Dear ETF Pro Plus Subscriber,
Welcome back!
The current lineup of ETFs is as follows: Long: INDA, URA, NLR, TBIL, TFLO, IAK, SMIN, KBWP, BUXX, GLD, AAAU, GXG, SHY, XLG, SPMO, FXB, SPLV, TLT, MTBA, EWN, EMXC, UUP, EWA, BBN, EPHE, PJP, BWET, BDRY, KSA Short: HYG, JNK, IWM, XRT, KRE, EWH, CORN, JPXN, WEAT, HYDR, JETS, RSP, MOON, EWP, EWS |
THEME 1: USA HITTING BACK-TO-BACK MONTHLY #QUAD4S
After 25 months of Trend slowdown off the cycle peak in November 2021, the most slothian cycle in history will slouch into its final phase. The confluence of further, organic deterioration and the hardest comps of the cycle will conspire to drive another deceleratory crescendo in 1Q24. We’ll detail the Quad 4 trajectory and RoC asymmetry that will characterize the first part of the year. We’ll dissect the probability and risk associated with the consumer, capex & mfg-industrial economies hitting a cumulative tipping point. And we’ll discuss the derivative implications associated with the policy pivot, the prospect for and cross-asset class implications of reemergent global divergences and the risk management strategy as the distribution of macro outcomes broadens and a potential cycle inflection comes into view as we push past 1Q24. Quick updates:
Click here and here to watch Keith McCullough's videos from the past week about the U.S. government's excessive level of spending to maintain the illusion of GDP growth. |
THEME 2: THE BIG (G) - DEFICITS & DEBT UPDATED
Government spending growth accelerated in each of the last four quarters, coming in at a brisk +4.9% Y/Y rate in Q3 based on the final revision (up from the already-hot earlier estimate of +4.5%). In the past two quarters, it has grown at more than twice the rate of personal consumption expenditures. Despite it being a) an election year and b) a year with uncapped commitments to green energy spending, total government spending’s contribution to GDP growth in 2024 will face among the steepest comps in years. We’ll review the setup here quarter-by-quarter looking out across 2024. Quick updates:
Click here to watch yesterday's webcast on demand from Danielle Di Martino Booth, JT Taylor and Neil Howe on massive U.S. debt and other election-year hazards. |
THEME 3: LONG INDIA AND GOLD VS. SHORT JAPAN
The signal remains bullish on India as shallow decelerations are overlooked for the shine and "relative" acceleration of its world-leading economic growth powered by buoyant domestic demand and government spending, moderated commodity prices, and strong credit growth. Meanwhile, real yields down, gold up, with the added long-term secular tailwind of fiat debasement and real asset supremacy in the age of fiscally drunk sovereigns. We expect real yields to experience downside pressure from the two most probable outcomes: nominal yield declines on slowing growth or a reacceleration in inflation due to a premature Fed pivot into easy comps. Lastly, Japan is past its peak with returns from accommodative monetary policy, a weaker yen, and heightened external demand due to exports and the wave of post-pandemic tourism diminishing. Accordingly, Japan is poised for back-to-back Quad 4s through 1H24. Quick updates:
|
GLOBAL QUAD OUTLOOK
Below is an updated list of the 44 current ETF Pro Plus tickers. Keep reading for an overview of our thesis for each of these current ETFs, along with what we’ve added and removed since the last newsletter.
New users should definitely check out the Appendix for a brief primer on our Macro process and how we select (and remove) the exposures in ETF Pro Plus. Review last month's edition of ETF Pro Plus.
CURRENT ETF LINEUP
COMMODITIES
We are bullish on shipping by both land and sea: Tanker Shipping (BWET) and Dry Bulk Shipping (BDRY). Current geopolitical tension – from Russia and Ukraine to the attacks in the Red Sea and even the continued conflict in Gaza – have disrupted traditional trade routes, sparking narratives of new opportunities in the shipping industry. Demand could be bolstered as older fleets are scrapped for new, more efficient boats. Despite commodities underperforming in a Quad 4 environment, we see shipping as a slept-on industry to capitalize on the long side.
