Paying Attention to the Value Names
I am not an economist but I get to play one with my charts. I don’t spend my time pouring over economic data as it is released. For the most part, except for the leading economic indicators, the data in an economic release is fairly stale by the time we see it or read about it. At the same time, it is often misunderstood. Take the GDP report that was recently released for the third quarter here in the US. The reported number was 33% growth. It is completely misleading. The Committee for a Responsible Federal Budget had this to say about the most recent report:
Today's advanced third quarter GDP estimates from the Bureau of Economic Analysis are being reported as showing 33 percent economic growth. This figure is highly misleading, both because it is an annualized number describing a one-time partial recovery and because it is measured off of a deflated base. In reality, GDP grew by 7.4 percent between the second and third quarters, recovering about two-thirds of the GDP loss since the end of 2019.
The other knock that I have against the traditional economic data is that it is often revised. Sometime for the better, sometimes for the worse. So now I really don’t know why I should track it all that closely. That’s also why I stick with my charts. Let’s assume that you believe, as I do, that markets are forward looking. That means they will generally do a good a job of anticipating the future. Does it get it right all the time? No. But generally speaking it is directionally correct. So why not just look there?
Despite claims that the economy was humming along prior to COVID, I have been making the argument that this is not true. Based on what was happening in markets, I was claiming that economic growth was not as strong as it was being made to seem. The question is which markets? Many people will look at the S&P 500 and conclude that stocks were paining a rosy picture, confirming what we were hearing as it relates to the economy. But the S&P 500 is not “the market.” There are many different asset classes that make up the market and I spend a fair amount of time looking at all of them.
The biggest “tell” for me was actually playing out in the commodity market. In particular copper and gold. Copper is an industrial metal, widely used through out the global economy. You probably have a lot of it running through your home. Gold is a precious metal. It does not have a lot of industrial use. People own gold when they are generally uneasy about the way the world is going. It’s not so much one or the other that I care a lot about, but their relationship to each other. If copper is doing better than gold, investors are likely expecting better economic growth. The reverse is also true. Copper lagging gold points to the prospects for slower growth.
Here is the chart that allows me to play an economist. The Copper to Gold Ratio. When the line is going up, copper is leading gold and we are expecting economic growth. When the line is going down, copper is lagging gold and we are expecting economic growth to slow or even decline. That big spike on the left is the “Trump Bump” when the prospects of tax cuts and an easier regulatory environment led us to believe that growth was picking up after the 2016 election. And it was until about the end of 2017. Then it began to roll over. This ratio continued to fall until April of this year. So economic growth was slowing well before COVID was a concern. As a matter fact, GDP growth began to move lower the first quarter of 2018, about four months after this ratio started to head down.
Look at what is happening now. The line is moving higher. Since April, it has made higher highs and higher lows. That is the text book definition of an uptrend. What does this all mean for investors? Well, when the line was going down (growth slowing) we wanted to own the “growth” stocks. The theory is that when economic growth is scarce, investors will pay a premium to own what is actually growing.
The opposite side of the coin is “value” stocks. These tend to be cheap based on their earnings. They tend to be the “old economy” types of stocks such as General Electric, many of the banks as well as many of the energy companies (the ones that drill holes in the ground) and the airlines.
But what happens if growth is no longer scarce. What happens when economic growth is showing signs of recovery, with the added kick of a possible COVID vaccine? I have written about how we are beginning to see signs of economic growth coming back. Those signs are, thus far, confirmed by my chart of copper and gold. So what do we get? We get what happened on Tuesday, the largest underperformance of growth vs value stocks in a single day (going back 10 years). Look all the way to the right.
We get one day of massive outperformance by bank and energy stocks. In short we get a big spike in the things that are closely tied to the economy.
At the same time we get selling of things like Zoom and Peloton (I sold mine as soon as the vaccine news hit) and other stay-at-home winners. You get profit taking in technology and internet-related names. You get a complete reversal from the things that were good when growth was slowing into the things that could be good if growth is picking up.
It’s called rotation and while one-day does make a trend, it gets my attention. A vaccine probably means that growth will pick up. Yes this will take time, there are more tests that have to be done before approval. Yes the logistics of distribution will be complicated. But the market is forward looking and if you believe in innovation, as I do, odds favor us figuring it out.
Just pay attention to the world around us. You get the sense that people want to go out, they want to travel, go to a game, go to a show, etc…I know I do. You get the feeling that people want to spend money. If I am right, it is probably time to be paying attention to the value parts of the market, that have largely been ignored for the better part of two years, in addition to the high quality growth themes which are still likely to endure.
Things are probably getting better for the economy!
I have been talking about this and other unfolding trends in the market with our clients for a the past few months. You can sign-up for a trial to get more in-depth thoughts here:
*Noting in this note should be considered investment advice.