Intelligence Briefing Takeaway — 10.1.22

The third quarter is closed. “Thank God it’s over!” “Good riddance!” “Don’t let the door hit your arse on the way out!” I think that sums up how we feel about the third quarter of 2022. We should have exited the week in a merrier mood. On Tuesday, QI’s favored GDP modeler, S&P Global’s Ben Herzon, was forecasting third-quarter GDP growth of 0.3%. There were two contributors to his upward revision. Imports were much weaker than he’d penciled in. Private demand – firms and households – are pulling back hard, right-sizing to weather recession. Separately, inventories, especially in Motor Vehicles & Parts, were much stronger than Herzon originally factored into his model. Combined, these revisions took his estimate to 2.2%.

READ MORE

QI PORTFOLIO STANCE

More than any time in postwar history, U.S. politics dictate economics.  Credit was already compromised when the pandemic hit. Rather than be capable of going at it alone as the Fed did post-GFC, a combined monetary and fiscal response was required but likely misallocated too universally, over-leveraging the COVID-induced supply-shock inflation. Post-pandemic, the under-appreciated risk of the debt limit, budget resolution, and removal of direct fiscal support and the resultant depleted tax refund flows for households should act as anchors on long-maturity Treasury yields. A flattening bias underlies the building stresses on household finances as the global and U.S. economies return to their pre-pandemic trajectories. 

QI QUICK QUILL CALLS

• The bear market we have predicting Q4 2021 is here and only mid-innings at best. The recession we have been predicting since Q1 we believe is manifest. *Maximize cash.*  Politics could catch anyone flat-footed, but not likely in a divided congress; a defensive path is the most prudent. Relative value plays are below. [9/23/2022]
• Overweight domestic Utilities within U.S. equity portfolios and underweight companies and sectors with high international exposure, namely Technology, Materials, and Consumer Staples. The U.S. Dollar is likely to stay stronger for longer, and this has yet to fully manifest in U.S. equities. [9/19/2022]
• Reinforcing our avoid Consumer Discretionary call with shorting the most discretionary of the durable spending sub-sector, namely recreational boats, recreational vehicles, and autos. [8/31/2022]
• Within equities exposure, Long Telecom Services & short Travel & Leisure. Given the widespread acceptance of recession among households, with upper income in the lead, it’s appropriate to be long the former and short the latter. [8/30/2022]
• Automation, Robotics, & AI are poised to continue thriving in America as high labor costs, on-shoring, and near-shoring gain momentum. While QI still advocates maximum cash positions at this time, we believe these subsectors will outperform on a relative basis. [7/26/2022]
• Shorting a basket of small-to-mid cap banks with high exposure to Commercial Real Estate makes much sense to QI at this juncture. Rates are rising, which is good for net interest margins, but CRE defaults are just starting. Several highly liquid ETFs likely make good shorting opportunities. [7/26/2022]
• With recession in the books, we reference the duration of the last two occurrences of 2s/10s yield curve inversions — the 9-month stretch in 1999-2000 and the 7 months in 2006. Because deflation in shelter will filter through with a lag. Short inflation breakevens. (i.e., long TLT, short TIPS) [5/3/22 updated 7/6/22]
• As the Fed tightens, already anemic liquidity gets tighter and asset price volatility rises. The VIX looks increasingly inexpensive. Look to build VIX entry points when stocks are in blind rally mode. [4/5/22]
• Macro fundamentals suggest downside for the auto sector. Auto Retailers in particular, who’ve reaped huge gains are likely to see those go into reverse. [3/24/22]
• With record low cap rates pushing 2%, half of 2007's prior record, if you own anything in CRE, even Industrial, sell and sell now.

ON QI'S RADAR

• High prices are already forcing consumers back to mean purchasing levels – or worse.  Debt accumulated to avoid any near-term pain will also hamper near-to-medium-term spending. Underweight Consumer Discretionary [3/12/2022]
• Be mindful of rampant corporate credit creation in a higher cost environment. More credit spread widening is likely on offer.