CwA: Brass Tacks

One of the most challenging things we face as investors is overcoming what is known as the wall of worry. Without a doubt, uncertainty has permeated through the financial markets and investor’s minds, and rightfully so. In a matter of just a few months, we have entered into a recession, battled COVID-19, witnessed an abrupt deleveraging and liquidity crunch, experienced unprecedented volatility, and to top it off we live in an era where political uncertainty is at its highest. It is hard to refute that these events have created a justifiable skepticism towards climbing over the wall of worry. But to be honest, we’ve seen these walls of worry before; the financial crisis in 2009, EuroZone debt crisis in 2011, oil and China bubble bursting in 2015, and now the COVID-19 pandemic of 2020. And while the events of 2020 are essential to be mindful of, we believe there is a better outlook ahead as cyclical forces will help investors climb over the wall of worry, just as it did in the past.

Today over coffee, we will get down to brass tacks as we review leading economic data and its signal for better times ahead.

As mentioned over coffee a few weeks ago, we’ve begun to see a broad-based reflation in leading economic data such as PMIs, housing, permit data, and commodities. Reflationary environments from cycle lows, like we saw in March and April of this year, usher in new sector leadership and pave the way for an acceleration in earnings growth, thus lead to higher stock prices. One of the best barometers we use in mapping the business cycle is the housing industry, given its contribution to economic growth (GDP, gross domestic product). Every recovery over the past 65 years has been preceded by the Federal Reserve easing interest rates, pumping money (liquidity), and lower inflation. The first industry to begin to see the positive effects of lower interest rates and disinflation is the housing industry.  The chart below shows the NAHB Housing Index rebounding strongly from the April 2020 lows.

With better than expected economic data being reported, we believe we are in the early inning of prolonged economic recovery and the start of a new business cycle. And, although the stock market has been volatile over the past few weeks, we believe the summer will see a range-bound stock market as a natural place to rest and consolidate before entering into a new uptrending market based on continued improvement in leading economic data.

As we enter this new period of economic growth, we expect to see volatility episodes as investors still grapple with the economic blind spot created from COVID-19. With the use of our DCA PIIL model, we see ample signs of an economic re-acceleration in leading economic indicators, which should pave the way for risk-on performance.

Sincerely,

Andrew H. Smith
Chief Investment Strategist
andrew@delosca.com
asmith971@bloomberg.net

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