Hello traders
I hope you all had a good week!
The volatility has persisted since my last update with the S&P 500 revisiting a level last seen in October, having made an intraday record high as recently as 4th January. There is no doubt that the rate of increase in benchmark government bond yields has put the pressure on valuation-sensitive segments of the market including tech and growth names specifically. The Nasdaq is in ‘correction’ territory with a decline of more than 10% from its peak, and companies like Amazon (AMZN) and Netflix (NFLX) are getting torn to shreds. Worse still, the surge in bond yields appears to have paused with rates coming lower for each of the past three sessions, whilst stocks continue to fall.
It seems to me that investors have been caught off-guard following their return from the Christmas break. The buzzword in the financial community seems to be “stagflation” which historically doesn’t tend to bode well for owning either asset class. However, I believe that the market may be overlooking the case for defensive growth stocks as we are enter a tighter liquidity regime where growth will become scarcer.
Here’s a chart that caught my attention this week. On Monday the PBOC cut interest rates in anticipation of economic disruption resulting from the spread of Omicron (seemingly a few weeks behind what we have seen play out here in the UK, and latterly the USA). But perhaps the Chinese were aware of the slowdown which was already taking place given the decline in the Credit Impulse, below.
This important lead indicator of the business cycle shows a peak in late 2020, before the uptick in the past couple of months (we’ll get on to that in a moment). Here’s why it is relevant not only to the domestic economy in China, but also for global business activity. The CCI (blue line) leads the global manufacturing PMI (black line) by approximately 10 months, so with the former having peaked in November 2020 it should come as no surprise to see the PMIs under pressure recently.
This graphic from Cornerstone Macro illustrates it perfectly in terms of the European PMI and effect on earnings revisions in the past few months.
So perhaps this is reason enough for equities to be falling, even before the run-up in yields since the turn of the new year. I certainly don’t view this as bullish for cyclical stocks though, and would prefer defensive growth names in a typical slowdown. For this reason I think that it is premature for investors to abandon positions in growth stocks which have for many years produced stellar returns according to the same ‘low GDP growth’ playbook. It might also put a cap on interest rates, or at least cause the Fed to reconsider the rate at which they look set to hike.
Earlier I referred to the more recent uptick in the Credit Impulse, which is displayed more neatly in the following graph. The white line shows the 6-month rate of change, versus the YoY change we were looking at earlier. Having bottomed in October, we could well see a positive catalyst for Western economies approximately 10 months later, in June. This would be the point at which, ceteris paribus, I would call time on the growth names and overweight cyclicals (favouring ‘value’, and companies in the travel, leisure and hospitality sectors alongside this as part of my ‘post-pandemic’ playbook this year).
I appreciate that I have waffled on about a lot of macro this week, but it has really captured my attention and I see a potential edge in it over the ‘pro value’ consensus currently.
Nevertheless, we should refer again to our process for analysing various asset markets in order to remain grounded and not get carried away in our prognostications. Our Monthly Checklist Report is available with immediate access to Trading Club members, and includes a full set of scores for each of the markets we monitor.
If you would like to learn more about our methods and join me for more analysis in real-time, head to milliondollartraders.com and check out MDT course and Trading Club pages where you can preview everything that we cover.
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Have a great weekend,
James
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