All posts by Charlie Bilello

Is Defensive Sector Leadership Forecasting Slower Growth?

Utilities and Health Care. These are the top two sectors in the S&P 500 this year, which may come as a surprise to many as we’re being told that economic growth is set to accelerate. Given this defensive leadership, one would assume the financial markets and economy would be having a more difficult year in 2014.

As illustrated by the highlighted years in the table below, this was the case in the past when defensive sectors (Utilities, Staples, or Health Care) occupied the top two spots.

Defense1

First, in 1990, we saw Health Care and Consumer Staples in the top two spots. The U.S. economy slipped into recession in July of that year which would last until March of 1991. We also saw a greater than 20% decline in the S&P 500 from July through October in 1990.

Next, in 2000, we saw Utilities and Health Care in the top two spots. The equity market would peak in March of 2000 and the economy would slip into recession the following year, in March of 2001.

Next, in 2008, we saw Consumer Staples and Health Care leading. The economy was in recession from the start of the year and the S&P 500 suffered its worst decline since the Great Depression.

Lastly, in 2011 we saw Utilities and Consumer Staples leading. The S&P 500 would suffer a decline during the year of over 20% before finishing the year flat. While leading indicators plummeted and growth slowed, the economy managed to avert a recession.

Which brings us back to 2014, where Utilities and Health Care stocks have been leading for the entire year. Meanwhile large-cap indices are still hitting new all-time highs, leading many to conclude that defensive market behavior no longer matters under the global coordinated monetary easing regime.

Perhaps, but I would note that the average stock has not ignored this defensive behavior, with the Russell 2000 roughly flat on the year while Utilities and Health Care are up well over 20%.

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I would also note that bond market participants are not ignoring this defensive leadership, with the yield curve (10-year minus 2-year) flattening for the entire year.

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High Yield investors seem to be paying attention as well, with credit spreads wider on the year and higher than levels from a year ago.

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What does this mean for markets going forward? As I wrote recently, strong momentum and seasonality are likely to support the equity market into year-end and at the very least prevent a large decline. But as we head into 2015, this is going to be the key question for investors: is defensive sector behavior signaling slower growth to come? It is hard to argue otherwise given the historical evidence and the confirming behavior in the Treasury and high yield credit markets.

But even if we accept that a slowdown is coming, the more difficult question still remains: will it matter in a market that has become more and more fixated on central bank easy money policy? No one can answer that question but what we can say is that most are assuming it will not matter, as reflected by the extreme love for equities in recent sentiment polls. We’ll find out in 2015 if this is the correct assumption.

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 writing.

CHARLIE BILELLO, CMT

Edward M. Dempsey Pension Partners New YorkCharlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts.  He is the co-author of two award-winning research papers in 2014 on Intermarket Analysis and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

You can follow Charlie on twitter here.

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Easy Money, Slower Growth: The Growing Disconnect Between Stock Markets and Economies

Promises of additional monetary easing measures seem to arrive on a weekly basis, providing a boost to share prices globally as investors are encouraged to take on more risk. At the same time, we’re seeing increasing signs of a global slowdown. History has taught us that the “stock market is not the economy.” We are seeing perhaps the most extreme example of this today.

Global Easing

China is the latest country to join the global easing party, lowering its one-year benchmark deposit rate by 25 basis points to 2.75%. Back in June, the ECB moved to negative interest rates. Mario Draghi is ramping up his “whatever it takes” rhetoric leading most to expect some form of quantitative easing to be announced in the coming months. Here in the U.S., we’re approaching six years of 0% interest rates with the Federal Reserve continuing to promise to keep rates at 0% for a “considerable time.”

Japan’s central bank is now the exemplar of easing, having held interest rates near 0% for almost 20 years. Earlier this month, the Bank of Japan announced additional quantitative easing measures that included increased direct purchases of equities by the central bank.

With all of these easing measures in place, how is global growth faring? To get snapshot, let’s take a look at the top five global economies in terms of GDP: The U.S., China, Japan, Germany, and France.

China

China is showing its slowest growth since 2009, with year-over-year real GDP down to 7.3%.

Easy1

China’s manufacturing index is down to a 6-month low, teetering on the edge of contraction (50 level).

Easy2

Japan

Japan has entered its fourth recession since 2008, with year-over-year real GDP down to -1.2% and two consecutive quarters of negative growth.

Easy3

Household spending in Japan is showing continued declines on a year-over-year basis.

Easy4

Germany-France: The Eurozone

GDP in the Eurozone is running at 0.8% year-over-year.

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Leading indicators there show this growth is likely to slow considerably in the coming months, with the most recent PMI reading hitting a 16-month low.

Easy6

Retail sales in the Eurozone are also likely to move to negative territory on a year-over-year based on recent PMI sales data.

Easy7

U.S.

That brings us to the U.S., which nearly everyone views as the best house. The U.S. is currently growing at 2.3% year-over-year. Not terrible but hardly an example of a booming economy. The current expansion that began in 2009 has been the slowest growth recovery in U.S. history.

Easy8

Great Expectations

Given this backdrop, why are so many economists and the Federal Reserve expecting growth rates to accelerate in 2015?

