Slow Motion

Markets moving nonchalantly in a complacent direction until they don't

Apr 07, 2023

Highlights

The entire ISM data series decelerated meaningfully for the month of March and the “resilient” Labor market showing cracks (reviewed below).
Growth slowing + liquidity all-time lows (M2 and ODL y/y) + earnings power lower= what could go wrong?
Temporary artificial liquidity support by US treasury, however debt ceiling deadline coming quickly.

Wishing everyone a Happy Pesach and Easter this weekend! US markets are closed today, the Master’s golf tournament has taken off, and the Atlanta Braves won last night on a walk-off in the bottom of the 9th during the home opener. Going to be a good weekend!

Quick recap of this last weeks performance. SPX -0.10%, QQQ -0.9%, RUT -2.66%, Mega-Cap-Tech -0.19%, and BTC -1.08%. This is where I will give an honorable mention to the SPX positive Q1 performance, well done, because I am sure everyone that is celebrating, “bought the lows”. For reference, approximately 90% of the SPX positive Q1 return came from 7 companies and 40% of that performance came from two companies. Microsoft and Apple, which were +1.14% and -0.15% on the week. Mega-Cap-Tech continues to hold-up with market with GOOGL +4.52% this week as well, but the strength is becoming more narrow. Just say, “AI” and the companies stock price will go up.

Last week started off with a bang with TSLA deliveries miss and OPEC Oil production cuts. Price of oil and energy companies went up on that, but why is OPEC cutting production? Economic growth and demand keeps getting worse. Two other notable SPX companies received this negative message alongside a slew of poor economic data were TSLA -10.80% and DE -10.47%. Additionally, Gold ramping to cycle highs and Bonds beginning to rally are also confirming this weakening demand and growth signal. Everything is ok though, no one owns those companies anyways!

The data will be the main focus of discussion this week, and these are widely viewed metrics that are often to be considered leading economic indicators. As mentioned above, the Gold and Bond markets understand the data that I will be showcasing below, and it is my view that Equity market is ignoring these signals. I promise that I am not just cherry picking data points. If I wanted to do that, I could just cite the aggregate -26.22% EPS decline for the 16/500 SPX companies and the -76.09% EPS decline for the 5/100 NASDAQ companies that have reported earnings to date (EPS data provided by Hedgeye Risk Management). However, it is still early in the earnings season and Banks are set to begin reporting next Friday, the 14th of April.

Astonishing to look back over the last year and see how long this slowdown has taken to play out within the overall economy and markets. Perhaps I am only seeing it this way because 2022-2023 is my first time ever risk managing my capital through a real recession and bear market, but this has truly been the equivalent of watching a train wreck in slow motion (I know there have been actual train wrecks this year, please don’t cancel). Q4 2021 was as good as US economic growth could get. Since then, US growth and company earnings have gone from: “the best” to “good” to “not as good” to “should we be concerned” to “bad” and ultimately heading towards “worse” over the next few months. The 10-2 yield curve inversion has been front running that process for over a year now.

In the fall, I wrote two pieces. One is named “Labor Losses” (dated 11/18/22) and the other is named “Bad is Bad” (dated 12/2/22). In one of those publications, I discussed a key attribute to the larger recessionary outcome will be the rise in unemployment. By this point in time, it will be too late for the Fed to act “proactively”. Labor is deemed by many credible economist/ analysts such as Danielle DiMartino Booth and Joshua Steiner (Hedgeye), as the latest of late cycle indicators. Cracks are beginning to show in the overall labor market, which I will highlight in the data below.

A core aspect of this slow motion deterioration of growth and earnings as realized in actual market prices has been the incessant citation by many market participants that “bad news is good news”. First of all, I can not think of a more irresponsible way to invest money. Things are getting worse, so buy TSLA $200 calls with a one-week expiration. Things are getting worse, so buy GOOGL because they are doing super cool “AI stuff”. This in all reality equates to, “Things are getting worse, so buy any type of risk because the fed will be there to bail everyone out”. The above is a core principle of bad news= fed put (the feds intervention to prevent large market drawdowns).

Thirteen years of quantitative easing has been a real beauty for anyone who has wanted to close their eyes and allocate capital. These conditions have also created a behavioral problem where by extraordinary risks are taken with no sense of consequence because someone will always be there to bail them out. The sweet effects of QE for over a decade have numbed investors new and old to the potential risks of the QE unwind. How can I blame them when this is the way they have been trained via government intervention. This core behavior has been at the center of low volume rallies fuel by short squeezes off the low ends of trading ranges. Each one of these sell-offs over the last year has been predominantly a period of time where capital has rotated to various S&P 500 sectors. The overall markets, ex-RUT, have nonchalantly drifted sideways during this time because the real selling has not yet begun in the SPX.

Diving into the data, it is first important to understand ISM and the significance. What is ISM Manufacturing? This is a survey based on responses from the purchasing managers from 300 manufacturing firms and the data is reported monthly. Strong indicator for the level of product demand based on ordering activity. For the entire ISM series, Readings that are above 50 are expansionary, while falling below 50 is a contractionary economic signal. The data reads contractionary 46.3 (March) vs. 47.7 (February) and this equals a new cycle low. Below is a chart of ISM Manufacturing.