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Editor's Note: Since this newsletter was published on February 7th, we have made the following changes...

Dear ETF Pro Plus Subscriber,

Welcome back!

In this month’s edition of ETF Pro Plus...

There are no changes since the last update to ETF Pro Plus on 2/3/2023. The current lineup of ETFs is as follows:

Long: UUP, BTAL, ITA, GDX, GLD, PPLT, SLV, GDXJ, SIL, SILJ, ENZL, EWH, KWEB, GRID, IIGD, IEF, EPU, WNDY, EEM

Short: XLK, XLY, XRT, GK, HYG, JNK, QQQ, IWM, EWI, GVIP, FXE, BITO, UAE, PAK, KRE, WGMI, PP, PSP

ETF Pro Plus: February Update (Q1 2023) - 02.06.2023 liquidity cartoon

Hedgeye CEO Keith McCullough just hosted our 1Q 2023 Mid Quarter Update today at 11am ET.

Below is a preview of those three themes with key excerpts transcribed from McCullough's commentary and a few supporting charts from today's 142-slide presentation. (If you're interested in upgrading to access more information about our Macro Themes email support@hedgeye.com).

THEME #1: US PROFIT RECESSION = CREDIT EVENT

Keith McCullough: So what happens when you have negative GDP, debt ceiling debate and a reversal in central bank easing? That's not good.

If you look at financial system liquidity on Main Street, this is a major problem. Consumer credit is turbo tightening. That sounds serious. On the right side of this chart you can see money supply growth, going back to 1960, has never been negative, except in 2022.

So what could possibly go wrong? A lot.

ETF Pro Plus: February Update (Q1 2023) - main street

McCullough: But then, look at this. Everything that everyone owns that they got bodybagged in from a bubble cap perspective has gained a third of its value after a $9 trillion drawdown. Google's revenue was down -4% and earnings were down -31%. Goldman was down -71%. Is that a bottom?

So a $9 trillion drawdown and all of those bubble cap signals remain bearish trend. No bottom.

ETF Pro Plus: February Update (Q1 2023) - bubble caps

McCullough: I think we're going from +4% earnings in 3Q 2023 to currently -3% or -4%, then by the 1Q and 2Q we get the flush. I think this is very similar to 2001, when even if there is a shallow economic recession there's a very deep profit recession. That's not the fundamental backdrop bottoms are made of.

Consensus estimates are mind-blowing. Next twelve month earnings estimates are only -6% from their highs. So, if you look at the numbers, everyone is looking for Powell to produce a nice soft landing but if Phase III of this cycle plays out like we think we go from re-rating multiples (the grey bar) to a reckoning on earnings revisions, so you get a falling multiple and falling earnings. That's where we're heading right now.

ETF Pro Plus: February Update (Q1 2023) - consensus

ETF Pro Plus: February Update (Q1 2023) - phase3

THEME #2: LONG GOLD & PRECIOUS METALS/MINERS

McCullough: The Macro set-up for Gold is easy to understand. Real yields go down and Gold goes up. Most people understand that. I think there's a peak underway in long-term interest rates, with that end of the curve sniffing out that growth is going to slow at a faster rate.

And another important point is the bone-chilling -81 basis points on the yield curve. An inversion has historically presaged real yield collapses.

So stay with the cycle. Historically, #Quad4 is real yields down. That's bullish for Gold.

ETF Pro Plus: February Update (Q1 2023) - yield curve

ETF Pro Plus: February Update (Q1 2023) - real yields

THEME #3: BUY CHINA?

McCullough: So China is the lone #Quad1 globally.

And then there's high frequency data like air traffic accelerating domestically, meanwhile, the other side of that in the U.S. and U.K. air traffic is far less exciting. And then you add in muted energy prices easing the pressure on Chinese stocks.

So if the leading indicators of mobility are going up, you should see things like China Retail Sales come off the lows. That's why I'm interested in what's levered to the Chinese consumer like China Internet (KWEB).

Everyone knows that China is coming off the lows, but if anything the data is picking up at a faster rate than we would have thought. The Services PMI went from the 40s to 54 in a straight line. That's way better than any rate of change data series you can find in a major country anywhere else.