In my view it stems from the belief that the stock market is a good representation of the health of the economy. If stocks are hitting new all-time highs every day, then the economy must be strong.  And if the economy is not strong today, then it must be signaling stronger growth to come.

While there certainly has been a relationship between the stock market and the economy in the past, they are anything but one in the same. And with unprecedented easing measures in place that are specifically targeting higher stock prices, this is truer today than ever before. We must now question whether some or all of the signaling power of stocks has been lost. For proof of this look no further than Japan whose economy is entering its fourth recession since 2008 while stocks are hitting new highs.

As for why the U.S. is considered to be the best house in the global economy, look no further than market prices. U.S. stocks have been, to put it mildly, crushing their global peers. In the chart below you can see that the S&P 500 Index has outperformed the rest of the world by over 60% in the past five years.

Easy9

The narrative created from this price action is that the U.S. economy is going to decouple from the world.

Perhaps, but an alternative scenario must also be considered and may warrant a higher probability than market participants are currently assigning to it. What if the stock market is wrong today and U.S. growth is set to slow here, catching the flu from its global peers? With an increasingly global economy and 40-50% of S&P 500 revenues coming from outside of the U.S., is decoupling a more realistic assumption than this?

Unconscious Re-coupling

We may be starting to see the early stages of a re-coupling. The growth rate in the ECRI Weekly Leading Index is quietly moving lower, in the opposite direction of the equity market. It recently turned below zero for the first time since 2012.

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The Flash PMI also came in at 54.7 this week, a 10-month low. While these figures are far from recessionary, they may be an early indication that growth in the U.S. is about to slow.

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Concluding Thoughts

The stock market is not the economy, particularly in the current environment of unprecedented monetary stimulus across the globe. The danger in assuming otherwise is twofold. First, from a signaling standpoint, similar to waiting for an inverted yield curve, it could lead investors awry who are buying stocks at extreme valuations on the belief that the economy is accelerating.

Second and more importantly, from a policy standpoint the assumption that the stock market is the economy is inherently dangerous. It can lead to the situation in which central bankers start targeting and pointing to higher stock prices as both proof that their policies are “working” (helping the real economy) and as an instrument of growth (wealth effect). If the public and fiscal policymakers buy into this unproven notion, they will sit idly by instead of engaging in true structural reforms that promote long-term economic and real wage growth. They will also continue to incur higher debt loads, borrowing from the future to satisfy the whims of today, as the cost of money is too cheap to resist. A boom-bust economy is thus created that is increasingly dependent on central bankers continuing to inflate asset prices and propping them up indefinitely. This precisely where we stand today.

If we continue on the current path the end game is clear even if the timing is anything but: another bursting bubble and the economic fallout that comes with it. Perhaps this is what most people desire (I personally doubt that given its deleterious effect on the middle class) but shouldn’t we at the very least be engaged in a national debate over it? Is this truly the economic and monetary policy we should be pursuing?

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 writing.

CHARLIE BILELLO, CMT

Edward M. Dempsey Pension Partners New YorkCharlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts.  He is the co-author of two award-winning research papers in 2014 on Intermarket Analysis and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

You can follow Charlie on twitter here.

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Are Junk Bonds Sending a Warning Signal?

Over the past month, we have seen a rip-roaring, v-shaped rally to new all-time highs in the large-cap U.S. equity indices. At the same time, volatility has been crushed in a move lower in the VIX Index that we have never seen before (above 30 to below 15 in the span of 2 weeks). The combination of these two factors has left individual investors feeling extremely optimistic about the future prospect for equities. There’s nothing investors love more than a straight up move with low volatility.

junk1

While this level of optimism is generally problematic on its own, there is another interesting factor at play here.  We are not seeing nearly the same level of risk-seeking behavior in the riskier areas of the credit market. This is atypical as junk bonds are normally highly correlated with equities and we would expect credit spreads to be hitting new lows here. Quite the opposite has occurred. High Yield credit spreads bottomed back in June at 335 basis points. They stand today at 446 basis points, higher than their levels from one year ago.

junk2

As the bond market is often a leading indicator of equities, this may be a warning signal. For if investors are demanding a higher spread in the riskiest areas of the credit market, they are becoming increasingly concerned about the economic environment and potential default risk. Naturally, if this persists, it is only a matter of time before they also become concerned about the lowest part of the capital structure: common equity.

This weakness in high yield is a new development in the market, for as can be seen in the chart below the credit market environment had been extremely benign since late 2012. Only recently have spreads turned higher on a year-over-year basis.

Junk3

If we look back historically, volatility in stocks is much higher (25% annualized) when credit spreads are up year-over-year as compared to when they are down (13% annualized).

Junk4

Higher volatility is of course something few investors are considering here with the VIX at 13 and promises of continued central bank easing seem to arrive on a daily basis. However, as Charles H. Dow said back in 1900, “the one fact pertaining to all conditions is that they will change.” Conditions are clearly changing here in the credit markets. How long will it be before the equity market takes notice?

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 writing.

CHARLIE BILELLO, CMT

Edward M. Dempsey Pension Partners New YorkCharlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts.  He is the co-author of two award-winning research papers in 2014 on Intermarket Analysis and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

You can follow Charlie on twitter here.

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