What’s the main thing about bull markets? They go up, and up, and up the elevator. And then they take the window on the way out.” –Hedgeye CEO Keith McCullough during our webcast
Are you bearish enough—do you understand what could trigger a market selloff?
That’s the subject of our most recent investing webcast hosted by CEO Keith McCullough and Senior Macro analyst Darius Dale.
Below are the key takeaways transcribed from this webcast. Also below is the replay from the entire 39-minute webcast.
Keith McCullough: So, first things first. Where are we? If you look backwards we’ve seen 7 consecutive quarters of accelerating economic growth. That only happened one other time in the 1990s. If you followed us, we obviously had the high on Wall Street for U.S. GDP forecasts for 5 consecutive quarters.
So you should’ve been long growth. And that’s been the point we’ve been making for over a year now.
Expensive gets more expensive when growth is accelerating. I loved expensive stocks because they were expensive. But now, what happens when growth starts to slow? Expensive gets less expensive, which is already starting to happen in the stock market.
McCullough: Let’s look at performance. This is the year-to-date. So “Captain Pie-Chart” guy—who’s long everything in the world and down year-to-date—what say you about global growth? Is it in ‘synchrony’ or is it ‘diverging’?
As you can see, last year was a globally synchronized recovery where we were all making money buying every damn dip in everything. Now, year-to-date, the Nikkei, Shanghai Comp, and the All World index are all struggling. 2018 is not 2017.
This is not good.
These are big issues and global bond yields nailed this. The rest of the world is slower for longer and inflation falling and the U.S. is late cycle with inflation accelerating. That’s the whole point of this. The U.S. is late cycle.
Have Retail Sales peaked? Probably.
What about the peak in High Ticket Consumer Discretionary? That’s not an opinion. That already peaked.
Is there a peak in Consumer Confidence? The most recent report is lower than the last one. And if this chart comes off the highs, it would be a dramatic decline from these levels.
I’m not saying everything will peak, then evaporate all at once. But you have to think about this. What’s the main thing about bull markets? They go up and up and up the elevator and then they take the window on the way out.
So we’re highlighting whether or not you’re bearish enough. Do you understand the components that could make the market go down? They’re largely economic driven, in particular driven by growth, inflation and profits.
Last year in Q1, we were very bullish on Tech and saying that earnings were going to accelerate and continue accelerating throughout the rest of the year. Earnings growth for Information Technology, within the S&P 500, were up 21.7% in 1Q17, 15.8% in 2Q17, 23.7% in 3Q17, and 22.9% in 4Q17.
Now, 8 of 68 Tech companies have reported for 2Q 2018 and they’re up 46% in the quarter to date. But if you only have 8 out of 68 companies reported the problem is that the remaining 60 of them could look a lot worse than Netflix (NASDAQ:NFLX) did this quarter.
So maybe this was as good as it gets post the Netflix print. Something to think about.
McCullough: Let’s look at earnings expectations going forward.
Wall Street, by its nature of looking backwards and extrapolating into the future, is looking for earnings to accelerate against tougher comparisons. We would say that’s a major market risk, especially since S&P 500 operating margins at the all-time highs going back to 1998.
So what would make S&P 500 operating margins go down?
One is late cycle wages going up. So when wages go up and sales starts to slow that’s called a squeeze on your profits. The other big thing is the dollar. If the dollar stops going down, 40% of S&P 500 operating profits are staring straight at the dollar as a headwind not a tailwind, since more than 40% of S&P 500 sales are generated overseas.
Darius Dale: Here’s a question from Jack. “You’re watching a bottoming process in the Dollar, but see inflation accelerating here in 2Q. Can both go up on a sustained basis?”
McCullough: Can the Dollar go up with inflation going up? Unlikely. That’s actually our forecast. I have inflation peaking sometime in the next 3-6 months. And that’s when we think the dollar starts going up. That’s a very astute point you made.
Dale: Yes, Jack you definitely hit the nail on the head. If you go to our GIP modeling slide on the U.S. Dollar. We backtest every relevant factor against our Growth, Inflation, Policy model. This one is relative to the global economy.
So we’re effectively coming out of a two year period that has historically been really negative for the U.S. dollar. The dollar tends to go down when the global economy is accelerating. We’re transitioning, in the back half of 2018, to a more stagflationary environment, that we call Quad 3 (Growth slowing, Inflation accelerating), for the dollar. That’s generally hit or miss for the dollar, and it’s likely trading sideways.
But we see the global economy headed to Quad 4 (Growth and Inflation slowing) in the back half of 2018. That’s historically been really, really positive for the dollar. We would expect the dollar to trade up into that, maybe sometime mid to late summer. We’re definitely calling that out as a key risk to Emerging Markets, Precious Metals and to a lot of other exposures in your portfolio.
Dale: Just because the U.S. Dollar isn’t going down anymore.
McCullough: Exactly. Emerging markets were in Quad 1 (Growth accelerating, Inflation slowing) for 7 consecutive quarters, same thing as the U.S. growth cycle. It’s no surprise that the two best places that you could have had your money in last year, from an equity market perspective, were Emerging Markets and Tech, because Tech is the best place to be within U.S. growth.
When you’re in Quad 1, whether it’s Emerging Markets or Tech, there are huge returns there.
But then there’s huge crowding, everybody gets sucked in and, on Emerging Markets, everybody says they’re cheap. Guess what? Emerging Markets are always cheap. So again, at the end of the day there are a lot of risks associated with the dollar going up. And in 7 of the last 10 weeks the dollar has been up or up marginally, call it flat. That’s the beginning of a bottoming process.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.