King Dollar

Welcome to The Observatory. The Observatory is how we at Prometheus monitor the evolution of both the economy and financial markets in real-time. The insights provided here are slivers of our research, that are integrated algorithmically into our systems to create rules-based portfolios.

Here are the top developments that stand out to us:

i. The outlook for profitability continues to deteriorate. The latest ISM Services data showed an expansionary reading of 55.3, implying 7% YoY earnings for the S&P 500. This reading surprised expectations with a reading of 55.3 versus the expected 54.

This datapoint was a sequential deceleration within a decelerating trend. The largest gaining segment was Deliveries and the largest slowdown was in Employment. This further deterioration in Services PMI’s coupled with the weakness in the ISM Manufacturing, paints a bleak picture for corporate profitability:

Above, we show how the new orders component of ISM manufacturing has typically allowed some insight into the state of corporate profitability. Based on this data, corporate profits would come in at approximately 3% versus the prior year. This number would be a nominal reading, and therefore, real profitability is highly likely to be negative.

ii. Durable goods orders remain strong, however, they reflect inflationary pressures. Manufacturers’ orders for durable goods remain positive, however, these demand pressures continue to manifest in the form of inflation. We show the composition of the latest print below:

New Orders for Durable Goods came in at 10.8%, a sequential deceleration from the last print. This print surprised expectations with a monthly change of 0.8% versus expectations of 0.7%. Transportation Equipment has been the largest contributor to these moves with a weighted year-over-year growth of 6.4%. Over the last year, Durable Goods New Orders have been in a downtrend and the latest values confirm this trend. Looking under the hood, we continue to see that transportation equipment remains the outsized driver of these moves:

New orders for durable goods remain well supported on a nominal basis, as nominal incomes and employment remain elevated. However, with real economic growth receding, profitability drying up, and the labor market saturated, it is unlikely that the economy can maintain high levels of nominal demand. We have already seen the slowdown in consumer spending on motor vehicles and transportation, and we expect new orders to soon follow suit as inventory starts to build.
We have seen the initial phases of the slowdown in the new orders data, and it will likely deteriorate further.

iii. The dollar remains king in the current environment. In both our ETF Strategy and Week Ahead notes, we have highlighted how we are in tightening liquidity environment. We show our proprietary high-frequency liquidity measure below, and how its typically precedes moves in the yield curve:

Based on this proprietary gauge, our systems expect the yield curve to move towards inversion. During tightening liquidity environments, yield curves typically invert and the dollar is a haven. We are seeing one of these conditions already met, with the dollar catching a strong bid across the board. Below, we show our return/risk gauges, which take into account trend, volatility, market environments, and correlations to rate assets on their potential value-add to portfolios.

As we can see above, our systems continue to tell us the dollar remains king and estimate that the best return/risk characteristics are LONG: Dollar & USDJPY and SHORT: EURUSD & GBPUSD.

Consequently, our systems remain long dollar & short equities and credit. We show how our Alpha Strategy is currently positioned:

This is a time for capital preservation above all else. Stay nimble.