There is no soft patch in the US. The OECD indicator is slowing, but this masks divergence on a country-by-country basis. The US indicator has just made a two-year high and is firmly in the 'expansion' quadrant. It matches our US economist Steve Blitz's view of the US expansion. The 'soft patch' is temporary and not global. Logically, therefore we should regard the current retreat in risk as a buying opportunity. Employment is improving, particularly in higher-wage industries. Wage growth also looks set to continue rising. Tax cuts and fiscal stimulus are doing their job. We reckon easing fiscal policy at this stage of the cycle is imprudent, but it is what it is. The experiment of running the US economy hot is beginning to show results. It looks like the next stage of the US expansion will be driven by personal and business capex. Households are feeling more confident.
Consumer discretionary (CD) stocks should perform well in this environment. We buy the XLY ETF, which tracks the consumer discretionary sector, at $104.10 with a stop at $99.50 and target of $115. The sector includes Amazon, whose p/e ratio of 68x forward earnings distorts the sector’s overall valuation. But given Amazon’s global reach, rising market share and policy of investing profits in capex, one can justify a sky-high price: the p/e ratio is not an appropriate measure of value for the stock. Valuations in the rest of the sector are a reasonable 16x forward p/e (compared to 20x for the S&P500 index), and buybacks – running at $22bn/quarter in this sector and $60bn/quarter in the S&P500 as a whole – should continue to support prices.
By 23 May 2018 the trade had made 0.8%. We raised the stop-loss to $102.90 to add some protection.
By 6 June 2018 the trade had made 4%. We raised the stop-loss to $104.75 to lock in some of the profit.
By 13 June 2018 the trade had made 6.3%. We raised the stop-loss to $106.5, locking in 2.5% profit to date.
By 20 June 2018 the trade had made 7.4%. We raised the stop-loss to $109 to lock in more profit.
On 27 June 2018 we closed the trade for a total gain of 4.7%. Over the same period a long SPX position would have delivered zero return.