- Negative GDP among 25 worst in history.
- European banks major source of risk.
- Mutual funds and separate accounts went defensive last week.
"I like the serendipitous surprises of reality." - Lawrence Wright
The S&P 500 (NYSEARCA:SPY) closed the week hovering around new highs as Treasury yields dropped on the heels of data that showed first quarter GDP was considerably worse than expected, revised down to -2.9%. Treasuries and Utilities (NYSEARCA:IDU), both inputs in our models used for managing our mutual funds and separate accounts, never once believed in the economic escape velocity and rising rare meme since 2014 began. Excuses for weakness have ranged from the weather, to Russia, to fluke data. While all of these have been factors, they were known. A fun stat making the rounds on Twitter from @JLyonsFundMgmt shows that the -2.9% print on GDP is among the worst 25 quarterly prints in history, and that every single one of those prints indicated recession.
Something remains amiss in the narrative of risk, fighting the Fed, and asset markets. If 2Q GDP comes in weak, or potentially negative, that would mean the US is in a technical recession. No one seems to believe that is likely, but the action in Treasuries and the compression of the yield curve does mean some "smart money" may be betting on poor data. While unlikely, keep in mind no one ever expected 1Q GDP to be negative, let alone this negative. We are in an environment where surprises should be expected regardless of how beautiful sounding and consistent the goldilocks narrative appears to be.
Equities do not need weak US GDP though to become more volatile. Perhaps all volatility needs is a nudge from Europe. Bank stocks have given back whatever gains they had following Draghi's move to negative rates and "shock and awe" stimulus. European financials overall are meaningfully underperforming European market averages, in a way reminiscent of US financials in early 2007. Whatever it takes doesn't seem to be enough for now, and any potential shock that comes from Europe could further justify defensiveness in bonds, Utilities, Staples, and Healthcare. At this point in the cycle, those areas simply should not be so strong.
But what about inflation? Indeed rising Oil prices can force cost-push inflation into the system as it did in Japan, but such a dynamic would only further hobble consumer spending which continues to be sluggish. While Consumer Discretionary stocks on a relative basis are likely due for some outperformance after unrelentingly poor behavior so far in 2014, intermediate term dynamics make betting on the consumer a tough trade. It is unlikely that we are in a recession, but we must still ask ourselves why relative intermarket behavior is sending such a concerning message.
In terms of our mutual funds and separate accounts, we did rotate into defense mode in our absolute return and equity sector rotation mutual funds and separate accounts. This has been a strong year for us thus far from a return and risk-adjusted return standpoint. Much of our approach to portfolio management relates to recognizing the conditions under which highly volatile periods and stock corrections are likely to occur. It's what our award winning papers discuss in depth using Treasuries and Utilities as predictors of conditions. While nothing in life is foolproof, investing and trading is entirely about odds, and every day that goes by where risk is ignored brings us closer to a moment when panic will return.
Until then, the stock market does not care...until it actually does.
Additional disclosure: This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this