Cam Hui, CFA | [email protected] Page 1
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Quantitative & Strategy
RECESSION AHEAD? FUGGEDABOUTIT!
February 4, 2019
EXECUTIVE SUMMARY
Recently, a number of prominent investors and analysts, including Jeff Gundlach, David
Rosenberg and Ed Yardeni, have warned about an ominous recession signal from the latest
Conference Board’s consumer confidence print.
Bespoke’s Paul Hickey observed that the spread between the Conference Board’s present
situation and expectation components of the consumer confidence indices are flashing
recessionary signals. In the past, whenever this spread has exceeded 50, recessions aren’t far
behind. It is now 82.3. Ouch!
Fuggedaboutit! The American economy isn’t going into recession. Call us bullish, but with
a caveat.
We believe the U.S. economy is unlikely to enter a recession based on long leading indicators,
barring a full-blown trade war. However, investors should expect a growth scare going into
Q2. In light of the powerful short-term price momentum in stock prices, timing the
inflection point between rebounding optimism and a growth scare will be a tricky task.
We remain cautiously bullish on equities. However, should the growth scare become the
dominant narrative in the coming days and weeks, it could become the trigger for a re-test
of the December lows. If that were to occur, investors should look through the “you won’t
want to buy” fears to step up and load up on equities.
Cam Hui, CFA [email protected]
Table of Contents
Confident About A Slowdown? .............. 2
A False Signal ...................................... 3
The Consumer Revival ........................... 5
Prepare for the Growth Scare ................. 8
Waiting for the “You Won’t Want to Buy”
Moment ................................................ 10
Cam Hui, CFA | [email protected] Page 2
February 4, 2019
Quantitative & Strategy
Confident About A Slowdown?
Recently, a number of prominent investors and analysts, including Jeff Gundlach, David
Rosenberg and Ed Yardeni, have warned about an ominous recession signal from the latest
Conference Board’s consumer confidence print.
Ed Yardeni’s analysis of the present situation to expectations spread was especially ominous for equity investors.
Exhibit 1: Present Situation to Expectation Spread and Bear Markets
Source: Yardeni Research, Inc.
Fuggedaboutit! The American economy isn’t going into recession. Call us bullish, but with a caveat.
Cam Hui, CFA | [email protected] Page 3
February 4, 2019
Quantitative & Strategy
A False Signal
To be sure, there are numerous signs that confidence indices of all stripes are rolling over, starting with the University of Michigan consumer confidence index.
Exhibit 2: Consumer Confidence Is Falling
Source: dshort.com
NFIB small business confidence is coming off its highs.
Cam Hui, CFA | [email protected] Page 4
February 4, 2019
Quantitative & Strategy
Exhibit 3: NFIB Small Business Optimism Coming Off Its Highs
Source: dshort.com
However, Renaissance Macro pointed out the recession probability signal based on present
conditions to expectations spread recession indicator is at 100%, but it has been elevated since
mid-2014. This is not a reliable and actionable indicator.
Exhibit 4: Not an Actionable Signal
Source: Renaissance Macro Research
Cam Hui, CFA | [email protected] Page 5
February 4, 2019
Quantitative & Strategy
The Consumer Revival
If you are worried about the American consumer, then ask yourself why real retail sales are
continuing to make new highs? Past recessions have usually been preceded by a peak in real
retail sales.
Exhibit 5: No Signs of a Peak in Real Retail Sales
Source: FRED, Federal Reserve Bank of St. Louis
Over on Wall Street, the relative performance of consumer discretionary stocks has been rising.
Most notably, the turnaround even as stock prices plunged in December and continued as the
market rallied.
Cam Hui, CFA | [email protected] Page 6
February 4, 2019
Quantitative & Strategy
Exhibit 6: Consumer Discretionary Stocks Are Outperforming
Source: Stockcharts
In addition, the housing sector, which is the ultimate form of cyclical consumer durable, is
showing signs of a turnaround. November new home sales surged and handily beat Street
expectations last week. In addition, the relative performance of homebuilding stocks have
begun to turn up as long rates have fallen. Similar the pattern of consumer discretionary stocks,
this group’s relative uptrend occurred ahead of the stock market sell-off last December.
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February 4, 2019
Quantitative & Strategy
Exhibit 7: A Relative Bottom in Homebuilders
Source: Stockcharts
Do these charts look the market signals of a weak consumer to you?
Cam Hui, CFA | [email protected] Page 8
February 4, 2019
Quantitative & Strategy
Prepare for the Growth Scare
This doesn’t mean that equity investors should entirely shrug off downside risk and the bulls
won’t have clear path up to all-time highs. Prepare for some volatility as there may be a growth
scare ahead.
We are indebted to the work of New Deal democrat, who has been monitoring high-frequency
economic data and categorizing them into coincident, short leading and long leading indicators.