Real GDP was saved by the government fudging numbers related to the GDP deflator, painting a façade of growth, but we see the real story. When the economy weakens, demand for corn, from industries such as food processing and ethanol production declines, putting downward pressure on prices. On top of these narratives (which do not factor into our quantitative process) both Corn (CORN) and Wheat (WEAT) are bearish trend on our VASP, implying you should short them.
We removed longs Silver (SLV and SIVR), Bitcoin (BITO) and Ethereum (ETHE) as they broke down based on our #VASP signal.
DOMESTIC EQUITIES
We're bearish on the U.S. economy, but still have a healthy dose of longs. (As a reminder, there's a difference between the economy and stocks.)
We remain long Insurance (IAK), which has been a strong performer even relative to the broader market, which has been gyrating wildly since July. We are also long Pharmaceuticals (PJP), as it falls under the umbrella of Health Care, a strong-performing asset class in Quad 4. The explosive popularity of GLP-1 drugs like Ozempic has turned heads as many are realizing the immense benefits of living at a healthier weight at a much quicker pace than traditional methods. This is all great, but it does not factor into our mathematical process, which pins PJP is a long.
High interest rates lead to higher investment income for Property & Casualty Insurance (KBWP) companies. An aging American population, and other demographic factors covered by analyst Neil Howe, bode well for KBWP.
This year, we anticipate continued growth for both Long S&P Momentum (SPMO) and S&P 500 Low Volatility (SPLV). SPMO is overweight Health Care and Communications and underweight Tech and Consumer-related cyclicals relative to its peers. Meanwhile, SPLV is a classic Quad 4 exposure with it's overweight to Consumer Staples and Utilities.
Meanwhile, our exposure to S&P 500 Top 50 (XLG) represents our near-term view (best expressed in our Momentum Stock Tracker product) that the top S&P 500 companies remain bullish trend. This ETF is composed of 50 of the largest companies in the S&P 500 (here's why we're bullish). The seven largest tech stocks in the S&P 500 were up a collective 92% in 2023, more than 20x the remaining 493. This factors into our reasoning to short S&P Equal Weight (RSP), as it is bearish trend on our VASP, and greatly outshined by the Magnificent 7 stocks driving nearly all of the growth.
Maybe it's that Hydrogen is expensive to produce and utilize, making it an unfavorable form of energy in comparison to traditional fossil fuels. The move to clean energy takes time, and Hydrogen is not leading the charge? Whatever the reasoning, McCullough's #VASP suggests Hydrogen (HYDR) is a short and now is a good time to capitalize.
Following a two-month rally from late October to late December, Russell 2000 (IWM) continues to be a roller coaster, with more downs than ups. The ETF is down -19% since its 2021 peak. Not helping matters is the fact IWM underperform in Quad 3 and 4 setups.
The Retail sector is volatile, and during the economic downturn mixed with re-acceleration in inflation, Retail (XRT) is a short facing several challenges. The labor shortage/slowdown is expected to continue based on the consumer tightening we have witnessed. Despite the reported increase in GDP, consumers are facing mounting pressure with student loan payments kicking back in. This surprisingly affects many high-income earners, who contribute greatly to the Retail sector. We remain bearish on XRT entering a reported recession. These headwinds also affect Financials to a greater degree, so we remain bearish Regional Banks (KRE) as well.
The consumer is clearly under great stress right now, with credit card bills and buy now pay later rates skyrocketing. Taking trips and buying expensive airline tickets is not in the budget for most, as many people are under stress paying for necessities. Jet fuel has also jumped in price due to the conflict in Ukraine, putting upward pressure on ticket prices and operation costs for airlines. Supply chain snags in manufacturing and staff shortages due to rising labor costs are squeezing margins. Narratives aside, our signal says to short Airlines (JETS), so we abide.
