2023-09-27 00:33:13 ET
Summary
- Traditional bottom-up investing has reduced utility in the modern day due to the rise of indexing and passive investing, emphasizing the importance of a top-down approach.
- Things have changed since our last article about the world economy. Economic winds continue to shift, revealing new opportunities, and the potential for a cross-Atlantic pair trade.
- We update our global economic outlook, including new data and commentary on the US, Europe, The UK, China, Japan, and India.
- Adjust accordingly!
A few months ago, we released an article titled " Leading Indicators Are Deteriorating; It's Time To Sell The Indices " that made the case that it was time to trim positions in global equities, given the worsening economic backdrop across the globe.
Since then, markets have been flat / down, but the global picture has shifted somewhat as leading economic data has continued to come in.
Today, the landscape has changed considerably, and in this article, we'll explain what's changed, why it matters, and how we're thinking about profiting from new emerging economic trends.
In short, the U.S.'s ( SPY ) outlook has improved somewhat, and the EU ( VGK ) continues to worsen - a dynamic that could lead to a solid pair trade in an otherwise volatile and uncertain environment.
Let's dive in!
Getting Up To Speed
In case you didn't read our first article, here's a quick summary of some of our main points regarding how markets work nowadays. It's relevant to understanding why we place so much importance on macroeconomics.
Hint: things have changed considerably over the last few decades.
Traditional Bottom-Up Investing : Historically, some investors (Warren Buffett included) have analyzed individual stocks one at a time, sourcing potential investment ideas through casual browsing. In this model, bottom-up investors cover a select group of favorite companies for extended periods, focusing on business drivers and economic effects on earnings.
Shift in Market Dynamics : However, there's been a significant shift in market dynamics due to the rise of indexing and passive investing. Many stocks, especially those without mega-cap status or compelling narratives, have become thinly traded. Fund flows now drive a majority of trades, which has reversed the traditional cause-and-effect relationship.
The "50/30/20" Rule : We referenced a rule that suggests that 50% of order interest in any given stock on any given day is influenced by market index fund flows. Then, 30% is influenced by industry or sector fund flows, and the remaining 20% is influenced by individual or institutional trading interests. In other words, macro dominates over single-stock efficiency.
Top-Down Approach : Given the dominance of macro-level market flows, we advocate for a "top-down" approach to investing. This approach emphasizes the importance of having a macroeconomic view and aligning with broader economic and industry trends. We also think that understanding the direction of the global economy is crucial for successful modern investing.
Thus, today, we'll be updating our global macro view such that we can hopefully generate you some alpha in your own trading.
The Global Economy
Alright; let's start looking at the main economic regions across the globe.
First up: The United States of America.
The United States
Overall, right now, the outlook for U.S. GDP is mixed.
In September, Manufacturing took a small step forward with a reading of 48.9, vs. 47.9 in the month before. While a positive rate of change indicates that a big chunk of the economy still may be weaker than expected, given the dominant "soft landing" narrative out right now.
This weakness was underscored by further declines in Services and Consumer Sentiment, the former of which is nearing the mid-point at 50, and the latter of which recently dove below 70, into "Contractionary" territory.
This is all on top of a negative Yield Curve.
Elsewhere, Housing and Junk Credit came in more bullish, with Junk Credit rating general economic risk as low, and housing in a solid zone.
Net net, the slowdown in Manufacturing and Consumer Sentiment has us concerned, leading us to favor defensive stocks right now.
We're split on whether or not we'll see a recession.
Europe
The Eurozone has significantly decoupled from the US in recent months, as the strength seen in US Services and Housing has not been mirrored on the other side of the Atlantic.
Manufacturing and Consumer Sentiment remain weak, and EU Services, the only bright spot, recently dipped under the 50 mark, signaling contraction.
The Yield Curve also remains inverted.
Taken together, we're quite bearish on EU cyclical stocks as the leading indicators continue to worsen and show no real signs of life.
Defensives look to be the most well-positioned place to hide out regionally until things improve.
The United Kingdom
The UK is in a similar position to the EU, as the region has decoupled from the U.S. and multiple leading indicators continue to worsen.
Manufacturing is continuing to weaken under 50, indicating contractionary conditions.
Services also took a turn for the worse in July, and the Yield Curve remained inverted.
That said, Consumer Sentiment did creep up in September and now lies within a Neutral Zone, which is an improvement.
Housing, which came in at 50.8, is the only bright spot for the region.
Add it all up, and the UK is still likely to be a drag on Global GDP growth. We favor defensive stocks.
China
China has a mixed / bearish setup at the moment.
Manufacturing recently crossed over into expansionary territory, and Services remained at a strong point with a reading that stuck above 50 - at nearly 52.
Our main concern here is Chinese Housing.
Housing starts are well behind last year's numbers, and given how important this sector is to the Chinese economy, less starts may mean less demand for commodities, which could trickle into global GDP.
Some expect the government to launch stimulus, but given the demographic / supply situation, we don't see any moves here being particularly effective.
Given the credit issues in the country, it's something we're watching carefully.
Net net, China's debt-fueled growth of the last decade-plus may finally be coming back to haunt the country.
Japan
While recent Manufacturing numbers have dipped into (and stayed in) contractionary territory and Consumer Sentiment remains zonally flat, Japan remains one of the more bullish setups out of the major economies globally.
Services and Housing remain relatively strong, and combined with a strengthening Yield Curve, it paints a broadly bullish picture of cyclical equities in the region.
India
India still remains in an envious global position.
Manufacturing numbers are strong, Services are indicating serious growth, and Housing continues to expand at an average rate YoY.
Consumer Sentiment is the only weak spot as it continues to sit under its midpoint, but it's been slowly improving over time, and the Yield Curve, while somewhat flat, remains positive, if only by the skin of its teeth.
Of all of the global economies, India and Japan seem like two of the most interesting places to hide from the economic fallout that's occurring in the EU.
How To Position Optimally
Given what we've just laid out in all of the global economies, the most obvious trade to us is to go long rock-solid U.S. companies and short weaker EU ones.
This is due to the fact that U.S. companies with strong businesses and balance sheets should be able to withstand the economic volatility, and weaker EU companies with earnings exposure to the economic cycle should see even weaker-than-average profitability.
Even if you're unable to trade these themes on a more detailed level, the big picture theme still remains: Long the U.S. economy ( SPY ), while shorting the EU one ( VGK ).
We expect that this, or a trade like it, should strongly outperform over the next 6 months or so, while also generating significantly less volatility than directional positions elsewhere on the globe.
Hope you enjoyed! If you did, be sure to share this article with a friend who may appreciate it.
Cheers!
For further details see:
Long America, Short Europe