This framework is highly useful for understanding the growth outlook in different time frames.
His latest update has pointed to persistent readings of short-term weakness, but a long-term
(one-year) strength indicating low recession risk.
The long-term forecast and the nowcast are slightly to the positive side, while the short term forecast is slightly
negative for the fourth week in a row. Some of this is due to the government shutdown, so we will have to
wait several more weeks to see is the changes are real.
The signs of short-term weakness into mid-2019 could be mistaken by analysts as the basis for
a possible recession. Cue the growth scare going into Q2. Troy Bombardia also observed that
the ECRI Weekly Leading Indicator has been consistently negative, which is another worrisome
sign.
Exhibit 8: Weakness in ECRI Weekly Leading Index = Possible Growth Scare
Source: Troy Bombardia
Another warning sign for equity investors is the continuing downgrade in forward 12-month
EPS estimates. To be sure, stock prices have held up well during a Q4 earnings season whose
beat rates are roughly in line with long-term averages, but how long can stock prices defy the
gravity of negative fundamental momentum?
Cam Hui, CFA | [email protected] Page 9
February 4, 2019
Quantitative & Strategy
Exhibit 9: Falling Forward 12-month EPS = Negative Fundamental Momentum
Source: FactSet Research Systems
The chart below depicts quarterly actual and estimated earnings. If New Deal democrat is right
about economic weakness in Q2, then equity investors should be prepared for either downward
revisions in Q2 EPS estimates, or downside reporting surprises.
Exhibit 10: Prepare For Q2 Weakness
Source: FactSet Research Systems
Cam Hui, CFA | [email protected] Page 10
February 4, 2019
Quantitative & Strategy
Waiting for the “You Won’t Want to Buy” Moment
For now, the current newsflow of a dovish Fed and a likely U.S.-China trade deal is tilting
sentiment and price momentum bullishly.
Exhibit 11: U.S.-China Trade Agreement Ahead?
Source: Twitter
However, we are concerned that the late December bottom seemed too easy. II sentiment has
normalized, and % bears spiked only briefly above % bulls. These readings are inconsistent
with past durable intermediate term bottoms.
Cam Hui, CFA | [email protected] Page 11
February 4, 2019
Quantitative & Strategy
Exhibit 12: Sentiment Returns to Complacency
Source: Investors Intelligence
Another worrisome sign evident during this rebound rally is the lack of apparent leadership.
The relative performance of NASDAQ and small caps are not showing signs of sustainable
leadership. If this rally were to carry itself further, what’s going to lead the way?
Cam Hui, CFA | [email protected] Page 12
February 4, 2019
Quantitative & Strategy
Exhibit 13: Where Is the Market Cap Leadership?
Source: Stockcharts
There is a trader’s adage on Wall Street that when it’s time to buy, you won’t want to. There
are too many investors and traders who are too eager to buy the dip.
It is difficult to see how the market could fall without some bearish catalysts. We have to wait
for the “you won’t want to buy moment”, which may occur when the market hits the growth
scare speed bump in the coming weeks.
In conclusion, the U.S. economy is unlikely to enter a recession based on long leading
indicators, barring a full-blown trade war. However, investors should expect a growth scare
going into Q2. In light of the powerful short-term price momentum in stock prices, timing the
inflection point between rebounding optimism and a growth scare will be a tricky task.
We remain cautiously bullish on equities. However, should the growth scare become the
dominant narrative in the coming days and weeks, it could become the trigger for a re-test of
the December lows. If that were to occur, investors should look through the “you won’t want
to buy” fears to step up and load up on equities.
Cam Hui, CFA | [email protected] Page 13
February 4, 2019
Quantitative & Strategy
Disclaimer
I, Cam Hui, certify that the views expressed in this commentary accurately reflect my personal views about the subject company (ies). I am
confident in my investment analysis skills, and I may buy or already own shares in those companies under discussion. I prepare and edit
every report published under my name. I depend on my colleagues for constructive criticism on my research methods and conclusions but
final responsibility is my own.
I also certify that I have not and will not be receiving direct or indirect compensation from the subject company(ies) in exchange for publishing
this commentary.
This investment analysis excludes any target price, and is not a recommendation to buy or sell a stock. It is intended to provide a means for
the author to share his experience and perspective exclusively for the benefit of the clients of Pennock Idea Hub (PIH). My articles may
contain statements and projections that are forward-looking in nature, and therefore subject to numerous risks, uncertainties, and
assumptions. The author does not assume any liability whatsoever for any direct or consequential loss arising from or relating to any use of
the information contained in this note.
This information contained in this commentary has been compiled from sources believed to be reliable but no representation or warranty,
express or implied, is made by the author or any other person as to its fairness, accuracy, completeness or correctness.
This article does not constitute an offer or solicitation in any jurisdiction.
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