ETF Pro Plus: February Update (Q1 2023) - china retail

ETF Pro Plus: February Update (Q1 2023) - china pmi

GLOBAL QUAD OUTLOOK 

ETF Pro Plus: February Update (Q1 2023) - g20

ETF Pro Plus: February Update (Q1 2023) - em quad

Best of luck out there,

Team Hedgeye

Below is an updated list of the 37 current ETF Pro Plus tickers. Keep reading for an overview of our thesis for each of these current ETFs, along with what we’ve added and removed since the last newsletter.

New users should definitely check out the Appendix for a brief primer on our Macro process and how we select (and remove) the exposures in ETF Pro PlusReview last month's edition of ETF Pro Plus.

CURRENT ETF LINEUP

ETF Pro Plus: February Update (Q1 2023) - current lineup edit

ETF CHANGES FROM LAST MONTH

ETF Pro Plus: February Update (Q1 2023) - add remove edit

COMMODITIES

ETF Pro Plus: February Update (Q1 2023) - commodities

We're long Long Precious Metals like Gold (GLD) Platinum (PPLT) and Silver (SLV) because we understand that:

A) Longer-term Bond Yields eventually break-down alongside SLOWER DEMAND … and
B) Yield Curve Inversion at NEW CYCLE LOWS of -81bps on 10s minus 2s is just plain bearish economically

This dynamic in yields ultimately benefits our precious metals longs.

Balancing out our longs is short Bitcoin (BITO). This one's simple: High volatility and fraud (across crypto) is a combustible cocktail during #Quad4. 

DOMESTIC EQUITIES

ETF Pro Plus: February Update (Q1 2023) - domestic equities 

We are staying short of Nasdaq (QQQ) and Russell 2000 (IWM). High Beta, Secular and Cyclical Growth, and Leverage are among the worst performing Equity Style Factors in #Quad4 according to the backtest, and thus further cements our positioning. 

In the high-beta, cyclical arena we remain short Tech (XLK) and Consumer Discretionary (XLY) given their backtests as poor performers in #Quad4. Another exposure that backtests poorly in #Quad4, we're still short Retail (XRT). We continue to reiterate the consumer has less cash to spend, as stimulus checks dry up, inflation remains high and equity/housing/crypto drawdowns have a negative impact on the wealth effect.

In February 2022, we added Gerber Kawasaki (GK) to the short side. Ross Gerber actively manages his titular ETF, with a focus on innovation, growth, tech, etc. GK is a high-beta ETF, which is everything you want to be short in #Quad4. Similar to Gerbs, Meet Kevin Pricing Power (PP) was added as a short (with TSLA and AAPL 39% of the fund).

We continue to stay short of the hedge fund industry's most popular holdings via Goldman Sachs Hedge Industry VIP (GVIP), which is basically a basket of the most over-owned names in the hedge fund space. Woof!

We added Regional Banking (KRE) to the short side. The latest CNBC “trade” is to “buy the Financials because they are cheap.” LOL. Sold to them, across the board, as one of plenty of places to get positioned for an ongoing CREDIT EVENT.

Recently, as the VIX fell out of the F-bucket (a level above 30) and into the Chop bucket (20-29), we added a collection of long ideas that are signaling bullish trend. US Market Neutral Anti-Beta Fund (BTAL), as a downside protection strategy that attempts to hedge (short high beta and long low beta). 

As we've travelled to the low end of the VIX Risk Range, among the sectors gathering signal strength are a grab-bag of Aerospace & Defense (ITA), and based on our bullish bias toward precious metals here, Gold Miners (GDX), Junior Gold Miners (GDXJ), Silver Miners (SIL) and Junior Silver Miners (SILJ). 

DOMESTIC FIXED INCOME

ETF Pro Plus: February Update (Q1 2023) - domestic fixed income

We continue to like short High Yield Corporate Bonds (HYG) and High Yield Bonds (JNK) as beneficiaries of wider credit spreads amid #Quad4, which serve as the fulcrum points of our Short Credit bias.

