See bottom of email for analyst certification and important disclosures.
Critical PMI data release in next week determine whether 'PMI bottom' thesis tracking....
Equities have enjoyed
a relatively solid earnings season (76% beating, 191 reported, and AMZN not
harming risk-on) and October overall (+1.4% MTD). But the S&P 500 put
in its all-time high on July 26, 2019 at 3,028 and while the current 3,022 is
not too far away, the burden is on the stock market to prove a bull market is
still in place.
Of course, our clients know that our thesis remains that ‘markets going nowhere’ (20 months) have resolved 3 of 3 times (since WWII) with massive upside breakouts. And this remains our central view and why we believe S&P 500 will surpass 3,125 by YE.
– But this thesis is predicated on the PMIs bottoming now (October or even November)
– And this turn in cyclical momentum AND coupled with Fed easing and coordinate global central bank easing AND record cash on sidelines, is a formula for a melt-up rally.
POINT 1: CLUE PMI BOTTOMED –> LOOK AT PROGRESSIVE RALLY OF CYCLICALLY SENSITIVE STOCKSThere is a steady growing participation and outperformance by sectors/indices sensitive to PMIs. Specifically:
– Semis started outperforming 5/28
– DAX (Germany, deep cyclical) started 8/16
– Capital Goods (CAT, etc) started 10/21
POINT 2: CLUE PMI
BOTTOMED –> LOOK AT ISM NEW ORDERS/INVENTORY WHICH IS TROUGHINGISM New Orders/Inventory and this ratio is back to levels seen at recession
levels and during peripheral crisis lows. In the current context, New
orders collapse (due to trade shock) and as the right chart shows, inventories
are falling sharply. Thus, this looks like “trade resolution”
plus “de-stocking” could drive a recovery in PMIs.
POINT 3: CLUE PMI
BOTTOMED –> LONG-TERM YIELD CURVE (30y-10y 9m chg) SAYS PMI BOTTOMINGLastly, dusting off the oldie but goodie, the long-term yield curve has
been a better predictor of PMIs than economist consensus. And this
long-term curve says PMIs should be bottoming (LT curve leads PMIs by 16
months). The 16 months is the average lead time of LT curve inversion to
recession start since 1950.
PLAYBOOK: OW TOP 3
SECTORS YTD + OW VALUEOur active manager clients know that we are trying to position them to
capture higher probability opportunities. For the final 10 weeks, we
found two strategies, which in the last 20 years, had a 63% probability of
beating the S&P 500:
– OW Top 3 YTD Sectors. Between 10/15 to YE, this beats by 0.4% and 63% of time
This year, this is Technology, REITs and Comm. Services;
– OW Value. Beats by 0.3% and 63% of time.
While this may not sound like much, given our expectation of a 3% to as much as 10% rally in next 10 weeks, capturing the relative return is important.
A risk with Cyclicals is winning strategy YTD and is one that makes sense if
PMIs are inflecting up. Thus, there is an alignment of this strategy.
25 STOCKS TO OWN INTO
YEAR-ENDThe roster of stocks to own into YE are as follows –> Top sectors YTD +
OW Value + DQM 1