Global Divergences, Challenging Cycles, Fragile Trends, Selective Allocation

Global Divergences, Challenging Cycles, Fragile Trends, Selective Allocation

The most powerful influence on equity performance this year has been the global divergence of growth between the US and the rest of the world. As highlighted a few months ago, http://chrisbelchamber.com/q1-2018-performance-review-markets-in-transition/,  international economies shifted to declining growth at the end of 2017, and yet US growth has powered ahead so far in 2018.

The chart above shows the significant impact this growth divergence is having on equity index selection. While global ex US equities, VEU, has just made a new YTD low, down 4.4%, the most domestically concentrated US equity index, IWM, continues to rally, and is now up almost 10%!

The Dow Jones Index, has a very substantial overseas earnings component so it is splitting the difference, and closed yesterday marginally down YTD.

These international downcycles are still at an early stage.

Looking ahead the international downcycles look like they are only just beginning. Indeed, it looks like Europe entirely missed raising rates at all, even from negative interest rates, in the upcycle last year.

Japan and Emerging markets also look like they are in challenging phases of their respective downcycles.

Globally, the US has remained a standout by hanging on to its growth uptrend in Q2 2018, and rapid profits growth.

However, peak growth has likely only been marginally delayed. Credit spreads continue to diverge from the S&P500 Index.

The yield curve has also continued to suggest that the US economic cycle is very mature, as yield curve flattening approaches historical turning point levels.

The corporate yield curve has already inverted.

https://www.zerohedge.com/news/2018-06-19/corporate-yield-curve-has-just-inverted

Record buybacks have supported US equities, but executives have been selling into the rally in record amounts. So presumably executives are buying with corporate cash while at the same time as they are selling for their own account. Are they doing the right thing for both the corporation AND their own account?

http://money.cnn.com/2018/06/11/investing/stock-buybacks-sec-report/index.html

Hedgeye’s high probability algorithm suggest US growth and inflation will be falling by Q4 2018.

From a cycle perspective is seems more likely that the US will join the rest of the world in a cyclical downtrend by the end of the current year. The cycle position must therefore be considered challenging. In the chart above declining GDP growth in the second half of 2018 has become the high probability outlook.

Fragile Trends

Even within the US equity market the trends have begun to look fragile.

The Dow Jones uptrend broke in February this year, and even now only 40% of these stocks are in established uptrends.

Even when the key sectors are examined only 3 of the main sectors are in established uptrends and only recently over the last month or so.

The energy sector is now questionable as a strong trend and has just experienced a significant correction. A high percentage of Consumer Discretionary is not in an uptrend and XLY is highly dominated by just one stock, AMZN. The best trend remains in Technology, but overall the breadth of uptrends has clearly weakened.

Asset allocation choices need to be selective and increasingly defensive.

The strongest sectors of the equity markets have a domestic and/or technology bias. International equity exposure should continue to be avoided, and/or used as a hedge, including the Dow Jones Index.

Allocation is also beginning to shift in favor of TIPS and possibly for the first time to bond proxies, REITs may be a good place to start with appropriate risk management.