When examining economic data, it is better to look at the annual rate-of-change than the headline numbers to get a picture of momentum, writes Landon Whaley.
This week’s “Headline Risk” focuses on the risk of buying into the Old Institution’s obsession with the “levels” of data and the noisy quarter-over-quarter change in data rather than the far more critical annual rate-of-change (ROC).
If you’ve been with us for any reasonable stretch of time, you know that one of the ways we can make macro calls and position correctly before markets move is by evaluating economic data in year-over-year terms. To us, it’s highly intuitive to watch the slope (rate-of-change) of annual data because this provides a clear signal for the data set in question, and it avoids the noise that necessarily plagues the growth rate from one month to the next. Yet what is intuitive to us eludes the Old Institution.
Last week, the Old Institution grabbed the better-than-expected +1.9% quarterly growth rate of Q3 GDP with both hands. Even our Tweeter-In-Chief took a victory lap for having created “the greatest economy in American history” despite lamenting “the economy is in deep trouble” seven years ago when U.S. GDP hit the exact same +1.9% level of GDP growth.
While the OI and the President are navel-gazing quarterly growth rates that are jumping all over the place like a toddler on a sugar high, the annual growth rate of U.S. GDP has been painting a crystal-clear picture for a year now.
Not only did the annual pace of Q3 2019 GDP growth (+2.0%) confirm the slowdown from Q2 2019 GDP (+2.3%), it established the Winter Fundamental Gravity that occurred from July to September 2019. Since peaking in Q3 2018, U.S. GDP growth has been in a bear market and is officially in crash mode, declining 38% from its peak growth rate of +3.2%.
For all the Old Institution cronies, and reformed brokers, telling you to buy stocks because growth slowing is now in the rearview, think again.
So far, we’ve seen eight critical U.S. data points for Q4, and they are painting the same growth slowing picture we’ve seen for the last four quarters. While there was a one-off improvement in October jobless claims and the ISM non-manufacturing Purchasing Managers Index (PMI), there has been a continued deterioration across auto sales, nonfarm payroll growth, average hourly earnings, consumer confidence surveys, and the all-important, ISM manufacturing PMI. We still have an additional 20 critical data points to come, but the early polling is indicating a Q4 GDP annual growth rate with a 1-handle!
If you’re in the Old Institution camp, insisting that the quarterly growth rate is the cat’s pajamas, an annual GDP growth rate with a one in front of it, means the quarterly growth rate will be sub-one percent. Guaranteed President Trump chirps Jerome Powell for not doing enough when Q4 GDP growth lays an egg when the report is released in late January 2020.
Remember, the business media/Old Institution “levels” obsession means they fail to spot shifts in Fundamental Gravities until months after the fact. By the time the data has deteriorated (or accelerated) to levels that send them a clear signal, asset classes have already responded to the new economic conditions. In short, by the time the Old Institution acknowledges the changed environment, the low-risk, high-reward trades are as dead as disco.
The headline risk bottom line is that the early Q4 data is confirming that the U.S. economy is firmly entrenched in the growth slowing regime that began 15 months ago. Couple this reality with the beginning stages of an inflationary impulse, and there is no doubt that Fall is here. Trade accordingly.
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