Maintaining Nominal Growth Positions

Welcome to our official publication of the Prometheus ETF Portfolio. Our primary takeaways for last week are as follows:

• Markets moved to price-in resilient nominal growth conditions, consistent with the trend in economic data.
• We expect headwinds for assets ahead as the policy liquidity drain begins to pick up its pace.
• Crosscurrents have begun to emerge in equities, with growth expectations elevated. We think staying close to the exits is important here. Dynamics continue to favor stocks versus bonds until activity decisively turns. 

Let’s dive into the data driving our assessment. Over the last week, our systems moved to price-in rising real growth, with Stocks rising by 2.4%. We show the daily path of returns through the week:

Using our understanding of cross-asset market pricing, we can derive the market-implied odds of varying regimes of growth, inflation, and liquidity. Currently, our proprietary process suggests that we are in a period of (+) G (-) I (+) L. We show our market regime monitor below:

As we can see above, the most recent market pricing has been consistent with tightening liquidity, though longer-duration pricing has yet to show this. We expect this tightening of liquidity conditions to persist, driven by the resumption of reserve balance drawdown through the combination of QT & Treasury issuance. Below, we show the reserve balances held at the Fed and the primary driver of strength (in blue) and weakness (in red):

We expect this change in bank reserves to drag on all markets over the next quarter, taking us into a consistent tightening liquidity path once again. Recall all assets suffer during periods of tightening liquidity. This is likely ahead of us, we show our estimates for the path of reserves below:

Barring changes to this path, we expect this to be a significant drag on all assets. Now, while liquidity determines returns across asset classes, growth, and inflation determine the relative returns between asset classes. Over the last week, the market reflected economic data, which showed continued resilience in economic activity. Construction spending, personal consumption, ISM Manufacturing PMIs, initial claims, and nonfarm payrolls all came in better than expected. We look through each.

The most recent data for July show construction spending increased by 0.7%, with 0.63% and 0.06% coming from residential and nonresidential spending, respectively. This data surprised consensus expectations of 0.5% and contributed to an acceleration in the twelve-month trend. Zooming out, we show the evolution of construction spending over the last year, which rose by 5.53. This was driven by a -2.7% decrease in residential spending and an 8.23% rise in nonresidential spending. Below, we drill down further to show the top 3 drivers of strength in blue (Manufacturing, Highway & Street, and Educational Spaces) and the top 3 drivers of weakness in red (Residential, Religious, and Communication):

The divergence between residential and nonresidential construction remains in play:

As we have detailed in prior research, this divergence is driven by manufacturing construction investment, which remains extremely elevated due to sizable investments by firms to increase semiconductor production:

This spending is likely to remain an ongoing contributor to the resilience of nominal spending. Next, we turn to consumption, which, much like residential spending, showed continued resilience across categories:

Next, we turn to ISM manufacturing data, which sequentially improved within a weak trend. The ISM Manufacturing data showed a contractionary reading of 47.6,  surprising consensus expectations of 47:

Additionally, jobless claims data continued to remain far from recessionary territory. In fact, they sequentially softened:

These employment conditions were further confirmed by slower-moving nonfarm payroll data. Nonfarm Payrolls increased 0.12% in August, surprising consensus expectations of 0.11%. This print contributed to a sequential deceleration in the quarterly trend relative to the yearly trend.

Overall, this was a week where economic resilience showed in the data, largely due to the acyclical nature of the data reported, which favored assets exposed to nominal growth. We see this in our trend measures as well. For context— we have developed a set of trend filters to help us better evaluate the sustainability of asset-class moves. As always, we have tested these trend measures over time to understand whether they can help reliably generate an edge in markets. As proof of concept, we show how these combined signals have performed relative to an underlying portfolio of the same four assets:

Currently, these signals suggest long positions in stocks, short positions in bonds, long positions in commodities, and long positions in gold.

We begin by showing our signals for stocks. We show both the full signal history and the most recent signal context:

Next, we show our system’s current readings for 10-Year Treasuries:

We now turn our attention to commodities:

Finally, we show our trend signals for gold:

Now, while these cross-asset trends continue to signal a positive outlook for nominal growth, we think it is time to start watching for a turn in equities. Revenue expectations largely follow the path of realized revenues, and our expectation is that further deceleration in nominal GDP is in the cards after a period of brief stabilization. Thus, we think there is potential for revenue expectations to decline alongside tightening liquidity:

Thus, while we continue to stay positioned for nominal growth, we stay close to the exits in the event these dynamics change meaningfully in the coming weeks. In this context, our systematic Prometheus ETF Portfolio was well-positioned last week. Over the last week, the Prometheus ETF Portfolio was up by 0.99%. Below, we show the contributions to this portfolio performance across securities:

Turning to next week, our systems are looking to position the Prometheus ETF Portfolio as shown below. The portfolio contains 18 positions heading into next week. We show these below:

POSITIONS: USHY: 16.25% XLV : 10.51% SPX : 8.46% XLI : 7.57% XLF : 7.02% XLB : 6.42% XLY : 6.08% XLK : 5.99% XLC : 5.77% XHB : 5.24% XLE : 4.91% SOYB: 4.34% DBC : 3.68% CANE: 3.33% SLV : 2.51% USO : 1.91% UGA : 1.77% Cash: -1.75% . Please note if cash position is negative it implies leverage.

Additionally, we show these positions aggregated into asset class allocations below:

The portfolio has a net exposure (ex-cash) of 101.75%, with a gross exposure (ex-cash) of 101.75%. This allocation has an expected volatility of 15.5%, with a maximum expected volatility of 10%. Next week is relatively muted in terms of the data calendar. We will be monitoring durable goods orders on Tuesday to understand the dynamics at play in the automobile industry. Until next week.