Data Source: Bloomberg
Go-Go the Mo-Mo as the Global Growth Story Continues
Source: Easton Chang (Public Domain)
Momentum style of investing is on a tear ( Exhibit 1a and 1b) as it continues to 'accelerate' well ahead of all the other primary styles of investing (quality, value, yield, size, low volatility). After having lagged considerably in the second half of last year, momentum's outperformance, led by large cap growth technology and consumer companies, demonstrates why it pays to own some portion of this style in your portfolio, contrary to what some leading academics argue. Momentum helps balance out our contrarian desire to beat the market by trying to stand in front of it. Keep in mind that the primary index representing momentum, MSCI USA Momentum Index will reconstitute at the end of May, but I would expect that it retains similar sector and risk characteristics following the reconstitution.
Exhibit 1a - US Momentum Extends Its Lead Over Other Styles
Exhibit 1b - US Momentum Well Ahead of Other Styles This Year
Momentum outperforming in the U.S. may just reflect heightened uncertainty over the cyclical reflationary trade (or Trump trade) as investors run towards certain (albeit pricey) growth and away from cyclical value, particularly energy. And despite U.S. Treasury rates dropping from their post-Trump highs, dividend yield strategies are also struggling this year. So far, what this largely amounts to is a bet against price, whether earnings or yield, in favor of high premium growth or quality.
U.S. stocks had been languishing for the first three weeks of April amidst concerns over geopolitical tensions (Syria, North Korea), perceived Trump administration policy failures, and lackluster growth following the initial burst in euphoria following the November election. U.S. small caps performed in line with large caps ( Exhibit 2a), partly in response to renewed prospects over a Trump tax reform package that could lower the tax burden of domestic companies. However, U.S. small caps are trailing large caps by a sizeable amount so far this year ( Exhibit 2b).
Exhibit 2a and 2b: U.S. Small Caps Struggle to Keep Up with Large Caps
U.S. equities (S&P 500) lagged the international markets ( Exhibit 3a) as international prospects look brighter than they have over the last several years. Momentum continues to build for investing outside the U.S. with emerging markets extending their leadership through the first four months of this year ( Exhibit 3b) followed by Europe which has largely shaken off the angst over this year's regional elections. Indeed, anxiety over the outcome of the 1 st round of the French election dissipated with the establishment candidate, Emmanuel Macron, projected to prevail over the populist candidate, Marine Le-Pen., in the second round (May 7). However, some risk remains of a Le Pen upset, given how badly the polls had tracked Brexit and the U.S. presidential elections. There are already signs that the gap is closing, and the main risk now is whether Macron takes the outcome for granted and tries to coast into the second round.
Exhibit 3a - U.S. Markets Lag Most Other Regions in April
Exhibit 3b - Emerging Markets and Europe Lead All Other Regions this Year
International economies may not be growing faster than the U.S., but they are improving and the shift in sentiment is what matters more to investors than the direction. Business sentiment looks strong in both Germany and Japan ( Exhibit 4) while global Purchasing Manufacturer Indices remain in expansionary territory ( Exhibit 5). European financial stress also remains low, especially after the French election, despite ongoing concerns over populist sentiment in Italy with elections likely to be held in late 2017 or early 2018. Latest polling shows strong support for the euroskeptic 5 Star Movement.
Exhibit 4 - German and Japan Business Sentiment Reflect Rosy Outlook
Exhibit 5 - Global Manufacturing Sentiment Also Positive
What about the weak 1Q17 GDP release of 0.7% (SAAR)? Despite the upbeat tone reflected in consumer confidence surveys, real consumer spending of only 0.3% drove the weakness reflected in lower spending for durable goods (autos). Yet the housing market remains robust which has typically led to follow through spending on durable goods. Businesses cutting back on inventories also contributed to the weakness, but inventories are lagging final sales, so expect the rebuilding of inventory stocks to help fuel subsequent quarters.
Finally, the economic team at Renaissance Macro Research updated their GDP/S&P sales growth estimate model using GDP inputs that more closely track S&P revenue growth. Their model looks at three components: nominal spending on durable goods, nominal business fixed investment and nominal exports. These three components explain 80% of the variance in S&P sales growth going back to 1996. So even with a weak 1Q release, improvements in these three categories should provide tailwinds for S&P revenue growth over the next year. So far, 1Q2017 released earnings are confirming this trend with Factset reporting the blended Q1-2017 earnings growth at 9.2%; the highest level since 4Q-2011. For all of 2017, consensus estimates reflect 9.7% earnings growth on top of 5.3% revenue growth.
Whipsaw in Bond Land
Towards the end of our 2016 Year-End Market Commentary, we observed that hedging interest rate risk, or shorting U.S. Treasuries, appeared to be a crowded trade as net speculative Treasury short positioning hit an all-time high. As the 10-Year Yield approached 2.60% in early March, that appeared to be the right call, but then the 10-Year dropped to as low as 2.17% in late April over concerns of D.C. policy failures and the pending French election. The 10-Year Treasury yield settled at 2.28% at the end of April, but not before taking speculative investors on a wild ride. Speculative investors seemed to have turned 180 degrees on the Trump trade with net futures positioning swinging from extreme bearishness to extreme bullishness ( Exhibit 6). Should the cyclical outlook continue (and not be derailed by D.C.), then we may be in for a bout of interest rate volatility as the Fed will likely stay the course on its rate hike outlook for this year.
Exhibit 6 - A Rollercoaster Ride in Treasury Yield Speculation
Credit is another story as credit risk remains quite stable, although energy-sector credit has sold off a bit from the lows in credit spreads back in February ( Exhibit 7). Just as equity investors are becoming less price-sensitive when buying stocks, fixed income investors seem to care less for what price when buying credit risk in their renewed thirst for global yield.
Exhibit 7 - U.S. Investment Grade and High Yield Credit Spreads: Increasingly Comfortable with Credit Risk
The Macro Backdrop Isn't Perfect but Still Supportive
Are there worrisome signs on the horizon? The automobile market looks a little shaky as the downbeat 1Q17 GDP was partly driven by reduced auto demand. Commercial and personal loan activity has also seen a marked decline while personal debt levels and servicing continue to get more burdensome. But Federal Reserve capital expenditure surveys point toward a strong intent for businesses to increase capital spending and financial conditions remain supportive despite two Fed rate hikes. Expectations for a Trump-led cyclical recovery may have gotten ahead of themselves, but the global macro backdrop should continue to benefit from the cyclical reflationary tailwinds that began last summer. Meanwhile, forward inflation expectations ( Exhibit 8) remain above 2% (although they dipped to 1.9% prior to the French election). High expectations needed to be moderated, but there are not too many macro signals suggesting a meaningful slowdown.
Exhibit 8: 5-Year/5-Year Forward Inflation Expectations (TIPs vs Nominal Treasury Yields)
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