  • While HYG and JNK are thematically similar in tracking below-investment grade corporate credit, there are a few slight different in their investment profiles
    • HYG has less BBB rated bonds and more BB, but also less B and less CCC rated bonds (HYG's quality is concentrated in the BB's, while JNK is a bit more spread across the credit spectrum)
    • HYG has a higher expense ratio
    • HYG is far more liquid (higher daily average volume)
    • HYG has a longer effective duration
    • HYG has over double the AUM

We added 7-10 Year Treasuries (IEF) recently because 7-10yr Yields are at the top-end of the Risk Range. We know why Bond Yields are up, across The Curve (hawkish jobs report have people thinking Powell is hawkish). But Powell has been hawkish (some people just don't listen) and B) tightening into this #Quad4 Recession should only make US GDP Growth SLOW at a faster rate. That's why you'd be buying IEF and Investment Grade Defensive (IIGD), to set up for the Recessionary GDP that should be reported by April.

EMERGING MARKET EQUITIES

ETF Pro Plus: February Update (Q1 2023) - emerging market equities

Among the Bullish Trends in global country-specific equities, we recently added bullish trend New Zealand (ENZL), Peru (EPU) and Emerging Markets (EEM).

Our expectation for China’s economic #acceleration is for #Quad1 in Q2 of 2023, a boon to Chinese consumers, which is why we added CSI China Internet (KWEB) to the long side.

Balancing out our long exposure are short United Arab Emirates (UAE) and Pakistan (PAK). UAE is heavily levered to energy exposure and with Oil's recent break to bearish trend, we like this short side. Meanwhile, PAK is another simple one. It remains bearish trend.

FOREIGN EXCHANGE

ETF Pro Plus: February Update (Q1 2023) - foreign exchange

We added the U.S. Dollar (UUP) to the long side all the way back in January 2022. It still remains. 

The Dollar's best performance, according to the backtest, is historically in #Quad4. Amid a poor global economic setup among developed countries and European weakness, the Dollar remains strong.

On the short side, we've added the Euro (FXE), as the Eurozone economy remains in Quad 4.

GLOBAL EQUITIES

ETF Pro Plus: February Update (Q1 2023) - global equities

We recently added Nasdaq Smart Grid Infrastructure (GRID), which has holdings typical to Utilities (i.e. low beta, predictable cashflows). We added long Wind Energy (WNDY) and this one isn't complicated, the ticker is bullish trend.

On the short side, CEO Keith McCullough's Risk Ranges remain bearish on crypto broadly and the Bitcoin Miners (WGMI), specifically. WGMI is bearish trend. Here's a fun one. As the U.S. economy continues to slow we think Private Equity (PSP) needs to take their marks on the assets in their portfolios. That hasn't happened yet, but just wait for GDP to go negative in 1Q-2Q 2023.

INTERNATIONAL EQUITIES

ETF Pro Plus: February Update (Q1 2023) - international equities

We previously added Italy (EWI) to the short side given #VASP weakness as well as its Quad setup: with #Quad3 expected through 4Q and #Quad4's through 2Q23, alongside broader weakness across the Eurozone.

Long Hong Kong (EWH) is a derivative play on our #Quad1 China call. And EWH is bullish trend.

INTERNATIONAL FIXED INCOME 

We currently have no active positions.

APPENDIX

We find two factors to be most consequential for forecasting future financial market returns: economic growth and inflation. We track both on a year-over-year rate of change basis to better understand the big picture then ask the fundamental question: Are growth and inflation heating up or cooling down?

From there, we get four possible outcomes, each of which is assigned a “quadrant” in our Growth, Inflation, Policy (GIP) model and the typical government response as a result (neutral, hawkish, in-a-box or dovish): Growth accelerating, Inflation slowing (QUAD 1); Growth accelerating, Inflation accelerating (QUAD 2); Growth slowing, Inflation accelerating (QUAD 3); Growth slowing, Inflation slowing (QUAD 4).

ETF Pro Plus: February Update (Q1 2023) - us quad

After building this base of knowledge, we can now select what we like and don’t like based on our historical backtesting of the different asset classes that perform best in each of the four quadrants. The chart above shows the U.S. economy remaining in #Quad4 in 1Q and 2Q 2023. 

Below is a chart that lays out precisely what we like and don’t like when an economy is in each of the four quadrants. This chart should help you make better investment decisions, even outside our recommendations in ETF Pro Plus. (For more on our Macro team's overall research process, click here to read our detailed "Macro Playbook.")

ETF Pro Plus: February Update (Q1 2023) - quad regime