US Innovation (MOON) seeks exposure to high-growth, disruptive companies. These companies are in the realm of our worst equity style factors in a Quad 4 environment, shorting high beta, momentum, leverage, secular and cyclical growth. Their holdings trade at inflated P/E ratios with low and unsteady cash flows. Rising costs, recessionary signals and profitability challenges abound all contribute to the headwinds these types of companies face, so we remain short.
We removed long Utilities (XLU) and shorts Real Estate (XLRE) and Industrials (XLI) as they broke down based on our #VASP signal.
DOMESTIC FIXED INCOME
We've been bearish on both The Cycle and High Yield Corporate Bonds (HYG) for going on two full years. We continue to like the HYG short and High Yield Bonds (JNK) as a fulcrum point for our Short Credit bias.
- While HYG and JNK are thematically similar in tracking below-investment grade corporate credit, there are a few slight different in their investment profiles:
- HYG has less BBB rated bonds and more BB, but also less B and less CCC rated bonds (HYG's quality is concentrated in the BB's, while JNK is a bit more spread across the credit spectrum)
- HYG has a higher expense ratio
- HYG is far more liquid (higher daily average volume)
- HYG has a longer effective duration
- HYG has over double the AUM
Yielding near ~5%, we continue to be long the US Treasury 3 Month (TBIL), Short-Term Treasury Bonds (SHY) and US Treasury Floating Bond Rate (TFLO).
Income Short Maturity (BUXX) provides investors with exposure to short-term, high-quality bonds while minimizing volatility. Due to their shorter duration, short-term bonds have less time to be impacted by changes in interest rates.
As recessionary fears loom amid swirling reports of mass layoffs and plummeting yields, 20+ Year Treasuries (TLT) has historically been a safe place to park your capital (according to our Quad 4 backtest). Taxable Municipal Bonds (BBN) also fall into the recession hedge category, as it offers stable cash flows and tax-free yields. It boasts lower interest rate sensitivity as well, so you never have no watch another FOMC meeting ever again! (Sadly, we're kidding.)
Mortgage-Backed Securities (MTBA) offer diversification in your portfolio, diluting volatility. The housing market is set to come back in a major way in the second half of 2024 and beyond. You can learn more about housing dynamics from Daryl Jones' recent webcast with Bill Pulte, housing market veteran and CEO of Pulte Capital Partners.
We removed long Quadratic Deflation (BNDD) as it broke down based on our #VASP signal.
EMERGING MARKET EQUITIES
Saudi Arabia (KSA) enjoyed GDP growth to close out 2023, and we expect the momentum to continue through the first three quarters of this year. Possible narratives driving the economy are rising oil prices and significant spending on infrastructure projects like the NEOM megacity.
Another country McCullough added today is Philippines (EPHE). Our forecast is GDP growth to pick up by the middle of the year.
Colombia (GXG) is bullish trend and remains Quad 1 through 1Q 2024.
Out of the 23 countries we track on our Emerging Market GIP Model, we're forecasting GDP growth for 18 at some point in the first half of the year, including the three countries we just mentioned. However, as our Macro Themes explained, we remain bearish on China. Our long call on Emerging Markets ex-China (EMXC) reflects this.
We continue to lean bearish on Hong Kong (EWH) as Keith’s #VASP signal confirms. Economic issues in broader Asia has faltered with China taking the lead, and as a result, EWH is bearish trend and remains a short.
We removed long Brazil (EWZ) as it broke down based on our #VASP signal.
FOREIGN EXCHANGE
After a four-week hiatus, U.S. Dollar (UUP) returns to the long list. When Quad 4 hits, the U.S. dollar goes up and Bitcoin breaks down, as we've already seen in recent weeks.
