the longest stretch without earnings growth since the late 1990s. What could possibly go wrong?
As a refresher course for those new to my ramblings, I’m not perma-bear or perma-bull; I’m data dependent. I wake up every morning, digest the latest ream of data from around the world, and update our Fundamental Gravity monitor for every economy we track. Wash, rinse, repeat.
Notice I didn’t say wake up every morning and turn on CNBC to hear what Jim Cramer thinks or for Pete’s sake, Steve Liesman’s take on economic developments. I can hear the television bulls now, “Q4 GDP growth was ‘better than expected,’ and the January ISM Manufacturing PMI is back in expansion territory!”
As my boy Lee Corso says, “Not so fast, my friends!”
First off, that U.S. Q4 GDP report looked like the paint by numbers data the Chinese government spoon-feeds investors. The U.S. government used a GDP deflator (inflation rate) of +1.6%, which is a far cry from their very own consumer and core inflation rates of +2.3%. This 30% understatement of inflation caused a dramatic overstatement in the quarterly and yearly GDP growth rates. Second, the combo platter of net exports and government spending accounted for 93% of the entire headline growth rate of 2.1%, which is the highest contribution to GDP since Q2 2009. What’s more, that healthy as a heifer net export number was caused entirely by a crash in imports. There is no domestic demand!
As for the January ISM reading, let’s pump the brakes on the “economic growth bottom is in” commentary. We fully expected a bounce in the ISM based entirely on the base effects, and we also fully expect this to be a one-off, or maybe a two-off, at the most. Not only is there a plethora of industrial and manufacturing data from January contradicting the ISM (check out the latest durable goods data), but I can’t see a single catalyst on the horizon for a phoenix to rise from the manufacturing sector ashes.
There hasn’t been one data point this year that’s changed our call for a Winter Fundamental Gravity environment (when growth and inflation both slow in tandem) between now and July, as well as the rising probability of a mid-year recession.
The economic data is clear, and so is the signal broadcasted by U.S. based financial markets. Yes, the S&P 500 is ripping, and so are tech stocks. But I’ll see your S&P/tech portfolio and raise you one comprised of utilities, Treasuries, gold, and REITs.
If the U.S. economy is as excellent as everyone on Wall Street wants us to believe, then the four horsemen of the apocalypse would be getting shredded right now. Instead, utilities (+6.3%) are the second-best performing sector year-to-date with REITs (+2.9%) running closely behind. As for the other two horsemen, both gold (+3.6%) and Treasuries (+6.7%) are outperforming the S&P 500 (+3.2%), and the latter has nearly matched the year-to-date performance of tech stocks!
Folks, the four horsemen don’t lead U.S. markets higher when everything is economically peachy.
We haven’t even mentioned the U.S. dollar! Heck, the U.S. dollar’s return (+2.7%) so far this year is only trailing the S&P by just -50 basis points. The dollar’s strength through the first five weeks of the new year is Exhibit A in our case for a Winter FG. Far and away, the most bullish environment for the U.S. dollar is a Winter FG; there is simply no other explanation for the dollar’s recent strength.
All of this adds up to a warning for those investors chasing the S&P 500, small caps, and other growth-y sectors of the U.S. equity market higher. The U.S. will experience a Winter FG sometime before July, and the risk of a recession is real. Trade accordingly.
Please click here and sign up to receive the latest edition our research reports as well as to participate in a four-week free trial of our research offering, which consists of two weekly reports: Gravitational Edge and The Weekender.
