By Kevin Muir of “The Macro Tourist” fame; reposted here with permission
This morning my twitter-pal Boris Schlossberg from @FxFlow (and a must-follow btw) sent me the following message:
Boris, funny you should message me that comment as we were just putting the finishing touches on an old chart that I dug up from my database.
It was a Reuters chart from a half dozen years ago that showed the 3-month return of U.S. stocks versus bonds versus the G10 Economic surprise index. It took some work to recreate, and we weren’t sure which bond index they were using, so we settled on the Merrill Lynch Total Return 10-year bond note index (it’s clean and replicable, so we figured it was as good as any bond index).
After some work, we were able to replicate the chart circa 2012:
Interesting relationship, n’est-ce pas?
The relative performance of US stocks versus bonds seems to be directly correlated to the amount of under/over performance of the G10 economy versus expectations.
So if Boris is correct, and the G10 economy slowdown accelerates, we should expect U.S. stocks to sag versus bonds (the exact opposite of what we have experienced over the past six months).
But what has this chart looked like since 2012? Maybe that was just an anomaly coming out of the Great Financial Crisis.
I know I am already guilty of committing a chart crime by having two Y-axes (want to lose your quant “cred”? Simply show them my chart and tell them how much you like it), but if we made a new chart using a fresh scale, then I would be doubly guilty!
Therefore to be at least somewhat intellectually honest, here is the same chart from 2012 to present-day using the same scale:
The astute reader will notice that the relative performance of stocks versus bonds seemed to stop following the G10 Economic Surprise index from 2014 to 2016, but maybe that was due to the economic index hovering so close to zero during this period.
When the Citibank G10 Economic Surprise Index pushed up in late 2017, U.S. stocks definitely outperformed bonds.
And if we rescale the chart (here comes the chart crime anyways), the relationship tightens up a little:
And finally, here is the whole series from 2003:
The takeaway from all these charts? Although America is attempting to become more of an economic island onto herself, the global economy probably dictates much more than most market pundits would like to admit.
If we are entering a global recession, it’s probably time to buy U.S. bonds and sell stocks…
I will provide an example using DAX companies. If you split by geographic area their revenues / profits we realize one fact: European sales are needed to close the bottom line at break even, US sales to have a positive profit but nothing exciting, Asian sales make the difference between a stock judged as “growth” or not. Margin sales from Asia are the ones boosting profits. This as regards the fundamental factor. Now draw three lines on the same chart, those of Dax, S&P500, and Shangai. You will see how Dax was well correlated to SP500 as usual till spring, then during the summer it starts declining, not as fast and deep like Shangai, but visually it’s clear that it followed Shangai too. I would say Dax became a mix of 60% SP500 + 40% Shangai. Because China makes the difference in the guidance and bottom lines. I don’t have enough data and time to make the same work for the SP500 but intuitively I’m rather sure that the story that American companies rely mainly on the internal market and are an isle is another narrative that will be proved wrong. So far in a month two narratives dropped like a castle of cards: 1) the inflation due to strong growth myth 2) the Russell 2000 “maga” narrative. The guys who analyzed the Ebitda and showed that in reality the Russell 2000 was even more exposed than the main index to international factors (dollar, tariffs) were right.
Great inside information Francesca, nothing surprising in the end, but very nice to see some of my gut feelings confirmed.