The Bank of England has been more hawkish than the Federal Reserve. That dynamic supports the long British Pound (FXB) signal Keith McCullough continues to highlight via the Pound's bullish trend.
We're Long Precious Metals like Gold (GLD) and Physical Gold (AAAU) because we understand that yield curve inversion remains near CYCLE LOWS and an inverted yield curve is bearish economically. Gold also tends to be inversely correlated with real interest rates (which has been falling lately alongside the move in bond yields).
GLOBAL EQUITIES
Uranium (URA) and Uranium+Nuclear Energy (NLR) have the highest absolute performance since being added as longs this summer. URA is up 42% since its addition June 23, 2023, and NLR is up 25% since being added July 20. Stick with them. Ride your winners.
We removed long Gold Miners (GDX) as it broke down based on our #VASP signal.
INTERNATIONAL EQUITIES
"If you ain't Dutch, you ain't much," McCullough said on Tuesday's episode of The Macro Show. Netherlands (EWN) is up 6.7% since Hedgeye’s CEO went long on January 5. After a full year of Quad 4 deceleration, Netherlands ended 2023 in Quad 1. We’re forecasting continued GDP growth for the country through the first three quarters of 2024.
Australia (EWA) is already up 3.4% since being added as a long just two weeks ago. We expect the country to move into Quad 1 by the middle of 2024.
Renowned economist Daniel Lacalle joined McCullough from Spain for a free webcast on January 18, stating, “I come from the future, my friends. I’m in Europe.” While the U.S. attempts to stave off a recession, Spain (EWP) and Europe are already deep within a slowdown of their own. Lacalle, the chief economist at Tressis SV, explained the issues he’s seeing in Spain now, and what he believes the U.S. will soon experience: “In the future, you’ll see that ‘huge debt doesn’t matter because it’ll always be refinanced,’ is horse crap.”
Speaking of horse crap, we remain short JPX-Nikkei 400 (JPXN) as we see Asia continue to break down. Japan saw worse manufacturing PMI numbers than China throughout 2023, and the trend looks to be worsening. Inflation is sitting around 3%, but nominal wages are rising slower than that inflation, causing discontent amongst the population.
Like Japan, Singapore (EWS) is an Asian country we’re short on. Our outlook is for a Quad 4 slowdown throughout the first half of the year.
But the news isn't all bad in Asia. Domestic demand, business confidence and industrial production have been accelerating and contributing to the bullish trend maintained by our favored India long exposures, INDA (McCullough's longest-held bullish ETF) and SMIN.
We removed long South Korea (EWY) and short Japan (EWJ) as they broke down based on our #VASP signal.
INTERNATIONAL FIXED INCOME
No current high-conviction ideas.
APPENDIX
We find two factors to be most consequential for forecasting future financial market returns: economic growth and inflation. We track both on a year-over-year rate of change basis to better understand the big picture then ask the fundamental question: Are growth and inflation heating up or cooling down?
From there, we get four possible outcomes, each of which is assigned a “quadrant” in our Growth, Inflation, Policy (GIP) model and the typical government response as a result (neutral, hawkish, in-a-box or dovish): Growth accelerating, Inflation slowing (QUAD 1); Growth accelerating, Inflation accelerating (QUAD 2); Growth slowing, Inflation accelerating (QUAD 3); Growth slowing, Inflation slowing (QUAD 4).
After building this base of knowledge, we can now select what we like and don’t like based on our historical back-testing of the different asset classes that perform best in each of the four quadrants. The chart above shows the U.S. economy teetering between Quads 3 and 4 in the first half of 2024. However, forecasts via our predictive tracking algorithm over a monthly periodicity, suggests the U.S. economy will be mired in Quad 4 through February.
Below is a chart that lays out precisely what we like and don’t like when an economy is in each of the four quadrants. This chart should help you make better investment decisions, even outside our recommendations in ETF Pro Plus. (For more on our Macro team's overall research process, click here to read our detailed "Macro Playbook.")