It’s been a strong week for the U.S. economy, and ironically it’s been difficult for many investors to embrace the good news amid a torrent of dismal headlines; a deadly terrorist attack in Spain, a potential North Korean nuclear attack, the horrible events in Charlottesville, and even speculation that Gary Cohn, President Trump’s chief economic advisor, could resign. It’s no wonder the stock market is getting whipped around. So what’s an investor to do?
Set the politics and emotions aside.
Investors should measure and map key economic data and place their money on the highest probability outcomes. Today’s highest probability bet is that the U.S. economy is accelerating. We remain bullish on both Technology (XLK) and Consumer Discretionary (XLY).
This week’s positive economic news includes:
- July’s retail sales data numbers revealed year-over-year acceleration to 4.2% from 3.4% in the prior month.
- Meanwhile, industrial production hit a year-to-date high of 2.2% year-over-year growth (totaling six consecutive months of acceleration) after contracting 20 straight months from April 2015 to November 2016.
- So far, 470 S&P 500 companies have reported aggregate year-over-year sales and earnings growth of 5.3% and 9.3% respectively
This is why you don’t hear much about the soft versus hard economic data argument anymore. Earlier this year, when measures of Consumer Confidence were hitting cycle highs, and the U.S. stock market was moving higher, many financial pundits mistakenly claimed that it was only “soft data” and would fail to filter into broader economic growth.
The economic data eventually poured cold water on that theory. The U.S. economy has rallied to 2.1% year-over-year growth in the second quarter of 2017, from the low of 1.2% year-over-year hit in 2Q 2016. Our forecasts indicate the U.S. continues to head higher. Investors get paid by recognize key inflection points. What matters is whether an economy, or the fundamentals of a company for that matter, is getting better or worse. On that score, U.S. economic growth is accelerating.
Nowhere is this more evident than in corporate profits data. These earnings numbers are just shy of a record set five years ago. According to FactSet, if earnings growth breaches 10%, this would mark the first time since the fourth quarter of 2011 that the S&P 500 has seen two consecutive quarters of year-over-year double-digit earnings growth.
This trend of profits accelerating comes after five consecutive quarters of negative year-over-year profit growth in which the U.S. economy also fell for five quarters from the first quarter of 2015 to the second quarter of 2016. In other words, the earnings turnaround is a promising barometer of future economic growth.
After stocks have had a great run (as we’ve seen recently), investors tend to believe economic optimism must be priced in, and it’s time to sell. They often cite the S&P 500 trading at 24 times trailing twelve month earnings; and Business Insider pointed out in December, “Stocks have only been this expensive during the crash of 1929, the tech bubble, and the financial crisis.”
Those are facts. But, valuation is not a catalyst.
The stock crashes during 1929, the Dot Com bubble and Great Financial Crisis were all precipitated by a meaningful slowdown in the U.S. economy that reset investor expectations. Until then, it was particularly painful being short the stock market on “expensive valuations.” Fast forward to today, since Business Insider’s “expensive” stocks story, the S&P 500 is up +8%.
The lesson? Don’t short the stock market based on valuation, as the U.S. economy is accelerating.
Hedgeye has been making this call for 10 months now. Throughout market history, part and parcel of a stronger U.S. economy is a rising stock market. Nothing goes up in a straight line. But this is why we’ve continually suggested investors buy the dips in Technology (XLK) and Consumer Discretionary (XLY). Our back-testing of asset class performance throughout the past 20 years of financial market history indicates these consumer-oriented sectors are most levered to the U.S. economy heating up.
That’s been working. These sectors are among the leaders in the S&P 500, up +17.8% and +8.4% year-to-date respectively versus 8% for the broader index. In the midst of Friday’s selloff, we reiterate our call to buy the dip today.
Hedgeye is an independent, conflict-free investment research and online financial media company. Click here to get a free month of Hedgeye’s newly-launched ETF product “ETF Pro.” It distills Hedgeye’s investment research down to tactical macro ETF exposures.
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